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Australian Energy Company Limited Submission in Response to; Carbon Pollution Reduction Scheme Green Paper This Submission has been prepared in response to the Australian Government’s Carbon Pollution Reduction Scheme (CPRS) Green Paper issued in July 2008. Australian Energy Company Ltd (AEC) strongly supports the objectives set by the Australian Government in the Green Paper while recognising the extent of the challenge. As well as commenting on the detailed contents of the Green Paper this Submission provides some factual and strategic background to our views. Summary of Submission 1. AEC has extensive experience in evaluating the implementation of clean coal technology, including CCS, and makes these comments based on this experience. 2. Australia must take on the role of a global leader in decarbonising the energy and resource supply systems of the future and this should be recognised in the design of the CPRS. 3. The Coal to Urea plant proposed by AEC for the Latrobe Valley is highly likely to proceed in the absence of the CPRS. 4. The AEC plant robustly meets the measures of emission intensity proposed in the Green Paper and by the BCA. 5. The impact of a carbon price on the project economics is equivalent to a 30% cost increase at $40/t CO2-e; sufficient to stop the project proceeding in Australia. 6. The AEC plant will incorporate carbon capture from the first day of operation; it will be Australia’s first true capture enabled coal facility. 7. The availability of a concentrated CO2 scheme would facilitate a large scale trial or be an early customer for a large volume infrastructure facility. 8. The AEC project will demonstrate commercially a clean coal technology capable of being used in future near zero emission power plant. 9. By using the higher value of Urea to establish a clean coal operation in the Latrobe Valley the AEC plant provides the missing bridge to commercial scale clean coal technology in Australia. 10. AEC supports the CPRS Green Paper. Submission on Carbon Pollution Reduction Scheme Green Paper 11. However, AEC believes that the EITE model is too simple to be effective. Recommended changes to the model include; a. Use of carbon cost as a percentage of added value as the intensity metric, b. Incorporation of a risk sharing mechanism so that higher real product prices do not lead to “double dipping” over time, c. Eligibility and compensation to be based at a facility, not industry, level, as this will assist accuracy and fairness, d. The approach should differentiate between existing and new facilities to more accurately represent their different characteristics and vulnerabilities to the carbon price. 12. AEC considers the implied mechanism for sourcing of permits for new industry to be a major challenge. The mechanism will come under increasing pressure over time and may fail to achieve the desired outcomes if there is a surge in proposed investment in new emissions intensive industry. Careful design will be needed to minimise the risk that the overall scheme objectives are not compromised. Background of Australian Energy Company Ltd The founders and core technical / financial team of AEC were the original founders of Australian Power & Energy Limited (APEL). This team won the Victorian Government’s global tender to utilize Latrobe Valley brown coal to produce about 50,000 Bpd of fuel (mainly diesel) in an environmentally sustainable way; the Victorian Power and Liquids Project. That project is now known as the Monash Energy Project and is being jointly developed by Shell and Anglo American. In tendering for the brown coal resource APEL recognised the need for large coal based processing plant to incorporate carbon capture and storage (CCS). In proposing this as an integral part of the tender submission in 2001 APEL was the first Australian company to actively promote CCS. In 2003 APEL developed the concept / scope and successfully applied for Government funding to undertake the ground breaking Latrobe Valley CO2 Storage Assessment study. This study confirmed the excellent strategic matching of Victoria’s brown coal resources with the offshore storage potential of the deep saline aquifers underlying the Bass Strait oil and gas province. Australian Energy Company Limited is now developing the Latrobe Urea Project (LUP). Details are as follows; Australian Energy Company Limited Page 2 Submission on Carbon Pollution Reduction Scheme Green Paper • A $2 billion fertiliser plant targeted to be on stream by 2012/13, incorporating the latest carbon capture technology producing 1.2 million tonnes of Urea annually. • Uses Victoria’s brown coal reserves rather than natural gas. The supply of brown coal has been secured. • The process involves the gasification of the brown coal and subsequent synthesis of ammonia through to Urea, including capture of the majority of the direct carbon emissions which will be sequestered once this is established practice in Victoria. • Replaces more than $300 million of current annual Urea imports; more than 30% of the Urea production will be exported generating export income of at least $150 million per annum. Other key aspects of the project include; • Establishes the critical technology for the higher value use of brown coal reserves into the future. • The cleaned, shifted synthesis gas generating process can be replicated as the front end of a near zero emission electricity generating plant. Such a plant would capture greater than 95% of the carbon in the raw coal feedstock. • 1000+ jobs in the Latrobe Valley during construction (2008-2012). 