Australia’s Sustainable Finance Taxonomy: Solving problems or creating new ones?

Last Tuesday, the Australian Sustainable Finance Institute (ASFI) released the Australian Sustainable Finance Taxonomy – a voluntary framework that financiers and investors can use to ensure economic activity they are investing capital in is consistent with a 1.5°C trajectory. 

One of the trickier aspects of the Taxonomy was whether to classify gas-powered generation, a fossil fuel energy source, as a “transition” activity to support net-zero. The final Taxonomy opted against this.

Here we take a look at how ASFI came to this decision, and the pragmatism of it.

Why does Australia need a Sustainable Finance Taxonomy?

ASFI has developed its Taxonomy to improve investor confidence that their capital is supporting the energy transition and reduce the risk of greenwashing by providing rigor to business claims that a product is sustainable or good for the climate.   

The Taxonomy does this by using a set of performance standards (e.g. emissions intensity thresholds) to classify various technologies or economic activities as ‘green’ (aligned with a 1.5°C scenario) or ‘transition’ (on a credible pathway to alignment).

These classifications extend across six key economic sectors, which coincide with the Federal Government’s ongoing sectoral pathways work: 

• Electricity generation and supply
• Transport
• Manufacturing and industry
• Minerals, mining and metals
• Agriculture and land
• Construction and buildings

While the Taxonomy is currently voluntary, it is expected that many financiers and investors will rely on the taxonomy’s classifications to guide investment decisions. Furthermore, Commonwealth Treasury has suggested it could become regulation in the future, so investors may look to get ahead of the curve.

Figure 1: Activity selection and classification for the electricity sector

Source: Australian Sustainable Finance Taxonomy, p88.

Why are some technologies not included?

Coal-fired generation is not in the electricity sector classification because its emissions intensity is too high, while nuclear generation has presumably been excluded due to it being prohibited by law.

A more surprising element of the Taxonomy is the exclusion of gas-powered generation from the ‘transition’ classification. This omission is despite the Australian Energy Market Operator’s optimal development pathway in the 2024 Integrated System Plan (ISP) projecting a need for about 15 GW of gas-powered generation in the National Electricity Market (NEM) to reach net-zero by 2050, and Western Australia’s Whole of System Plan (WOSP) likewise forecasting an important role for gas in firming renewables.

ASFI has said its performance standards use average emissions intensity levels for the various technologies and that the Taxonomy is therefore “unable to account for the inherent system-level uncertainties around when and whether the back-up function [of gas] provided will be required”. In other words, ASFI is not confident gas-powered generation will only play a firming role and wants to avoid “carbon lock-in”.

To overcome this limitation, the Taxonomy has prepared separate guidance altogether for gas-powered generation, which is referred to as “entity-level firming advice” (Appendix 4). This advice recognises the projected system-level role for flexible gas-powered generation and sets out expectations for what businesses must do to ensure gas fits within a “credibly transitioning portfolio of assets”.

Figure 2: ASFI’s key considerations for gas firming in transition plans

Source: Australian Sustainable Finance Taxonomy, p146.

Pragmatic or convoluted?

While the entity-level firming advice gives the impression of robust transition planning, many stakeholders have been left wondering what value it really adds.

This is because it seems to be taking a bet each way. On the one hand, the Taxonomy says it cannot classify gas as a transition technology because of uncertainty over its output, even though AEMO, the independent energy market operator, has given guidance on this: a typical gas generator may generate just 5% of its annual potential, but will be critical when it runs.

Figure 3: Gas-powered generation offtake, NEM (TJ/day 2014-15 and 2039-40, Step Change)

Source: AEMO Integrated System Plan, p70.

But then on the other hand, the Taxonomy is providing entity-level firming advice “in recognition of the currently anticipated role of firming articulated in AEMO’s 2024 Integrated System Plan”. This would seem to suggest that ASFI’s concerns about “carbon lock-in through the emissions performance of the whole activity” is a purely academic exercise. The ISP is the system-level advice to ameliorate such concerns. No additional advice is needed.

Further complicating the Taxonomy’s use is the stated expectation that the majority of firming will need to be decarbonised under 1.5°C pathways, and the ISP’s optimal development path. But these are not the same thing. AEMO’s optimal development path in the ISP, the Step Change scenario, is 1.8°C scenario so using it as reference would contradict 1.5°C alignment.

The Taxonomy then goes on to say that if the system-level assumptions are not in line with 1.5°C then the firming capacity assumptions would also not be aligned, suggesting reliance on AEMO’s optimal development path does not represent a credible assumption.

The unfortunate reality is that 1.5°C transition pathways are very optimistic, and most pertinently, have little role for new gas-powered generation. This is because they speculate that other technologies, which are currently not commercial, will mature quickly enough to perform this firming role.

As one example, the CSIRO’s economy-wide 1.5°C scenario relies on an enormous buildout of renewable generation, huge increases in hydrogen production via electrolysis, uptake of CCS technology, and negative emissions (e.g. direct air capture, land sequestration) abating close to 180 Mt CO₂-e per year by 2040 (essentially the equivalent of abating the whole current electricity sector every year).

Businesses using these types of assumptions, especially around CCS technology and negative emissions, would face strong scrutiny about their plausibility and perceptions that it is delaying real abatement.

Nonetheless the Taxonomy maintains there are “readily deployable alternatives” to gas-powered generation, although does not elaborate on what these alternatives are and why AEMO has not used them in their optimal development pathway. 

Could the Taxonomy accelerate investment in these alternative technologies?

It is of course possible that widespread adoption of the Taxonomy could direct capital towards cleaner technologies that can perform a firming role (such as green hydrogen or long duration energy storage). But these technologies are not readily deployable: they have very high capital expenditure, long and increasingly delayed build times, insufficient incentive frameworks, and in hydrogen’s case, uncertainty over the technology’s ability to mature to provide a return on investment.

Arguably more likely is the Taxonomy inadvertently enabling greenwashing by forcing any investment case for gas-powered generation to prove it is 1.5°C compatible. This is theoretically doable because the transition pathway to 1.5°C involves so many assumptions and variables that all revolve around one wicked question: who gets to use the “net” in net-zero? Any individual business can say it is them, even if collectively these claims are inconsistent with 1.5°C.

Conclusion

While the good intentions of the Taxonomy are plain to see, sometimes less is more. Businesses are already doing extensive climate scenario and transition planning through Treasury’s climate-related financial disclosure framework.

Given the Taxonomy seeks to encourage “interoperability with international taxonomies”, it would be simpler and more practical to follow the lead of the European Union and classify gas-powered generation as a transition activity.