Fossil Fuel Supply Under The CPRS: Obligation Transfer Numbers
The exposure draft of the Carbon Pollution Reduction Scheme Bill 2009 (CPRS) states that scheme obligations for emitters of greenhouse gases will generally apply to operators of facilities that have direct greenhouse gas emissions of 25 000 tonnes of CO2 equivalent a year or more.
However, this general rule of liability is not always practical. In relation to fossil fuels, the government has determined that scheme obligations will be applied to upstream suppliers, to capture the diverse sources of emissions encountered in supply chains. The draft legislation outlines a number of ‘eligible upstream fuels’ for which importers, producers and suppliers will have scheme obligations (including LPG, LNG, and black brown and coking coal among others). Generally, the entity who first supplies the fuel will have scheme obligations.
The application of liability to upstream suppliers is problematic where those entities cannot access information about downstream fuel use. The fuel supplied may be sequestered in manufactured products, exported, transformed or only partially combusted. This divergence of use would leave the upstream supplier liable for emissions that may not actually occur. Consequently, the government has provided for the establishment of an administrative mechanism, the Obligation Transfer Number (OTN) to provide for the ‘netting-out’ of fossil fuels at various stages of the supply chain.
Under the draft bill, an entity may apply to the authority for an OTN or be issued an OTN. Once the OTN has been issued, the holder can quote the OTN when purchasing eligible upstream fuel from a supplier.
The supplier’s scheme obligations are transferred to the OTN holder for the particular volume of fuel and the OTN holder directly manages these obligations.
In some cases, quoting an OTN will be mandatory, in others voluntary. This has been determined on the basis of the fuel being supplied and the nature of that fuel’s supply chain. The government will require large users of fossil fuels (other than petroleum liquid fuels), re-suppliers of natural gas and LPG and feedstock users of LPG to quote their OTN when purchasing fuel. Large users are defined as entities that operate a facility that emits 25 000 tonnes of CO2-e a year or more from the combustion of a single type of fuel.
A number of entities will be allowed to voluntarily quote their OTN in order to directly manage scheme obligations related to fuel supplied to them. These entities include large users of eligible upstream fuels, entities that sequester fuels into product, exporters or entities that transform the fuels from one type to another.
The OTN mechanism is designed to avoid double counting of emissions and gaps in coverage of the supply chain. However, the government has recognised that the administration of the OTN mechanism will need to be refined, via consultation, following the release of the draft bill. It is also clear that any impact on fossil fuel supply arrangements by the CPRS not addressed via the OTN mechanism will need to be resolved contractually.
Good Faith in Contracts
Many commercial contracts contain clauses requiring the parties to act “in good faith”. In most cases, these ‘good faith’ clauses appear in relation to prospective negotiation or dispute resolution, the idea being that parties should resolve disputes amicably. But what does ‘good faith’ mean, and how should parties subject to good faith clauses behave?
The purpose of a good faith clause is to inhibit inappropriate behaviour, and promote cooperation and honesty under the contract. However, while the words look nice on paper, they are inherently difficult to define. In the US, ‘good faith’ has been described as “an intangible and abstract quality with no technical meaning or statutory definition”. The same is true in Australia, where no accepted interpretation exists.
Courts have attempted to respond to this ambiguity by prescribing lists of conduct that embody or breach obligations of good faith. It has been said that the “essential or core obligations” of good faith negotiation are: firstly, to undertake to subject oneself to the process of negotiation; and secondly, to undertake to have an open mind in considering and suggesting options for the resolution of the dispute (Aition v Transfield (1999) NSWSC). These are positioned as positive undertakings in negotiation.
Another view of the meaning of ‘good faith’ is the minimalist view that good faith amounts to a duty not to act in bad faith. By this view, a party must refrain from being unreasonable in negotiation, refusing or delaying negotiation or acting unilaterally in a way that might harm negotiation. Only where a party acts in bad faith will they breach the contractual good faith clause.
It is important to note that, given the ambiguous nature of the concept, good faith clauses are often difficult to enforce. There have been a number of cases where courts have found such clauses to be unenforceable. Some cases however, have seen damages for breach of good faith clauses awarded. It seems the best approach is to assume that good faith clauses are enforceable and to take all reasonable steps to act in good faith should the clause be invoked.
