CPRS White Paper: Oil & Gas issues

Introduction

The 15 December 2008 White Paper outlines the Australian Federal Government’s:

• medium-term 2020 target for Australian greenhouse gas emissions reductions, and
• intended final design of the Carbon Pollution Reduction Scheme (CPRS).

This document summarises the implications of the White Paper for the oil & gas industry, including for the production of Liquefied Natural Gas (LNG) and Carbon Capture & Storage (CCS).

Key commercial implications

Key commercial implications of the White Paper for the oil & gas industry include:

1. knowing the medium-term target, price cap and that there will be no quantitative limit on the Kyoto credits that can be used, means there is now much greater certainty regarding the likely price impacts of the CPRS. Therefore mitigative measures can be explored and implemented
2. LNG and other oil & gas activities will receive Emissions-Intensive Trade-Exposed (EITE) compensation
3. natural gas producers will benefit from the EITE compensation regime being broadened to compensate feedstock users of natural gas in respect of the extraction and production of the natural gas
4. CCAF funding may be available to the oil & gas industry, and
5. there is funding available for CCS activities.

It will be critically important to ensure that the CPRS legislation is correctly drafted to achieve the industry’s goals. The draft legislation is scheduled for public release in late February 2009, with government consultation in March and April 2009, so there will be very limited time for stakeholders to digest the ramifications of the legislation and lobby for changes.

The oil & gas industry will also need to quickly respond to the government’s EITE compensation guidance paper, to be released in early 2009.

Carbon pricing

Targets

The Federal Government previously stated its long-term target for a 60 per cent reduction against 2000 emission levels by 2050.

The White Paper sets out a medium-term target for a 5–15 per cent reduction against 2000 emission levels by 2020.

Price cap

There will be a price cap in the first five years of the CPRS at $40/tCO₂e, rising by five per cent per annum after inflation.

International permits

Kyoto Protocol flexibility mechanism credits, including Certified Emission Reductions (CERs) under the Clean Development Mechanism (CDM) will be permitted to be used under the CPRS without quantitative limit.

The market for these credits is developed and large compared to Australia’s total emissions and will operate as a further ceiling on the carbon price in Australia. If the price for purchasing Australian permits (either direct from the Australian Government, from forestry producers or on the secondary market) rose above the price of the Kyoto credits then businesses could simply purchase the Kyoto credits instead. These Kyoto credits now cost about $26.75(€13)/tCO₂e on the secondary market, or about $16.44(€8)-$20.55(€10)/tCO₂e direct from accredited projects. However, the Kyoto credit price can be expected to rise as demand increases and opportunities to source credits directly becomes more difficult which is already occuring.¹

CCS is not currently included in the CDM mechanism. Australia pursued recognition of CCS under the CDM mechanism at the recent UN Poznan Conference. However, it was prevented by Brazil and a small group of other countries. It has been indicated that the matter will be further raised at future UN meetings.

Carbon price

The Commonwealth Department of Treasury’s modelling, released on 30 October 2008, predicted the carbon price under both five per cent and 15 per cent reduction targets (the extremities of the White Paper medium-term target), in models called CPRS-5 and CPRS-15. This modelling was based on Australia’s action taking place within a simple multi-stage global policy framework, where Australia and other developed countries take comparable action from 2010, and developing countries gradually adopt emission reduction obligations from 2015 to 2025. The following table presents the Treasury’s predicted carbon price under this modelling:

The indications are that the carbon price at commencement of the CPRS on 1 July 2010 will more closely align with the CPRS-5 modelling than CPRS-15.

Potential impact of the carbon pollution reduction scheme on key energy companies

The following table appeared in the Australian Financial Review on Wednesday 17 December 2008:

Coverage and point of obligation

The White Paper indicates that the CPRS will apply to the oil & gas industry as follows.

Fugitive emissions from natural gas pipelines and oil & gas production

CPRS obligations will apply to entities with a facility that has direct fugitive emissions of 25kT CO₂e per annum or more.

Domestic emissions from using fossil fuels

Netting-out arrangements

The White Paper addresses a netting-out arrangement for fossil fuels, and provides for an administrative transfer mechanism—an Obligation Transfer Number (OTN)—to enable CPRS obligations to be transferred between entities, at the same time the fuel is supplied, down the supply chain.

The starting point under the White Paper is that the initial producer/importer will be liable under the CPRS for the emissions from the final use of all product (that is, final combustion emissions).

The White Paper then provides that the following entities must use an OTN to assume CPRS liability from the upstream supplier for the final use emissions:

• large users of fossil fuels other than petroleum liquids (that is, entities with a facility that emits 25kT CO₂e per annum or more from combustion of a single fuel)
• retailers of natural gas and other pipeline gases, and
• LPG marketers.

