The Abbott government’s proposed design for the emission reduction fund (ERF) has a fatal flaw: it will only award contracts of five years’ duration. Indeed, by dumping emissions trading or a fixed price on carbon the government is making the task of achieving its 5% reduction target far harder than it need be.

But it’s worth highlighting some positive attributes of the proposed design outlined in the green paper. It’s possible the government may see sense and accept the need for abatement purchasing contracts of longer terms …

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1. A contract with the government is readily financeable (provided the contract term is extended beyond five years to better fit with project finance lives)

Winners of bidding rounds under the emission reduction fund will be awarded contracts where the government will guarantee a set price per tonne of abatement delivered. You would be hard pressed to find a lower risk counter-party in a contract than the federal government. Not even a bank itself is as good a counter-party as the government (hence why banks readily took up the government’s guarantee during the global financial crisis).

A contract with the government provides a far better level of financeable security than a legislated emissions trading scheme or carbon tax because, under our system of law, the government would have to compensate you for any alteration of the contract. The government faces no such requirement to compensate for the consequences of changed legislation.

The previous Labor government, through its dumping of the price floor and then the fixed price plus the virtually unconstrained linkage to the European Union emissions trading scheme, so undermined the predictability of Australia’s ETS that permits were reduced to little better than a junk bond.

If the government was prepared to sign abatement purchase contracts longer than its current position of five years then we have something that banks could lend against.

2. Ignoring ‘co-benefits’ and focusing exclusively on lowest cost abatement

Given that a number of members of the Coalition seem to think climate change is a myth driven by a leftist conspiracy, and the emphasis on Direct Action policy supporting things that would do more than just reduce emissions, there was a fear the ERF would be commandeered to support other political agendas. For example, some in the Coalition seemed to think the ERF could help fund projects more focused on expanding economic activity and population in the far north of Australia.

However, the green paper makes it pretty clear the government will select projects based purely on price per tonne of CO2 abated. In addition, it proposes employing standardised contracts across all participants. Such an approach reduces the potential for political interference from the likes of Cory Bernardi, Ian McDonald and Barnaby Joyce to fund their pet projects.

3. Requiring polluters who exceed emissions baselines to purchase abatement credits to ‘make good’

One of the fundamental problems with the emission reduction fund is that it is dependent on government funding via the budget. Budget-funded emission reduction programs are notorious for being here today and gone tomorrow and come under constant threat as other more pressing political events of the day come to the fore. For example, see what the Labor government did when the Queensland floods transpired.

The green paper has put forward a proposal that might broaden demand for abatement beyond that funded by the government purse. While not locked in concrete, it is proposed that if a production plant were to exceed its historical rate of emissions it would be required to purchase abatement credits to effectively neutralise its emissions “exceedance”.

While baselines based purely on historical levels (with allowance for upward adjustments if production were to expand) would not represent a particularly large source of demand for credits, over time such baselines could be tightened. This would then allow polluters to assume a greater share of the cost of emissions abatement, reducing the burden on taxpayers as a whole and improving the durability of the scheme.

4. Requiring selected abatement providers to make good on under-delivery of contracted abatement

A major problem with past government emission abatement programs has been that those who were granted funding by the government never actually delivered their proposed projects. This has occurred time and time again. It made for a fantastic smokescreen for the government. The government could pretend it was doing great things for the environment and allocating lots of money to the problem when, in fact, nothing at all was happening.

On the other side it creates an environment that encourages speculative and highly optimistic bids because project developers face no penalty if they fail to deliver.

Requiring winning abatement providers to make good on any under-delivery of abatement should act to ward off the white-shoe brigade, who can corrupt an auction process by putting in very low bids, but have no real capability or good understanding of what’s required to deliver a project. At the same time it should help to avoid providing the government with a convenient smokescreen where it holds a spectacularly successful auction with large amounts of abatement promised at unrealistically low prices, which a few years later turns out to be illusory.

5. It won’t try to second-guess the financial viability of abatement projects

A major problem with programs in the past that try to reward firms for the absence of CO2 emissions is that the absence of CO2 can’t be physically measured, only its presence. Working out whether a project or a firm has reduced emissions depends on making an assumption about how much CO2 would normally be there were it not for government providing an incentive to reduce it. In many cases businesses will reduce CO2 as a matter of standard business practice as they try to strive to reduce costs through, say, reducing fuel use.

To avoid giving taxpayers money to firms to do something they would have done anyway, bureaucrats can be tempted into analysing the economics of individual projects to assess their financial viability without government assistance. This is an absolute minefield of complexity and can become an administrative nightmare. But the green paper says that the government will not get in the business of trying to second-guess the economics of individual abatement projects.

*This article was originally published at Climate Spectator

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