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HG Alert: What the Carbon Pollution Reduction Scheme will mean for CSG producers - 28 July 2009

The Australian Government released exposure draft legislation that would give effect to the Carbon Pollution Reduction Scheme on 10 March 2009. A package of legislation, which included the Bill, was introduced into Parliament on 14 May 2009. Coal seam gas (CSG) producers are among those significantly affected by the Scheme, which is scheduled to begin on 1 July 2011.

Liability of CSG producers

The Carbon Pollution Reduction Scheme Bill provides for a greenhouse gas emissions trading scheme. Under the Bill, the Government will set up a national Scheme cap for each financial year, and the Australian Climate Change Regulatory Authority will issue Australian emissions units. Importantly, the Bill outlines those entities that will be directly liable for emissions, and will therefore need to acquire and surrender Australian emissions units under the Scheme.

A discussion of the mechanics and nature of Australian emissions units under the Scheme is beyond the scope of this article. This article will provide a short analysis of how the emissions trading scheme will impact upon CSG producers and suppliers.

The Carbon Pollution Reduction Scheme Bill provides for three broad categories of entities liable under the Scheme. These are:

  • direct emitters of greenhouse gases;
  • importers, producers or suppliers of eligible upstream fuels; and
  • importers, manufacturers or supplies of synthetic greenhouse gases.

For direct emitters, the Carbon Pollution Reduction Scheme Bill proposes to fix the point of liability for surrendering emissions units at the point where the emissions actually occur. However, under clause 17(4) of the Bill, liability will generally only be attributed to operators of facilities that have direct greenhouse gas emissions of at least 25,000 tonnes of carbon dioxide equivalent (CO2 E) during the relevant financial year.

This general rule of liability is not always practical. For example, the natural gas market (a large component of which is supplied by CSG) involves a large number of small emitters. It would be both inefficient and uneconomical to attribute individual liability to each.

Natural gas is used in many different applications in the residential, commercial and industrial sectors. Residential and commercial uses include heating, cooking and water heating. Industrial uses include direct heating in minerals processing to manufacture products, steam raising in the food, chemical and paper industries, as feedstock in the manufacture of fertilisers, explosives and acid, by power stations for electricity generation and as a transport fuel in its compressed form.

Each emitter on its own may fall short of the annual threshold of 25,000 tonnes of CO2 E (and therefore escape direct liability under the Carbon Pollution Reduction Scheme). However, the combined emissions from those entities may be significant. Therefore, while it is undoubtedly impractical to attach liability to many different small emitters, the intention and objectives behind the Scheme would be undermined should those emissions not be included in the national Scheme cap.

The Carbon Pollution Reduction Scheme Bill addresses this issue by attributing liability to importers, producers or suppliers of eligible upstream fuels under certain circumstances. An ‘eligible upstream fuel’ is defined to include CSG.

A supplier of CSG will be a liable entity under clause 33 if:

  • during an eligible financial year, the person supplies an amount of eligible upstream fuel to another person;
  • the fuel is not the result of the supplier carrying out the recognised transformation of another type of eligible upstream fuel;
  • the fuel is not liquid petroleum fuel; 
  • if the fuel is imported, the supply is the first supply of the fuel after the fuel was entered for home consumption;
  • if the fuel is not imported, the fuel was not supplied in Australia to the supplier;
  • the other person did not quote the other person’s Obligation Transfer Number in relation to the supply mentioned in the first bullet point; 
  • the supply mentioned in the first bullet point was not into a prescribed wholesale gas market (as defined under the regulations); and
  • the potential greenhouse gas emissions embodied in the amount mentioned in the first bullet point have a CO2E of a particular number of tonnes.

Similar terms are found under clause 35, which deals with ‘transformed’ fuels.

The rationale behind attributing liability to a supplier of eligible upstream fuels, rather than end emitters through combustion of those fuels, is clear. As mentioned earlier, the natural gas supply and consumption chain involves diverse sources of emissions, potentially involving many different types of small emitters. Rather than attaching liability to each emitter to whom CSG is supplied, the Carbon Pollution Reduction Scheme Bill achieves efficiency by applying liability at the earliest point of the fuel supply chain. This would mean that the point of liability would lie with the upstream CSG suppliers. It also means that there is no volumetric threshold for liability (that is, a specific volume of CSG need not be supplied before liability will arise).

