Carbon Price: How not to Overcharge or be Overcharged
Here we are at the end of a 6-year negotiation that began with the CPRS and NGERS and has finished with the Carbon Pricing Mechanism (CPM) and the Carbon Farming Initiative (CFI).
There has been scarce communication from the Commonwealth as the issues have been free flowing, subject to ongoing negotiations at both the specialist and political levels, and in the case of waste, are very complex.
Waste is more problematic from a pricing perspective that most other emitters. Waste sent to landfill today could give rise to carbon emissions and therefore liabilities that could go on for 40 years. Pricing that risk and liability is difficult.
Costs ranging from $2 per input tonne of MSW to $55/t have been estimated. Here I will discuss the main issues and principles for clients of landfills so they understand the complexity of landfill pricing for methane emissions, and for operators so that they don’t overcharge (and lose market share to competitors).
Modelling the likely emissions from your waste
The Department of Energy Efficiency and Climate Change (DEECC) has supplied four ‘methods’ by which landfill operators can calculate their liable emissions for a tonne of waste delivered. These are set out in the National Greenhouse and Energy Reporting Scheme (NGERS).
Operators are free to choose any method (and will choose the one that minimises their liability to buy carbon permits), although there’s no reason why clients could not require a certain method be used in calculating the liability from their waste. These are summarised below:
1. Method 1: All Defaults (Default composition and default k)
This methods uses an MSW default methane generation factor of 1.19 tonnes of CO2e for each tonne of MSW, 1.08 tonnes of CO2e per tonne of C&I, and 0.17t of CO2e per tonne of C&D. It then uses a default constant of decay known as the ‘k value’ that determines the rate at which the methane potential of the waste is released by the landfill into the atmosphere.
2. Method 1: ‘Waste mix type’ and default k
Materials are individually classified. Thus if a landfill takes a disproportionate amount of inert materials such as dirt, this can be factored in to reduce emissions liability. The emissions factors are given below:
3. Method 2 Default Composition and site-specific k
This method is essentially the same as Method 1, except under Method 2 the landfill operator is allowed to set a site-specific ‘k value’. Composition uses the default MSW, C&I and C&D values of 1.19, 1.08 and 0.17 tonnes of CO2e per tonne.
4. Method 2 ‘Waste mix type’ and site-specific k
As above but using the weighted average composition of waste specific to the landfill receiving the waste.
It is important to note that all subsets of Method 1 limit the potential gas capture rate to 75%, while no limit on gas capture is imposed under Method 2. However, Method 2 is currently being reviewed by DCCEE and is likely to also include a maximum gas capture rate higher than 75%.
Gate fee charging options
The applicable carbon price is known with reasonable certainty between 2012 and 2015 (the fixed price period), starting at $23 per tonne of CO2e and growing at 5% (assuming and including 2.5% CPI). MRA has described two charging options for landfill owners to pass on the emissions liability:
- ‘One off’ pricing; and
- ‘Pay as you go’ pricing
‘One off’ charging recognises that the landfill operator has only one opportunity to pass on the full life liability of methane emissions (40 years or more) arising from a tonne of waste delivered. That is, at the time the waste is delivered over the weighbridge.
‘Pay as you go’ charging suggests that the landfill operator will charge only the premium required to cover the emissions liability arising for the landfill in the current year. It results in a lower gate fee premium being required because it defers the full life liabilities to later periods (lower price may equal more market share). However, it may also result in an under-funded liability arising from emissions occurring after the landfill stops receiving waste (assuming the landfill is still emitting above the 25 kilotonne threshold). It therefore creates a risk that the landfill goes into liquidation.
Dealing with future uncertainty
The Australian Landfill Owner Association (ALOA) amongst others has documented the high level of uncertainty associated with estimating future emission liabilities and future carbon prices over the long term. Some operators are using complex future projections and discount factors to estimate a Net Present Value for carbon liability. I believe that is much too complicated and unnecessary.
