The NEG, and what it means for Australia’s carbon credit market

Now that COAG has kicked the design of the National Energy Guarantee (NEG) down the road, it is a good time to step back and consider the implications for Australia’s climate policies.

We have a challenge ahead if we are to fulfil our commitments under the Paris Climate Agreement and as yet, no clear pathway – particularly given how little we seem to be prepared to require of the electricity sector under the NEG.

The policy levers to drive emissions reductions outside the NEG boil down to the Emissions Reduction Fund (ERF) and the Safeguard Mechanism (SGM).

At this point we can disregard the ERF because the initial tranche of funding is close to exhaustion and while the 2017 Climate Policy Review said additional funding would be released, no indication has been given on either the timing or the amount.

The only effective policy available to the Commonwealth is the Safeguard Mechanism.

With the work falling to Australia’s largest emitters covered by the Mechanism, the market for Australian Carbon Credit Units (ACCUs) for covered entities to acquit their liabilities becomes more important.  In this article we consider the implications.

This analysis begins by calculating Australia’s emissions under business as usual (BAU) and the gap that must be closed if Australia is to meet our 2030 target.  We then explore the abatement activities to close that gap and how they can be implemented [1].

As a significant portion of the emissions reductions needed will be activities funded through the SGM, this article looks at the potential flow of ACCUs around the country.

Emissions under business as usual and the gap to be closed to meet our Paris commitments

This next figure shows Energetics’ forecast of BAU emissions to 2030. BAU in the context of the SGM includes the 26% reduction in emissions from the electricity sector as required by the NEG.

The forecast for the remaining sectors continues past trends. For instance, there is a strong relationship between the national GDP and emissions from the transport sector and stationary energy sectors. These relationships are assumed to also apply in the period to 2030.

Details of our approach to forecasting business as usual emissions in 2030 are available on the Energetics website

The chart above shows how emissions due to electricity fall as the requirements of the NEG are met.

While this analysis is not about emissions reductions in the electricity sector, we note that the fall in emissions in the sector will occur as old coal-fired power stations are closed and are replaced by renewable energy generators.

Yet, other major sources such as transport and stationary energy rise. The net result is a slight fall in the period to 2030.

However, Australia’s BAU emissions in 2030 are forecast to be 539 Mt CO₂-e, or approximately 103 Mt CO₂-e higher than required by Australia’s 28% emissions reduction commitment.

Note that we use the upper limit of the 26 to 28% band in the expectation that Australia will be under pressure to do more as emissions reduction commitments are reviewed every five years.

The emissions reduction task

Earlier work on Australia’s abatement task provides some insight into the measures that can close the 103 Mt CO₂-e gap. The following table summarises the outcomes.

Some emissions reductions measures do not need financial incentives

The national abatement cost curve identifies a range of measures that have a negative cost to implement. This generally means that the barriers preventing their pursuit are most likely not related to financial costs.

Instead, relatively light government intervention is required.

For instance, an important opportunity is the adoption of more stringent fuel efficiency requirements for light vehicles which will deliver net benefits to the Australian economy but requires governments to implement regulations. The situation with electric vehicles is similar.

Governments can address non-market barriers such as concerns about availability of charging stations, as the economics of EVs evolves.

Several commentators have flagged that the 26% emissions reduction target for the NEG is less than what BAU will achieve.  Reflecting this, we have assumed that the zero cost opportunities will see electricity emissions fall by 30%.

The SGM will facilitate the creation and trading of up to 62 million ACCUs in 2030

Addressing the low-cost measures currently held back by non-market barriers will realise 42 Mt CO₂-e of abatement in 2030.

As these measures provide a financial benefit to participants and in many cases may be driven by government regulation they will not meet the additionality criteria required for ACCU creation.

However, the situation is different with the remaining 62 Mt CO₂-e of emissions reductions required to close the gap on Australia’s national abatement target. Financial support is necessary.

At this point, the SGM is the policy lever available to the Commonwealth to push abatement requiring financial support.

Baselines for covered facilities will need to fall. Net emissions from covered facilities in 2016-17 were 132 Mt CO₂-e and this total will need to drop to 69.8 Mt CO₂-e through the creation, trading and acquitting of 62 million ACCUs (less any reductions in emissions from covered facilities due to their own actions).

Victoria and NT are the winners and WA is the loser in ACCU trading

The Regulator reports the location of the facilities impacted by the Safeguard Mechanism, so we get a picture of the states where demand for ACCUs by 2030 will be greatest. The largest demand for ACCUs will be from WA (32%), followed by Queensland (26%) and NSW (22%).

The SGM will promote the trading of ACCUs within states and across state borders. An examination of the distribution of resources required to create ACCUs allows us to develop a map showing the flow of trade.

We allocated LULUCF measures to the states based on fertile land area. Agricultural emissions reductions were based on the economic value of farming.  All other measures were based on gross state product.

For instance, we found that Queensland will generate most of their ACCUs through changes in land-use because of its suitability for activities such as afforestation and reforestation. On the other hand, WA, despite having a very large land area has less opportunity because so much of that land is too arid.

The figure shows the demand for ACCUs in each state as driven by the SGM, the likely supply and the net export or import. Most states are in a net positive balance in that they generate more ACCUs than are required to meet the SGM obligations of covered facilities in the state.

The exception is WA which must import 9 million ACCUs. Victoria and the Northern Territory will have a surplus to export to other states.

Assuming the ACCU price correlates with the weighted average cost of these abatement activities, the value of the market for ACCUs could conservatively be around $1.3 billion in the year 2030.

A key question though is whether the cost to the economy of allowing the electricity sector to meet its emissions reduction obligations through BAU measures while imposing a $1.3 billion cost on the SGM covered facilities in 2030 is the best outcome.

Seeking further reductions in emissions from the electricity sector through the curtailment or closure of power stations will take pressure off the SGM facilities. To date the Government has chosen not to explore this question.

[1]Assuming there is no international trade of ACCUs and international units cannot be surrendered to meet SGM requirements

Dr Gordon Weiss is a Principal Consultant and Associate with Energetics. His expertise lies in energy and carbon policy development, renewable energy technologies and energy management in the resources sector. He has worked with a number of governments on the development of energy and greenhouse gas programs and policies, and is arguably one of Australia’s leading forecasters of emissions reduction trajectories.