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Focus: Foreign investment implications of the Australian carbon pricing scheme

25 July 2011

Chinese language version
 

In brief: The Australian Government has released details of its proposed carbon pricing scheme, which will operate initially like a carbon tax with a fixed (but increasing) carbon permit price and will then transition into a cap and trade scheme after three years. This scheme is set to be implemented in legislation that is to be introduced into the Australian Parliament later this year. Partners Grant Anderson and David Wenger report.

How does it affect you?

  • On 10 July 2011, the Australian Government released details of a new carbon pricing scheme. The scheme will operate in two phases: a fixed price phase commencing 1 July 2012, followed by a floating price phase commencing automatically on 1 July 2015.
  • The scheme will cover emissions from the stationary energy, industrial processing, mining and waste sectors in Australia. Entities that have operational control of a facility that emits more than 25,000tCO2-epa1 in greenhouse gas emissions from activities covered by the scheme will be required to surrender carbon permits to cover those emissions. Natural gas retailers will be liable for the greenhouse gas emissions embodied in the gas that they supply.
  • Transport fuels will be excluded from the carbon pricing scheme, but will be subject to an effective carbon price through changes to the fuel tax credit and excise regimes. Emissions reductions in the agricultural and land sectors (which will not be covered by the scheme) will be encouraged through the Government's Carbon Farming Initiative.
  • Emissions-intensive trade-exposed industries and coal-fired power generators will be eligible to receive assistance, primarily in the form of free carbon permits. The Government will seek to buy out some 2,000 MW of Australia's most emissions-intensive coal-fired power generation and will introduce measures to ensure stability in electricity supply markets.
  • The Government will establish a Clean Energy Finance Corporation to invest $10 billion of new funds into the commercialisation of renewable energy and energy efficiency technologies. This initiative, along with a range of other programs to encourage business and community investment in renewable energy, energy efficiency and land sector abatement, represents a significant opportunity for companies operating in clean and renewable energy industries to obtain Government funding of their projects.
  • Liable entities will need to consider how they allocate liability under the carbon pricing scheme within their corporate group or within the Australian unincorporated joint ventures of which they may be members. This will require a consideration of both statutory and contractual liability and cost transfer and allocation mechanisms.
  • Foreign entities operating in Australia that supply or purchase emissions-intensive or energy-intensive goods or services will need to consider whether their existing contractual arrangements provide for the pass through of costs associated with the carbon pricing scheme and will need to take into account the allocation of such costs when negotiating future contracts. It is highly desirable that contractual provisions for the pass through of carbon pricing scheme costs are tailored to the particular transaction and include appropriate incentives designed to minimise those costs.
  • Directors of liable entities should put in place strategies to manage their companies' liabilities under the carbon pricing mechanism, including by implementing appropriate purchasing and hedging strategies, and through the implementation of effective compliance programs.
  • Australian listed companies, or foreign listed companies with operations in Australia, should consider whether the announcement of the details of the carbon pricing mechanism triggers an obligation under the relevant securities exchange listing rules to disclose to the market the likely impact of the carbon pricing scheme on their operations.

Overview of the carbon pricing scheme

The fixed and floating price phases

The carbon pricing scheme will operate in two phases: a three-year, fixed price phase from 1 July 2012 to 30 June 2015, moving to a floating price phase on 1 July 2015. In both phases, liable entities will be required to acquire and surrender carbon permits equivalent to their annual emissions from activities covered by the scheme.

In the fixed price phase, the carbon price will commence at $23/tCO2-e, indexed annually at a real rate of 2.5 per cent pa. In this phase, the Government will sell to liable entities an uncapped number of permits at the applicable fixed price, which will be automatically surrendered by those entities to meet their liability and cannot be traded or banked for future use. While international permits2 will not be able to be used to acquit liabilities under the scheme during the fixed price phase, an entity will be able to acquit up to 5 per cent of its annual liability during this phase by surrendering Kyoto-compliant carbon credits generated under the proposed Carbon Farming Initiative.3 A limited number of carbon permits with a vintage year that occurs during the floating price phase will be auctioned during the fixed price phase so as to enable the establishment of a forward price curve.

