Tendering for climate change projects: key issues

Simon Watt, Partner | October 2003

The "Projects to Reduce Emissions" mechanism is a key component of the Government's climate change policy.

Under the scheme, organisations can tender for an incentive, in the form of tradable emission units, for projects that would reduce greenhouse gas emissions.

The first round of tenders closes on 24 October 2003.

One emission unit corresponds to an emission reduction of one tonne of CO2 or CO2-equivalent.

To be eligible for emission units, a project must reduce emissions below a level that would have occurred in normal business conditions.

The value of the emission units is intended to tip the balance so that an otherwise non-viable project becomes financially viable.

Participants will gain value from emission units by selling them on, most likely to international buyers.

The types of projects that are likely to qualify include those using renewable energy sources such as wind or bio-energy, projects associated with the waste sector and projects that propose fuel switching.

The Government has set aside emission units totalling 4 million tonnes of CO2-equivalent for the first tender round.

At an estimate of NZ$10 a tonne for carbon, that is NZ$40 million worth of emission units.

If you need further information on the scheme, visit www.gets.govt.nz or www.climatechange.govt.nz.

There are a number of commercial and legal risks associated with the projects mechanism and the subsequent Project Agreement, which you should factor in when assessing the financial benefits of participation.

Key issues include:

• Timing
  
  
• Pricing and on-sale of emission units
  
  
• Negotiability of agreements
  
  
• Onerous contract terms
  
  
• Confidentiality.

Timing

Ratification puts Kyoto in doubt

As project emission units are tied to emission units available under the Climate Change Response Act 2002 and the Kyoto Protocol, participants are taking a risk if they incur substantial project costs before Russia has ratified the Protocol.

The Russian decision is still awaited, but if Russia does not ratify the Protocol, it is not expected to come into force.

In that case, the Crown would not be liable to transfer any emission units to the project participant, and any benefits due under the Project Agreement to the participant would cease.

The participant might still be able to derive value from emission reductions through some form of emissions trading, possibly under a new climate change policy regime.

No reductions recognised beyond 2012

Emission units will only be provided for the five-year period from 2008 to 2012.

Although projects may continue to generate emission reductions beyond 2012, these will not be recognised.

It is worth checking with the Crown during the tender process the possibility of participants securing benefits from emission reductions beyond 2012, whether through further emission units or in some other form.

Choose between Projects or NGAs

During the project tender process, the Government will also be prioritising and progressing negotiated greenhouse agreement (NGA) negotiations.

Any organisation negotiating NGAs with the Crown will not be eligible to apply for a project.

Any organisation that meets competitiveness-at-risk criteria for NGA eligibility and is prioritised for negotiations will have to decide whether to tender for a project or to await an NGA negotiation.

Possible delays in receipt of emission units

The Crown will only transfer emission units to a participant after the end of the calendar year in which the emissions are achieved ? and the Crown will not necessarily accept a participant?s claimed emission reductions at face value.

There may be a delay in the transfer of emission units if the Crown audits, verifies, and possibly disputes claimed emission reductions.

This possible delay should be considered before committing to any proposed on-sale of emission units after they are received from the Crown.

Pricing and on-sale of emission units

Sale of emission unit rights

The exact value of emission units will depend on international market conditions.

Although emission units will only be transferred to participants after emission reductions have been achieved, participants can sell their rights to future allocation of emission units ? and this may help finance their projects.

The value of emission units under any advance sale would no doubt be discounted to reflect uncertainties around eventual achievement of the emission reductions and future delivery of the units.

Risk of emerging market

As the emissions trading market is still emerging, participants will be taking a risk on the liquidity of this market and their ability to sell at an acceptable price at a future date.

Counterparty/credit risk

Sale of emission unit rights will entail counterparty or credit risk on both sides, dependent on the parties? ability to meet contractual obligations, such as payment for or transfer of emission units.

Trading terms

There is a range of other issues associated with the sale of emission units. Participants should consider not only the implications of the Crown?s proposed project agreement but also the tradability of emission units and the sorts of terms and conditions that would apply to any emission unit rights transactions.

Tax treatment

The Crown has no view on the tax treatment of emission units, so participants should get their own expert tax advice.

Negotiability

Agreement non-negotiable

The Crown sees the Project Agreement as non-negotiable. Project-specific details can be included in schedules but the standard terms in the body of the Project Agreement will prevail in the event of any conflict with the schedules.

