House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Climate Change and Energy Efficiency, the Hon Greg Combet AM MP and the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)

Chapter 6 Regulation impact statement - Carbon pricing mechanism coverage of non-transport gaseous fuels

Background

The gaseous fuels sector

Liquefied Petroleum Gas

6.1 LPG is produced either directly through the processing of crude oil and natural gas or as a by-product of the petroleum refining process. LPG is generally supplied for consumption in pressurised containers and is composed of mixtures of propane and butane, with bottled LPG used for domestic purposes usually composed solely of propane.

6.2 Key non-transport uses of LPG include residential and leisure (for uses such as heating and gas barbecues), manufacturing, materials handling (such as warehouse forklift use), and commercial.

6.3 LPG for non-transport uses is supplied by approximately 5 or 6 resellers. Of these, 3 are responsible for approximately 90 per cent of supply of non-transport LPG and 2 or 3 smaller resellers are understood to be responsible for the remainder. The supply chains by which LPG reaches the end consumer can be complex. In some rare cases, it will not be readily determinable at the marketer level whether a particular supply of LPG is ultimately used for transport or non-transport purposes (for instance, where LPG is delivered by the marketer into a tank from which LPG used for both automotive and stationary heating is withdrawn).

6.4 Transport uses of LPG were brought under the fuel tax system on 1 December 2011 to implement the longstanding plan for energy content based taxation of alternative transport fuels, but will not be subject to a carbon price. Non-transport LPG is not currently covered by the fuel tax system. However, under the Clean Energy Package it will be brought into the fuel tax system from 1 July 2012 to allow for the application of an equivalent carbon price.

6.5 In 2009-2010 approximately 800, 000 tonnes of LPG was sold into the stationary LPG market. This would result in approximately 2.4 million tonnes of carbon dioxide equivalent emissions. This would account for approximately 0.7 per cent of total estimated emissions to be covered under the carbon pricing mechanism in 2012/13.

Liquefied Natural Gas

6.6 LNG is natural gas (primarily methane) that has been cooled to approximately minus 163 degrees Celsius. LNG produced in Australia is primarily exported, with domestic LNG consumption accounting for less than one tenth of 1 per cent of Australian production. Key uses of LNG are as an industrial chemical and for electricity generation.

6.7 LNG is generally produced at large processing facilities, and sometimes from upstream supplies of natural gas that will not have been subject to coverage under the carbon pricing mechanism. There are 3 large producers of LNG for domestic non-transport consumption, and it is expected that in most cases downstream uses of supplies of LNG will be readily determinable.

6.8 Domestic LNG consumption in 2009-2010 was in the region of 35,000 tonnes, leading to approximately 105,000 tonnes of carbon dioxide equivalent emissions. Based on this level of emissions, domestic LNG consumption would account for about 3 hundredths of one per cent of total emissions estimated to be covered under the carbon pricing mechanism in 2012/13.

Compressed Natural Gas

6.9 CNG is created by compressing natural gas for storage in tanks at pressures of around 200-240 bar. Key "non-transport" uses of CNG are as fuel for forklifts and off-road mining vehicles. Non-transport CNG is generally produced for own use on-site, from supplies of natural gas that will be subject to carbon pricing mechanism coverage.

6.10 Disaggregated statistics for domestic non-transport CNG consumption are not available, but CNG consumption is expected to be lower than LNG consumption.

Current treatment of gaseous fuels under the Clean Energy Future Plan

6.11 Under the Clean Energy Future Plan, an equivalent carbon price will be applied to emissions from non-transport LPG, LNG and CNG through a reduction in fuel tax credits or through changes to excise from 1 July 2012.

6.12 Gaseous fuels are used in large part as transport fuels, and were included under the fuel tax arrangements along with liquid transport fuels that face an equivalent carbon price for certain business transport and non-transport uses. Transport gaseous fuels are already covered under the fuel tax arrangements (for the purpose of applying excise duty rather than the carbon price). As noted in the regulation impact statement for the Clean Energy Future Plan, applying a carbon price to transport fuels thorough the fuel tax system has several advantages over the use of the carbon pricing mechanism, including making use of existing business systems and avoiding the need for liable entities to deal with both the ATO and the CER.

