Page 1 Submission: Review of Australia’s climate change policies, May 2017

5th May 2017 Submissions Climate Change Policies Review - Discussion Paper 2017 Review Branch Department of the Environment and Energy E: climatechangereview@environment.gov.au

Submission: Review of Australia's climate change policies RepuTex welcomes the opportunity to make a submission to the Department of the Environment and Energy on its discussion paper, “Review of climate change policies”. RepuTex is Australia’s largest energy and emissions advisory firm, providing in-depth analysis of the local carbon, electricity and renewable energy markets. With over 150 customers in Asia-Pacific, RepuTex works with a diverse range of public and private sector customers, including Power, Energy, Metals & Mining and Industrial companies, Project Developers, Land-use, Financials, Government departments, entities and agencies. RepuTex has a depth of expertise in energy & climate policy and market analysis, utilising our proprietary models to help companies and governments to analyse the economic impacts of Australia’s low carbon transition, and the influence of policy on market supply-demand and pricing dynamics. We specialise in pricing and modelling services within the following segments: Electricity sector, Renewable energy, Emissions markets and policy; and the Emissions Reduction Fund. This submission draws on our recent market study, titled, “Achieving a 2-degree target: A cost curve for emissions reductions in Australia to 2030”, which provides Australian businesses and policymakers with a quantitative basis for identifying emissions reductions opportunities across the economy, including analysis of what emissions reductions can be achieved by 2030 and the cost of action. By providing a detailed view of abatement potential and marginal costs by industry and policy, our marginal abatement cost (MAC) curve provides insights on the most effective levers to capitalise on domestic abatement opportunities, and how much policies can contribute to Australia’s long-term emissions reduction objectives. Below, we summarise our key policy recommendations:

1. The National Energy Productivity Plan (NEPP) can deliver cost savings and large-scale abatement. The NEPP can be aggressively applied in the immediate-term to deliver large scale emissions reductions at a negative marginal cost. In this way, the NEPP is able to become the main driver of Australia’s emissions reduction policy framework, with support from industry via the safeguard mechanism.

2. The Safeguard Mechanism must curb industry emissions to protect gains made by the NEPP. Even if aggressive policy is introduced under the NEPP, emissions gains can be undermined by a small number of Australia’s largest businesses if these firms are not held accountable to stronger emissions baselines, or required to offset emissions increases. Subsequently, tighter emissions controls under the safeguard mechanism are required if Australia is to meet its current 2030 target.

3. A baseline reduction of 1 per cent per annum may suffice to meet Australia’s 2030 target. If the aforementioned recommendations are implemented, we estimate that a baseline reduction of as little as 1-2 per cent per annum from 2018 may suffice to enable Australia to meet its current 2030 target. This may be subject to regular review in line with emissions trends and the possible scale up of Australia’s 2030 target.

Page 2 Submission: Review of Australia’s climate change policies, May 2017

4. By relying on direct regulation, Australia can emulate the California’s climate policy plan. In designing regulation to unlock negative cost efficiency opportunities, Australia is uniquely positioned to imitate California’s successful climate policy plan, where direct regulation was designed to be the main driver of emissions reductions prior to 2020, supported by a smaller contribution from industrial sectors via a cap andtrade or emissions baseline mechanism.

5. A voluntary ‘Early Action Scheme’ (EAS) may provide guidance for high emitting companies shoulddeclining baselines be postponed. While an EAS is not a mechanism to achieve Australia’s contributionunder the Paris Agreement, the design of voluntary early action rules for safeguard sectors can facilitate ahedge for high emitting companies if regulations do form part of Australia’s emissions reduction strategy inthe future. A new voluntary scheme may therefore deliver early abatement without the application of apenalty, and without constraining economic development.

6. The Land-use sector will be critical to Australia’s future 2030 target. The Land-use sector represents aconsiderable opportunity for emissions reductions in Australia, and will lay the foundation for Australia tomeet a future net zero target by 2050 under any long-term policy framework. Subsequently, it will be criticalto address the land-use sector as part of any effective plan that seeks a large-scale reduction in Australia’s emissions, be it via public or private investment.

Should you have any questions regarding this submission please contact me directly on (03) 9600 0990, or contact our head of research, Bret Harper.

