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Focus: Government announces 'broad architecture' for new carbon price

1 March 2011

In brief: The Federal Government and the Greens have announced an agreement on high-level aspects of a new carbon price scheme. The scheme will operate in two phases - a fixed price phase (effectively a tax) and a floating price phase (emissions trading scheme) – and could commence as early as July 2012. Many significant aspects of the scheme, including the fixed price for permits in the first phase, the medium-term emissions reduction targets, the assistance package for industry, household compensation arrangements and the treatment of petrol have yet to be agreed. Partner Grant Anderson (view CV) and Lawyer Fergus Green report.

How does it affect you?

  • Companies in all major greenhouse gas-emitting sectors of the economy (except agriculture) could be liable to pay a carbon price in respect of their emissions from as early as 1 July 2012 under a new carbon price mechanism.
  • Designed as an emissions trading scheme, the mechanism would initially operate as a carbon tax by imposing a fixed price for emissions permits for at least three to five years which escalates over that period, following which an emissions cap will be imposed and the price of the permits will be set by the market.
  • The details of the scheme will be negotiated over the coming months and these negotiations are likely to be fraught, with the Government needing to retain the support of the Greens and win the support of key independents in the face of vigorous political and industry opposition. If affected companies wish to influence the development of the scheme, they will need to closely follow these negotiations.
  • While there is no certainty that the carbon price mechanism will be implemented, affected companies should accommodate the possibility that it will be implemented by including carbon pass through and liability allocation clauses in their longer term contracts.

Background

On 24 February 2011, the Federal Government and the Greens announced an agreement on the 'broad architecture' of a carbon price mechanism that would require companies in the most emissions-intensive sectors of the Australian economy to purchase emissions permits in respect of their greenhouse gas emissions by as early as July 2012.

Documentation of the agreement released by the Multi-Party Climate Change Committee (MPCCC) reveals the specific areas of consensus between the Government and the Greens on certain 'high level issues', although even these are expressed as possibilities rather than concrete commitments (the independent members of the committee only agreed that the document should be released for discussion). The Federal Opposition, which has declined to participate in the MPCCC, is staunchly opposed to any such carbon price mechanism, and the Leader of the Opposition has committed it to repealing the scheme if it wins power at the next election.

According to the MPCCC document, the scheme is likely to be designed as an emissions trading scheme that will function in two distinct phases: a fixed price phase that operates like a carbon tax, followed by a floating price phase that operates like a pure cap-and-trade scheme.

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The fixed-price phase and the floating-price phase

The fixed price phase could commence as early as July 2012 and last for three to five years (or longer, as discussed below). Under this proposal, a price for emissions permits will be fixed for the first year and this price will increase for each subsequent year in accordance with a predetermined rate of indexation. Liable entities under the scheme would then be required to purchase emissions permits sufficient to cover their greenhouse gas emissions at the (indexed) fixed price for each year during this phase.

Importantly, during the fixed price phase, liable entities may not be entitled to use international emissions units for compliance. If so, this would mean that international 'offsets' such as those generated under the Kyoto Protocol's Clean Development Mechanism could not be surrendered by Australian companies in lieu of purchasing Australian permits. This would in turn compel Australian companies to reduce their own emissions (or pay the indexed fixed price) rather than rely on cheaper offsets likely to be available from emerging markets overseas.

The MPCCC document envisages that the floating price phase would commence at the conclusion of the fixed price phase, at which point emissions would be capped at an annually decreasing rate and liable entities would need to obtain emissions permits sufficient to cover their greenhouse gas emissions at government-run auctions or on the secondary market (the structural adjustment package for industry is also likely to provide for companies in emissions-intensive sectors of the economy to be allocated some permits for free). In this phase, international offsets could be used for compliance purposes (possibly up to an annually capped amount) provided they meet certain criteria (yet to be developed) that ensure the quality of those offsets.

The rationale for the two-phased approach is that for a cap to be set under a (floating price) emissions trading scheme, the Government must decide on a medium or long-term emissions reduction target. It has traditionally been assumed that this would follow from international negotiations on a successor treaty to the Kyoto Protocol, the first commitment period of which concludes at the end of 2012. However, the slow pace of international negotiations over countries' targets and associated emissions accounting rules (see our previous Focus articles on Cancun and Copenhagen) has complicated the already challenging task of setting Australia's 2020 emissions reduction target. In this context, starting with a fixed price regime will allow Australia to commence the structural transformation towards a lower-carbon economy while a target is being negotiated both internationally and domestically.

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The transition between the fixed and floating price phases

In recognition of the fact that issues relating to international carbon markets and targets may not be settled even by the end of the proposed three to five year fixed price period, the MPCCC document proposes that the scheme include an option to defer the commencement of the floating price phase (and extend the fixed price phase) following a review of international and domestic developments. Such a decision would be required at least 12 months before the scheduled end of the fixed price phase,1 and would be based on factors including:

  • developments in international carbon markets (including the availability, integrity and price of international units) and key competitor economies (including the adoption of a carbon price mechanism and emissions reduction targets for those economies);
  • Australia's internationally agreed targets and progress towards meeting them, including whether they have been incorporated into a binding legal agreement, and the fiscal implications of any on-budget purchases of internationally accepted emissions units that may be required for Australia to comply with such a target; and
  • localised economic impacts on the Australian economy, including impacts on households and industry competitiveness and on investment in clean technologies, energy efficiency and carbon markets.

Should the floating price phase be deferred, the review would also consider whether to change the price and indexation rate of the fixed price for permits based on the level of international carbon prices and local economic impacts. As is evident from the above criteria, the government of the day will have plenty of scope for deferring the transition from the fixed price to the floating price phase. The real challenge in managing this transition will be to ensure that there is not a dramatic increase or decrease from the final fixed price to the opening floating price, and this will require a fixed price path that ends somewhere near the likely market price at that time.