In the floating price phase, the Government will set annual caps on the number of carbon permits to be issued in each year and the price of those permits will be determined by the market forces of supply and demand. The exception is that, for the first three years of this phase, there will be a carbon permit floor price of $15 (increasing at 4 per cent per annum in real terms) and a carbon permit ceiling price of $20 above the 'expected international price'4 (which will increase by 5 per cent per annum in real terms). This collar is intended to minimise the price volatility that may otherwise ensue upon the switch to the full market trading of carbon permits under the floating price phase. As under the fixed price phase, liable entities will be able to acquit their liabilities under the carbon pricing scheme using Kyoto-compliant Carbon Farming Initiative carbon credits – but, unlike for the fixed price phase, there will be no limit on the number of such carbon credits that may be used for this purpose. In addition, international permits5 will be able to be used to acquit carbon pricing scheme liabilities up to a maximum of 50 per cent of a liable entity's carbon permit surrender obligation. Carbon permits issued for the floating price phase will be able to be banked without limit, and liable entities will be able to 'borrow' such carbon permits from one vintage year (up to 5 per cent of their liability) in order to meet their liability for the immediately preceding vintage year.

Critical to the operation of the floating price phase is the establishment of annual scheme caps and targets. The Government has announced a 2020 emissions target of at least 5 per cent below 2000 levels, and has increased its 2050 emissions target from 60 per cent to 80 per cent below 2000 levels. A new independent Climate Change Authority will advise the Government on the annual scheme caps, which will be set on a five-year rolling basis. If the Government does not adopt the Authority's recommendations, it will need to table its reasons for this before Parliament.

There is not much detail about future linkages with carbon schemes in other countries. However, this is a very significant issue because access to lower-cost emissions reductions in other countries will provide liable entities with a more cost-effective way of meeting their obligations. Conversely, the use of such emissions reductions will lower the carbon permit price and diminish the revenue that the scheme raises, being revenue that is necessary to provide assistance to industry and to be invested in low-emissions technologies. Accordingly, we expect further debate on this issue.

The next federal election could be held as early as 30 November 2013. Opposition Leader Tony Abbott has threatened to repeal the carbon pricing scheme if the Liberal/National Party coalition is elected. However, given that the Greens party is likely to hold the balance of power in the Senate until at least 1 July 2017, the Labor Party and the Greens will be able to combine in the Senate to block any attempts to repeal the scheme legislation.

Carbon pricing scheme coverage

The carbon pricing scheme will cover the emission of four of the six Kyoto Protocol greenhouse gases (carbon dioxide, methane, nitrous oxide and perfluorocarbons) from the following economic sectors:

  • stationary energy (eg electricity generation);
  • industrial processing (eg aluminum smelting);
  • fugitive emissions (other than from decommissioned coal mines); and
  • emissions from landfill waste and waste water treatment (with an exemption for emissions from legacy waste, ie landfill waste deposited before 1 July 2012).

As such, it is proposed to cover around 60 per cent of Australia's emissions.

Agricultural emissions (which account for about 16 per cent of Australia's greenhouse gas emissions) and land sector emissions will not be covered by the carbon pricing scheme, while Kyoto-compliant forests will not be able to be opted into the carbon pricing scheme for the purpose of creating carbon permits through carbon sequestration. This is because the Government's Carbon Farming Initiative is intended to stimulate carbon biosequestration and greenhouse gas emissions reduction in the land and forestry sectors.

The other major exclusion from the carbon pricing scheme is transport fuels, which account for about 17 per cent of Australia's greenhouse gas emissions. However, transport fuels will face an effective carbon price, to be applied through changes to the system of fuel tax credits and fuel excise effective from 1 July 2012 in certain circumstances.6

Other exclusions from the carbon pricing scheme include emissions from the combustion of biofuels and biomass.7 Hydrofluorocarbons and sulphur hexafluoride will also be excluded from the carbon pricing scheme, but they will be subject to an equivalent carbon price through changes to existing import and manufacturing levies applicable under the Ozone Protection and Synthetic Greenhouse Gas Management Act 1989 (Cth).

Structural adjustment assistance

The carbon pricing scheme includes the following measures designed to provide structural adjustment assistance to those industry sectors that are likely to be particularly adversely affected by the introduction of a carbon price.

