Australian strategy on land-use emissions at Copenhagen to achieve deeper cuts is no revelation
If you have been reading the Australian media and newspapers today and yesterday, you might believe that the Australian Governments’ strategy at Copenhagen to include land-use emissions to assist in meeting deeper national emissions cuts is an amazing new revelation.
For example, see Messrs Borschmann and Pearse in the Sydney Morning Herald, who apparently needed to be in Copenhagen to spot this story.
It should come as no surprise, however.
The strategy has been there for all to see for some time. My readers will know this by reading my previous blog on the subject for example, which outlines the issues in some detail, and is based on publicly-available negotiating text.
The tricky thing is separating out the risk from the opportunity in pursuing the range of carbon sequestration options – which is what the Australian strategy sets out to do.
Despite the science of sequestration being fraught with difficulty, the promise of accounting for sequestration emissions holds great danger. All it would take is a major bushfire or two at the end of a Commitment Period to blow the national carbon budget out of the water.
Such an event would require at the last minute a possibly significant foray into the international carbon market to buy permits in order to balance the books. That could be a costly exercise, given carbon market volatility.
It seems it would be a smart risk management exercise to ensure that emissions reductions are also coming from elsewhere in the economy in order to avoid such nasty surprises – i.e. through the implementation of an emissions trading scheme as a part of a package of measures……
In Explosive Leaked Memo, Liberals brainstorm non-market-based measures to address post-2012 GHGs
In a critical closed-door meeting, and with a view firmly on an impending election in which ALP holds a key policy differentiation, leaked minutes reveal a Liberal leadership seeking ideas from large industrial emitters on a post-2012 climate policy that does not involve market-based measures to reduce greenhouse gas emissions.
Instead of a market-mechanism, senior representatives propose a joint industry/government fund as the key policy, which would serve a number of key aims simultaneously:
- to accelerate investment into technology to reduce GHGs,
- not detrimentally impact industry – particularly with a view to ensuring jobs are not driven offshore,
- produce certain outcomes,
- produce greenhouse outcomes at low-cost,
- be funded substantially by large energy-users.
At the meeting, the Liberals leader’s ideas ‘were by no means concrete’ and he was ‘in search of alternatives’.
He recognises that ‘there is a limit to what Australia could do alone’, and that Australian expenditure into this work should be leveraged.
Tony Abbot, Nick Minchin and Barnaby Joyce discussing their new low-cost strategy in late 2009?
Nope.
Merely a summary of the May 2004 leaked Low Emissions Technology Advisory Group minutes taken by Rio Tinto at the meeting with John Howard and Ian MacFarlane.
It goes to show that, five and a half years later, the Liberal leadership still have no credible policy on the reduction of greenhouse gas emissions, and are still drifting aimlessly on this issue.
They do not realise the ability of emissions pricing both to raise the revenue needed but also create the incentives for technology innovation (e.g. see David Popp’s work at Syracuse) and investment in the lowest-cost source of greenhouse gas emissions.
At least Malcolm Turnbull seems to have grasped the utility of market mechanisms, and the absurdity of a free-market Party implicitly advocating ‘command and control’ (regulatory) approaches through their rejection of market-based approaches.
Turbull also states:
The Liberal Party is currently led by people whose conviction on climate change is that it is “crap” and you don’t need to do anything about it. Any policy that is announced will simply be a con, an environmental figleaf to cover a determination to do nothing.
This insight rings true, as it clearly isn’t far removed from ‘pre-enlightenment’ Liberal policy on climate change.
It is too hard to see the Liberals being able to realise their folly in the two months before a vote, and back the reintroduced emissions trading scheme - the Carbon Pollution Reduction Scheme.
The Liberals are stuck in the land that time forgot, in a time warp, with a view on policy measures that are now clearly understood to be ineffectual and insufficient. It seems like it’s back to the bad old days of 2004: all smoke and mirrors, but no action – other than to pass ‘the pub test’, to use the then-Liberal leader’s words.
The world has moved on, but has Australia?
Will we be tired of being sold the same horse twice, when asked at the polls?
Or can the electorate call out the Liberals for the sham policy they are attempting to pursue, on this issue of deep environmental and economic significance?
On a day on which Malcolm Turnbull, the leader of the opposition, is wondering what his numbers will be in the Senate to support the Carbon Pollution Reduction Scheme (CPRS – the Australian Emissions Trading Scheme), I find myself considering a whole set of completely different numbers, but numbers which are likely much more important to determining the extent to which climate change is addressed.
On my desktop, I have two web pages open. One is a good article in the New York Times about the U.S. Government deficit and interest payment position. The other is the second version of McKinsey’s greenhouse gas abatement cost curve.
Both contain some fascinating numbers. Both are worth thinking about and provide an interesting point of reference for ambitions to address climate change during the critical twelve months to come, during which one might expect both political and implementation agreements for a global climate accord to be agreed.
Both items ask the question: how are we going to pay?
Both issues imply both an inter-generational and intra-generatianal equity aspect: our generation has been living beyond our means either financially or environmentally, and that mechanisms must be developed to manage the payment of that debt and debt-servicing among ourselves, and between us and a future generation.
The NYT article reminds us of the current status of the US deficit: $12 trillion. It is such a staggeringly large number that it hardly seems conceivable. It is an abstract concept to most.
US Treasury results point to a $1.4 trillion deficit in FY09 alone – an estimated 10% of US GDP.
The IEA Energy Technology Perspectives suggests an investment of $1 trillion per annum out to 2050 is required in the development and deployment of 17 key energy technologies to meet a 450 ppm greenhouse gas emissions target. McKinsey estimates incremental investment costs of $445 bn in 2015 to $1.14 trillion in 2030.
That number is about 1.1% of global GDP.