Finally, it is worth mentioning that there has been a decisive shift away from the use of broad good faith clauses in standardised mediation agreements, with terms like ‘co-operation’ being preferred. Parties to any contract should be aware of the nature of good faith clauses, and their potential consequences.
The OTN Process
The above diagram depicts a situation where Company X is a coal re-supplier and exporter. Company X quotes its OTN to the coal mine (the initial entity liable for scheme obligations) and assumes liability for the coal (150 000 tonnes of CO2-e). Company X then exports and re-supplies this coal to various entities. Where the entity receiving the supply from Company X quotes their OTN, they become liable for the scheme obligations for the amount of coal supplied. So the large coal user is liable for the emissions embodied in the coal supplied to it (40 000 tonnes of CO2-e). Company X is not liable for the emissions embodied in exported coal because the CPRS only covers domestic sources. Therefore, in the end, Company X is only liable for the emissions embodied in the coal supplied to the small users (10 000 tonnes of CO2-e) and the supply will include a carbon price.
The Queensland GHG Storage Bill
In February 2009, the Queensland Government passed the Greenhouse Gas Storage Bill 2009 (the Act). This new Act aims to reduce greenhouse gas emissions by facilitating the process called greenhouse gas geological storage (GHG storage).
The process involves the capture and storage of CO2 emissions from emitters like gas or coal-fired power plants.
The Act facilitates GHG storage by establishing GHG permits under which authorities may explore GHG storage possibilities in the permit area. Under the Act, the authorities (called ‘GHG authorities’) can explore for or use underground geological formations or structures to store carbon dioxide. The Act also provides for the regulation of the exploration. In announcing the Act, the government discussed a number of GHG storage projects underway or under consideration.
Carbon Cost Contracting
Following on from the February 2009 Edition of E&R Matters, this article considers some of the issues involved in drafting carbon cost pass-through clauses in contracts.
The Carbon Pollution Reduction Scheme (CPRS) will impose a carbon price on the Australian economy. Carbon cost pass-through is essential for the efficacy of the CPRS as it ensures the price of carbon is shared across the economy and allows for more ambitious emission reduction targets. In most cases, the cost of carbon will be passed on under contractual arrangements (however, as discussed on page 1, there are other administrative mechanisms for transferring liability under the scheme).
It is vitally important that parties, who have direct obligations to the CPRS, as well as parties to contracts generally, think about how carbon cost pass-through can be incorporated into a contractual arrangement. Especially seeing as the government has decided to take no action with respect to contractual impediments, and to monitor developments following the release of the draft legislation on 10 March 2009.
It is possible that carbon cost pass-through may be achieved by ‘generic’ contractual clauses. These may include generic ‘change of law’ or ‘change of tax’ clauses, ‘good faith’ clauses, indemnity clauses or price escalation clauses. However, the effect of such clauses is extremely unclear and, given the complexities of calculating carbon costs, will likely be ineffective vehicles for carbon cost pass-through.
Without doubt, the most effective way for parties to protect their arrangements, both current and future, from the effects of the CPRS and to ensure effective carbon cost pass-through is with a specific ‘carbon clause’. Such a clause may contain a number of provisions and may include: a statement of the objective of the clause; the specific formula for calculating costs passed through (including taking government compensation into account); information sharing and confidentiality provisions; rights to price variation; definition of points of liability and the types of costs transferable; and reviews of price (taking in to account the price of carbon and emissions abatements achieved by the parties).
The exact clause will obviously depend on the nature of the parties and the contract, but parties must be aware of the contractual implications of the CPRS.
Recent News
In its first major decision on Chinese investment in an Australian mining company since the global financial crisis took hold, the Foreign Investment Review Board has allowed the Chinese smelter Zhongjin to buy a majority stake in the Broken Hill miner Perilya.
Although the release of the exposure draft of the CPRS Bill 2009 generally reflects the White and Greet papers and holds few surprises, stakeholders and interested parties may still submit comments on the scheme for consideration by the Government. The draft Bill remains open for comment up until COB 14 April 2009.
Chairman of the Australian Nuclear Science Technology Organisation, Ziggy Switkowski, announced to a uranium conference in Adelaide earlier this month that in the face of the global economic crisis, Australian-made goods will suffer under a carbon trading scheme, burdened by costs that countries with nuclear power will not incur.
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