  • Under the Jobs and Competitiveness Program, the Australian Government aims to mitigate the effect of the carbon pricing scheme on those industry sectors that compete in global markets and sell their output at a world price by allocating free carbon permits to these industry sectors. Under this program:
    • the highest emissions-intensive activities (ie those for which emissions exceed 2,000tCO2-e/$m in revenue or 6,000tCO2-e/$m in value-added), such as aluminium smelting, will receive free carbon permits sufficient to cover 94.5 per cent of their average emissions initially (ie for 2012-13), decreasing at the rate of 1.3 per cent per annum; and
    • moderate emissions-intensive activities (ie those for which emissions are between 1,000 to 2,000tCO2-e/$m in revenue or 3,000 to 6,000tCO2-e/$m in value-added), such as LNG production, will receive free carbon permits sufficient to cover 66 per cent of their average emissions initially (ie for 2012-13), decreasing at the rate of 1.3 per cent per annum.
  • Australia's Productivity Commission will review these assistance rates in 2014-15. LNG producers will receive an additional allocation of free carbon permits to the extent this is necessary to ensure that they receive sufficient free permits to cover 50 per cent of all the emissions associated with the LNG production process (ie extraction, production, transport and energy use in compression).
  • $5.5 billion worth of assistance will be provided to emissions-intensive coal-fired electricity generators (ie those with an emissions intensity of more than 1tCO2-e/MWh of electricity).The ongoing provision of assistance to a generator will be conditional on:
    • the generator adopting a clean energy investment plan showing how it will reduce its emissions; and
    • the capacity of the generation plant not being reduced unless the market operator determines that such a reduction in capacity will not have an adverse impact on power system reliability (including because the generator replaces that capacity with lower emissions-intensity capacity).
  • In addition, the Government will seek to buy out some 2,000 MW of Australia's most emissions-intensive coal-fired power generation and will introduce measures to ensure stability in electricity supply markets.

The Australian Government has also proposed other funding packages for the steel and coal industries that do not yet have enough support to pass through the Australian Parliament.

Other climate change initiatives

The carbon pricing scheme proposal includes the following new complementary measures designed to promote renewable energy, improve energy efficiency and conserve biodiversity and carbon stocks in the land sector.

  • Under the Clean Technology Program, the Government will provide matched grants worth:
    • $1 billion over six to seven years to food processors, metal forges/foundries and certain manufacturing businesses to assist in the adoption of low-emissions and energy efficiency technologies; and
    • $200 million over five years to support business investment in research and development for renewable energy, low-emissions and energy efficiency technologies.
  • An independent Clean Energy Finance Corporation will be established with $10 billion (over five years) in government funding to support the deployment and commercialisation of renewable energy, low emissions intensity and energy efficiency technologies (excluding carbon capture and storage).
  • Another new independent body, the Australian Renewable Energy Agency, will be established to administer the $3.2 billion worth of funds allocated (or planned to be allocated) to various existing government programs (such as the Solar Flagships program) that support the research, development, demonstration and commercialisation of renewable energy technologies. This will replace the current patchwork of programs and institutes administering these different programs.
  • The Government has committed to continuing the Energy Efficiency Opportunities Program through to at least 2016-17 and expanding it to include energy transmission and distribution networks, major greenfield and expansion projects, and a voluntary scheme for 'medium' energy-intensive businesses (ie that use less than 0.5PJ per year).
  • In addition to the Carbon Farming Initiative, the Government will establish a Biodiversity Fund of $946 million (over six years) that will be applied to:
    • establish biodiverse carbon plantings in areas of high conservation value, such as wildlife corridors, riparian zones and wetlands;
    • prevent the spread of invasive species across connected landscapes; and
    • manage existing biodiverse carbon stores, including on land already under conservation covenants or subject to land clearing restrictions, and publicly owned native forests.

Implications for foreign investors in Australia

The carbon pricing scheme is a far-reaching economic reform that will affect a range of businesses. While only 500 businesses are expected to be directly liable under the scheme, the imposition of a carbon price will increase the cost of energy-intensive and emissions-intensive inputs (such as electricity, gas, aluminium, steel, glass and cement) that are used by many businesses. Overall, this is expected to increase the CPI by 0.7 per cent initially and a further 0.2 per cent when the scheme transitions from its fixed price phase to its flexible price phase.

Although the carbon pricing scheme will impose additional costs on many businesses in Australia, it also creates a number of opportunities for businesses and foreign investors. As noted above, the Australian Government is committed to providing more than $15 billion in funding through various programs to support the deployment and commercialisation of renewable energy, low emissions intensity and energy efficiency technologies and projects. This represents a significant opportunity for companies operating in clean and renewable energy industries to obtain government funding of their projects.