In a recent report on technology transfer financing under the UNFCCC, ECN quotes a Project Catalyst report which estimates the total international North-South funding flow requirement under an international climate agreement to be to the tune of $76-111 bn.
This estimate tallies with the EU’s estimate of Euro 100 billion - of which the EU expects Euro 22-50 billion should be publicly-funded, with the balance privately financed through the carbon markets. The EU further expects the ‘fair’ share of the EU to the public funding to be between Euro 2-15 billion per annum. The EU agreed finally on a sum of Euro 3-5 billion per year for the next three years for international public climate finance.
The GDP of the EU 25 is $16.5 trillion. The EU commitment is therefore equivalent to approximately two-one hundredths of one percent of GDP.
The GDP of the US is 14.2 trillion. Might we expect, following the EU lead, the US to commit between Euro 2.5-4.5 billion per annum approximately?
It is hard to see how, at this rate, commitments will reach any more than $15 billion per annum from Annex 1 countries in aggregate for international public climate finance.
Now consider the climate change invesment funding requirement in the context of US debt interest payment, as the NYT reports:
Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury’s average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education.
But that could seem like a relatively modest pinch. Alan Levenson, chief economist at T. Rowe Price, estimated that the Treasury’s tab for debt service this year would have been $221 billion higher if it had faced the same interest rates as it did last year.
Treasury interest payments alone - not repayment of capital - in FY09 was $383.4 billion.
FY09 outlay for the US Department of Energy was $24 billion.
On the one hand, the US figures make the climate agreement seem manageable: we can now relate in some capacity what the ‘billions’ and ‘trillions’ mean – the debt and expenditure figures provide a familiarity and detatched comfort sufficient for us to be able to consider the climate change investment requirements as potentially something feasible – as perhaps something that is not totally outlandish.
On the other hand, the US debt figures remind us of the difficulties that will be faced in securing an appropriate investment in low-emissions infrastructure, and in North-South transfers. Governments in the West are suffering reduced income receipts due to unemployment, and are carrying substantial deficits. Their ability to continue to fund additional infrastructure publicly going forward will for some time be constrained. In a scenario in which the Bureau of Labour Statistics point to official unemployment of over 10%, and the NYT reporting braader unemployment rates in the US are more akin to 17.5%, prospects for substantial expansion of international funding commitments from the US is bleak. Without that strong lead from the US, others are unlikley to act.
These deficits may preclude the investment required for future generations – whether it be in terms of sustainable health or retirement programmes for the US, or low-emissions technology application in developing countries.
However, in the context of the required climate change funding being equivalent to just a tiny shift in debt-servicing interest rates of the US alone, the ability to generate the required investment is surely imaginable.
When economic studies of climate change mitigation weigh up the costs of inaction versus the cost of action, the direct and indirect financial effects of climate impacts are typically utilised. This is true of the reports of both Stern and Garnaut.
It is often noted that Australia is particularly susceptible to climate change. There are often references to drought, and to bushfire (particularly this week with the heatwave and ‘catastrophic’ fire risk in South Australia so early in the season).
However, not all financial impacts have been internalised into economic models – and Australia wants to keep it that way in the real world.
How?
Climate change will increase emissions from Australia’s land-use sector. This would represent a real, financial liability to Australia should these emissions be included formally in Australia’s national inventory, and thus have a tradeable market price. Australia therefore wants emissions from things like drought and bushfire to be kept out of the national inventory.
As part of a global climate deal, Australia wants to be able to benefit from demonstrating enhanced sequestration from land-use activities, but not be liable for ‘non-anthropogenic’ emissions within their inventory.
At present, most of the mitigation options from agriculture are included already in the Kyoto Protocol greenhouse gas accounting articles (in particular Articles 3.1, 3.3 and 3.4 as options, but Australia has elected not to account for Article 3.4 activities (rangelands, mulga, soil carbon (carbon storage) and Savanna (carbon storage), while biochar could be added to this category.
If Australia did report those activities, then there would be an obligation to report on emissions from e.g. forest fire and drought – and be liable for any change.
As the Garnaut Review states:
It is important for efficient global mitigation that the international community move to comprehensive carbon accounting related to agriculture and forestry. This is particularly important for Australia.
Comparative carbon accounting, among much else, would bring to account all carbon sequestered by and emitted from managed lands. This would provide significant revenue opportunities for landowners. It would also bring risks, especially, as would be required in logic, if all emissions arising from fires and the effects of drought are covered.
The Australian Government position for the second Commitment Period of the Kyoto Protocol (i.e. the negotiations at Copenhagen in December), is for Australia to pursue separate treatment of natural- and anthropogenic sources and sinks of emissions from Article 3.4 categories.
This would enable recognition of anthropogenic changes/improvements such as improvements in carbon sequestration through improved rangelands grazing practice, while avoiding the potential substantial inventory risks associated with the inclusion of e.g. bushfire and drought-induced emissions.
Australia does not want to be saddled with a category which would increase its national emissions – and thus make the national target harder. Others have noted this strategy.
What is the quantum of the risk from land-based non-anthropogenic emissions? By way of illustration only, personnel from the Bushfire CRC in February made statements to the effect that just two of the major bushfires in the last decade account for greenhouse gas emissions of between 70-105 MT CO2e.
In November last year The Centre for Australian Weather and Climate Research – a joint CSIRO/BOM institution – released a study entitled ‘Assessing the impact of climate change on extreme fire weather in southeast Australia’ .
I’ll save you having to read the technical document, by providing remarks from the summary below:
The research results reveal an increasing danger under climate change conditions for both of the two contrasting scenarios investigated. The models selected by our analysis show under the low and high emissions scenarios an increase of respectively -41-208% and -22-1072% in the number of cases of potential fire weather by the end of the twenty-first century.