180 direct ongoing jobs, with 200 jobs in supporting industries. • Plant will provide long term security of domestic supply for fertiliser, with import replacement and export earnings benefits • Some of the CO2 captured will be utilised in the Urea synthesis with the excess being geo-sequestered once this is established practice in Victoria. • Plant will use waste and recovered water to the maximum practicable extent as input to the plant. • The plant components technologies are proven with similar plant currently being constructed in Germany and China. • Urea is an important agricultural chemical, high in nitrogen, crucial for Australia’s broad acre agricultural and horticultural production. Australian and New Zealand demand is 2 million tonnes a year which comes predominantly from the Middle East. • Supply is subject to competing and rapidly growing world demand not only for Urea but also increasing competing demand for the gas feedstock for fuel and heating. As a result both gas prices and Urea prices have been rapidly increasing in recent years. This trend is likely to continue. Conversely, the price of Latrobe Valley brown coal will remain very low compared to other energy sources, providing the ideal starting point for the manufacture of fertilisers and many other products. • Australia must seek sustainable solutions to secure its own long term supplies of fertiliser if it is to meet its national need. Australian Energy Company Limited Page 3 Submission on Carbon Pollution Reduction Scheme Green Paper AEC is also the owner of a proposed coal to liquids project in Montana, USA; The Many Stars Project. From this background AEC is well placed to comment authoritatively on the challenges inherent in meeting the objectives outlined in the Green Paper. The Broader Global Context to the CPRS Proposal While the Green Paper presents the scientific underpinnings behind the need to reduce greenhouse gas emissions it does not directly address two other interrelated and important issues. One is the need to address the vast imbalance in global living standards and the other is the increasing pressure on supply of affordable, useable energy; principally oil. These issues must be addressed with the same sense of urgency and commitment as the risk of climate change. Tackling these three global challenges together will, to some extent, require a broader response than would be the case if considering only climate change. Australia has historically been a provider of energy and resources to the world. This is part of the reason for the relatively high per capita emissions. Moving away from this role, as some community groups advocate, would ease the challenge of abatement within Australia; but would transfer the burden to other economies less able to cope. While this effect is described as “carbon leakage” within the Green Paper it is much more. It represents both a turning away from the fundamental economic dictum of building on competitive advantage and a blatant ignoring of the needs of our global neighbours. Rather, Australia must take on the role of a global leader in decarbonising the energy and resource supply systems of the future. The Australian Government recognises this through the $500 million National Clean Coal Initiative and the Climate Change Action Fund. However, unless the implementation of the provisions of the CPRS complements the objectives of these schemes there is a risk that the desired outcomes will be negated. Towards a Decarbonised Energy System At this time there are many different technologies which have the potential to play a role in decarbonising Australia’s energy system ranging from renewables (wind, solar, geothermal), to natural gas, clean coal (including carbon capture and storage (CCS)) through to nuclear. Each one is characterised by differences in technical / commercial maturity, cost, practicability, environmental impact and social acceptability. Given the scale of the abatement challenge it is too soon to discount any particular technology on economic, environmental or social grounds. Keeping all Australian Energy Company Limited Page 4 Submission on Carbon Pollution Reduction Scheme Green Paper options in play is the best way of ensuring that the final solution is the most robust and economic. This Submission will focus on the natural gas and coal options. It is clear that in order to meet Australia’s long term abatement targets it will be necessary to capture carbon dioxide from both natural gas and coal based plants in the medium to longer term. The current