Australia: Kyoto Protocol Now in Force: Implications for Australian Business

The Kyoto Protocol, an international treaty designed to slow down global warming by lowering greenhouse gas (GHG) emissions and introducing an international carbon trading scheme, came into force on 16 February 2005. Although the protocol has been ratified by 141 nations, Australia, together with the United States, has steadfastly refused to ratify the protocol.

This article considers the Commonwealth Government's policy on the protocol and its likely implications for Australian business. While the Australian Government is not a signatory to the protocol and cannot participate in any of its market-based mechanisms, there is still scope for Australian business to pursue opportunities in those countries that are a party to the agreement.

It has now been more than seven years since the negotiation of the Kyoto Protocol in December 1997. The protocol came into force on 16 February 2005 after the Russian Parliament ratified the treaty. This brought the total carbon dioxide emissions of developed nations party to the protocol above the required minimum of 55 per cent for the year 1990.

The protocol requires developed countries signatory to the treaty to lower their emissions of GHGs by at least five per cent below 1990 levels in the period from 2008 to 2012, with specific targets varying from country to country. Developing countries, or countries that are currently making the transition to a market economy, do not have set emissions targets, although they are able to participate in the protocol's market-based mechanisms and are likely to be bound by emissions targets in future negotiations.

There are three market-based mechanisms that have been established under the protocol:

• International Emissions Trading (IET): this involves the buying and selling of emission reduction units (ERUs) among developed nations. At the end of the period 2008 to 2012, developed nations can either buy units in order to meet their commitment under the protocol, or sell their surplus units to other developed nations for financial gain. Alternatively, developed nations with a surplus of units can bank them to offset against emission reduction targets in the future.

• Joint Implementation (JI): in addition to trading emission rights through the IET, developed countries can acquire ERUs by developing and financing projects in other developed nations.

• Clean Development Mechanism (CDM): developed countries can acquire certified emission reduction units (CERs) by developing and financing projects that reduce emissions in developing countries.

The administrative framework for the implementation of these market-based mechanisms was settled in November 2001 through the Marrakesh Accords. The Marrakesh Accords provide for registry systems to be employed by each party to the protocol, and a transaction log to be maintained by the protocol's secretariat to record and track the acquisition, transfer and cancellation of emission units.

Notably, while the protocol applies to sovereign governments rather than corporations, the Marrakesh Accords also provide that businesses, other organisations and individuals can participate in the market-based mechanisms under the authority of parties to the protocol.

The Commonwealth Government and the Kyoto Protocol

Since the negotiation of the Kyoto Protocol, the Commonwealth government's decision to not ratify the protocol has been the subject of considerable debate in Australia. The central reason provided by the government for this policy has been made clear on several occasions. This is that the protocol does not impose targets on developing nations, and developing nations are, in several key sectors, direct competitors to Australia. Maintaining Australia's international competitiveness is a top priority for the government.

Although the Commonwealth government has refused to ratify the protocol, it has reaffirmed its aim to achieve the target for Australia under the protocol of 108 per cent of 1990 levels of GHG emissions in the period from 2008 to 2012. The government has certain targeted support and legislative measures to assist Australian businesses in lowering their GHG emissions. These include the:

• Mandatory Renewable Energy Target (MRET), which requires the sourcing of additional electricity from renewable sources by 2010

• Greenhouse Gas Abatement Program, which has provided the Australian Greenhouse Office (AGO) with $400 million in funding to facilitate large-scale projects, and

• Greenhouse Challenge, to encourage and assist industry to undertake voluntary GHG abatement programs.

However, although the Commonwealth Government has introduced some laudable initiatives, the government's climate change policy has recently been subject to extensive criticism. Generally speaking, the number of measures taken to respond to climate change in Australia by the government has been small. Although many of the measures have been supplemented by state and territory government action, most of the Commonwealth Government's initiatives affect a relatively limited number of enterprises and are based on voluntary participation.