6.13 On this basis, it was considered that it would be relatively straightforward and minimise compliance costs to use the fuel tax system to apply a carbon price to non-transport uses of gaseous fuels, which are also used for transport purposes. However, there are a number of differences between transport and non-transport supplies of gaseous fuels compared to liquid fuels. Transport gaseous fuels would be subject to coverage under the excise system irrespective of whether or not carbon pricing is applied, whereas non-transport gaseous fuels would not be subject to fuel tax system coverage in the absence of the carbon price. By comparison, liquid fuels used for both transport and non transport purposes are covered under the excise system irrespective of whether or not carbon pricing is applied.

6.14 Non-transport gaseous fuels also have a lower frequency of supply and billing in some instances. For instance, on some occasions LPG is supplied to a central tank for distribution to multiple users via a reticulated (pipeline) system for commercial use. A substantial period of time may elapse between the delivery of LPG and billing for supply after a user withdraws LPG from the reticulated system, potentially exacerbating cash carrying costs of carbon price payments relative to transport uses.

The problem

6.15 Industry stakeholders for non-transport LPG and LNG have raised compliance cost and efficiency concerns with the inclusion of non-transport gaseous fuels under the fuel tax arrangements rather than the carbon pricing mechanism.

6.16 Coverage under the fuel tax arrangements generally requires the settlement of excise returns on a weekly basis with an additional 6 days provided beyond the weekly excise period to enable suppliers to reconcile invoices issued during that week and finalise settlement. By comparison, submission of reports and settlement of liabilities under the carbon pricing mechanism would occur twice for each year of the mechanism's fixed price period (2012-13 to 2014-15) and once for each year of the mechanism's flexible price periods (2015-16 and onwards).

Compliance costs

6.17 Coverage of non-transport LPG and LNG under the excise system imposes compliance costs for suppliers on top of the costs incurred as a result of their participation in the excise system for transport gaseous fuel. These additional costs relate to the need to submit excise returns and make payments in relation to a larger volume of supplies.

6.18 In the case of CNG an unknown but small number (estimated at up to 50) of producers of CNG for non-transport purposes that would not otherwise be required to participate in the excise system would also be required to install relatively expensive metering equipment to meet the requirements of the excise system. More importantly, industry feedback indicates that the costs of installation of this equipment would curtail expansion of production and use of CNG by small producers.

Efficiency and fairness concerns

6.19 More regular payments under the fuel tax system during the mechanism's fixed price period will result in increased cash carrying costs for suppliers of gaseous fuels relative to other non-transport energy sources, such as natural gas and electricity. In addition gaseous fuels suppliers will not have access to the flexibility in meeting emissions obligations provided by the ability to purchase units on international and domestic markets available under the carbon pricing mechanism.

6.20 These differences, relative to carbon pricing mechanism coverage, will potentially create marginal distortions affecting the competitiveness of non-transport gaseous fuels when compared with other non-transport fuels over the longer term.

Objectives

6.21 The problem being considered is the best approach to apply a carbon price to non-transport gaseous fuels. In this context, the key objectives for any approach adopted are to:

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Maximise the economic efficiency of the carbon price, and in particular to:

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Incentivise emissions reduction at least cost by sending out a clear signal about which activities should be reduced;

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Minimise any competitive disadvantage arising from the way in which the carbon price is applied;

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Ensure the equitable application of the carbon price;

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Minimise the compliance and transitional costs for liable entities paying the carbon price;

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Ensure the administrative simplicity and workability of the carbon price.

Options

LPG and LNG

6.22 The following options were considered for the coverage of non-transport LPG and LNG:

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Option A: Maintain the status quo of coverage under the alternative fuel tax arrangements.