Excluding the one model that showed a far stronger trend than the others, these percentage increases equate to a change from around one event every two years during the 20th century, to around 1 event per year in the middle of the 20th century, and 1-2 events per year by the end of the 21st century, but with a great degree of variation between models.
So – one might conclude that, if the episodes referred to by the bushfire CRC were to be taken as typical events in terms of emissions release, one might expect Australia’s emissions inventory to be very heavily impacted by the inclusion of non-anthropological emissions from LULUCF, and worsening over time.
Australia finds itself in a bit of a fix: to take advantage of the (often low-cost) biophysical sequestration potential in Australia of 1000 MT CO2e per annum, changes must be made to the Kyoto Accounting rules. Otherwise, it’s too much of a risk to include these elements of LULUCF in the inventory, in case emissions exceed sequestration.
Until non-anthropogenic disturbances are included, Australia will not have a direct financial liability associated with the impacts of climate change in terms of the price of the greenhouse gas emissions permits in the national inventory associated with drought and bushfire emissions. (The question, of course, is how to differentiate between natural and un-natural bushfires and drought, in order to establish the marginal financial implications of climate change impacts.)
Marginal additions caused by climate change to LULUCF emissions can structurally be limited through reducing global atmospheric concentrations of greenhouse gas emissions – thus limiting climate change itself.
In order to do that, developed countries, including Australia, must assume deep cuts.
Without biophysical sequestration, a deep emissions target for Australia is unlikely to be forthcoming due to perception of high costs.
So we would ordinarily be hoping that Australia’s position wins through so that it can take on a deep cut target through the inclusion of anthropogenic emissions sequestration from LULUCF.
However, there is little evidence of a deep cut being on the table from Australia in any circumstance – and there’s lots of wriggle room in Australia’s position with the definitions used.
So all the inclusion of LULUCF offsetting or sequestration activities would likely achieve is to drive down the price of permits in Australia by substantially increasing supply. This is a potential major opportunity to alter Australia’s risk profile.
As Giles Parkinson points out, having a low carbon price as an over-riding objective should not be the principle concern.
One might imagine that, should Australia take on responsibility the real costs of climate change as evidenced through the dollar value of climate change-related increases to LULUCF emissions, it is much more likely that the imperative to act aggressively to address greenhouse gas emissions across the economy, but also from emissions from increase in drought and bushfire, would be evident.
After all, money talks.
Agriculture: RET and CPRS: Fool me Once – Shame on You. Why farmers might be better off getting on with core business.
Over the weekend, the willingness of the Government to parlay with the Opposition on the treatment of Agriculture has become clear. An emerging compromise would be sensible: competitiveness and food security are at risk with unconstrained potential cost increases.
Actions to enable agriculture to participate in greenhouse gas emissions abatement are also under exploration. These actions might include a range of direct greenhouse-gas emissions abatement activities, which may be regulated or included as offset activities within the CPRS. Obviously, farmers want to have their cake and eat it. But there is reason for caution in pursuing this dream.
Already, carbon forestry looks like an attractive prospect for farmers to generate carbon credits. However, it is likely that many will respond with distrust to locking up land in forestry following the recent history of MIS, and the rebound in demand from agriculture and mining.
There are also options for land managers and rural industries to generate low-emissions and renewable power.
There have been a few more articles in the press in the last few weeks relating to sugar industry renewable energy developments which are illustrative of how different players are responding to Renewable Energy Certificate (REC) prices in the sector.
On October 5 in the Australian, Nicola Berkovic raised the prospect of two bagasse-fired electricity generation assets closing in NSW as a result of a rapid decline in REC prices. These assets are relatively new, but now running at a loss as REC prices are substantially below those prices envisaged prior to the passing of the Renewable Energy Target (RET) expansion.
The over-supply of RECs from Solar Hot Water heaters in the Renewable Energy Target has caused the REC price depression.
It means that, for the next few years, it is hard to see capital-intensive plant continuing to be run at a loss – as reflected by the article in the Australian. It would appear to represent a pretty substantial policy stuff-up if the RET really was meant to support low-emissions electricity generation – with the consequence that much investment will now likely be shelved.
CSR seem to be in the same boat – the REC price is unhedged, and their corporate literature suggests a more optimistic view of REC prices than we are currently experiencing. If this is the case, will CSR continue to subsidise the loss-making cogeneration assets? They are likely to, given that they are integral to core sugar assets, and given the relatively small weighting of cogeneration assets relative to sugar – so relativly low impact of losses from this division – both now and for the de-merged entity.
On the flip side, it is interesting to note the continued confidence in the sugar price re-bound, with expectations of continued strength in sugar values and correlative sugar land values.
Into the mix, North Queensland Bio-Energy Corporation are reported by the Townsville Bulletin to have purchased 107 hectares of land at Ingham, secured contracts for 2 million tonnes of sugar cane from 2012 with local farmers, and reportedly have made substantial progress being made in off-take and funding (reportedly to the tune of $400m) for sugar, ethanol, and electricity generation.
It seems that this investment reflects a medium-term view of the market – with no assets currently operating at a loss, NQBE can continue to plan assets that will not be on-line until 2012, in the expectation that REC (and electricity) prices will have recovered. The investment decision may reflect a positive view of future REC market developments, a potential to cross-subsidise through sugar and ethanol components of the plant, and blind faith. Whether NQBE can secure commercially-viable electricity and REC off-take contracts is yet to be seen.
For prices to improve substantially in the short-term, REC oversupply from Solar Hot Water needs to be addressed. Eliminating one or other of the existing double subsidy of the direct $1600 Government grant or the REC creation potential would be a good start. Continuation of current REC market conditions will mean continuation of stalled or cancelled investment in renewable energy generation.