state of these technologies was analysed by the US Department of Energy1. This study showed that CCS could reduce CO2 emissions to below 0.1 t / MW for both natural gas and coal based plant; that is equivalent to a 90% reduction in emissions compared to the current average for Australian coal fired power stations. In the model used by the DOE (onshore injection within 80 kilometres of source) the cost of the storage injection and monitoring represented less than 10% of the total cost. While greater distances and offshore storage locations would be more costly it would not change the fact that the capture component is the most expensive part of CCS. The DOE work also confirmed that low emission coal based electricity was competitive with gas at coal / natural gas price differentials of around US$6/GJ. Over the last four decades Australia has enjoyed both low price electricity – underpinned by cheap coal – and low price gas arguably capped by the low electricity price. Failure to develop an environmentally acceptable coal based power sector will leave gas prices free to rise to increasingly high global levels. The technology to achieve this end result exists today but there are considerable barriers to timely implementation. The Australian Coal Association and others have stated that2; “The current barriers to investment in CCS in Australia (and internationally) include: • uncertainty over legal and regulatory frameworks; • uncertainty over the availability and location of long-term storage sites; • the expense of establishing infrastructure to access storage sites; • the large capital and operating costs of high-risk experimental CCS facilities; and 1 Cost and Performance Baseline for Fossil Energy Plants, Vol. 1, DOE/NETL-2007/1281, May 2007. A Pathway to accelerated deployment of Carbon Capture and Storage Policy proposal April 2008 The Australian Coal Association Construction, Forestry, Mining and Energy Union The Climate Institute WWF Australia 2 Australian Energy Company Limited Page 5 Submission on Carbon Pollution Reduction Scheme Green Paper • the inability of investors to capture all the benefits of experimental low emission fossil-fuel plants”. The creation of the National Low Emissions Coal Council and a Carbon Storage Taskforce in July 2008 reflected the Australian Governments acceptance of the thrust of the ACA view. Without in any way undermining the importance of the ACA view and the Government’s response neither appears to recognise a possible alternative pathway towards the desired objective of low emissions coal based power. A coal to Urea plant such as proposed by AEC would implement all of the technology steps necessary to build a genuinely CCS ready power station while also supplying an essential agricultural input which is currently largely imported. The global price of Urea; underpinned by high global gas prices, helps to offset the risks identified by the ACA in implementing the highest cost component of CCS; capturing the CO2. By demonstrating at a commercial scale the key technologies for producing a clean, hydrogen rich synthesis gas from brown coal AEC would take a major step towards establishing the technology for near zero emissions power generation in the Latrobe Valley. Paradoxically, while Australia has large supplies of gas it is, arguably, better environmentally and economically to sell that as high value LNG, thereby displacing coal in overseas markets, and produce domestic Urea from coal using clean coal technology. The Latrobe Valley Storage assessment study showed that it is necessary to develop transport and storage infrastructure with a capacity of about 15 million tonnes per annum of CO2 to achieve the economies of scale for cost effective storage. With direct emissions of around 1.1 million tonnes it would not be economically feasible to incorporate this facility in the AEC project. However, the availability of a concentrated CO2 scheme would facilitate a large scale trial or be an early customer for a large volume infrastructure facility. Initially the LUP will emit, directly and indirectly, about 2 tonnes of CO2 per t of Urea. Given development of commercially viable CCS infrastructure and the decarbonisation of the power supply system emissions will drop to about 0.1 tonnes of CO2 per t of Urea. Over a forty year plant life the project will emit on average about 0.6 tonnes of CO2 per tonne of Urea. However, unless projects such as the AEC plant can be largely shielded from the domestic cost of carbon until such time as there is a global carbon price this national strategic opportunity will be lost. Australian Energy Company Limited Page 6 Submission on Carbon Pollution Reduction Scheme Green Paper It is clear that assistance available under $500 million National Clean Coal Initiative and the Climate Change Action Fund are not suitable to assist projects such as AEC. Most of this money is directed to relatively small scale research activities. The cost of assisting with implementing commercial scale solutions has not yet been fully or adequately addressed. While it is