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Option B: Mandatory coverage of all LPG and LNG under the carbon pricing mechanism. Under this option some supplies of LPG and potentially also LNG would remain under the fuel tax arrangements. However, this would occur in very limited circumstances, as noted above, where it is not possible for the supplier of LPG or LNG to distinguish whether the supply is going to be used for transport or non-transport purposes. For instance, this would occur where a marketer of LPG supplies LPG into a tank from which LPG is withdrawn for both transport and non-transport purposes.

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Option C: Coverage on a voluntary opt-in basis under the carbon pricing mechanism, with currently legislated fuel tax arrangements for a carbon price continuing to apply to those entities that choose not to opt-in.

6.23 Also as with Option B, some supplies of LPG and potentially also LNG would remain under the fuel tax arrangements (and could not be opted in). However, this would occur in very limited circumstances, as noted above, where it is not possible for the supplier of LPG or LNG to distinguish whether the supply is going to be used for transport or non-transport purposes.

6.24 Because of the difficulty and associated costs in identification by LPG and LNG suppliers of the end uses of all non-transport gaseous fuel, complete mandatory coverage was not considered a viable option.

6.25 A secondary question for consideration was the date of commencement of carbon pricing mechanism coverage under options B and C, with dates of 1 July 2012 and 1 July 2013 considered.

CNG

6.26 The following options were considered for the coverage of CNG:

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Option A: Maintain the status quo of coverage under the alternative fuel tax arrangements.

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Option B: Mandatory coverage of CNG under the carbon pricing mechanism.

6.27 Opt-in coverage was not considered for CNG as the ability for individual CNG producers to opt-in or out of direct management of liabilities can be provided under mandatory carbon pricing mechanism coverage. This is possible because mandatory coverage would involve natural gas suppliers being liable for gas supplied to entities that manufacture CNG, and the existing obligation transfer number mechanism provided for in the CE Act will allow CNG producers to take on obligations from their supplier for natural gas used to produce CNG.

6.28 A similar approach to mandatory coverage is not possible for LPG and LNG as the former is not always produced from natural gas and the latter is not produced exclusively from supplies of natural gas that will be subject to carbon pricing mechanism coverage.

Impacts and analysis

LPG and LNG

6.29 The impacts for options for LPG and LNG are summarised in diagram 5.1 and set out in more detail under the headings below.

Option A: maintain the status quo

6.30 The main advantage of continuing coverage of non-transport LPG and LNG solely under the alternative fuel tax arrangements is avoiding complexities and costs associated with businesses being required to participate in two systems, one for non-transport fuels (the carbon pricing mechanism) and the other for transport fuels (the fuel excise system), as would be the case for Option B.

6.31 An associated advantage is avoiding the need for the ATO and the CER to maintain and reconcile dual systems for compliance under the fuel tax arrangements and the carbon pricing mechanism. Dual systems would be required under Option C, and, to a lesser extent, Option B.

6.32 The disadvantages of maintaining the status quo are:

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Compliance costs for industry associated with submitting regular excise returns for a larger volume of supplies of LPG and LNG.

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Cash carrying costs for LPG and LNG suppliers from more regular payments under the fuel tax arrangements relative to a cash carrying advantage under the carbon pricing mechanism during the mechanism's fixed price period. For instance, one of the three large LPG suppliers, which is responsible for about 30 per cent of the sector's supply, would on this basis be required on average to make 52 weekly carbon price payments each year of approximately $300,000, but also would generally be billing their customers on a regular basis. Under the carbon pricing mechanism, it would make one payment of approximately $12 million towards the end of the financial year, and a further payment of approximately $4 million in the February next following the financial year.

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Reduced flexibility for LPG and LNG suppliers to meet obligations by purchasing emission units during the carbon pricing mechanism's flexible price period.

Option B: mandatory coverage

6.33 The advantages of mandatory coverage of non-transport LPG and LNG are:

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Reduced cash carrying costs for LPG and LNG suppliers during the carbon pricing mechanism's fixed price period relative to the status quo.