Whether and how much agriculture can substantially benefit from other low-emissions activity investment is likely to emerge though political negotiation, and consideration of market, budget, and scientific considerations. Of particular interest is clearly the extent to which agriculture might participate in generation of carbon offsets under the CPRS.
However, farmers are unlikely to find an easily-accessible El Dorado through the CPRS in the short-term.
When one looks at experience to date with the RET, solar rebates, and prevarication and lack of clarity around CPRS thus far, it will not be surprising if agricultural industries are suspicious and less amenable to being ‘fooled twice’ when presented with promises of profit-making market-based opportunities under emissions trading. No point getting excited quite yet.
In the MYEFO last week Treasury provided an updated view on the revenue and expenditure impact changes associated with the CPRS.
The main conclusion was that the CPRS would now generate a AUD$1.2bn net fiscal cost – AUD$2.5 billion out to 2019/20.
This is due to improved terms of trade and the strengthening of the $AUD which would suppress the carbon price (and therefore revenue from permit sales). A further significant influence is increased emissions in uncovered sectors, which Treasury suggest would lead to lower permit issuance availability to covered sectors.
The report also points out that expenditure for some components (e.g. Climate Change Action Fund) of the assistance programme are in no way indexed to the carbon price – and that therefore ‘discrete policy action’ needs to be taken for the scheme to be calibrated to the price. The inference is that unindexed assistance represents a fiscal risk.
The report states (Part 3, P10) the difficulty in generating forward estimates with:
components of the package significantly affected by the state of international climate change negotiations and scheme linkages, as well as changes in world carbon prices and the outcomes of scheme review processes
These last few points highlight a point that I’ve made in a previous post regarding budgetary liabilities and the design of the emissions trading scheme.
This point is that the Government, through scheme design of the CPRS, and in nearly every statement made, indicates an implicit guarantee to assume carbon price risk.
In a short space of time, Treasury has adjusted their view as to an Australian carbon price by about 10% – from AUD$29 to AUD$26.
Treasury notes, in the quote above, that effectively the carbon price might do anything in the future. For example, if Parties to the negotiations at Copenhagen move closer to a reasonable cut, and leave out substantial inclusion of some major supply-side prospects of the market, then one might reasonably expect a 2012-2020 global carbon price to increase relative to current assumptions.
This scenario might increase public revenue through permit sales but, through a preliminary fixed carbon price and carbon price cap thereafter within the CPRS, it may increase public fiscal liability.
Government would need to intervene more substantially in covering a national inventory shortfall through purchasing international carbon credits.
This situation might actually be exacerbated by the increase in emissions from uncovered sectors. The Treasury analysis suggests that the impact of the increase in these emissions would be fewer permits made available to covered sectors, thus reducing revenue.
The effect may not be so much on the revenue side of the balance sheet, however, but on expenditure.
Given that the Government is clearly pliable to the demands of exposed sectors in the CPRS, a more plausible scenario might be for permits to be auctioned to the same extent as before to the covered sectors. Granted, this trajectory of hand-outs under the CPRS is now under pressure.
Should the Government cover shortfall either through buying AAU permits from other Governments or CERs from CDM projects, neither covered nor uncovered sectors would have to assume the burden of a carbon budget deficit.
The Government (a.k.a.: taxpayer) would effectively assume the national carbon budget risk – rather than pass that liability (through a domestic permit shortage) to the private sector.
In addition, the recent communiqué from the G20 meeting in St Andrews emphasises
the need to increase significantly and urgently the scale and predictability of finance
This would come from significant private investment, leveraged by public finance, with an implied role for emissions trading.
Australia is signed up to this. Australia will need to pony up for a substantial increase in investment in international permits – the choice is on the spread of the origin of this additional investment – whether from the private sector or public purse, or both.
Given that at least some Government intervention in international carbon markets is a plausible option, then a sensible question to ask is what liability (expenditure) provisions might be made within budget forecasts for additional Government intervention in international carbon markets.
A broader implied question is whether a the CPRS - with substantial assistance programmes and a low target - is a viable design.
Are the Australian public budget and CPRS participants, prepared for the signficant increase in North-South financial flows to which Australia seems bound to contribute, which is at the core of a global deal on climate change at the UNFCCC?
PS: In an interesting piece, Alan Kohler at the Business Spectator has also noted the conundrum for the G20 (and Australia) as to how emissions abatement is paid for.
Deforestation is a major contributor to greenhouse gas emissions. There is strong in-principle global support for action to reduce emissions from this source. But there are also numerous disagreements and difficulties around programme design, incentives and investments. Can the issues be resolved and, if so, when?
Deforestation and land degradation accounts for approximately 20% of global greenhouse gas emissions - more than transport, and second only to energy generation.
Every month, more than 1 million hectares of tropical forests are lost, resulting in more greenhouse gas emissions than the total emissions of the European Union emits in a month.
Reducing Emissions from Deforestation and forest Degradation – REDD - is therefore a critical component of the negotiations at the UNFCCC meeting at Copenhagen for the post-2012 framework.
The action agenda for REDD was first set at COP 11 at Montreal, with the policy approaches being considered under Decision 1/CP13 (para 1.B(iii) of the Bali Action Plan. Relevant information and formal negotiation documentation can be accessed here.
Much of the emissions related to deforestation emanate from emerging economies. They need to be incentivized to put measures in place to reduce, and ultimately halt, the rate of deforestation. These measures are not currently subject to substantial investment, as programme standards have not been formalised, and the measures are not eligible under the Clean Development Mechanism (CDM) carbon credit project mechanism of the Kyoto Protocol. (Further information about treatment of Land-Use and Land-Use Change under the Kyoto Protocol can be found here).