the intention of the CPRS that market forces, in the form of higher power prices, will facilitate the development of the new low energy technology the government faces a “Catch 22”. As indicated by Dr Parkinson the likely initial abatement trajectory will be prudently assessed to prevent needless economic damage3. But such an approach will delay the commercial development of the needed low emissions technologies. Projects such as the AEC coal to Urea plant will help bridge this commercialisation gap provided they are not prevented by the introduction of the CPRS. AEC Comments on the Green Paper Section 9; Assistance for emissions-intensive trade-exposed industries The focus of this section is the proposed approach to providing assistance to emissions-intensive trade-exposed (EITE) industries. The format used is to provide comments on each of the main features based upon the Summary of Preferred Positions as outlined below in bold italics. 9.1 The key rationales for providing assistance to emissions-intensive tradeexposed (EITE) industries would be to: • address some of the competitiveness impacts of the scheme on EITE industries in order to reduce carbon leakage • provide transitional support to EITE industries that will be most severely affected by the introduction of a carbon constraint • support production and investment decisions that would be consistent with a global carbon constraint. The Government’s support for EITE industries would be balanced against its objectives for non-assisted sectors and households. EITE assistance would be adjusted over time to ensure that all parts of the 3 CLIMATE CHANGE: REACTIONS TO THE GREEN PAPER Dr Martin Parkinson, Secretary, Department of Climate Change Committee for Economic Development of Australia (CEDA) Melbourne, 28 August 2008 Australian Energy Company Limited Page 7 Submission on Carbon Pollution Reduction Scheme Green Paper economy contribute to the objective of reducing emissions. The EITE assistance policy would be reviewed at each five-year scheme review to determine whether that assistance continues to be consistent with the rationale for assistance, appropriately balances the competing policy objectives and continues to be consistent with Australia’s international trade and climate-change obligations. While AEC supports these rationales and principles it will be necessary to design the approach to ensure that it is not self defeating. For example, a five yearly review would be acceptable for existing industry but would introduce considerable, possibly fatal, uncertainty for new investments. This is the first of a number of aspects of the proposed model which point to a separate approach for new versus existing industry. 9.2 The proposed assistance would be provided to emissions-intensive tradeexposed industries in the form of free allocations of carbon pollution permits at the beginning of each compliance period, contingent on production. 9.3 The proposed emissions-intensive trade-exposed assistance would be provided on the basis of the industry-wide emissions from a process or activity to ensure that assistance is well targeted and is equitable both within and between industries. This is a highly idealised approach which assumes a high degree of homogeneity between entities in an industry and does not readily accommodate industries with limited numbers of participants or for new industries being established based upon new technology and energy cost paradigms. For example LNG plant emissions are determined in the main by the CO2 content of the supplying gas field and can range from 2% to 20%. At the lowest level the industry does not require any assistance while at the highest level assistance could be necessary (although this depends on the benchmark LNG price). Similarly the methane content of coal fields is highly variable. It is likely that similar affects will apply in other industries. How “processes and activities” are to be defined and grouped is critical to the effectiveness of this provision. The varying age of plant (and hence technology and efficiency) is also a major factor in introducing significant variability between facilities. A facility based approach is not that difficult to construct using the same principles as the proposed model but applying this to an independently Australian Energy Company Limited Page 8 Submission on Carbon Pollution Reduction Scheme Green Paper audited baseline of the historic actual emissions or design emissions for a new facility. It should be understood that existing emissions intensive industry are licensed under the various state environmental protection acts and are required to monitor, control and plan to progressively abate emissions. For new facilities, in new industries, there is no alternative but to base the level of compensation on design data. Again it should be recognised that rigorous state and federal planning and regulatory processes will prevent gaming of this approach. Such an approach is arguably more equitable within and between industries as the proposed model as the data used will be more specific and the outcome more accurate. There is an argument that a compensation model based upon industry averages is necessary to ensure that shielded industries still have an incentive to carryout abatement activities that are justified at the prevailing carbon price. This is not correct. Provided the permit allocation per unit of production is fixed over time the incentive to optimise remains as the firm benefits from any reduction in carbon permits required by having to buy less top up permits or by selling surplus permits. 