The White Paper then further provides that the following entities may use an OTN to assume CPRS liability from the upstream supplier for the final use emissions and directly manage their CPRS liabilities:

• entities that use fossil fuel as feedstock in a chemical transformation or consume fossil fuels other than by combustion
• entities undertaking solid fuel transformation (making coal char, coke, briquettes and by-products)
• upstream suppliers of natural gas, LNG, CNG, ethane, coal seam gas, underground coal gas and town gas that acquire gaseous fossil fuels from another entity to manufacture those gases
• intermediate suppliers of fossil fuels
• entities using fuel for international voyages or for other purposes that do not result in domestic emissions, and
• large users of petroleum liquids.

Whether these entities choose to assume direct responsibility for the CPRS liability of the fuels they use will depend on their particular circumstances.

Where CPRS liability is transferred through the OTN process then the entity assuming the CPRS liability will be responsible for acquitting permits directly to the government in respect of final use emissions for the product supplied under the OTN process, not the upstream supplier. Therefore the OTN mechanism will have commercial ramifications for the sale of fossil fuels, where:

• if the upstream supplier holds the CPRS liability then the sale price will incorporate that CPRS price, and
• if an entity assumes CPRS liability then they will incur direct CPRS costs themselves and consequently the sale price will not incorporate the CPRS price.

The full mechanics of the OTN process are not yet known and we expect they will most likely be contained in the CPRS regulations. The government has stated that it expects to refine the administration of netting out arrangements in consultation with stakeholders following release of exposure draft legislation.

The following legend applies to the diagrams below.

• Yellow boxes are those entities with initial liability under the CPRS.
• Blue arrows and boxes indicate transactions and entities that must or may use an OTN to assume CPRS liability (therefore no CPRS price will be included).
• Brown arrows and boxes indicate transactions and entities where an OTN cannot be used and CPRS liability cannot be assumed (therefore the sale price will include the CPRS price).
• This legend and the diagrams presented have been taken from the White Paper.

Natural gas

Petroleum products

The White Paper confirms that transport emissions will be covered by the CPRS, with CPRS obligations to be applied to upstream suppliers of petroleum transport fuels. As a transitional measure the Federal Government has committed to initially reducing the fuel tax on transport fuels, to offset the increase in price due to the CPRS.

LPG, CNG and LNG are alternative transport fuels, but are not currently subject to fuel tax and therefore would not benefit from the fuel tax cuts. Instead, a CPRS fuel credit will be available on these fuels to an appropriate entity in the supply chain. These measures mean these fuels will maintain their relative price and competitiveness against other transport fuels. The CPRS fuel credit will be available:

• for three years on LPG, consistent with the standard transport fuel tax cuts, and
• for one year on CNG and LNG, consistent with the regime for heavy on-road transport where those fuels are primarily used, and will be reviewed after that time.

LPG

Products used for feedstock

International use

Emissions that occur outside of Australia (for example from LNG exported), or for international voyages (that is, international shipping or aviation fuel), will not be covered by the CPRS.

CCS

White Paper treatment

Emissions that are injected and stored in CCS facilities will not be counted towards the originating entity’s gross emissions. However, CPRS obligations for fugitive emissions from CCS and associated transport activities will be imposed on the relevant CCS facility.

In practice this means that a natural gas processer will not be liable under the CPRS in respect of reservoir emissions that are sequestered, but a liability will arise (and permits would need to be acquired and surrendered) in respect of any fugitive emissions.

CCS will therefore become more commercially viable as the price of carbon under the CPRS rises, that operators will be able to choose between purchasing permits or undertaking CCS.

Legislative developments

CCS regimes have been enacted at a state and federal level in Australia. The Offshore Petroleum Amendment (Greenhouse Gas Storage) Act 2008 (Cth) (Act) commenced in November 2008², and the Federal Government is currently consulting with stakeholders regarding the regulations which will be made under that Act. Onshore legislation has also been passed in Victoria and a Bill has been introduced in Queensland Parliament. 

Compensation & funding

Emissions-intensive trade-exposed (EITE) compensation

The following White Paper table provides a summary of the key features of the EITE assistance program:

The White Paper has modified and expanded the scope of EITE compensation. Major developments against the Green Paper for the oil & gas industry are:

Lower EITE compensation thresholds

The EITE compensation arrangements have been significantly broadened to include industries that previously would have missed out on EITE compensation. The threshold of 2,000t/$million revenue has been retained from the Green Paper, above which EITE firms will be eligible for 90 per cent free permits. However, the lower threshold at which 60 per cent of permits are provided free has been dropped from 1,500t to 1000t/$million revenue. Based upon the data contained in the Green Paper, this change means LNG processing and some other significant oil & gas activities will exceed this lowered threshold and therefore receive 60 per cent of their required permits for those activities for free.

Additional route for determining eligibility

The second significant change is that entities can elect to use a value added metric for determining emissions intensity (a different threshold for assistance would apply to each to provide broad equivalence in impact).

Scope of assistance

The scope of assistance has been broadened, both in terms of the assessment of emissions-intensity and the amount of compensation provided.