Best Regards,

Hugh Grossman Executive Director RepuTex (AU) Pty Ltd Level 2, 443 Little Collins Street, Melbourne Victoria, 3000 | T: (+61 3) 9600 0990 | E: hugh.grossman@reputex.com

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BRIEFING: Achieving a 2-degree target - A cost curve for emissions reductions in Australia to 2030

Background to our Market Study In ratifying the Paris Agreement, the government has agreed begin to transform Australia’s economy. At the same time, debate continues over the design of policy to meet Australia’s 2030 target, including which emission reduction opportunities should be pursued, and the cost of transitioning the economy to a 1.5- to 2-degree emissions trajectory. As policymakers and businesses begin to consult on policy design, our market study1, "A 2-degree target: A cost curve for emissions reductions in Australia to 2030” provides Australian businesses and policymakers with a quantitative basis for identifying emissions reductions opportunities across the economy, including analysis of what emissions reductions can be achieved by 2030 and the cost of action. This market study is the second in a series of publications and datasets exploring the cost and opportunity for emissions reductions across the Australian economy. Our first report, titled: “An Energy Trilemma: A cost curve for emissions reductions & energy storage in the Australian electricity sector“ 2 presented our updated marginal abatement cost (MAC) curve for the electricity sector in 2020 and 2030, along with analysis of the “full cost” for renewables to supply reliable power, including storage, referred to as the levelised cost of “firm” energy (LCOFE). This market study builds on our earlier MAC curve for the Australian market, released in 2015, which developed a greenhouse gas (GHG) abatement database of the size and cost of 90 emissions reduction activities across 10 sectors, for both 2020 and 2030. The report aims to measure what reductions can be achieved, which sectors are able to continue large-scale emissions reductions, and how much it would cost to meet Australia’s 2030 emissions target. Considering the high likelihood of the scale up of Australia’s target, analysis considers a range of emissions targets, including Australia’s current nationally determined contribution (NDC) and the cost of achieving a 1.5- to 2- degree target. By providing a detailed view of abatement potential and marginal costs by industry and policy, our marginal abatement cost (MAC) curve can provide key insights on the most effective levers to capitalise on abatement opportunities, and which rules are likely to contribute to Australia’s long-term emissions reduction objectives. In this way, we aim to provide a robust set of figures from which corporate leaders, academics, and policy makers may make better informed decisions on the design of policy to achieve emissions reductions. Analysis presented in our MAC series of reports was supported by consultation with over 45 industry participants, including high emitting companies, large industrial electricity consumers, offset suppliers, project developers, industry groups, financial institutions, investors, and policymakers. Over the course of the four month consultation, stakeholders provided up-to-date feedback on technology readiness, cost assumptions and barriers to investment for emissions reduction activities across the Australian economy. Input was built into our modelling assumptions and our proprietary cost databases, which we present in detail within the full market study. Analysis presented below is a summary of our full report and discussion of the policy implications of our key findings. For more information on our full market study click here.

1 To access this report: “Achieving a 2-degree target: A cost curve for abatement in Australia to 2030” click here. 2 RepuTex Carbon, “The Energy Trilemma – A cost curve for abatement & energy storage in Australia”, March 2017. Summary report available here.

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Abatement potential in Australia to 2030 - By policy A key consideration of Australia’s climate change policy review is ensuring the government’s policies remain effective in achieving Australia’s 2030 target and its commitments under the Paris Agreement. The Paris Agreement’s central aim is to strengthen the global response to the threat of climate change by limiting global temperature increases to well below 2-degrees Celsius, and to pursue efforts to limit temperature increases to 1.5-degrees Celsius. In assessing the effectiveness of Australia’s emissions reduction policies, it is helpful to understand the realistic volume and marginal costs of opportunities to reduce greenhouse gas (GHG) emissions. Our estimates for both are summarised by a MAC curve, which can be a useful tool for policymakers and businesses to compare GHG emissions reduction options across the economy and by policy mechanism. Below we present our MAC curve for Australia, showing the size and cost of each activity to reduce emissions in 2030, and the potential for these activities to contribute to a series of emissions reduction targets. Figure 1: Australian marginal abatement cost (MAC) curve in 2030 - By policy

Source: RepuTex Carbon, 20173

3 RepuTex Carbon, 2017. Market Study: “Achieving a 2-degree target: A cost curve for abatement in Australia to 2030” click here.