9.4 Emissions-intensive trade-exposed (EITE) assistance would be provided for the direct and indirect electricity emissions associated with the activity or process. Only emissions covered by the scheme would be considered in determining EITE assistance. A measure of emissions per unit of revenue would be the most transparent and comparable indicator of the materiality of the carbon cost impact across different traded industries. The main merit of this approach is simplicity and the ready availability of the required data. However, it cannot achieve the objectives of the EITE scheme as it does not measure the real driver of economic vulnerability; added value. Nor can a scheme based upon such simplicity be expected to account for the range of different situations which will be encountered during implementation. Such an approach has the potential to inadvertently create winners and losers without regard to individual merit. Added value as a proportion of revenue for EITE industries can vary from less than 10% in oil refining to approaching 60% for the LNG industry. At an emissions intensity of 1000 tco2-e/$m and a carbon price of $40 /t co2-e one industry sees a 40% reduction in gross margin and is highly likely to close while the other sees a 7% Australian Energy Company Limited Page 9 Submission on Carbon Pollution Reduction Scheme Green Paper loss and has to do some belt tightening. Thus this approach cannot be justified as being equitable or meeting the objectives of the scheme. There does not appear to be any reason why independently audited added data for the benchmark price set cannot be provided by the 1000 or so entities likely to be in the scheme (excluding agriculture which is discussed below). 9.5 All industries, other than those for which there exists a physical barrier to trade, would be considered for emissions-intensive trade-exposed assistance. 9.6 Up to around 30 per cent of Australian carbon pollution permits would be freely allocated to emissions-intensive trade-exposed (EITE) activities. At the outset of the scheme, if agricultural emissions are excluded from scheme coverage, this would be up to around 20 per cent of permits. As is acknowledged in the green paper, bringing agriculture into the CPRS is a major challenge due to both the nature of the emission sources and the large number of small scale entities. The paradox is that a substantial administrative effort is required to account for their emissions and an equally substantial effort required to shield them for their loss of global competitive ranking. Effectively two costly administrative processes where the sum of the inputs and outputs approaches zero! It would appear much more practical to consider the agriculture sector as a special case outside of the EITE model. Indeed the solution which is finally adopted for agriculture may be outside of the CPRS entirely in recognition of the fundamental differences of the sector. Making this decision in principle at the white paper stage would give the development of the CPRS and the EITE mechanism much greater focus. Eligibility for EITE assistance would be based on the industry-wide emission intensity of an activity or process being above a threshold of about 1,500 tonnes carbon dioxide equivalent (CO2‑e) per million dollars of revenue. Initial assistance would cover around 90 per cent of emissions for EITE activities that have emissions intensities above about 2,000 tonnes CO2‑e per million dollars of revenue and around 60 per cent of emissions for EITE activities that have emissions intensities between about 1,500 and 2,000 tonnes CO2‑e per million dollars of revenue. Australian Energy Company Limited Page 10 Submission on Carbon Pollution Reduction Scheme Green Paper The fundamental problem with this metric is the use of gross revenue as outlined above. However any criteria which has such a sharp cut-off is also subject to criticism on equity grounds. A more graduated transition from the maximum level of compensation to the zero level is preferable. While this approach has been defended on the basis that it has been carefully calibrated to minimise such effects this calibration was undertaken on out of date 2001 ABS industry data. Using data from the proposed 2006/7 benchmark period will dramatically change the relativities as many energy and resource prices have tripled over the intervening period. Also any modelling based upon aggregated data using ABS industry classifications is fraught with potential difficulties as the data is being used for a purpose far removed