Commentary 15th Apr 2015

Explainer: how does today’s Direct Action reverse auction work?

The Emission Reduction Fund (ERF) reverse auction, the first round of which runs today and tomorrow, is no different to a tender process used by the government to procure other types of goods and services.

The process calls for confidential formal bids from different providers and generally chooses the lowest-priced ones – in this case, the bids are proposals to reduce emissions using money from the A$2.55 billion ERF, the central plank of the federal government's Direct Action climate policy.

In the ERF auction, the Clean Energy Regulator, acting on behalf of the government, buys greenhouse gas emissions reductions at lowest prices through a competitive tender process. The measurement used for the ERF auction is the Australian Carbon Credit Unit (ACCU), where 1 ACCU represents 1 tonne of greenhouse gas emissions reduced.

The ACCUs will be created by successful bidders who propose to undertake specific emissions-reductions projects. Projects can be in the transport, mining, energy, manufacturing, commercial and municipal landfill sectors, and must first be registered with the regulator to be eligible for the auction. Rural projects such as reforestation, reducing livestock emissions, and improving soil carbon levels, are also eligible.

When the auction starts, bids are received from participants who will nominate the project(s), the number of ACCUs offered for sale, and the unit price of ACCU they would be prepared to accept. The bids are made via Austender, an online bidding platform, over a two-day window of for the first auction. No dates have yet been announced for future auctions.

Projects that are above a "benchmark price" will not be selected, while most bids below that level would be accepted. The accepted bids get the bid-price and not the "benchmark price", meaning that different accepted projects would get different returns to the bidders.

The Clean Energy Regulator sets the benchmark price but this is not revealed to the bidders beforehand. The regulator also has a budget constraint, set by the Government, which cannot be exceeded. The budget for the first auction is not known to the public.

The government thus faces a policy risk. A low benchmark price could discourage participation in future auctions, while a high benchmark price would restrict the purchase volume.

Gujji Muthuswamy

To the victor, the spoils

The winning bidders enter into a standard commercial contract with the regulator for the delivery of the promised emissions reductions. Payment will be made only after the projects' emissions reductions have been achieved and verified. The contract specifies how non-delivery would be dealt with, depending on the specific situation involved.

Unlike the now-defunct carbon tax, which forced businesses to pay the government for the right to emit, under the ERF the government pays emitters to reduce their emissions. Hence the regulator's brief is to maximise the returns for the taxpayer dollar.

The key question at the moment is the benchmark price that the regulator would be setting.

The first-round bids may be dominated by the transitioning of the Carbon Farming Initiative projects that were started under the Gillard government's carbon tax regime and which have now been deemed eligible for the ERF. These ACCUs were selling above the A$18 level during the carbon tax era, when they represented better value than the initial A$23-a-tonne mandatory price for emissions.

However, the regulator is now the only buyer for these ACCUs, and it website advises prospective bidders that "the best strategy for success at auction is to bid the lowest price at which it is worth your while to undertake the project. Participants with the most competitive prices will be successful."

As the ERF is voluntary, this price risk could prompt some potential bidders to adopt a "wait and see" attitude during the first couple of auctions.

The government thus faces a policy risk. A low benchmark price could discourage participation in future auctions, while a high benchmark price would restrict the purchase volume. For example, at A$18 a tonne, the ERF's total budget of A$2.55 billion would buy only 142 million tonnes of emissions reductions, which would not be enough to meet Australia's target of a 5% reduction on 2000 levels by 2020. Other policy measures would be needed to meet that target, at extra cost to the economy.

For now, we don't know what prices are written on the sealed bids as they are handed in. The regulator will announce the results, including the weighted average price of the successful bids, next week.

Gujji Muthuswamy is an Industry Fellow in the Department of Banking and Finance, Monash University and lectures on carbon pricing. He has been working in the Victorian electricity industry for more than 30 years.

This article has appeared in The Conversation.

  • gujji-muthuswamy-banking-and-finance-pr

    Mr Gujji Muthuswamy

    Industry Fellow, Department of Banking and Finance Monash Business School

    Read more