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Client Update: Draft legislation to bring forward the emissions trading scheme phase released

30 July 2013

In brief: The Federal Government has released exposure draft legislation to give effect to its recently announced policy of commencing the emissions trading scheme phase of the carbon pricing scheme one year before the scheduled date of 1 July 2015. Partner Grant Anderson and Lawyer Albert Yu report.

Background

The Clean Energy Act 2011 (Cth) and associated legislation establishing a national carbon pricing scheme was passed into law in late 2011 (see our Focus: Carbon price scheme becomes law – what to do next; amendments in relation to LPG, LNG and CNG; and the amendments in relation to the linkage of the Australian carbon pricing scheme with the European Union's emissions trading scheme and other matters). The carbon pricing scheme currently operates in two phases. During the initial three-year 'fixed price phase' (1 July 2012 to 30 June 2015), liable entities are able to meet their scheme liabilities by acquiring and surrendering carbon units at a fixed price: $23/tCO2-e (for 2012/13), $24.15/tCO2-e (for 2013/14) and $25.40/tCO2-e (for 2014/15)1. On 1 July 2015, the scheme automatically switches from the fixed price phase to the 'floating price phase', during which there is a cap on the number of carbon units that can be issued for each year (at auction and under the industry assistance programs), with the market price of those units being determined by the forces of supply and demand. Given that liable entities will be able to meet up to 50 per cent of their annual scheme liabilities during the floating price phase by acquiring and surrendering international units (primarily European Union allowances but, to a lesser degree, Kyoto Protocol units), it is expected that the price of Australian carbon units will be largely dictated by the European Union allowance price (which is currently around $4 to $5 per unit). For the first three years of the floating price phase, there is to be a ceiling on the price of Australian carbon units that commences at $20 above the expected 2015/16 international price and increases at 5 per cent pa in real terms; the effect of this is that, if international unit prices are above this ceiling, liable entities will nevertheless be able to meet their scheme liabilities by acquiring the carbon units that they require from the Clean Energy Regulator at that capped price. In addition, during the floating price phase (and in contrast to the fixed price phase), carbon units can be banked (ie earlier vintage carbon units can be surrendered to meet carbon liabilities arising in subsequent financial years) and, to a limited extent, borrowed (ie liable entities can meet up to 5 per cent of their annual scheme liability by surrendering carbon units that have a vintage of the immediately following financial year)2.

On 16 July 2013, the Federal Government announced that it would start the floating price phase on 1 July 2014, one year before the scheduled date of 1 July 2015. On 25 July 2013, the Federal Government released exposure drafts of the legislative amendments required to implement this policy position. Given that Parliament is unlikely to sit before the next election and that this policy does not have the support of either the Opposition or the Australian Greens, the successful passage of these amendments will depend upon the outcome of the next election. Submissions on the exposure drafts are due by 15 August 2013.

Key amendments

The key amendments proposed are as follows.

  • The floating price phase will commence on 1 July 2014, so that the 2014/15 year will now be a 'flexible charge year' rather than a 'fixed charge year'. The effect of this is that liable entities will be required to surrender sufficient emissions permits to cover their emissions for 2014/15 by 1 February 2016 (there will be no interim surrender, to cover around 75 per cent of their liability, on 15 June 2015). In addition, liable entities will be able to meet their 2014/15 scheme liabilities by surrendering international units (see below), as well as be able to bank carbon units with a 2014/15 vintage for surrender in subsequent years and borrow carbon units with a 2015/16 vintage to acquit up to 5 per cent of their 2014/15 scheme liability.
  • There will be a cap on the number of carbon units that can be issued with a 2014/15 vintage. This cap will be prescribed by regulations that must be tabled by 31 May 2014 (with the relevant cap being determined taking into account the recommendations of the Climate Change Authority3) or else a default cap of 25 million tonnes below 2012/13 liable emissions will apply.
  • The price ceiling that is to apply from the commencement of the floating price phase will potentially apply for a four-year period from 2014/15 to 2017/18, with regulations setting the price ceiling to be made by 1 July 2014. However, provision has been made for regulations to be made that vary the 5 per cent pa increase in the price ceiling or to preclude the application of the price ceiling in any of the 2015/16, 2016/17 and 2017/18 years. The Government has not indicated how, or in what circumstances, it would propose exercising this new regulation-making power.
  • It is proposed that two advance auctions of 2014/15 vintage carbon units will be held in February and June 2014, with there being four auctions of 2014/15 vintage carbon units during 2014/15 and one 'catch up' auction of 2014/15 vintage carbon units between 30 June 2015 and 1 February 20164. If no regulations have been made for the purpose of prescribing a cap on the number of 2014/15 vintage carbon units that can be issued, then up to 40 million 2014/15 vintage carbon units will be able to be auctioned at these two advance auctions.
  • As stated above, liable entities will be able to meet their 2014/15 scheme liability by surrendering international units. For 2014/15, as with other years of the floating price phase, the use of international units (European Union allowances and Kyoto Protocol units) for this purpose will be limited to meeting 50 per cent of a liable entity's 2014/15 scheme liability. However, in contrast to future years, the proportion of a liable entity's 2014/15 scheme liability that can be acquitted using Kyoto Protocol units will be 6.25 per cent (rather than 12.5 per cent). While the Australian carbon scheme will only link with the European emissions trading scheme from 1 July 2015, Australian liable entities will still have time to acquire European Union allowances for surrender for 2014/15 scheme liabilities because the surrender date for 2014/15 is 1 February 2016.
  • While there will be no changes to the methodologies for calculating the number of free carbon units that will be issued under the Jobs and Competitiveness Program (apart from those necessary to accommodate 2014/15 being a flexible charge year), coal-fired electricity generators which are entitled to receive free carbon units under the coal-fired electricity generation assistance program will now receive their 2015/16 allocation of free units on 1 September 2014 (together with their 2014/15 allocation) and there will be no allocation of free carbon units for 2016/17.
  • The fuel tax credit adjustment necessary to reduce the fuel tax credits that may be claimed by entities that acquire liquid fossil fuels in respect of 2014/15 will be based on the weighted carbon market price (as it would for subsequent years) rather than on the previous fixed carbon unit price of $25.40 for 2014/15.

