The commencement of the Australian Carbon Pollution Reduction Scheme (CPRS) will impose an obligation on liable greenhouse gas emitters to acquit emission permits. These liable entities must analyse the economic balance of investing in internal abatement projects – to reduce the number of permits required – or to source permits on market. A third option is to participate in, or purchase credits from, international projects such as those generated under the Kyoto Clean Development Mechanism (CDM).

This article examines the CDM and how the Government’s proposed CPRS impacts upon CDM projects for Australia’s clean energy industry.

What is the CDM? The CDM is one of three flexible mechanisms adopted under the Kyoto Protocol to encourage project based improvements in greenhouse gas performance. The scheme works by allowing companies in Annex 1 – i.e. developed – countries to acquire Certified Emission Reductions (CERs) from projects based in non-Annex 1 countries – i.e. developing countries that have no emission caps. Examples include wind energy, industrial process upgrades and energy efficiency.

The incentive to invest in CDM projects arises from the creation of CERs which have commercial value for two reasons. First, CERs can be used to meet the emission compliance requirements of a company where a company’s country of domicile has a legislated cap on greenhouse gas emissions. Secondly, in an increasingly environmentally conscious market, CERs can be used in order to substantiate marketing claims, for example, that a product is ‘carbon neutral’.

However, only greenhouse gas abatement projects which satisfy an ‘additionality’ requirement are eligible to create CERs. Essentially, the additionality test is a twostep calculation. Step one involves assessing a project’s environmental and economic performance without the requirement to acquire permits. This is known as the baseline or Business As Usual (BAU) scenario.

Step two repeats this calculation but includes the additional revenue for the project in the form of CERs - which represent the value of the reduced emissions against the BAU scenario. The project must be assessed using a methodology approved by the Executive Board of the United Nations Framework Convention on Climate Change (UNFCCC). If the project is only financially viable due to the creation of permits then, in many cases, it can be said that the project would not have commenced but for the CERs generated, therefore it is ‘additional’.

The CDM market has developed strongly, with annual volumes exceeding US$13 billion ($18 billion) in 2007, with both compliance buyers and aggregators active in the market.

CDM generated CERs under the CPRS The Federal Government has expressed a desire to link the Australian CPRS with other international schemes to enable the importing and exporting of units (including Kyoto permits) between schemes. However, it has yet to decide if, and to what extent, Kyoto permits (including CERs) will be able to be surrendered by liable entities to meet their CPRS obligations.

In its Green Paper, the government flagged the possibility of quantitative and qualitative restrictions on the use of Kyoto permits for CPRS compliance.

The quantitative restrictions are primarily intended to insulate the CPRS during the implementation phase against carbon price volatility on global markets. These restrictions will be published in the White Paper in late 2008 and are likely to be expressed as a maximum percentage of a liable entity’s permit obligations.

Importantly, any quantitative restrictions on the surrender of CERs under the CPRS will not affect the ability of an entity to trade in Kyoto permits beyond its compliance requirements. This means that an entity may trade an unfettered quantity of Kyoto units from the Australian national registry both domestically and internationally to meet consumer demand, for example, for ‘carbon neutral’ products. This may be particularly attractive to financiers and aggregators offering compliance and hedging services.

In terms of qualitative restrictions, the government is yet to decide whether it will recognise any or all CERs generated under CDM projects. Although it has noted that recognising CERs under an Australian CPRS aligns with its broader goal of linking the CPRS with international schemes, it has noted a range of concerns in relation to CDM derived CERs. These concerns include: • The potential for manipulation of the ‘additionality’ test • The exclusion of certain projects – e.g. nuclear • Individual country nuances between schemes – e.g. CERs cannot be generated from hydroelectric projects in the EU • Time limits on permits relating to forestry projects and the uncertain treatment of CERs during the Kyoto Protocol’s second commitment period.

Increasing investment in Australia’s clean energy industry It is likely that the CPRS will allow some form of CER recognition. This will have two important impacts for the Australian clean energy industry.

It will create a large demand for carbon in Australia, which will provide additional support for CDM projects. It will also provide an opportunity for the Australian clean energy industry to export its skills and know how to developing countries, particularly in the Asia Pacific region.