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Reading a marginal abatement cost (MAC) curve A marginal abatement cost curve depicts the emissions reduction potential from a baseline projection in a specific year and the corresponding marginal cost of abatement activities today. The width of each bar represents the emissions reduction potential that an individual opportunity can deliver in the specified year compared to the baseline projection. The height of each bar reflects the marginal cost of reducing one tonne of carbon dioxide equivalent for that activity. Activities may aggregate similar opportunities, with the marginal cost representing a weighted average. In its consolidated form, the full marginal abatement cost curve reflects the potential emissions reduction from activities within the modelled organisation or sector. The curve can be used for comparative analysis of the potential volume and relative cost of different emissions reduction opportunities, within a sector, and across the Australian economy. However, for the purposes of producing a single curve, this analysis takes the sum of abatement from all activities as representing one scenario relative to the baseline projection. Significantly more or less abatement can occur in different scenarios. The cost curve indicates the following major conclusions:

• Australia has ample domestic abatement to fulfil a 1.5- to 2-degree target under the Paris Agreement. Analysis indicates that approximately 600 million tonnes (Mt) of emissions reductions are available across all sectors of the economy by 2030, equivalent to Australia’s emissions in 2005, the baseline year of Australia’s contribution to the Paris Agreement. Australia therefore has ample domestic abatement to meet a 45 to 63 per cent reduction on 2005 levels by 2030 (270 - 375 Mt), as recommended by the Climate Change Authority to contribute to a keeping global warming between 1.5- to 2-degrees Celsius.

• Australia has a significant volume of cost saving opportunities, with potential savings of $12 billion attributed to efficiency gains. Analysis indicates that 20 per cent of all abatement activities - equivalent to 125 Mt of CO2e in 2030 – have a ‘negative marginal cost’. These opportunities include distributed solar photovoltaics (PV), fuel efficiency standards, and industrial efficiency. Each of these represents a major opportunity to reduce emissions with a positive return over the lifetime of an investment. The average marginal cost of abatement from these activities is just less than -$100 per tonne, representing around $12 billion in total savings.

• The marginal cost of achieving Australia’s current 26 per cent emissions target is forecast to be around $20 per tonne of CO2e. Although a robust carbon price forecast cannot be made in the current policy environment, this price represents an implied price per tonne to meet Australia’s current target. Accounting for negative cost opportunities, Australia could theoretically meet its current target at net savings of $75 per tonne. In the event that the electricity sector is excluded from the modelled scenario, the marginal cost of achieving the target rises.

• The Electricity and Land Use, Land Use Change, and Forestry (LULUCF) sectors make up two thirds of Australia’s total abatement opportunities to 2030. These sectors will therefore be relied on to achieve a deeper 1.5- to 2-degree aligned target as Australia’s current target is scaled up in subsequent years.

Implications for policy design in Australia MAC analysis enables Australian businesses and policymakers to identify what emissions reductions can be achieved by 2030, and the relative marginal cost of action. Analysis is also able to inform the role of policy to create incentives for emissions reductions needing to be achieved. By providing a detailed view of the opportunities for emissions reductions by policy, the marginal cost-curve can inform the design of policy to achieve current and future emissions targets, and the policy implications associated with those targets.

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Analysis indicates that Australia has considerable potential for large-scale, cost effective emissions reductions, however, policy action will be critical to unlocking these emissions reduction opportunities. The abatement potential identified above is not forecast to be realised until an effective emissions reduction policy is enacted. Below, we draw on key conclusions to discuss the implications for the design of policy to meet Australia’s 2030 target, and position itself to achieve a 2-degree pathway.

1. Policy must create incentives to trigger emissions reductions. While a large volume of abatement exists in Australia, capturing the targeted amount of reductions depicted by the MAC curve will be challenging. Policy changes will be required to unlock emissions reductions. This can occur by incentivising high emitting companies, consumers, and governments to be responsible for their GHG emissions, and by reducing the upfront and net costs of action. Designing policy to achieve this now can hedge against larger costs and disruptions Australian businesses may face by 2030 should no action be undertaken.