Deforestation and forest degradation are driven by agricultural expansion, forest resource exploitation, and infrastructure development. Local communities, national economies, and rural industry are all stakeholders in managing forest exploitation. REDD must incorporate considerations of capacity, conservation, sustainable forest management, and enhancement of carbon stocks. Therefore, the solutions to deforestation are highly complex.
This means that flexible, but credible approaches, will need to be established to incentivize and manage REDD, which will need to take into account national and local public, civil and private sector institutions and participants – and be palatable to the negotiating Parties at Copenhagen.
A report by the Informal Working Group on Interim Finance for Reducing Emissions from Deforestation and Forest Degradation (IWG-IFR) – a document designed to ‘inform and be informed’ by the ongoing REDD negotiations – estimates a 25% reduction in deforestation could be achieved by 2015 with a financial commitment of US$22-29 billion for the 2010 - 2015 period.
This would represent a cumulative reduction of 7 gigatonnes of CO2 equivalent by 2015, reducing deforestation by 3 million hectares per year. That’s a very large potential contribution to short-term global emissions reduction requirements.
It implies a not-insignificant level of North-South investment enabled only by substantial emissions reduction commitments by Annex 1 Parties (‘developed’ countries) and both government-to-government transfers as well, likely, as linking to emissions trading and thereby private sector participants in ‘industrialised’ countries.
Both industrialised and developing country Parties are supportive of REDD. There were strong statements (at the UN Secretary-General’s high-level REDD event on the margins of the 64th UN General Assembly) to the effect that inclusion of REDD in a post-2012 package is critical.
For developing countries, REDD represents an opportunity to realise the value of a mis-priced asset (ecosystem services provided by forests), drive and manage investment into rural industries and communities as well as the potential for signficant benefits to national revenue. Industrialised countries see a politically palatable and low-cost option to secure substantial greenhouse gas emissions abatement through mechanisms that may appear as extensions to existing bilateral and multilateral aid programmes. In addition, a sectoral benchmark and approach opens an avenue to the potential for developing countries to assume commitments.
The Meridian Institute, in a March 2009 report on options for REDD developed for the Government of Norway, proposes a three-stage approach to incorporating REDD, including capacity building, payment for specific activities, and finally participation in compliance markets through a sectoral approach. It is proposed that the approach be compatible with other forestry, agriculture and other land-use activity treatment.
The IWG-IPR takes a similar approach:
In the first phase developing forest countries would receive grants to develop a REDD+ strategy. In the second phase, the REDD+ strategy implementation phase, grant support would be provided to build capacity, while large-scale payments would be provided for demonstrated results in reducing emissions relative to an agreed reference level, as estimated by proxies for greenhouse gas emissions. In the third phase, countries would receive payments for verified emission reductions and removals, as measured by compliance grade and transparent measurements of environmental integrity, and for the conservation of existing stocks.
However, it is not just financial incentive structures and stakeholder participation issues that need to be established and agreed, but also procedures for setting emissions reference levels (historic and dynamic), methodologies for monitoring, reporting, and verification.
The reference year chosen, and reference deforestation emissions rates, will strongly impact the extent of apparent abatement achieved and potentiality to attract investment flows. Therefore, there are critical technical and political dimensions to those decisions.
At present, payments are deemed to occur only once emissions reductions have occurred. This facet implies that resource-constrained developing countries may not be able to fund the implementation and certification resources required (if there is no forward market).
The nature of emissions removals means that developing countries would effectively assume long-term constraining liabilities for forest protection in return for a one-off payment. Problematic indeed.
As a consequence of these many considerations, there are as many proposals relating to how REDD might be approached. The numerous proposed approaches are outlined in a 2008 publication ‘The Little REDD book’.
If it sounds far-fetched that REDD will overcome all the challenges and become operational, we (in Australia) sit in the one place that has overtly benefitted so substantially already from avoided emissions from land use degradation. That benefit came in the way of Article 3.7 of the Kyoto Protocol – known as the ‘Australia clause’ – which enables Australia to benefit from reduced rates of land-clearing since the baseline year (1990). Emissions from land-clearing in 1990 in Australia were 103 MtCO2e and are now about half of that. The reduction is effectively due to business-as-usual trends. It has meant that Australia has an eminently achievable emissions reduction target, potentially allowing for surplus carbon for export if low-cost emissions abatement could be found elsewhere in the economy.
Australia is already investing $200m in REDD-related activities in PNG and Indonesia.
Achieving emissions abatement potential from REDD requires substantial investment – of the level that industrialised countries are evidently not yet prepared to countenance. While developing country and technical concerns should not be overlooked, availability of investment is a primary factor for success.
As per the IWG IFR :
Developed countries are hesitant to generate payments at the scale required because of uncertainties over whether the results will be achieved in a sustainable way, will be measurable and verifiable, and will demonstrate environmental, political, and social integrity.
(….)
Furthermore, developed country governments face challenges in articulating to their citizens why they would be facilitating large-scale financial transfers to developing forest countries during difficult economic times
As it stands, the phased approach to REDD which is emerging, dictated by the requirement to resolve technical and resource issues, will mean that it is unlikely that there will be any short-term large-scale programmatic investment into REDD.
How investment can practically be phased and tapped through the framework being devised at the negotiations is a critical issue if the emissions abatement from REDD is to be secured.
Let’s hope it doesn’t take too long to operationalise – the forests will continue to fall in the interim.
The World Bank have recently published an agriculture and rural development note on ‘Reduced Emissions and enhanced adaptation in Agricultural landscapes’ which reports key messages from a Bank conference in January.
It includes some succint messages about the potentiality and issues related to integrating adaptation and mitigation in agriculture, including in the context of the post-2012 framework. With the meetings in Barcelona and Copenhagen, the timing of the release of the note is clearly opportune.