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Increased flexibility to manage emissions obligations through the purchase of emissions units during the mechanism's flexible price period relative to the status quo.

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Reduced administrative complexity in comparison to Option C, associated with the ATO and the CER maintaining and reconciling dual systems for compliance under the carbon pricing mechanism and under the fuel tax arrangements.

6.34 The disadvantage of mandatory coverage is the potential compliance costs associated with carbon pricing mechanism participation. These include costs associated with managing unit obligations. A broadly analogous estimate for costs of participation of a large natural gas supplier under the previously proposed Carbon Pollution Reduction Scheme was that initial costs to set up systems for compliance would be approximately $375,000 and that ongoing costs of compliance would be approximately $291,000. To the extent that the largest LPG suppliers will already be managing carbon pricing mechanism liabilities in respect of other operations these costs will be largely mitigated. However, for smaller suppliers of LPG and LNG and those that are not participants in the carbon pricing mechanism these costs would be new.

6.35 In respect of timing of coverage, mandatory coverage from 1 July 2013 would require participation by LPG and LNG suppliers under the fuel tax arrangements for one year from 1 July 2012 to 1 July 2013, when coverage under the carbon pricing mechanism would commence. This would entail LPG and LNG suppliers facing increased cash carrying costs for one year. However, coverage from 1 July 2012 would create substantial risks that implementation agencies would have insufficient time to develop detailed systems for carbon pricing mechanism coverage and adequately test these with industry stakeholders.

Option C: voluntary opt-in coverage

6.36 The advantages of a voluntary opt in approach to coverage of LPG and LNG are:

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Reduced cash carrying costs for LPG and LNG suppliers during the carbon pricing mechanism's fixed price period, relative to the status quo.

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Increased flexibility to manage emissions obligations through the purchase of emissions units during the mechanism's flexible price period, relative to the status quo.

6.37 The ability to elect whether to opt-in or remain under the carbon pricing mechanism allows LPG and LNG suppliers to assess the costs and benefits of participation under each approach and adopt the one that best reflects their particular circumstances. For instance, smaller suppliers that would not otherwise expect to develop unit purchasing and liability management capabilities may elect to remain under the fuel tax arrangements whereas large suppliers that expect to have obligations under the carbon pricing mechanism for other activities might choose to opt-in to mechanism coverage.

6.38 The disadvantages of opt-in coverage are that this option would have the highest administrative complexity for the CER and the ATO as it would require dual systems for compliance under the carbon pricing mechanism and fuel tax systems and close interaction between the two agencies to reconcile these systems. Coverage under the fuel tax arrangements will apply for both the relatively limited LPG and LNG supplies that will be impracticable to cover under the carbon pricing mechanism, and for any LPG and LNG suppliers that choose not to opt-in to the carbon pricing mechanism. Introducing an opt-in element will introduce an additional element of complexity to already complex fuel tax arrangements for gaseous fuels.

6.39 Only a small number of businesses (around 8 or 9 in total comprised of 5-6 supplying LPG and 3 supplying LNG) supply non-transport LPG and LNG. In addition feedback from the three largest suppliers of LPG (which account for approximately 90 per cent of the market) is that they would participate in the carbon pricing mechanism, and it is possible that LNG suppliers and the smaller LPG suppliers would choose to participate in the carbon pricing mechanism. Given these factors the expense of setting dual systems may not be justified.

6.40 Similarly to Option A above, opt-in coverage from 1 July 2013 would require participation by LPG and LNG suppliers under the fuel tax arrangements for 1 year from 1 July 2012 to 1 July 2013, when voluntary coverage under the carbon pricing mechanism would commence. This would entail those LPG and LNG suppliers that would choose to opt in to mechanism coverage facing increased cash carrying costs for one year. However, coverage from 1 July 2012 would create substantial risks that implementation agencies would have insufficient time to develop detailed systems for carbon pricing mechanism coverage and adequately test these with industry stakeholders.