In our view there are two and only two options:
- ‘Cash only’ – NOT recommended
Raise the gate fee equivalent to the full life liability of the waste and bank the cash. This approach leads to Carbon Price Premiums of upwards of $35 per tonne in 2012 (as the carbon price rises faster than inflation and the operator needs to build in future price risk).
- ‘Buy and Bank permits’ – recommended
Raise the gate fee equivalent to the liability and buy and bank a permit for each future tonne of CO2e liability generated from receiving the waste today. That is, if one tonne of waste comes over the weighbridge, charge the carbon liability as if it occurred today and purchase permits to that value. This method eliminates the risk of future rises in the carbon price.
Please note; the CPM scheme prohibits banking of permits in the fixed price period to 2015. As a result landfill operators will need to bank the cash in this first period without knowing what the price will be on 2 July 2015. So initially they do need to build in some price risk premium to account for possible higher carbon prices in 2015.
Examples of carbon price premium
Under a one-off and Buy and bank strategy, the carbon premium can be calculated using the formula:
Carbon premium per tonne = Emission Factor x Current Price of carbon x [1-Capture rate (%)].
So the expected gate fee premium for a well run landfill with say 90% gas capture under each method are given as follows and these will rise by 2.5% plus CPI for each future year to 2015:
1. Method 1- Defaults (Composition and k):
Carbon premium per tonne approximately equal to $6.84 per tonne MSW.
Assuming 75% gas capture rate (maximum allowable under Method 1).
2. Method 1 – ‘Waste mix type’ and default k:
Carbon premium per tonne less than or equal to $6.84 per tonne MSW.
Assuming 75% gas capture rate (maximum allowable under Method 1). [Note the = reflects the fact there may be a higher proportion of inert material (rocks etc) which do not give rise to a carbon liability. Further, it is assumed that should a waste audit reveals that the actual waste mix gives rise to more emissions than the defaults, the operator will simply go with Method 1- Defaults instead.].
3. Method 2- Default Composition and site specific k:
Carbon premium per tonne approximately equal to $2.74 per tonne MSW
Assuming 90% gas capture rate (potentially allowable under Method 2; see above).
4. Method 2- ‘Waste mix type’ and site specific k:
Carbon premium per tonne less than or equal to $2.74 per tonne MSW
Assuming 90% gas capture rate (potentially allowable under Method 2). (Refer to the assumption in point 2 above as to why $2.74 per tonne will be the maximum payable under this scenario).
It is important to point out that these are for a well-run landfill with high gas capture. A landfill emitting above the 25kilotonne threshold and with no gas capture would be facing a carbon liability premium of approximately $27.37/input tonne MSW in 2012. This will grow with CPI and will float (probably upwards) after 2015.
Finally, the landfill operator may also be earning carbon-offset credits by capturing legacy gas emissions from the landfill. This new revenue stream may be used to offset some or all of the non-legacy permit liability. That is a commercial decision for landfill operators and a negotiation position for clients.
It is obvious from the above calculations that there are many assumptions which affect the per tonne carbon premium price. In particular the actual gas capture rates, the banking decisions and the use of CFI credits will have a significant impact on the applicable gate fee.
For well run landfills a $2-$7 per tonne MSW (at $23 per tonne CO2e) (depending upon CFI credit usage) is a relatively small component of the applicable landfill gate fee (as transfer station prices in Sydney are at $210 per tonne MSW in 2012 and rising by $10 per tonne and year plus CPI). For landfills without gas capture a price premium of $27 per tonne MSW and higher can be expected and this will grow with the carbon price.
Operators don’t want to overcharge and lose market share to their competitors but at the same time they can’t (and should not) under price and create an unfunded liability.
Landfill customers want a fair price that reflects the real changes in carbon law. The best advice MRA can give is to understand your assumptions and become carbon savvy or use someone who is.
Mike Ritchie is the Director of Mike Ritchie and Associates Consultants.