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Client Update: Australia's EU carbon price linkage and its consequences

29 August 2012

In brief: The Federal Government announced yesterday that the Australian and European Union emissions trading markets will be linked from 1 July 2015 and that, to facilitate this, the Government will abandon the carbon floor price and restrict the use of Kyoto emission reduction units under the Australian scheme. Partner Grant Anderson and Law Graduate Albert Yu report.

Background

When the carbon pricing scheme legislation was passed, it was intended that, for the first three years of the floating price phase (1 July 2015 to 30 June 2018), there would be a price collar comprising a floor price of $15 (rising to $17.05 in the third year) and a ceiling price of $20 above the prevailing international emissions unit price (increasing by 5 per cent pa in real terms over the three-year period). During the floating price phase, liable entities are entitled to acquit up to 50 per cent of their annual carbon liability1 using eligible international emissions units (ie specified Kyoto Protocol emission reduction units).2 The purpose of the price collar was to ensure a smooth transition from the fixed price phase to the floating price phase and to build 'safety valves' into the scheme to avoid price spikes or plunges, as might arise if there were to be a significant divergence between the fixed price for 2014-15 and the price of international emissions units in the following year.3 The Government was also of the view that a price collar would reduce the risk for businesses as they gained experience in having a market set the carbon price.4

In order to maintain the floor price, it would have been necessary to specify minimum reserve auction prices consistent with it and to require liable entities surrendering international emissions units to make a 'top up' payment to the extent the price of those units was below the floor price.5 The Federal Government has been consulting on the manner in which to calculate this top-up payment, but all of the proposals discussed to date have proven to be problematic.

When the carbon pricing scheme legislation was passed, the Federal Government also stated its intention to link Australia's carbon market with other trading schemes such as the European Union and New Zealand emissions trading schemes.6 This was to occur if the schemes were of a suitable standard, based on a range of criteria including:

  • an internationally acceptable (or, where applicable, a mutually acceptable) level of mitigation commitment;
  • adequate and comparable monitoring, reporting, verification, compliance and enforcement mechanisms; and
  • compatibility in design and market rules.7

Changes announced

Yesterday, the Federal Government announced that, following agreement with the European Commission, European Union emissions trading scheme allowances (the EU allowances) would be able to be used by liable entities to acquit their annual carbon liability under the Australian carbon pricing scheme, subject to the overarching 50 per cent limit on the use of international emissions units for that purpose. In other words, there will be a 'one way' link between the Australian and European Union trading schemes. Negotiations are under way for there to be a 'two way' link in place by 1 July 2018, under which Australian carbon units will be able to be used to meet European Union emissions trading scheme liabilities as well as EU allowances being able to be used to meet Australian emissions trading scheme liabilities; however, this will require the negotiation of a treaty between the European Union and Australia.

As part of the agreement with the European Commission, there will be no price floor for the Australian emissions trading scheme and (within the 50 per cent limit) Kyoto Protocol emission reduction units will only be able to be used to acquit up to 12.5 per cent of a liable entity's annual carbon liability under the Australian scheme. The consequence of this is that, from 1 July 2015, the Australian carbon price will effectively be determined, not by a floor price or by the price of Kyoto Protocol emission reduction units, but by the price of EU allowances.

The Australian carbon pricing scheme will retain a ceiling price for the first three years of the floating price phase, but that ceiling price will now be set at $20 above the expected price for EU allowances in 2015-16, indexed at 5 per cent pa in real terms.

Consequences of changes

EU allowances are currently trading at around $10, and Kyoto Protocol emission reduction units at around $3.50. However, the European Commission is looking at ways to increase the price of EU allowances, including through reserving (ie deferring the issue of EU allowances into the market).

The principal consequence of the changes that the Federal Government has announced is that, from 1 July 2015, Australian liable entities will be able to acquit their carbon liabilities at international carbon prices, which (due to the constraint on the use of Kyoto Protocol emission reduction units) will be the EU allowance price. The implications of this for Australian liable entities are that:

  • they can bank cheaper international emissions units now for the purpose of meeting some of their floating price phase liabilities;
  • in order to forecast future Australian carbon prices, they will need to be familiar with the drivers of EU allowance prices; and
  • the Australian carbon price will effectively be dictated by the EU allowance price, which, in turn, means that the price of Carbon Farming Initiative credits, and the incentives to implement emissions reduction technologies and to invest in renewable energy, will depend upon EU allowance prices.

In so far as the Federal Government is concerned, the risk is that EU allowance prices are lower than those necessary to fund its household and industry assistance packages, which will place pressure on the budget (this will compound that existing issue which is that, to the extent that liable entities purchase and surrender EU allowances rather than Australian carbon units, there will be revenue leakage in any event). Legislation will be required to implement these policy changes, but it appears that the Federal Government has the support of both the Australian Greens and the key independents so that the passage of the legislation is assured.

Footnotes
  1. Clean Energy Act 2011 (Cth) (the CEA), s133(7).
  2. These include certified emissions reductions from Clean Development Mechanism projects, emission reduction units from Joint Implementation projects and removal units: see the CEA, s5; Australian National Registry of Emissions Units Act 2011 (Cth), s4.
  3. Explanatory Memorandum to the Clean Energy Bill 2011 (Cth), p.32; see also par.3.82.
  4. Explanatory Memorandum to the Clean Energy Bill 2011 (Cth), p.32.
  5. See Clean Energy (International Unit Surrender Charge) Act 2011 (Cth), s8; see also Explanatory Memorandum to the Clean Energy Bill 2011 (Cth), pars 3.84, 4.77.
  6. Explanatory Memorandum to the Clean Energy Bill 2011 (Cth), par.3.110.
  7. Explanatory Memorandum to the Clean Energy Bill 2011 (Cth), par.3.111.

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