CNG

6.41 The impacts for options for CNG are summarised in diagram 5.2 and set out in more detail under the headings below.

Option A - maintain the status quo

6.42 The advantage of a retaining coverage of non-transport CNG under the fuel tax arrangements is that to the extent that any CNG producer wishes to manage its carbon pricing obligations directly it is possible that it may prefer to do so by making payments under the excise system rather than under the carbon pricing mechanism.

6.43 The disadvantages of coverage under the fuel tax arrangements are:

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The imposition of a requirement for an indeterminate number of small users to install metering equipment to enable participation in the excise system. Installation of metering equipment would be costly, and industry feedback indicates that this cost would be sufficient to stop expansion of the use of CNG.

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The requirement that all producers of CNG directly manage carbon pricing obligations through participation in the excise system (with the exception of producers of CNG for non commercial "home" use which are exempted from excise system and instead face a passed-through carbon price under the carbon pricing mechanism on the supplies of natural gas that they convert to CNG).

•

To avoid incurring a 'passed through' carbon price from their natural gas supplier, CNG producers would also need to obtain and use an obligation transfer number which would also require them to register and report under the National Greenhouse and Energy Reporting Act, and to manage carbon price liability for any natural gas that is supplied to them and that is not used to manufacture CNG.

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More regular payments under the excise system and lack of flexibility to manage obligations through the purchase of emissions units.

Option B - "Mandatory" carbon pricing mechanism coverage

6.44 The advantages of mandatory coverage of non-transport CNG under the carbon pricing mechanism are:

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The removal of the requirement for producers of non-transport CNG to (i) register and report under the National Greenhouse and Energy Reporting Act, and (ii) install metering equipment to allow for excise system compliance and reporting.

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The removal of the requirement for non-transport CNG producers to actively manage carbon pricing obligations. The carbon pricing mechanism obligation will by default rest with the supplier of natural gas, which will pass through the carbon price to users, including CNG producers.

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Flexibility for non-transport CNG producers to opt-in to manage carbon pricing obligations. CNG producers will be able to use existing provisions of the carbon pricing mechanism to quote an obligation transfer number and directly assume obligations under the carbon pricing mechanism if they wish to do so.

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A reduction in administrative costs associated with the ATO administering and ensuring compliance for up to approximately 50 small CNG users under the excise system.

6.45 The disadvantage of mandatory coverage is that there may be a small increase in the amount of liabilities for natural gas suppliers. However, any increase in costs is likely to be negligible as the increase in liability will be tiny relative to size of obligations managed by gas suppliers for residential and commercial gas users.

Consultation

6.46 In submissions made during the passage of the Clean Energy Bills in 2011 and in representations to Government, LPG sector businesses requested coverage under the carbon pricing mechanism instead of under the fuel tax arrangements. On this basis, the Government committed to consult on options for including gaseous fuels in the carbon pricing mechanism similar to the liquid fuels opt-in scheme, and established an industry technical working group in November 2011.

6.47 Membership of the Technical Working Group included the three largest LPG sector participants responsible for the supply of over 90 per cent by volume of non-transport LPG, and also representatives of LPG producers and distributors of transport LPG. Producers and distributors of LNG, and CNG producers were also represented on the Technical Working Group.

6.48 The key messages from the working group in relation to LPG and LNG were:

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there is broad support for the coverage of non-transport LPG and LNG in the carbon pricing mechanism, including support from participants responsible for the supply of over 90 per cent by volume of non-transport LPG for coverage under the carbon pricing mechanism from 1 July 2012;

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there was concern from some participants that adequate time should be provided to allow for the implementation of coverage and along with opportunity to identify and resolve any potential unintended impacts on transport uses of gaseous fuel, which would remain within the excise arrangements.