2. The NEPP can deliver cost savings and large-scale abatement.

Analysis indicates that Australia has a large volume of negative marginal cost opportunities, most notably, waste reduction, vehicle and energy efficiency. These opportunities may be capitalised on via the design of direct regulation under the NEPP, with potential for this policy lever to contribute around 43 per cent of Australia’s abatement task, or 66 Mt of emissions reductions in 2030. Negative cost opportunities represent Australia’s low hanging fruit for policy design, specifically via improved energy efficiency and fuel efficiency standards. Significant analysis of policy such as mandatory vehicle efficiency targets has been undertaken by the government4, with potential for direct regulation to achieve around 37 per cent of all emissions reductions available by 2030 at a negative marginal cost. The NEPP is therefore able to be aggressively applied in the immediate-term to deliver large scale emissions reductions while also triggering considerable financial benefits. In this way, the scheme is able to become the main driver of Australia’s emissions reduction policy framework. Australia cannot rely solely on the NEPP, however, to unlock all cost saving investments, or meet its 2030 target. Additional negative cost abatement such as manufacturing fuel efficiency and mining operation and controls will be more efficiently accessed via other policy levers such as the safeguard mechanism.

3. The Safeguard Mechanism must manage industry emissions growth to protect gains made under the NEPP and ERF.

While direct regulation under the NEPP is able to become the main driver of Australia’s emissions reductions to 2030, near term emissions goals will not be reached without the contribution of high emitting facilities, with analysis indicating that the safeguard mechanism will be required to deliver around one quarter of all abatement to meet Australia’s 2030 target. Like the NEPP, most emissions reductions will be negative marginal cost opportunities. In this way, the safeguard mechanism can work with the NEPP to target cost saving abatement not captured by the NEPP.

The role of the Safeguard Mechanism Mining and manufacturing remain a vital part of Australia’s economy, however, many of these businesses have decreased their investment in advanced controls, fuel, and operational efficiency due to reduced accountability, such as the unwinding of the former Energy Efficiency Opportunity (EEO) and Carbon Price Mechanism (CPM) programs.

4 National Energy Productivity Plan 2015-2030: Annual Report 2016, Commonwealth of Australia, 2016.

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The weak business case for equipment replacements has led to growth in industry GHG emissions, creating a key roadblock to achieving Australia’s 2030 target. In light of this, even if aggressive policy is introduced to target energy efficiency under the NEPP, these gains are likely to be undermined by just a small number of Australia’s largest businesses if these firms are not held accountable to a stronger emission baseline, or required to offset emissions. High emitting facilities covered by the National Greenhouse and Energy Reporting (NGER) scheme contribute over 60 per cent of Australia’s total emissions footprint. Within this segment, facilities covered by the safeguard mechanism (>100,000 tCO2e per annum) are projected to contribute around one third of Australia’s emissions growth to 2030. Without stronger accountability of covered sectors, Australia’s current emissions target either will become excessively expensive to achieve - or not be met - with emissions continuing to grow in line with current expectations. This would risk locking higher emissions activities into the Australian economy for subsequent years, with potential for high emissions infrastructure such as buildings and electricity generators to remain in the market for multiple decades. In a cumulative sense, this can have considerable impact on Australia’s emissions target, while considerably increasing the cost of meeting Australia’s emissions reduction target.

Aligning emissions baselines with the 2030 target

As the remaining policy in the Australia’s toolkit able to deliver large scale emissions reductions from the sectors driving national emissions growth, the safeguard mechanism is emerging as a critical policy cog for the government. The Climate Change Authority (CCA) has proposed that changes be made to strengthen the safeguard mechanism, including that baselines for covered facilities be set to decline at a uniform rate consistent with meeting Australia’s target under the Paris Agreement. While the CCA did not quantify what a baseline rate of decline should be, it was argued that the commencement of emissions cuts from safeguard facilities was critical to position these sectors for further emissions reductions likely to be needed beyond 2030 under the Paris Agreement. In determining the contribution of safeguard sectors as part of its policy review process, the government has a range of options, for example:

• Use the safeguard sectors to meet the current target – assuming 100 per cent of Australia’s abatement task is distributed to covered sectors under the safeguard mechanism via a linear baseline decline. This is assumed to be a ‘high’ exposure scenario for covered sectors.

• Comparative share allocation – assuming safeguard and non-safeguard sectors contribute a quantified share of the effort based on ‘relative contribution’ to national emissions (e.g. if covered sectors contribute 55 per cent of national emissions, they contribute 55 per cent of emissions reductions).

• Indicative policy pathway – assuming policies in other sectors (such as the ERF, NEPP, etc.) are incrementally scaled up between 2020-30, leaving a ‘remaining abatement task’ that is allocated to safeguard sectors in the form of a linear annual reduction in emissions baselines.

