Reverse auctions: implications of the Coalition’s Direct Action Policy

by Neil Salisbury

With the Coalition announcing its planned repeal of the carbon price legislation, Australia needs to understand the implications of its Direct Action Policy, in particular, its proposed reverse auction process.

Competitive reverse auctions are not new in this space and have been used for a long time to drive low cost abatement. There are a number of examples from around the world including China’s wind concession program, India’s PAT scheme, Brazil’s PROIFNA Scheme and the UKs NFFO program. Closer to home we have the water buyback and the biodiversity offset programs. These examples are valuable as they provide insight into some of the issues and risks associated with reverse auctions.

This competitive reverse auction process can help the Government maximise the conservation benefits purchased under agreements within a given budget constraint – i.e. it can ensure value for money*. However, we also need to consider the example of other reverse auction programs troubled from poor design and implementation?

So what are some of the likely issues and risks that need to be considered?

Under bidding:
The most significant danger in a traditional reverse auction process is that of underbidding, which was quite visible in the Brazilian and Chinese experiences. This is where participants offer projects at unrealistically low costs, which are then not delivered, preventing viable projects from being implemented. This problem was quite visible in both the Chinese and Brazilian programs. In China, the lowest-bid wins criterion was eventually replaced by one in which other criteria were taken into account, but this remained largely ineffectual. In the Brazilian case (PROIFNA), a combination of penalties and incentives appeared to form the beginning of a powerful mechanism for preventing underbidding, but enforcement of these provisions will be critical to ensuring effective functioning of the policy and we have yet to see whether this can be achieved.

Lack of Participation:
A number of programs around the world (China is a clear case in point) experienced a distinct lack of participation due to high upfront project costs, real or perceived uncertainty and a real or perceived over-complication of the process. The primary aim of the expanded Carbon Farming Initiative (CFI) under Direction Action is to obtain lowest cost abatement, where it looks like energy efficiency is going to be a potential winner. However, we are going to see increased participation risk for project types, such as many land sector projects and more complex energy efficiency retrofits, that typically have higher upfront costs and longer lead times, or smaller energy efficiency projects that require complex aggregation.

Robust M&V process:
A scheme that does not have a robust M&V process creates market uncertainty, inflates claims of achieved abatement, loses credibility and subsequently adversely impacts participation rates. For example, if we consider the VEET Scheme in Victoria, much of the certificate creation has been in relation to Standby Power Controllers (SPCs). However, due to behavioural and technical issues with use of the SPCs, anecdotal evidence indicates that a large number of these were either not installed or removed shortly after installation. The lack of a robust M&V process around these SPCs has distorted the VEET market. Contrast this with the NSW Energy Savings Scheme, where a long history of strong governance and effective auditing has resulted in a program with strong integrity.

While the NGER and CFI schemes have world-class M&V processes, the planned introduction of new project activity types, such as energy efficiency, will require new auditor skills and additional capability to ensure that this process remains robust.

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* Marsden Jacob, Review of the Environmental Stewardship Program, December 2010

Neil Salisbury is a Director of Net Balance (neil@netbalance.com), 
one of the world’s leading sustainability advisory firms.
Neil is based in Melbourne.

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