6.49 Engagement by CNG stakeholders in consultation was more limited, partially reflecting the more dispersed nature of CNG production. However, feedback identified:

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some concerns with compliance costs associated with the current position of excise system coverage for small scale CNG production, thereby limiting opportunities for expansion of CNG;

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a general level of comfort with carbon pricing mechanism coverage, particularly to the extent that this may reduce some of the administrative and compliance costs associated with excise participation.

Conclusion

LPG and LNG

6.50 On balance the advantages of coverage of non-transport LPG and LNG under the carbon pricing mechanism of reducing compliance costs and providing greater flexibility for liable entities in the sector to meet carbon pricing obligations warrant the inclusion of non-transport LPG and LNG in the Carbon Pricing Mechanism. Therefore, Option A (the status quo) is not preferred.

6.51 On balance a mandatory approach is preferable to a voluntary approach to coverage as it would reduce the complexity of the carbon price and associated compliance and administration costs. On this count Option B (and also Option A) is superior to Option C.

6.52 Mandatory coverage requires that liable LPG and LNG suppliers assume the costs of managing emissions unit obligations and participating in the carbon pricing mechanism. However, most liable entities for LPG and LNG will already be managing liabilities under the carbon pricing mechanism. From the perspective of the Government, mandatory coverage has advantages in reducing administrative complexities and costs compared to an opt-in coverage.

6.53 Conversely opt-in coverage may reduce overall compliance for a small number of smaller LPG suppliers (two or possibly three), by providing them with flexibility to assess which approach is best for their particular business circumstances. However, it is not clear whether the smaller LPG suppliers would chose to remain under the fuel tax arrangements and this flexibility comes at a significant cost in the form of increased administrative complexity and cost for the Government. Therefore given the uncertainty surrounding the use of the opt-in scheme and the administration costs associated with its provision regardless of its use, on balance Option B is preferred overall.

6.54 Regarding timing of coverage, the significant risks associated with implementing coverage by 1 July 2012 outweigh the cash carrying costs for LPG and LNG suppliers for one year of coverage under the fuel tax arrangements. The preferred timing option (for either mandatory or voluntary opt-in coverage) is for coverage to commence from 1 July 2013.

CNG

6.55 There are clear advantages to Option B (coverage of non-transport CNG under the carbon pricing mechanism) in terms of reduced compliance costs for small producers, and reduced administrative costs for the Government relative to the status quo. Moving to mandatory coverage under the carbon pricing mechanism also provides greater flexibility for CNG producers to choose whether or not to directly manage their carbon pricing obligations.

6.56 The preferred option is Option B.

Implementation and review

6.57 Amendments to the CE Act would be required for carbon pricing mechanism coverage of non-transport LPG and LNG (whether on an opt-in or mandatory basis), along with the development of detailed implementing regulations.

6.58 For mandatory coverage the primary implementing agency would be the CER. However, the ATO would retain responsibility for administering the continuation of the excise arrangements for those limited supplies of LPG and LNG that would not be subject to coverage under the carbon pricing mechanism.

6.59 For opt-in coverage the ATO would retain a larger role in relation to the fuel tax arrangements commensurate with the potentially higher level of coverage. In either case systems and procedures will be developed to clarify the interaction between the CER and the ATO on the administration of carbon pricing arrangements for LPG and LNG.

6.60 The additional burden for the CER would be small, as the number of additional entities responsible for LPG and LNG will be small (at around 8 or 9 in total) and most will already be participants in respect of other emissions.

6.61 The implementing agency for the coverage of CNG will be the Clean Energy Regulator. Legislative arrangements for coverage of CNG will be initially implemented via legislative changes to excise arrangements for CNG producers and the adjustment of administrative arrangements by the ATO.

6.62 The additional burden for the Clean Energy Regulator would be small, as the default liability for CNG will rest with natural gas suppliers that will already be liable entities under the carbon pricing mechanism, and the number of CNG producers that might wish to quote an obligation transfer number to directly take on obligations under the scheme is likely to be small (as it is estimated there are up to 50 non-transport CNG producers, and only a small proportion of these are likely to wish to