On the mitigation potential represented:
There is significant biological/technical potential for GHG mitigation within agriculture through both emissions reductions (mainly of N2O and CH4) and removals of CO2 (with increasing storage of carbon (C) in soils and biomass on agriculture land), on the order of 5.5 to 6 Pg CO2e yr, over a 10-30 year time horizon (IPPC – Working Group III, 2007). The dominant component (about percent) of this potential is associated with soil carbon sequestration in cropland and grazling lands and restoration of degraded lands in developing countries (IPCC – Working Group III, 2007).
It goes on to state the security of the science in the sequestration potentiality of soil carbon, emphasising instead that lack of detailed policy consideration of soil carbon sinks is due in part to lack of understanding of capabilities to measure soil carbon:
‘The fundamental problem with respect to direct measurement of soil carbon stocks and stock changes is not so much an issue of measurement capabilities, but rather a question of applying efficient sampling designs and rigorous protocols.
Accuracy in measurement is possible through direct measurement, but practical application and transaction costs make it unfeasible. Modelling is also possible, but variables in factors mean that accuracy is brought into question. This means that a protocol involving elements from both approaches to measurement is required.
Establishing and financing soil carbon programmes may rest heavily on the possibility to include them in emissions trading. This in turn will depend upon whether Parties to the Kyoto Protocol will allow appropriate treatment of Article 3.4 to the Kyoto Protocol on ‘Additional Activities’. Article 3.4 is used to guide how countries account for changes in greenhouse gas emissions in national inventories from agricultural soil, land use change and forestry. The broad activities and rules, and methods for monitoring and verification of which were defined at COP 11 (Montreal).
The Bank note recognises that for article 3.4 sinks to be included:
there needs to be substantial investment in research and development of both emissions and sequestration on agricultural land
Required investment includes pilot projects, establishment of lab and field protocols, scaling activities, data consolidation, funding mechanism establishment, capacity building.
Given the substantial sequestration possibilities at low-cost, and with co-benefits, it is likely that soil carbon activities will be increasingly subject to the interest and investment that is needed. Secure mechanisms and protocols will take time to develop, but pilot activities, including incorporation into emissions trading, have already been initiated.
Challenges remain, but in anticipation of the political will and technical potentiality for a positive outcome, we can expect that there might be a little of the wild west in the build-up to defined rules.
In amongst the debate over which country will accept what form of climate change target (if any), there is a sleeping, giant, bear that threatens to undermine abatement commitments at Copenhagen and the global carbon market. This is the massive surplus of Assigned Amount Units (AAUs) – the tradeable emissions units under the Kyoto Protocol – amassed by the Economies in Transition over the period to 2012 – In particular Russia and the Ukraine.
In effect, when the economies of the former Warsaw Pact and Soviet Union contracted substantially in the 1990s, their Kyoto emissions targets based on previous high, inefficient, levels of industrial production became obscure, thus creating a substantial surplus of available credits to sell on the international market through the flexible mechanisms of the Kyoto Protocol. In 2005, these countries were on average 35% below the emissions levels of 1990. The Kyoto target for Russia and the Ukraine was 101% of base year emissions.
Colloquially, this phenomenon is known as ‘Hot air’.
While Annex 1 countries develop their domestic and international mandates and positions for emissions reduction commitments leading up to the climate change negotiations at the UNFCCC in Copenhagen, Russia remains substantially out of the press in terms of it being a determinant factor for success. All the talk is of the US, China, and India.
Unless a workable agreement can be reached with Russia, there is a risk that the surplus AAUs, if sold into the market, could significantly undermine investment in domestic, and international, emissions reductions. Downward pressure on carbon prices would be substantial, and investment in emissions reductions in emerging markets through the Clean Development Mechanism and other means would all but dry up.
I build upon my previous comments about the implications for distribution of mitigation within the economy and the prospects for substantial deficit in Australia. A nation state would be able to assume a tough target on a national basis but confer modest targets on industry and the rest of the economy, while also avoiding potentially high cost of imported credits.
How? This would be achieved through formation of a bilateral agreement with Russia to transfer large volumes of AAUs for the balance of the remnant emissions deficit – at a low price.
BarCap estimates Russia and the Ukraine, the two countries with the largest Assigned Amount Unit inventory (the national carbon ‘currency’ of the Kyoto Protocol), could have around 6.5 billion tonnes (6.5 GtCO2e) available for sale from the 2008-2012 Kyoto period which they have amassed.
These countries can bank surplus from the 2008-2012 ‘Commitment Period’ to a subsequent commitment period.
Anna Korppoo and Thomas Spencer have labelled this phenomenon ‘The Dead Souls’ in their recent paper for the Finnish Institute of International Affairs.
Korppoo and Spencer give a figure for a possible pre-2012 surplus of between 3.5-5 GtCO2e from Russia – likely at least at the upper end of this estimate now, as a result of the economic crisis.
To illustrate the scale of this surplus, this is more than three times the annual CO2 emitted by all industry under the EU’s Emissions Trading Scheme and nearly six times the estimated global demand for AAUs pre-2012.
Australia’s entire annual emissions amount to less than 600 MTCO2e, while a 25% emissions cut by 2020 would represent 249 MTCO2e reduction from a business-as-usual scenario. The existing Russian surplus alone is twenty times Australia’s future deepest cut target to 2020!
During the post-2012 Commitment Period, the Russian economy is likely once more to be substantially long.
The Russian Ministry of Economic Development analysis shows that only under the most ‘pessimistic’ emissions scenario for Russia will emissions in 2020 surpass the emissions level (3,048 MT) of 1990.
