Tuesday, 20 September 2022

GIDI and the Emissions Reduction Plan

The Environment Select Committee invited me to provide a supplemental submission on the Emissions Reduction Plan. My initial submission had taken EECA at its word that they had received no advice about the additionality of projects funded under GIDI. More the fool me.

Recall that GIDI is the funding line to subsidise investment in lower carbon tech. Some $600m in new funding for it was announced at the last budget. And this kind of approach is all over in the Emissions Reduction Plan. 

One particularly fun bit: the consultant noted that applicants for GIDI were all over the map in their assumptions about future carbon prices and future fuel prices. That'll matter in assessing whether funding for a project was additional or whether it was something that the company would have done on its own without funding. See 3.6, below.

From my submission:

3.1 Evaluation of the documents released by EECA suggest that GIDI projects do not reduce national net emissions. EECA’s conception of additionality relates to whether a project would have been undertaken as quickly in the absence of funding, not whether net emission reductions then obtain. 

3.2 Recall that cost-effective additionality of GIDI subsidies requires that emissions are mitigated relative to the counterfactual, that those emissions are mitigated at lower cost per tonne than going ETS prices, and that government is able to reduce the number of carbon credits issued because of the measure. If the cost of abatement is lower than the going ETS price, then companies already have strong incentive to pursue mitigation without subsidy; if the cost of abatement is higher than the going ETS price, government could do better by buying back and retiring outstanding ETS credits. 

3.3 Comparison to ETS prices introduces something of a knife-edge. If a company’s investment, proposed for subsidy, mitigates emissions at lower cost than current and expected ETS prices, why is the company not already doing it? If it mitigates emissions at higher cost than the current and expected ETS price, why is the government subsidising something that is not cost-effective? The subsidy has to help the company or industry overcome some other market failure to be cost-effective. And it has to consequently allow the government to reduce the number of issued ETS credits. 


3.4 Concept Consulting’s presentation was developed to help improve the application process for future rounds of GIDI funding. The additionality of funded projects is first assessed at point of funding application; if a project is not considered likely to result in investments that otherwise would not have taken place as quickly, the project will be less likely to be funded. Concept evaluated five applications for GIDI funding. 

3.5 The presentation noted deficiencies in GIDI 1.0 that could and should be improved in future rounds, including insistence that every application use standard assumptions about future changes in fuel costs, in inflation, and in ETS prices. Applications used 2030 ETS prices that varied from $40/tonne to $140/tonne, and 2040 prices that varied from $40/tonne to $180/tonne. Gas prices in 2040 ranged from just over $10/GJ to over $20/GJ. 

3.6 It is somewhat surprising that GIDI 1.0 allowed applicants to set their own assumptions on ETS prices, fuel prices, and inflation. Treasury’s guidelines for cost-benefit assessment and its CBAx tool, for example, are set to provide a consistent approach. Projects should be assessed using the same ruler. If one project is funded, and another is not, because the projects made different assumptions about ETS prices and future inflation rates, the right decision will have been made only by chance. Worse, if applicants know that they can manipulate the process by setting assumptions painting a rosier picture of their project’s suitability for funding, it would be foolish to expect that they would not do so. 

3.7 The section on additionality says, “It appears that four of the five projects evaluated may not be additional.” Concept considered that, on the applicants’ assumptions, every proposed project would have paid itself off in less than four years, without a subsidy. And three of the four projects would pay themselves off within four years even if carbon were not priced. In other words, most of the projects Concept evaluated could and should have been undertaken by the companies on their own, even if the ETS price were zero. 3.8 Concept noted that, in some cases, small projects with high internal rates of return may not be undertaken without government support. They provided examples where resource constraints or financing constraints mean the project with an attractive-seeming internal rate of return may not make it to the top of a company’s priority list. 

3.8.1 As simple example (provided by us rather than by Concept, by way of illustration), a $10,000 project with a 200% internal rate of return might not be worthwhile if it sucks up a lot of internal administrative resources that are not appropriately costed in determining the rate of return. The real internal rate of return could be strongly negative if undertaking the $10,000 project meant diverting the attention of a project manager responsible for a $10,000,000 project with a 10% internal rate of return. 

3.9 In other words, if a project seems to make sense but is sufficiently small that a company does not find it to be worth prioritising, government support for the project may be necessary. But if that is the case, it seems quite unlikely that the project can do much to affect national net emissions. 

3.10 In other cases, debt constraints were considered as potential hindrance against taking up projects with a promising internal rate of return. If covenants on existing debt set hurdles on taking on further debt, then some projects might not be pursued. 

3.11 But other alternatives might be available in such cases if the potential returns were substantial. A company might lease equipment rather than purchase it. Or it might seek an equity contribution from shareholders, if those shareholders could be convinced that the rate of return were high enough to warrant the investment. In general, should it be the role of government to provide grants to companies that have found themselves credit-constrained? If it is, might we expect more companies to find themselves to be credit-constrained? 

3.12 In both cases, EECA subsidy might encourage a company to change its priority ordering of projects, perhaps bringing forward a low carbon project while pushing back another project. There could be some reduction in that company’s emissions over the period in which the investment is in place thanks to GIDI funding before the company would have made the investment on its own. In that case, any benefits of the funding should only be assessed over that short interval of time, rather than over the lifetime of the equipment. And any wider cost-benefit assessment would need to consider the costs of deferring the projects that were pushed back in the priority ordering. 

3.13 Concept notes that GIDI 1.0 evaluation placed 20% weighting on economic stimulus driving domestic employment and 10% weighting on speed of spending. Neither makes any sense in assessing projects for carbon reduction but may be important for make-work projects. Make-work projects might be ill-advised when Reserve Bank views employment rates as unsustainably high. 

3.14 Concept notes that GIDI 1.0 evaluation scoring placed 10% weighting on “level of innovation and co-benefits”. Concept noted that demonstration benefits can be valuable, but “should potentially come with a requirement that information is shared with the wider industry.” 

3.15 EECA Chief Executive Andrew Caseley noted, in his defence of his agency’s view that Concept’s advice constituted author opinion, that assessing additionality is complex and requires information on a range of factors that might not have been available to Concept, including companies’ “internal decision-making processes, their risk appetite, financial measures such as cost of capital, sector norms in decarbonisation decision-making etc.” 

3.16 Concept may not have had information on each of these in assessing the five applications, but its presentation and correspondence clearly suggested that it was thinking about these issues. Sector norms in decarbonisation would be a rather plausible reason for considering the benefits of demonstration projects. Concept had to point out to EECA that the value of demonstration projects is higher if the funded business has to share information with others that might benefit from it.

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