from that which the original classification was developed. As argued elsewhere an entity based approach will be more effective and fairer. AEC believes that the metric of carbon cost as a percent of added value as proposed by the Business Council of Australia would be preferable. The main reason for this view is that it would facilitate a more flexible system including a mechanism to reduce over compensation as discussed below. These thresholds and rates of assistance may be reconsidered on the basis of further information provided through the consultation process to ensure that the total quantum of EITE assistance would be limited to around 30 per cent of permits (inclusive of agricultural emissions). In reassessing the overall model all factors must be capable of review in order to ensure that the scheme meets its objectives. The 30% allocation of permits is as much an outcome of the initial modelling data as are the thresholds. While accepting that an increase in the size of the allocation is unlikely it should also be recognised that shrinking this portion to a much smaller extent will exacerbate the new industry issue discussed below. 9.7 Allocations of assistance for direct emissions of new and existing emissions intensive trade-exposed (EITE) entities would be calculated on the basis of: • an Australian historical industry-average emissions-intensity baseline for each EITE activity • the output of the EITE activity for each entity • the assistance rate for that EITE activity. Australian Energy Company Limited Page 11 Submission on Carbon Pollution Reduction Scheme Green Paper Allocations of assistance for indirect electricity emissions of new and existing EITE entities would • be calculated on the basis of –– an Australian historical industry-average electricity-intensity baseline for each EITE activity The use of the same metric for new and existing entities must lead to inefficiency in achieving the overall objectives of the EITE compensation process as the point of vulnerability of these entities is very different. It is essential that EITE compensation is focussed only on existing industry which is truly vulnerable to closure and on prospective industry where the loss of investment attractiveness relative to other countries is significant. To achieve this outcome requires a more complex compensation model than the current proposal. The assumption of industry homogeneity which underpins the approach is not necessarily true. This is discussed in respect of the LNG industry above but is likely to be true of many other industries. An approach based upon the characteristics of individual entities is likely to be more effective and equitable. The impact on the two categories of entity, existing and new, of the CPRS may be substantially different even if they have the same emissions intensity. Most EITE industry is highly capital intensive. The major risk point for such industry is the initial investment point. Once the facility is built and capital / debt are paid back cash flow is generally highly robust. While a carbon price may impact value it will not necessarily bring a significant risk of closure. However, the impact of a carbon price on the relative attraction of investment in a new plant may be very significant. For the AEC Urea facility the impact of a $40 carbon price is equivalent to an increase in capital cost of about 30%; more than sufficient to prevent the project proceeding. The impact on an existing plant can vary from year to year as market and exchange rate conditions fluctuate such that in some years compensation thresholds may be reached while in others they will not be. Setting thresholds based upon a view of entitlements fixed in time creates the risk of over compensation if thresholds are set too low and under compensation if they are set to high. It would be more efficient to allow for the level of compensation to vary with price fluctuations (sales income and carbon price) above some established floor price (plus indexation). As with the existing scheme qualification would be a once off exercise established at the beginning of the scheme or at the time of financial commitment for a new investment. In that way overcompensation would be avoided. Australian Energy Company Limited Page 12 Submission on Carbon Pollution Reduction Scheme Green Paper It is also prudent that thresholds for existing plant are set at levels which are at the tougher end of the spectrum. Five yearly reviews of the level of compensation would be a practical approach for existing industry. For new investment there is a need for protection from carbon price throughout the period during which the return on capital is established and debt is paid down. Normally this is 20 years from start-up. To achieve the objective of the scheme it is necessary to neutralise the risk of a unique Australian carbon price on investment decisions. This can be done through a risk management process above an agreed floor price as proposed for existing facilities. That is if the real price of the product rises above the floor price the number