Two problems may arise with this approach to liability. First, a CSG supplier who is liable under clause 33 may supply fuel to an emitter who is also liable under clause 17 (that is, an emitter who emits greater than 25,000 tonnes of CO2 E). This would result in the double-counting of emissions. Secondly, the diversity of use of CSG may result in the upstream supplier being potentially liable for emissions that may not actually occur (for example, where supplied fuel is sequestered in manufactured products and is exported or is only partially combusted).

To address this, the Carbon Pollution Reduction Scheme Bill introduces an administrative mechanism known as an Obligation Transfer Number (OTN). The OTN allows Scheme obligations to effectively be transferred from an upstream supplier to intermediate suppliers and end users or recipient. If the recipient quotes the OTN, then it will assume liability for the emissions, and therefore the supply will not count towards the supplier’s liability for the relevant financial year. In certain cases, it will be mandatory to quote an OTN and therefore mandatory to assume liability). In other cases, this will be voluntary.

Under clauses 52 to 55 of the Bill, it will be mandatory for the following recipients to quote an OTN:

  • large users of eligible upstream fuels, other than petroleum liquid fuel. A large user under clause 52 is an entity that operates a facility that emitted, during the previous financial year, at least 25,000 tonnes of CO2 E that is attributable to the combustion of the eligible upstream fuel supplied;
  • retailers of natural gas;
  • marketers of liquid petroleum gas; and 
  • recipients that use supplied liquid petroleum gas, refinery grade propene or ethane for the purpose of carrying on a business that involves using the fuel as a feedstock.

Under clauses 56 to 64AA, it will be optional for the following recipients to quote an OTN:

  • large users of eligible upstream fuels that operates a facility that emitted, during the previous financial year, an amount of CO2 E to be specified by regulation and that is attributable to the combustion of the eligible upstream fuel supplied; 
  • recipients who use the fuel to manufacture a product or consume the fuel, other than by way of combustion; 
  • recipients who undertake a recognised transformation of the fuel into another type of eligible upstream fuel; 
  • recipients who export or re-supplies eligible upstream fuels; 
  • recipients who export or re-supplies synthetic greenhouse gas; and 
  • recipients who use synthetic greenhouse gas as a feedstock.

The OTN scheme is intended to avoid the double-counting of emissions and to address any gaps in the coverage.

Carbon sequestration rights and opportunities for CSG producers

Part 10 of the Carbon Pollution Reduction Scheme Bill addresses reforestation. The Government introduced the reforestation provisions in recognition of the fact that forests can effectively sequester carbon dioxide. Under the Scheme, free Australian emissions units may be issued to eligible persons who undertake reforestation projects. An entity will only be entitled to free Australian emissions units if it:

  • is a recognised ‘reforestation entity’ within the meaning under section 201; 
  • holds a ‘carbon sequestration right’ within the meaning under section 240 in relation to the project;
  • it is undertaking a reforestation project within the meaning under section 209; and
  • is not subject to the requirements under part 10 to relinquish a number of Australian emissions units.

It is not within the scope of this article to consider these criteria in any detail. It is worthwhile noting, however, that the reforestation provisions of the Carbon Pollution Reduction Scheme Bill may present an opportunity for CSG producers to obtain free emissions units and also manage ‘CSG water’ at the same time.

CSG water is a by-product of the CSG production process. The amount of water produced as a result of CSG activities will depend on a number of different factors, including the depth and permeability of the coal seam. The rapid expansion of the CSG industry in Queensland has seen an equally rapid rise in the amount of CSG water being produced. This water is high in salt content and various other minerals, and is typically disposed of on-site in evaporation ponds.

The Queensland Government is currently developing a policy to manage and constructively use the significant amounts of CSG water produced. The Coal Seam Gas Water Management Policy will make CSG producers responsible for treating and disposing of CSG water. This may create an opportunity for CSG producers to create forestry plantations and benefit from the carbon sequestration provisions of the Carbon Pollution Reduction Scheme Bill.

On 15 May 2009, Santos announced approval for the beneficial use of CSG water in the creation of a large scale forestry plantation, in what may potentially be a ground-breaking solution to CSG water management. Each plantation could provide significant opportunities for carbon sequestration, leading to the possibility of free emissions units under the Carbon Pollution Reduction Scheme. In addition, CSG water would not require the same level of treatment for forestry as it would for human consumption.

CSG producers may therefore kill two birds with one stone, taking advantage of the carbon sequestration provisions of the Carbon Pollution Reduction Scheme Bill while beneficially disposing of the mega litres of water produced each day in the extraction of CSG.

For more information on the Carbon Pollution Reduction Scheme’s impact on coal seam gas producers, please contact HopgoodGanim’s Climate Change specialists.