• Trial period or flexible compliance period – assuming a nominal decline in emissions baselines is allocated to safeguard sectors, e.g. around 1 per cent per annum, enabling industry to begin to curb emissions growth and access offsets under a controlled or ‘soft start’ environment. This would be subject to further review of emissions and tighter baseline controls from 2020.

As noted in earlier research5, we estimate that a baseline reduction of as little as 1-2% p.a. from 2018 may suffice to enable Australia to meet its current 2030 target. This would be subject to the scale up of complementary policy

5 RepuTex Carbon, Industry to the fore? Meeting Australia’s 2030 target without an EIS: http://www.reputex.com/research-insights/industry-to-the-fore-meeting-australias-2030-emissions-target-without-an-eis/

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levers, such as the NEPP, and the commencement of tighter emissions controls for high emitting companies prior to 2020, such as accountability to emissions baselines, recommended by the Climate Change Authority. The nominal rate of our modelled baseline decline reflects the modest size of Australia’s current emissions reduction task, and the ease of meeting the 2030 target should growth in industry emissions be controlled. In this way, the scalability of the safeguard mechanism makes it an ideal ‘catch all’ for Australia’s climate policy toolkit, with the ability for policymakers to implement a moderate decline in emissions baselines as a ‘first phase’, subject to regular review in line with emissions trends and the possible scale up of Australia’s 2030 target. Recognising that the overall objective of the Paris Agreement is to achieve deep decarbonisation of the economy within the next half century, such an approach would ensure a closer alignment of Australia’s emissions reduction obligation with the national emissions profile, while positioning more sectors to contribute to our 2030 target, in a way that is scalable over the long-term as policy ambitions change.

Start date for declining emissions baselines We model potential national emissions reductions across the Australian economy in 2030, assuming actions to reduce emissions commence in 2018. Considering the current framework employed by the safeguard mechanism, we view July 1, 2018 as a logical commencement point for tighter emissions baselines, implemented from current baseline levels. As noted, any delay beyond this point is likely to undermine complimentary policy action, such as the effectiveness of direct regulation under the NEPP.

4. By relying on regulation, with support from large emitters, Australia

can emulate California’s climate policy plan In relying on regulation to unlock negative cost efficiency opportunities, Australia is able to emulate the successful Californian climate policy plan, adopting direct regulation as the main driver of emissions reductions, supported by controlled emissions reductions from industry. In that market, negative cost abatement opportunities were targeted via direct regulation (for example the Low Carbon Fuel Standard, efficiency standards, renewable energy portfolio standard) providing approximately three-quarters of all emissions reductions. California’s cap and trade program was subsequently implemented in support of direct regulation, contributing approximately one quarter of the state’s emissions reductions. This enabled policymakers to better target low cost abatement opportunities via direct regulation, while positioning all sectors of the economy - including high emitting companies - to contribute to the state’s 2020 target, and be prepared for greater emissions ambitions after 2020.

5. A voluntary ‘Early Action Scheme’ (EAS) can contribute emissions reductions from industry prior to a safeguard scheme

Should the introduction of more robust settings under the safeguard mechanism be postponed beyond 2018, we believe an opportunity exists for an ‘Early Action Scheme’ (EAS) to be introduced to provide short-term guidance for high emitting companies to voluntarily reduce emissions - or purchase offsets - ahead of future emissions regulation. Early action rules exist in China, Europe, California and the United States, defining what constitutes early (or ‘pre-legislative’) action to reduce emissions, and providing assurance that voluntary action undertaken today will be credited against any future emission reduction regulations. When designed properly, an EAS can act as a transition mechanism to support greater investment from industry in the land sector by rewarding early actors, while providing a complimentary source of demand to support the supply of high value domestic offsets such as land sequestration.