In terms of the protocol, critics have highlighted the fact that by committing itself to meet its obligations under the treaty without ratifying, the Commonwealth Government is making a financial commitment without entitling Australia to any of the corresponding benefits of participating in the protocol's trading scheme.
As the Australian Government has not ratified the protocol, it cannot participate in any of the market-based mechanisms, such as JI or CDM projects. Further, and most importantly for Australian businesses, no investment within Australia, from internal or external sources, will be able to generate emission reduction units. This effectively excludes the Australian Government and, to a certain extent, Australian business from a potentially lucrative global carbon trading market.

It can be anticipated that there will continue to be substantial market growth in carbon trading in the remaining quarters of 2005 and beyond. A report commissioned by the World Bank's Carbon Finance Unit and completed in mid-2004 concluded that GHG trading had already increased significantly. The analysis shows that traded volumes in tonnes of carbon from 13 million tonnes in 2001, to approximately 29 million tonnes in 2002, to approximately 78 million tonnes in 2003. Total volumes traded during the first four months of 2004 equalled approximately 64 million tonnes.

Because Australia is not a party to the protocol, no investment within Australia, from internal or external sources, will be able to generate emission reduction units under the protocol. Arguably, this will lower incentive for Australian businesses investing in GHG reduction projects and technology in Australia, as well as discourage further investment from overseas into Australia for these types of activities.

However, there are still opportunities for Australian business to participate in the protocol's market-based mechanisms in countries that have ratified the treaty. The Marrakesh Accords do not distinguish between businesses, organisations and individuals from countries that have and have not ratified the protocol.

In order to participate, an Australian business may register as a legal entity. This requires the authorisation of a party to the protocol. The Marrakesh Accords entitles parties to the protocol to authorise businesses from any foreign jurisdiction to participate as legal entities. Once registered as legal entities, businesses can hold an account in the authorising party's national registry, acquire, cancel and transfer ERUs, and participate in JI and CDM projects.

Alternatively, it is conceivable that an Australian business may seek to become involved in a JI or CDM project through a contractual arrangement. A direct agreement with a signatory to the protocol or perhaps more preferably, with an authorised legal entity, would not require formal authorisation. In other words, an Australian business providing technology, equipment, or another type of contribution to a CDM project may find it more cost-effective and less time-consuming to contract directly with an firm or organisation already authorised by the party to the protocol to participate in the project.

In either case, where the Australian business is authorised as a legal entity by the party to the protocol or has contracted with a private or public entity participating in the project, the Australian firm must be careful in defining its rights and legal obligations to emission reduction credits arising from the project. In the case where an Australian business is authorised by a party, it has certain administrative rights and responsibilities under the Marrakesh Accords as of right. This includes the right to negotiate a share in the emission reduction units arising from the project.

Finally, and most importantly, an Australian business must ensure that the project is eligible under the Kyoto Protocol for emission reduction units. The approval process for JI and CDM projects are different:

• a JI project is subject to the approval processes of the two developed countries involved, and

• a CDM project is subject to the approval processes of the parties involved, in this case, a developed and a developing country. However, the project must also be approved by the CDM executive board, which is an international body established under the Marrakesh Accords.

Australian businesses will need to be familiar with the approval processes of the parties involved, as well as any other domestic regulation that might apply to the project. For CDM projects, the provision of finance, technology or equipment will need to be contingent on approval by the CDM executive board.

While in some quarters there has been considerable criticism of the Commonwealth Government's decision not to ratify the Kyoto Protocol, this should not preclude Australian business from exploring opportunities to participate in projects in countries that are parties to the protocol. Either by seeking the authorisation of a party to the protocol, or contracting directly with an authorised legal entity, a firm can potentially input technology, equipment or financing into a project and gain emission reduction credits in return.

As more time passes, the practical operation of the protocol's market-based mechanisms and the feasibility of Australian business investing in JI and CDM projects will become clearer. In the meantime, Australian business should monitor developments in the emerging global carbon market closely, and seek to benefit from the increased opportunities that it is likely to bring.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.