of permits allocated is reduced depending upon the actual carbon price at the time. Such a mechanism ensures there is no “double dipping” if global prices rise. The, the duration, threshold and review mechanisms would need to be appropriate to the requirements for certainty which investors and financiers require. Based upon the Green Paper analysis very few industries are likely to qualify for compensation. Based upon ABARE statistics there was an average of about 30 new major energy and minerals projects each year for the last decade and, based upon the profile of current projects, most of these would not meet any likely emissions intensity threshold4. Therefore, it appears that the administrative burden of taking a project specific approach (within guidelines) for new EITE industry will not be overwhelming. –– an electricity factor, where the electricity factor is determined to reflect the likely average electricity price impact of the scheme –– the output of the EITE activity for each entity –– the assistance rate for that EITE activity • take into account whether the EITE entity has contractual arrangements with regard to electricity supply that would shield them from increases in electricity prices as a result of the introduction of the scheme. If an entity ceases operating an EITE activity, it would be required to return carbon 4 ABARE's list of major minerals and energy projects, April 08 Australian Energy Company Limited Page 13 Submission on Carbon Pollution Reduction Scheme Green Paper pollution permits that had been allocated to it for production that did not occur. The comments on the previous Section also apply to this aspect. However, we note the proposal for an entity specific application in relation to electricity supply contracts; this reinforces our arguments above. 9.8 The emissions-intensive trade-exposed (EITE) assistance rate would be reduced over time with the intent that the share of assistance provided to the EITE sector does not increase significantly over time. Such a broad statement without any detail raises significant uncertainty in regard to this process. While understanding the challenge the EITE scheme objectives can only be met if the rules are clear, particularly for new industry. From recent statements from the Secretary of the Department of Climate Change this approach appears to be unchangeable. If this is the case then the detail design will be critical to the effectiveness of the EITE compensation scheme. Where the permits come from to underpin new EITE industry in the period before an effective global carbon price mechanism is in place is a significant issue. If, say, permits allocated for the total EITE industry (excluding agriculture) are fixed at 100 million pa initially and the total pool shrinks by 1% pa to achieve a targeted level of abatement then, it appears, permits for new projects must come from the same pool. How quickly such new projects come on line, the rate at which the pool of permits is diluted, and the mechanism for allocation between new and existing will determine how well individual entities are shielded. The longer it takes to achieve a global carbon price, or equivalent, the more challenging the permit allocation process will become. The largest existing sector, aluminium smelting, emits 30% of the EITE quota and there are no firm plans for new capacity although two current studies could see a 10% increase in capacity (i.e. take 3% of the permits). The cement industry would require about 7 million permits and production has grown at 3% pa over last five years. However, unit CO2 emissions are reducing at an equivalent rate so future new growth is uncertain. The black coal industry is the next highest emitter with 22% of the EITE emissions. However, there is considerable doubt about whether this industry would qualify for shielding as; • The major price increases since 2001 place them well below the Green Paper and BCA thresholds, Page 14 Australian Energy Company Limited Submission on Carbon Pollution Reduction Scheme Green Paper • • Most of the emissions are from coal seam methane and there are available and economic methods of recovery. Emissions are estimated to drop by around 10% each year, There is a Government funded program to aid reduction already in place. The alumina industry provides about 14% of the EITE emissions and there are capacity expansions equivalent to a 45% increase in various stages between committed to under study. It is problematic whether industries which were close to the lower Green Paper threshold (e.g. Iron and steel, basic chemicals and oil and gas) will qualify for shielding given price increases. However, there are likely to be other industries (e.g. oil refining (8 to 10 Mt/a), paper and pulp (2.5 Mt/a)) which may qualify if the metric is based upon added value. New capacity is considered unlikely in these industries. At current LNG prices even the potentially high CO2 emitting Gorgon project would only just meet the lower threshold of the BCA model. Given the large number of such projects and the highly variable