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While current regulation does not prohibit early action, voluntary rules under the National Carbon Offset Standard (NCOS) are ambiguous in their application for ‘covered’ facilities seeking to reduce a future liability. Voluntary action under NCOS sets requirements for companies to become carbon neutral. In doing so, the scheme provides guidance on what is a genuine voluntary offset unit, including: Australian Carbon Credit Units (ACCUs), Certified Emissions Reductions (CERs), Removal Units (RMUs), Voluntary Emissions Reductions (VERs) and Verified Carbon Units (VCUs). In this way, NCOS is not consistent in coverage or scope to the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (“the safeguard rules”), which limits the use of offsets to ACCUs. In addition, NCOS does not provide guidance on how voluntary ‘early action’ by high emitting companies will be recognised under any future compliance policy, such as how voluntary emission reductions will be accounted for if emissions baselines decline in the future, or any limit on the use of offsets. In a baseline system derived from historical emissions, such as the safeguard mechanism, this uncertainty can create a perverse incentive for companies to potentially be penalised for early action, or be rewarded for increasing emissions. For example, facilities that act to reduce their emissions in advance of regulations may be penalised if they are subject a uniform baseline reduction off a lower emissions base (i.e. baselines are set from ‘current’ emissions in 2018). Inversely, firms that increase their emissions could be advantaged by receiving a higher baseline setting. The lack of clear regulatory guidance on early action rules may be a missed opportunity for policymakers to better support the land-sector, with a defined EAS likely to send an important investment signal to covered entities and offset suppliers. Ensuring that covered facilities clearly understand what actions will and will not qualify for early action credits may therefore provide regulatory certainty, while early investment may be directed to areas policymakers deem most important, such as the agricultural sector. This may facilitate a win-win for industry and the land-sector, while providing policymakers with an opportunity to encourage emissions reductions without applying a penalty or handbrake to economic development.

Design considerations The creation of rules or guidelines to allow early action would require minimal change to Federal regulation. We envisage a two-step process to create regulatory certainty and increase market confidence to support investment.

1. The creation of new “early action guidelines”. Early action guidelines may be established under the existing Safeguard or NCOS schemes, or as a new policy mechanism at the State level (or between like-minded states). The guidelines would clarify how early action undertaken by “covered facilities” will be recognised under a future compliance mechanism. For example, providing guidance on:

• Assurance that one tonne of emission reductions will equal one tonne of credit against any future domestic emission reduction obligation;

• Definition of how an early action credit will be counted against future baselines - for example will early action credits comes out of an allowance (i.e. under an emissions baseline) or be awarded in addition to a limit (i.e. above an emissions baseline). In addition, how will early action credits interact with re-baselining provisions and the setting of future emissions baselines;

• Definition of when specified emissions reductions must have occurred;

• Definition of the permitted use of carbon offsets by type (e.g. Australian Carbon Credit Units, etc.), possibly including international units;

• Definition of the permitted use of carbon offset methodologies to ensure environmental integrity and additionality of allowable units;

• Definition of any limits on the use of offsets (for example: no more than 5% of total permits, averaged over any three-year period may be used under a future compliance scheme as suggested by Hamilton and Karoly in their dissenting report for the Climate Change Authority special review);

• Definition of any incentive clauses, such as future allowance benefits, or favourable multiyear compliance treatment, or possible tax concessions to kick start early abatement activities (etc.).

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2. Early investment signal from the government. A signal from the government will be required to incentivise the market to accelerate voluntary emissions reductions. This may be in the form of a statement to introduce tighter restrictions on high emitting companies by a specific year, even if the statement is in general terms. For example, should tighter emissions controls under the safeguard mechanism be planned for the post-2020 period, the announcement of this intention, in parallel to the announcement of an EAS, would be likely to trigger greater volumes of activity within a voluntary scheme. Without such a statement of intent any EAS is likely to be significantly limited in its effectiveness.

Benefits of an early action scheme An early action scheme is not a mechanism to achieve Australia’s contribution under the Paris Agreement, or a specific state emissions target. However, a voluntary scheme for high emitting companies can facilitate a softer landing for high emitting companies in the event that regulations do form part of Australia’s emissions reduction strategy in the future. In this way, an effective voluntary scheme can result in emissions reductions without the application of a penalty mechanism, and without constraining economic development. In creating an early action offset scheme, we see a range of benefits for high emitting companies, policymakers, and the carbon farming industry. These include:

• Remove disincentives for early action. Clarification of early action rules can remove disincentives for firms to reduce emissions in advance of regulation by better defining how emissions reductions undertaken now will be treated against future compliance settings.

• Support the decarbonisation of the Australian economy. Early investment in actions that reduce emissions will reduce the risk of investments becoming stranded and lead to considerably lower cumulative emissions over the next decade. In this way, delayed action is an unnecessary cost to the economy.