Of particular relevance to domestic natural gas producers is that EITE assistance will also be assessed and provided to end users in respect of emissions associated with the extraction and production of natural gas and its derivatives when used as a feedstock (that is, when the final use does not itself produce emissions). For entities to receive this assistance they will need to use an OTN to purchase natural gas as a feedstock net of the carbon price (as described above). We expect that the practical effect of this amendment is that natural gas producers will be able to pass on all or a portion (potentially that which isn’t covered by their own EITE assistance) of their CPRS costs associated with emissions arising in the extraction and production of natural gas and its derivatives when used as a feedstock.

Longer data period for revenue to be used

A longer time series of four-and-a-half years can be used, from 1 July 2004 to 31 December 2008, in respect of revenue for EITE eligibility assessment, as opposed to two years. This will assist to smooth the impact of commodity prices and exchange rate fluctuations. However, the period of emissions data to be used will still only be two years, 2006/07 and 2008/09.

Rate of EITE assistance will decline

The rate of EITE assistance will decline (ie from 90 per cent or 60 per cent) by 1.3 per cent per year, that is, to 88.8 per cent and 59.2 per cent in 2011–12 and 87.7 per cent and 58.5 per cent in 2012–13 etc. The total pool of EITE assistance is not capped and no adjustments will be made to the rates of assistance for new or existing entities.

EITE assistance program reviews

However, the EITE assistance program will be reviewed every five years or at another date requested by the responsible minister. The review will consider the experience of the CPRS and international developments, including the extent to which competing countries have introduced carbon constraints.

Form and timing of assistance

EITE compensation will be provided by an administrative allocation of permits at the beginning of each financial year.

Activity basis

An activity basis will be used, rather than an industry, company or facility basis. Principles are set out for determining activities.

Trade exposure

A test of trade exposure has been introduced.

Data collection

The process for determining trade exposure and emissions intensity is outlined. A guidance paper was issued on 18 February 2009 regarding the provision of data by entities to the government to give effect to the trade exposure test and assessment of emissions intensity.

The government will then use the data to determine trade exposure and emissions intensity for each activity averaged across all entities conducting the activity. For activities that meet the assistance thresholds a baseline to calculate the number of permits to be allocated to each entity conducting the activity will be determined. The baselines will then be included in the draft regulations.

Climate Change Action Fund (CCAF)

The CCAF will be a $2.15 billion fund available over five years (from 1 July 2009) to smooth the transition for businesses, community sector organisations, workers, regions, and communities to an operating environment that includes a price on carbon. A priority of the CCAF will be businesses that are ineligible for other forms of assistance associated with the CPRS, or receive the lower level of EITE assistance. Therefore the CCAF will be available to LNG and natural gas producers if they receive the lower level of EITE assistance.

The CCAF will have four streams, of which the relevant stream for the oil & gas industry is stream 2. It will provide grants and incentives for businesses to invest in energy efficiency projects and low emissions technologies, processes and products. This stream will have $1.4 billion over five years. In particular there will be a sub-program for ‘Innovation in Climate Change’, being for competitive grant funding to contribute to the cost of innovative low emission technologies, production methods, supply-chain improvements or products, and energy savings projects with long pay back periods. The competitive funding round will begin in late 2009. It will complement the government’s existing range of energy technology specific funds.

CCS

Federal Government assistance for investment in CCS is being delivered through the:

• National Low Emissions Coal Initiatives (NLECI), with $500 million available over eight years, with the intention to generate $1.5 billion through partnerships with industry, focused towards coal-related CCS technological development, and
• Global Carbon Capture and Storage Institute (GCCSI), up to $100 million per year will be contributed to a new Global CCS Institute.

Notably, the Federal Government’s rhetoric around these initiatives is primarily focused towards coal related CCS (and entirely in the case of the NLECI) and not the storage of CO₂ liberated through the LNG production process.

As noted above, CCS is not currently recognised under the CDM mechanism despite Australia’s attempts at Poznan. Increased industry support may assist. CDM recognition would pave the way for funding for CCS projects in developing countries, and therefore significantly increase CCS R&D investment, by allowing those projects to generate CERs. Without this funding there are few commercial drivers for CCS projects in developing nations.

Next steps

The indicated timetable for implementing the CPRS and related matters is set out below. The next key events will be he indicated timetable for implementing the CPRS and related matters is set out below.

The next key events will be:

• the EITE assessment guidance paper being issued in early 2009; and
• the release of exposure draft legislation, currently indicated for late February 2009, with the opportunity for public submissions.

The Rudd Government intends to have the CPRS legislation through parliament by June 2009. In the Senate, the government will need the support of either the Opposition Liberal and National Parties (the support of the Liberals alone would be sufficient), or all minor parties (the Greens, and the independents from Victoria and South Australia). The initial reaction of the Greens has been negative to the medium-term target, and the Opposition, consistent with its policy to delay introduction of an emissions trading scheme until global economic conditions improve, announced on 15 December 2008 that it has commissioned an economic analysis of the proposed CPRS. There is potential division between the Liberals and Nationals. A Senate inquiry seems likely. Therefore, there will continue to be scope to lobby in respect of the CPRS design.

Endnotes

This article was written by Stuart Barrymore, Partner, Michael Voros, Solicitor and Nick Hemelaar, Articled Clerk.

More information

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