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Scheme coverage

Like the Rudd Government's proposed Carbon Pollution Reduction Scheme, this new carbon price scheme is proposed to cover all six greenhouse gases covered by the Kyoto Protocol and the following sectors of the economy:

  • stationary energy;
  • transport;
  • industrial processes;
  • fugitive emissions (other than from decommissioned coal mines); and
  • emissions from non-legacy waste.

Sectoral coverage, particularly of the transport sector, is likely to be the subject of considerable public debate in coming months. Under the Carbon Pollution Reduction Scheme, the Government sought to cancel out the increase in petrol prices that would result from the imposition of the carbon price by reducing petrol-related taxes. Because this blunts the incentive effect of a carbon price on petrol consumers (motorists), this initiative (while politically popular) attracted criticism from other industry sectors, the Greens and Professor Ross Garnaut, and it will be interesting to see what approach the Gillard Government adopts in this respect.

As under the Carbon Pollution Reduction Scheme, emissions from the agricultural sector would also be excluded from coverage (though opportunities for generating abatement revenue in this sector will remain under the Carbon Farming Initiative). However, this does not mean that the agricultural sector will not be impacted by the new carbon price scheme – the imposition of a carbon price will increase the price of inputs used by that sector such as electricity, fuel and fertilisers. Coverage of the land sector is another issue that has yet to be decided (see below).

There is the possibility that coverage of sectors will be introduced in a staggered manner (as is the case for the New Zealand emissions trading scheme), in which case the electricity sector is likely to be the first sector covered.

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Matters yet to be determined

Critically, many important aspects of the scheme have yet to be determined even at the level of 'in-principle' agreement between the Federal Government and the Greens. The issue of coverage of the scheme is discussed above. Other significant matters still to be determined are described below.

The fixed starting price of emissions permits and the level of their indexation during the fixed price phase have not yet been agreed. Under the Carbon Pollution Reduction Scheme, permits were to be sold at a fixed price of $10 per permit for the first year of that scheme. However, it is generally accepted that a carbon price of less than $25 per tCO2-e will not be sufficient to encourage the start of Australia's transformation to a low carbon economy.

An important element in fixing the carbon price path, and in the operation of the floating phase of the carbon price scheme, is the establishment of annual emissions reduction targets including a 2020 target. The Government has only committed to a 2020 target of reducing greenhouse gas emissions by 5 per cent below their 2000 levels. On the other hand, the Greens have specified a 25 per cent reduction below 2000 levels as their minimum 2020 target.

The structural assistance package for emissions-intensive trade-exposed industries, and heavily affected (non trade-exposed) industries such as coal-fired electricity generators have yet to be agreed. This will be a major subject of future negotiations: the Government has expressed a general preference for compensation arrangements similar to that under the Carbon Pollution Reduction Scheme, while the Greens will be seeking stricter limits on industry compensation that cover trade exposure but not loss of profits per se.

It is also unclear whether any revenue from the scheme will be invested in measures aimed at the research, development and commercialisation of clean technologies. If the initial carbon price is relatively low then, together with existing market barriers, the carbon price mechanism will be unlikely to catalyse a significant shift to mature renewable energy sources, let alone large-scale investment in the development of less mature clean technologies or enabling network infrastructure. This means that the Government will need to consider investing in other, more direct measures to achieve this purpose. The forthcoming update to the Garnaut Review is likely to echo the 2008 Review (see chapters 18 and 19) in arguing for using a significant proportion of the carbon price revenue in this way.

Another politically contentious issue that will need to be resolved is the compensation package for low and middle income households. Recent studies have suggested that a household's average energy bill will increase by $110 per year by 2015 with an emissions reduction target of 5 per cent on 2000 levels by 2020.2 While this is only a small part of the $884 increase that is forecast as arising for other reasons (including the need to increase investment in energy infrastructure), the Government will be anxious to demonstrate that low income households will not be worse off under the carbon price scheme – and may in fact be over compensated by these assistance measures.

Finally, the treatment of abatement from the land sector is also yet to be resolved. The MPCCC document says options could include allowing Kyoto-compliant forests (ie new forests established on land cleared before 1990) to generate carbon permits or alternative arrangements for encouraging forest-related abatement (the Greens are in favour of a Green Carbon Fund). While biosequestration may have a number of 'co-benefits' (including in relation to biodiversity conservation), increasing forest coverage poses some challenges for water and food security which will need to be managed.

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Next steps

The Government has invited parties who wish to have input into the proposed scheme to contact the MPCCC via its email address MPCCC@climatechange.gov.au or mail address:

The Multi-Party Climate Change Committee Secretariat
GPO Box 854
Canberra ACT 2601
Australia

Other important inputs into the scheme that will be released in coming months include the Productivity Commission's report into the effective price of carbon in key competitor economies and Professor Garnaut's updated Review.

Political debate and negotiations over both high-level aspects and details of the scheme will continue over the coming months. The Government is likely to seek to legislate its proposed scheme some time after 1 July 2011, when the new Senate (in which the Greens will hold the balance of power) will take over.

If you would like further information in relation to the proposed new carbon price scheme please contact one of the people below.

Footnotes
  1. The MPCCC document notes that, unless there is a deferral, a particular 2020 target could be set no later than this date.
  2. See Michelle Grattan and Adam Morton, 'Voters Knew Labor stance on Carbon Price, Says PM', The Age (26 February 2011), p.9.

For further information, please contact:

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