• Greater investment in the carbon farming sector. The creation of new sources of demand for ACCUs has potential to reduce the land sector’s dependence on fiscal drain of the Emissions Reduction Fund and the on the Federal Budget, while supporting increased investment in the land-sector from covered facilities under the Safeguard Mechanism.

• Ensure early action in advance of future policy. Given that emissions reduction policy can take many years to design and implement, early action rules are a way for State and Federal policymakers to provide the investment certainty for high emitting companies to begin executing emissions reduction plans in support of Australia’s 2030 target while policy develops. These companies, with the highest emissions have, to date not participated in emissions reduction policies such as NCOS or the ERF.

• Improved risk management activity from high emitting companies. Not all sectors will share the burden and benefits of emissions reductions equally, with high emitting sectors likely to face a larger liability to reduce emissions in line with their relative contribution to Australia’s emissions profile. In this way, an improved voluntary framework may provide a basis for effective risk management by providing high emitting companies with a means to design a ‘soft landing’ in readiness for future compliance obligations. This may also become an effective way to communicate risk management to regulators such as the Australian Prudential Regulation Authority (APRA)[1].

• Providing a transition framework to a future regulation. The design of an early action scheme can ensure a smoother transition to any future compliance scheme, or provide the basis for a scheme between likeminded States in advance of a federal policy. While current Australian regulations do not prohibit early action, voluntary rules under the National Carbon Offset Standard (NCOS) are ambiguous in their application for high emitting facilities seeking to reduce a future emissions liability.

6. The Land-use sector will be critical to Australia’s future 2030 target As noted, the LULUCF sector represents a considerable opportunity for emissions reductions in Australia, and could become a key pillar for Australia to meet its current 2030 target - and a future net zero target by 2050 - under any

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long-term policy framework. Subsequently, it will be critical to address the land-use sector as part of any effective plan that seeks a large-scale reduction in Australia’s emissions. While managing deforestation will continue to be important to Australia’s national emissions, the bulk of the capacity to reduce emissions further lies in carbon sequestration. Investment in sequestration is currently supported by the federal government’s $2.55 billion (bn) Emissions Reduction Fund (ERF), formerly the Carbon Farming Initiative (CFI). The ERF is the centrepiece of the government’s Direct Action Plan climate policy framework, operating as a competitive reverse auction process to tender contracts for Australian Carbon Credit Units (ACCUs) at the “lowest available” cost. The ERF is administered by the Clean Energy Regulator (Regulator), which enters contracts with successful bidders, guaranteeing payment in return for delivery of ACCUs.

Investment in the Emissions Reduction Fund (ERF) The ERF was designed to be supported by a “safeguard mechanism” to ensure that emissions reductions paid for through the ERF are not offset by significant increases in emissions elsewhere in the economy. The safeguard mechanism commenced on 1 July 2016, with emissions baselines for covered facilities set at the high point of each facility’s emissions from 2009-10 to 2014-15. As noted in earlier analysis, while the ERF has been successful in contracting ACCUs, the policy has not curbed Australia’s net emissions due to the high rate of Australian emissions growth, which is outpacing annual abatement purchased by the ERF. The success of the ERF policy must therefore be measured by the sum of its parts – the ERF and the Safeguard Mechanism. In this context, further investment in the ERF will be ineffective in helping achieve Australia’s 2020 emissions reduction target unless facility baselines under the safeguard mechanism are tightened. While the land-sequestration sector is able to deliver large scale emissions reductions, relying exclusively on public investment to support the Emissions Reduction Fund is likely to place considerable strain on the federal budget. Under the current ERF scheme, the federal government is the only source of demand to acquire ACCUs, with investment supported by public funding allocated under the federal budget In this context, we do not view public funding as a viable long term solution to support land sequestration, with the allocation of new funding likely to place ongoing strain on the federal budget, while potentially creating a political impasse between budget repair and Australia’s international commitment under the Paris Agreement. Even if funding for the ERF is topped up, we believe that we are unlikely to see the ERF abatement profile – concentrated in the land sector – align with Australia’s emissions growth profile, which is underpinned by the industrial sectors. This is due to the lack of industry participation in the ERF, with negative market sentiment driven by the low average price of Australian Carbon Credit Units (ACCUs), currently $11.83 over five auctions, and the commercial and administrative complexity of the scheme. This has created significant barrier to participation for many firms, particularly high emitting companies, with most registered projects ‘economically stranded’ with little incentive for further bidding given the current low price environment. Looking forward, this may limit ACCU crediting and issuance, potentially dampening supply of domestic ACCUs for use as offsets. Furthermore, projects that continue to be registered are more likely to be non-additional “anyway” projects (those that would have occurred irrespective of the ERF), with greater tolerance for low contract prices. This reflects a broader design flaw in the scheme, with low-quality abatement being contracted.