The best indication of Russia’s medium-term cut commitment is 50-80% on 1990 levels by 2050. This range potentiality is evident from the Russian signed statement at l’Aquila, and statements shortly thereafter.
Evidence suggests that there is strong potential for no-cost signficant greenhouse gas emissions abatement in the Russian economy, thus presenting the prospect of further surplus creation if a Russian national target for 2012-2020 is not at a challenging level.
A joint IFC/Centre for Energy Efficiency paper which examines in detail the potential for energy use reduction in the Russian economy states:
Russia can save 45 percent of its total primary energy consumption. Russia’s current energy inefficiency is equal to the annual primary energy consumption of France. Achieving Russia’s full energy efficiency potential would cost a total of $320 billion to the economy and result in annual costs savings to investors and end users of about $80 billion, paying back in just four years. Benefits to the total economy are much higher: $120-150 billion per annum of energy cost savings and additional earnings from gas exports.
If its energy efficiency potential was to be fully realized, Russian CO2 emissions in 2030 would be approximately 20 percent below the 1990 level. Russia’s energy efficiency potential translates into a CO2 emissions reduction of 793 million tons of CO2 equivalent per year (about half of 2005 emissions).
The 10-15% abatement range by 2020 proposed by Russia does not reflect the efficiency potential or trends of the Russian economy.
From almost any angle, Russia is a large, inefficient, user of energy – a major contributor to national greenhouse gas emissions. Russia is the most energy intensive economy per unit of GDP of the top ten energy consuming countries, and is number three in absolute terms for energy consumption. Russia ranks among the top 25 energy intensive countries in seven major areas of economic activity: agriculture, hunting and forestry; construction, manufacturing; transport, storage and communications; wholesale, retail trade, restaurants and hotels; and other activities. It has a relatively slow pace of reduction of energy intensity. This should confirm the potential to easiliy reduce the energy intensity of the economy.
The Moscow Higher School of Economics suggests a possible 30% greenhouse gas emissions reduction on 1990 levels by 2030 purely as a consequence of the current economic crisis.
A curious effect of energy efficiency implementation in Russia will be the impact on international energy exports from Russia, and the potential relative downward impact on regional and/or global prices. At a current annual natural gas production of around 350 bcm the IFC reports a potential saving of 240 bcm. In addition, 43 million tons of crude and refined products, and 340 billion kWh of electricity could be saved. Thus, through cutting domestic consumption, there will be greater availability for export, or reduced demand for imports, in the future. Russia therefore has a clear economic interest in the reduction of domestic greenhouse gas emissions.
At the same time, perversely, this will have the impact of marginally reducing global energy prices, thus reducing incentives for investment in energy efficiency and low-emissions research and development in other markets. (The shadow of reduced, or fluctuating availability of fuel exports from Russia looms large in Europe in particular).
However, the main implication for climate negotiations is that, based on all but the very highest end of any Annex 1 country abatement targets, the cumulative Russian surplus will swamp demand.
As Korrpoo and Spencer clarify:
If the surplus AAUs from all countries is transferred, 700 – 1000 million AAUs would be available to replace domestic emission reduction measures in industrialized countries each year up to 2020. In total, this represents ca. 4-6% of total Annex 1 emissions in the base year, i.e. ca. a sixth of a 30% Annex 1 target or a third of the existing 10–16% reductions pledged by Annex 1 countries.
The following solutions are options proposed by Korrpoo and Spencer, and the World Bank:
- Encourage Russia to hang on to the surplus, for the future – thus not sell into the short-term market
- Have Russia and Annex 1 countries commit to deeper targets
- Sell AAU surplus to finance initiatives in developing countries, and/or domestically (Green Investment Scheme)
- Buy the surplus and cancel – government to government (where does the cash come from?)
- Simply not allow the AAUs to be eligible post-2012 – politically unfeasible if Russia is to be on board an agreement
Clearly the AAU surplus is a substantial issue to be addressed.
Their worth is deemed a sovereign asset by those nation states. Should the units be brought substantially into play to meet what appear to be modest mid-term targets, then environmental additionality of post-2012 targets and the carbon markets will be at risk.
There is no obvious solution, and relatively little focus upon the issue. While many criticise the institutional arrangments that allow for the trading of permits from one country to another as a threat to the integrity of targets, the establishment of the markets in permits was a major driver behind the political acceptability of assuming cuts.
Now, it may be the existence of the permit markets which provide continued incentive for responsible governance by those countries that hold surpluses of the international climate regime. This is because the countries that are substantially long on permits may place more value in banking much of the balance of their surplus into a post-2020 Commitment Period, rather than sell into the forthcoming period. Targets are sure to become harder in time, and value and market prices for permits higher.
Greater detail of the proposed demerging deal structure of ASX-listed building materials and agriculture group CSR has been revealed. It promises to create a new, large Australian listed industrial with a more substantial emphasis on renewable energy.
The plan to demerge into the two entities has been known for some time. There will be a building products company, and a ’sugar and renewable energy’ business. Despite the predominant business of raw sugar production of the entity, management explicitly emphasise the renewable energy aspect of the latter business.
The renewable energy in question is ethanol fuel, and bagasse-fired cogeneration.
In 2008 CSR was the sixth largest sugar producer in the world.
Clearly, management are thinking that the climate change, low-carbon, ‘wow’ factor might lead to an ability to secure greater interest in the listing.
Branding and detail is to yet to be developed, but for clarity here I will call the latter entity SugarCo, to use the terminology from the half-year results.
I thought it interesting to consider what prospects might be afoot for this new renewable energy business.
SugarCo will consist of production of raw sugar from production and refining, as well as ethanol and liquid fertiliser from process waste (molasses), and renewable energy production (cogeneration) fuelled by bagasse (can trash).