If participants are uncomfortable with provisions in the Project Agreement, they should address these issues with the Crown before submitting a tender.

There may be scope for further benefits to participants to be incorporated in the schedules, provided these do not conflict with the standard terms.

Finalisation of agreement

The tender process document says that the Crown will ?finalise the contract agreement, schedules and other provisions? with the participant after acceptance of a tender.

Therefore, it is not clear that the participant is immediately bound by the terms of the Project Agreement upon the Crown?s acceptance of its tender.

However, assuming the Crown maintains its stance of non-negotiability, the process of finalising the contract will probably focus more on incorporation of relevant technical and project details into schedules rather than negotiation of fundamental terms.

Onerous contract terms

Cost of monitoring

The provisions of the Project Agreement will require rigorous monitoring and recording of emissions.

While this is to be expected in order to ensure that emission reductions are actually achieved, these requirements are likely to incur reasonably substantial costs that should be factored in when assessing the overall benefit of participation.

Agreement clauses

Specific clauses in the Project Agreement that are onerous or put at risk the benefits of participation include the following:

• Clause 5.4 excludes the Crown from liability to transfer emission units to the participant if the Kyoto Protocol does not come into force or ceases to be in force for any reason.
  
  
• Clause 5.5 largely excludes the Crown from liability if the participant is unable to trade emission units.
  
  
• Clause 8.3 allows the Crown unilaterally to change the reporting requirements under the Project Agreement, albeit linked to compliance with the Kyoto Protocol.
  
  
• Under clause 9, the participant could be required to reimburse emission units to the Crown, or pay the current international price for the emission units, where emission reductions are in fact less than those reported and accepted by the Crown. This is not unreasonable but could be a costly contingency to deal with.
  
  
• Despite the fact that participants carry the greatest risks under the Project Agreement ? bearing in mind the Crown?s key obligation is to transfer emission units and it only has to do this after the participant?s obligations have been performed ? under clause 11, participants provide a broad indemnity to the Crown, which even covers consequential and indirect losses.
  
  
• Clause 18.1(b) allows the Crown to terminate the Project Agreement at any time prior to 1 January 2008 if the Crown reasonably considers that the Kyoto Protocol will not come into force. The termination provisions are generally weighted more heavily against the participant even though the participant carries most risk under the Project Agreement.
  
  
• There is a wide definition of a force majeure event, which means that under clause 19 either party could be excused from performance of its obligations as a result of a requirement, restriction or decision of ?any review body whatsoever?. The Crown is more likely to be able to rely on this open-ended exoneration clause. The possibility of some form of review occurring that might affect Project Agreements cannot be ruled out, given the fluid climate change policy environment.

Confidentiality

Lack of confidentiality clause

Tenderers will be concerned to protect the confidentiality of commercially sensitive information included in their tenders or when reporting on their project if they are successful.

There are, however, no confidentiality provisions in the Project Agreement.

The tender document asks for confidential information to be identified but recognises the possibility of disclosure under the Official Information Act or in Parliamentary reporting.

Unless tenderers can persuade the Crown to enter into a confidentiality deed before submitting their tenders, they should identify confidential elements of their tenders clearly and precisely, giving specific reasons why such information should not be released with reference to particular withholding grounds under the Official Information Act.

Is it worth the risk?

While we have identified a number of legal and commercial risks, potential participants should weigh up the benefits of early mover advantage when considering whether to tender.

If you believe that climate change policy in some shape or form is here to stay, then it is likely that emissions trading will be an element of any future regulatory regime.

Given the complexities associated with emissions trading, and more generally with climate change policies, those businesses with early exposure will have an advantage when the more significant compliance costs (such as the proposed future carbon tax) start to bite.

Information and advice

Bell Gully has significant expertise in climate change. We have advised businesses and organisations in a number of sectors on the implications of the Kyoto Protocol.

We have advised on the drafting of NGAs and a memorandum of understanding with the Crown in relation to carbon tax exemptions in return for emission reductions.

We have also advised on the development of a legal framework for trading in greenhouse gas emissions and on related aspects in the drafting of the Climate Change Response Act.

If you would like more information about the Projects to Reduce Emissions, please contact our team at the numbers below.

Simon Watt
Partner

Chris Hay
Senior Associate