Transition to private funding The creation of new sources of demand for ACCUs has potential to reduce the fiscal drain of the Emissions Reduction Fund, with investment in the land-sector able to be supported by covered facilities under the Safeguard Mechanism. In this scenario, facilities exceeding their emissions baseline may be able to source offsets where external abatement is cheaper than internal emissions reduction activities. In the event that emissions baselines under the current safeguard mechanism are tightened in line with Australia’s 2030 target, and baselines enforced (rather than allowing re-baselining, etc.) such a mechanism would be an effective way to increase private demand for ACCUs.

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Such an approach is also able to support low cost emissions abatement for high emitting industries facing a high cost of internal abatement such as Mining and Energy. For these industries, low-cost offsets are able to replace high-cost internal emissions reductions, reducing the economic cost of meeting Australia’s emissions reduction target, and reducing competitive impacts, while ensuring contribution from all high emitting sectors to meet the 2030 target. While an offset scheme is able to ensure emissions above a set baseline are offset by industry, the objective of such a scheme is to leave overall emissions flat, with a credit used to offset an equivalent increase in emissions. Subsequently, while an offset scheme may cause emissions to decline, it will not support additional emissions reductions. In this context, while an offset scheme may support the avoidance of emissions growth, and facilitate substantial reduction in compliance cots, it will not support large scale emissions reductions, nor will it support the broader transition of high emitting industries away from emissions intensive activities.

Summary of recommendations Australia’s current policy toolkit could provide considerable opportunities for emissions reductions in line with Australia current 2030 target, and the potential scale up of Australia’s target under the Paris Agreement. Below, we summarise our key policy recommendations:

1. The National Energy Productivity Plan (NEPP) can deliver cost savings and large-scale abatement. The NEPP can be aggressively applied in the immediate-term to deliver large scale emissions reductions at a negative marginal cost. In this way, the NEPP is able to become the main driver of Australia’s emissions reduction policy framework, with support from industry via the safeguard mechanism.

2. The Safeguard Mechanism must curb industry emissions to protect gains made by the NEPP. Even if aggressive policy is introduced under the NEPP, emissions gains can be undermined by a small number of Australia’s largest businesses if these firms are not held accountable to stronger emissions baselines, or required to offset emissions increases. Subsequently, tighter emissions controls under the safeguard mechanism are required if Australia is to meet its current 2030 target.

3. A baseline reduction of 1 per cent per annum may suffice to meet Australia’s 2030 target. If the aforementioned recommendations are implemented, we estimate that a baseline reduction of as little as 1-2 per cent per annum from 2018 may suffice to enable Australia to meet its current 2030 target. This may be subject to regular review in line with emissions trends and the possible scale up of Australia’s 2030 target.

4. By relying on direct regulation, Australia can emulate the California’s climate policy plan. In designing regulation to unlock negative cost efficiency opportunities, Australia is uniquely positioned to imitate California’s successful climate policy plan, where direct regulation was designed to be the main driver of emissions reductions prior to 2020, supported by a smaller contribution from industrial sectors via a cap and trade or emissions baseline mechanism.

5. A voluntary ‘Early Action Scheme’ (EAS) may provide guidance for high emitting companies should declining baselines be postponed. While an EAS is not a mechanism to achieve Australia’s contribution under the Paris Agreement, the design of voluntary early action rules for safeguard sectors can facilitate a hedge for high emitting companies if regulations do form part of Australia’s emissions reduction strategy in the future. A new voluntary scheme may therefore deliver early abatement without the application of a penalty, and without constraining economic development.

6. The Land-use sector will be critical to Australia’s future 2030 target. The Land-use sector represents a

considerable opportunity for emissions reductions in Australia, and will lay the foundation for Australia to meet a future net zero target by 2050 under any long-term policy framework. Subsequently, it will be critical to address the land-use sector as part of any effective plan that seeks a large-scale reduction in Australia’s emissions, be it via public or private investment.

Page 13 Submission: Review of Australia’s climate change policies, May 2017

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