A point of interest is the relatively small contribution, relative to revenue, that the sugar business has historically contributed to CSR. According to company presentations, earlier in the year, while the sugar contributed 39% of revenue to CSR, it contributed only 18% of EBIT. In contrast, building products and aluminium contributed twice, and three times respectively as much as the sugar business in terms of EBIT over revenue coverage.
However, there is the potential for growth in the main product areas of SugarCo – fertilizer, ethanol, and renewable energy. According to management, raw sugar and refining prospects also look strong, but it’s not a subject I know anything about so I’ll avoid all speculative comment. What is true is that EBIT contribution from sugar in the last period has increased over 300%, apparently due to improvements in refining and world sugar prices. The 2009 half-year results demonstrate this remarkable change..
Management see substantial relative EBIT growth going forward for SugarCo – with EBIT expanding from $82m over $1,411 YEM09 revenue to $113 over $1,050 YEM10 revenue next year, representing a move from a 5.8% EBIT margin to 10.8%.
The CSR Sustainability report gives a view on the actual and potential renewable energy production from their assets:
CSR is Australia’s largest renewable energy producer from biomass. We currently generate enough renewable electricity, which, together with a small amount of external fuel, is sufficient to operate each of our seven sugar mills in North Queensland. We have two mills, Invicta and Pioneer, where a significant surplus is produced.
That surplus, which is approximately 300 Gigawatt hours (GWh) per annum is exported into the National electricity grid and is enough to power approximately 80,000 homes.
The availability of large amounts of bagasse (waste sugar cane fibre) and cane trash provides CSR with the potential for producing significant additional generation capacity. An additional 1100 GWh of renewable electricity (enough to support ~170,000 households) could be produced from identified bagasse fuelled projects, while a further 800 GWh of renewable electricity (enough to support ~120,000 households) could be produced from cane trash fuelled projects.
It will be interesting to learn about the Levelised Electricity Cost for any marginal increase in electricity production capacity. While there is technical potential, the economic potential is not clear from available documentation. The financial feasibility will be dependent upon additional investment cost, and power and REC prices under the newly expanded Renewable Energy Target.
Unfortunately, in view of the current REC price trend, CSR’s earnings from the renewable energy component of the business looks like taking a hit in the short term – if the price doesn’t improve – out to 2015.
According to their statements last year:
Approximately 75% of CSR’s REC production is exposed to market price, with the balance contracted at fixed prices until 2015
If, on average, 285 GWh of electricity is exported, then an approximate contribution revenue of REC sales at an average historic REC price of $45/MWh would normally generate $12,8m for SugarCo. At $30 per REC for 75% of their generation and $45 for the remaining fixed 25% (these are just approximations), this revenue would fall to $9.6m annually – a ‘loss’ on Business as Usual revenue of $3.4m.
Potentially more importantly, the REC price modelling on SugarCo presentation prospects indicates a rosier view of the REC market than many currently anticipate – reflecting the moment of optimism pre-passage of the RET legislation when many foresaw a potentially booming REC price (which may explain why such a high proportion of the SugarCo REC production is taking market risk). The implication is that forecast esimates of revenue and EBIT growth for the cogeneration part of the refining business may be misplaced in the short term at least.
However, with SugarCo YEM09 Revenue of $1.41 billion this price decline is hardly noticeable as a revenue impact – but may show up more in EBIT.
Irrespective, CPRS legislation, and wholesale volatility and price increases in the future, will be major underpinning determinants of profit growth in this area. The fact that SugarCo is not negatively exposed to this price volatility, due to consumption of on-site generation, will in any case mean that SugarCo refining and milling is not exposed to these energy market risks.
Whether the new entity will foray into further renewable energy power generation opportunities, thus expanding the contribution of renewable energy generation to revenue and EBIT, is not yet clear.
As far as ethanol is concerned, SugarCo would have a 38 million litres fuel-grade production capacity, with a further 22 ml added potential upon completion of dehydration unit (assuming all current industrial ethanol production is converted). The ethanol production capacity is 1.1 billion litres from molasses and cane.
There has been substantial and rapid growth in the groups fuel ethanol sales recently. However, Ethanol still is the smallest sub-group EBIT contributor. In YEM09 Ethanol EBIT represents 12% of SugarCo EBIT (compared to 49% contributed by Refining, and 39% from Milling (including Cogeneration). EBIT/Revenue coverage of the sub-groups is not clear.
CSR argue a 50% CO2 greenhouse gas emission reduction on a lifecycle basis on conventional petrol.
As the Carbon Pollution Reduction Scheme (CPRS), in its current format, proposes to include transport fuels within its coverage, ethanol will benefit from a relative competitive price advantage. The relative impact will be largely dependent upon the carbon price, but an increase in interest from large fuel users is likely. However, the price impact difference is likely to be only a few cents a litre, leaving underlying fundamental energy market price and volatility issues as a more substantial market driver. CSR see continued growth in demand for fuel ethanol globally and in Australia.
Lastly, the liquid fertilizer product is certified as organic. The future continued success of this product stream will obviously be largely dependent upon trends in the agriculture sector. It is possible that the nutrient-enriching and organic characteristics may also assist in soil carbon sequestration depending upon application - which could drive additional sales and value should such carbon sequestration offset projects be deemed eligible under the CPRS. In the short-term, this is unlikely due to the multiple technical issues in measurement, monitoring and verification (not to mention the market impact potentiality and potentiality for conflict with international trade policy).
In conclusion, it is not clear that either the Renewable Energy Target or CPRS will substantially drive growth in EBIT or revenue in the SugarCo business in the short-term. Conventional underlying market fundamentals in agriculture, global raw sugar, and ethanol will prove more influential.
To understand plans for the distribution of future EBIT growth, it will be instructing to see further detail in the information memorandum.