CO2 content of the various fields there could be many LNG projects which lie close to the threshold. LNG projects may be seen as a special case as the barriers to implementing CCS for such a project are much lower than for coal based projects. This is because CO2 capture is already required to meet product quality, the developing companies have the required expertise to manage the risks and they have access to storage sites adjacent to licence areas. Given that, if such new LNG projects are established as genuinely vulnerable to the CPRS, it would be much more sensible to promote the wholesale adoption of CCS through targeted tax breaks. This would promote a rapid adoption of CCS and make Australia a world leader in this activity while easing the pressure on the EITE scheme. If LNG is outside the EITE scheme the currently identified new plant growth in the sector comprises alumina refining at about 7 Mt/a and the AEC Urea plant at about 2 Mt/a. It is in the nature of such an analysis, at this point in time, that the bias will be towards under estimation due to incomplete data. However the analysis does point towards a 2 to 3 %pa growth rate in new plant emissions being required to be accommodated within the overall EITE cap. A more comprehensive analysis will be needed to ensure that sufficient capacity exists to allow the scheme to function effectively and meet its established objectives. AEC believe that any emissions growth from incremental production increases (debottlenecking) within existing plants should remain unshielded as it is impractical to manage efficient and effective shielding at that level. Usually the economics of such incremental expansions are very robust and as such will occur in any event. Australian Energy Company Limited Page 15 Submission on Carbon Pollution Reduction Scheme Green Paper Brown fields investment in complete new production trains should qualify as new plant but should be assessed on an incremental intensity basis. How the reducing quantity of permits is then apportioned between new and existing industry will be a critical test of the effectiveness of the EITE scheme. The inclusion of a risk sharing mechanism which sees the shielding reduced if prices move above a floor level is seen as a way of avoiding overcompensation while still achieving the desired scheme objectives. As such it would add to the efficiency and practicality of the EITE scheme. In his recent paper5 Professor Garnaut, while supporting shielding of EITE industry, proposed an alternative compensation model based upon estimating world commodity prices assuming a global carbon price was in place. While conceptually simple we doubt whether it will achieve the desired objectives or be practical in reality. It assumes that prices are set on a simple cost plus basis and that industry does not change to meet new circumstances. The existence of a global carbon price and the acceleration in the abatement trajectory which is likely to follow, will unleash many new economic forces which will radically change existing relativities. It is highly likely, as one example, that gas, including LNG, will be transformed into a highly sought after spot commodity to balance energy / emission books throughout the world. In much the same way as low sulphur coal was used in the USA to balance regulated SO2 emissions gas will become increasingly a premium commodity. How this will flow through the economy and affect the price of energy derivative products, such as chemicals and fertilisers, is impossible to predict. To claim that the shielding required to ensure that investment decisions are consistent with a world global carbon price can be deduced by adding on some simple carbon price factor seems excessively optimistic and unnecessarily risky for Australian industry. 9.9 Between 2010 and 2020: • assistance would be provided to emissions-intensive trade-exposed industries as proposed unless broadly comparable carbon constraints are introduced in key competitor economies, in which case assistance be withdrawn. Beyond 2020: • assistance would be withdrawn if broadly comparable carbon constraints are introduced in key competitor economies or 5 Targets and Trajectories, Supplementary Draft Report, September 2009 Australian Energy Company Limited Page 16 Submission on Carbon Pollution Reduction Scheme Green Paper • assistance would be phased out over a five‑year period in the event of acceptable international action that places obligations on an industry’s major competitors • assistance would be continued as proposed in the absence of broadly comparable carbon constraints or acceptable international action. We believe that investors and financiers will need more certainty about the level of shielding for new plant investment than is provided by this proposal. We believe that the guarantee period should commence with new plant start-up and continue for 20 years before being subject to phase down. The mechanism to prevent over compensation proposed above will operate if global prices rise significantly. Australian Energy Company Limited Page 17