Foreign investors with current or prospective investments in affected industries should be aware of the following:

  • It is important that you determine whether you are directly liable under the scheme. You will be directly liable if you:
    • undertake an activity in the stationary energy, industrial processing, mining or solid landfill/waste water treatment sectors that produces direct greenhouse gas emissions (including fugitive emissions) in excess of 25ktCO2-epa, and the greenhouse gas emissions take the form of carbon dioxide, methane, nitrous oxide or perfluorocarbons (a lower threshold of 10ktCO2-epa applies to landfills that are located close to large landfill facilities); and
    • you have 'operational control' over the emitting facility, meaning you have the authority to introduce or implement operating, health and safety, or environmental policies for the activity or (if more than one entity has such authority) you have the greatest authority to introduce and implement operating and environmental policies for the activity.
  • You will also be directly liable if you are a natural gas retailer, in which case you will be liable for the greenhouse gas emissions embodied in the natural gas and that liability will crystallise when you supply the gas to a customer.
  • If you are liable, you:
    • will need to decide how to manage your carbon liability – that is, to which company within your corporate group the liability should be allocated, how that liability is to be acquitted (eg the strategy that is to be adopted to enable the acquisition of the necessary carbon permits in the most cost-effective way) and whether the costs associated with that liability can be passed through to customers; and
    • should consider whether you are entitled to structural adjustment assistance (eg under the Jobs and Competitiveness Program or the coal-fired electricity generation assistance package) and how to obtain this assistance.
  • If you:
    • are a directly liable entity; or
    • supply or purchase energy-intensive or emissions-intensive goods or services,
  • you should review your existing contracts to determine the extent to which you will be able to pass through (or resist the pass through of) costs associated with the carbon pricing scheme.
  • If you have an investment in an affected Australian listed company, or if you are a foreign listed company with operations in Australia (eg participating in an unincorporated joint venture), you should consider whether such listed company should be making disclosures to the market regarding the likely effect of the carbon pricing scheme on its operations.
  • If you are a director or officer of an affected Australian company, you will be under a duty to ensure that the company has in place strategies to manage its liability under the carbon pricing scheme, including by introducing lower-emissions technologies and processes and implementing purchasing and hedging strategies to mitigate the company's carbon costs.
  • If you wish to trade in such permits, you will likely be required to hold an Australian Financial Services Licence, because carbon permits will be 'financial products' for the purposes of the financial services regulatory regime under the Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth).

Next steps

The Government has indicated that it intends to release an exposure draft of legislation to implement the carbon pricing scheme on 31 July 2011, following which the legislation will be introduced into Parliament by the end of this year. The aim is to commence the carbon pricing scheme on 1 July 2012.

If you would like further information about the proposed operation of the carbon pricing mechanism or its potential implications for your business, please contact any of the people below.

 
Footnotes
  1. Twenty-five thousand tonnes of CO2 or CO2 equivalent.
  2. Such as certified emissions reduction units generated under the Kyoto Protocol Clean Development Mechanism.
  3. The legislation to implement the Carbon Farming Initiative is currently before Parliament and will be the subject of a forthcoming Focus article when it becomes law.
  4. By which the Government seems to mean the price of certified emissions reduction units under the Kyoto Protocol Clean Development Mechanism. The exact starting ceiling price will be set in regulations by 31 May 2014. 
  5. Such international permits include certified emissions reduction units (CERs) under the Kyoto Protocol Clean Development Mechanism, emission reduction units (ERUs) under the Kyoto Protocol Joint Implementation arrangements, removal units issued by a Kyoto Protocol country on the basis of land use, land-use change and forestry activities and any other international units that the Government may allow by regulation (eg units from the European and New Zealand emissions trading schemes). However, there will be some quality restrictions imposed – eg forestry CERs, nuclear CERs/ERUs, and CERs/ERUs from the destruction of trifluoromethane (HFC-23) or of nitrous oxide from adipic acid plants or from non-compliant large scale hydro electric projects, will not be eligible for surrender under the carbon pricing scheme.
  6. The relevant circumstances are: liquid fuels for business transport (other than in the agriculture, forestry and fisheries industries), including liquid fuels used in the domestic aviation, shipping and rail sectors; liquid fuels used for non-transport purposes (eg diesel used for power generation); and compressed natural gas, liquefied natural gas and liquefied petroleum gas used for off-road transport and non-transport uses.
  7. The Renewable Energy Target scheme will be amended to exclude biomass from native forests (including by-products and waste associated with the clearing or harvesting of native forests) from being an eligible renewable energy source.

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