Implications of the proposed amendments

The (early) commencement of the floating price phase in 2014/15 will result in a drop in the carbon price from $24.15 in 2013/14 to around $6 in 2014/15, which is the currently-expected price of European Union allowances. (See the relevant Australian Government Fact Sheets here and here.) This will mean that liable entities will pay considerably less than the $25.40 per tCO2-e of emissions that they would otherwise have paid. At least in theory this should, in turn, reduce the cost of energy and emissions-intensive production inputs such as electricity and gas.

Conversely, bringing forward the floating price phase by just one year is unlikely to have much impact on clean energy (or, indeed, emissions-intensive) investment, even taking into account the early discontinuance of the coal-fired electricity generation assistance program. This is because investments are undertaken on the basis of multi-year horizons rather than a single year, and so it is the longer-term outlook for carbon prices that is of more importance to investment (and the investment mix). In this regard, because the floating price will be driven largely by the price of European Union allowances, investors will need to understand not just domestic carbon-related developments, but also the drivers of the European Union allowance price. These drivers may derive from the operation of the market (eg its response to changes in economic activity) as well as policy changes. For example, the European Parliament has recently voted in favour of a 'backloading' proposal which is designed to deal with the oversupply of European Union allowances in the market that has resulted in low allowance prices, but it remains to be seen whether this proposal will be approved by the Council and (if it is) whether it will be sufficient to underwrite substantially increased European Union allowance prices in the longer term.

Having said this, the biggest uncertainty for carbon-impacted investments at the moment is political uncertainty. If the Opposition is elected as the next Government, then it will replace the current carbon pricing scheme with its Direct Action Plan – assuming it is able to garner sufficient votes in the Senate (whether at the next election or through a subsequent double dissolution election and/or joint sitting). Indeed, even the implementation of the current Government's proposal to bring forward the floating price phase is dependent on the outcome of the next election because there will be no opportunity to put the amending legislation to Parliament before then.

If anything, these uncertainties and the prospect of low carbon prices highlight the importance for renewable energy investment of the continuation of the mandatory renewable energy target scheme, which currently appears to have bipartisan support although that scheme will continue to be subject to periodic review and there appears to be some support for reducing the target.

In so far as liable entities are concerned, if the floating price phase is brought forward, then they will need to prepare for this by implementing strategies to deal with a floating price, including entering into carbon price hedging arrangements and deciding how they will source the emissions permits that they require (eg domestically or internationally, at auction or on the spot market etc). Assuming that contractual carbon pass through clauses have been drafted sufficiently broadly, so that they are not based on the assumption that there is a fixed price phase of three years, then there should be no need for liable entities or their contract counterparties to renegotiate their contracts to accommodate an early start to the floating price phase.

Footnotes
  1. Liable entities can also surrender free carbon units that are issued under the Jobs and Competitiveness Program or the coal-fired electricity generation assistance program, as well as meeting up to 5 per cent of their annual liability by surrendering Kyoto-compliant Australian carbon credit units that are issued under the Carbon Farming Initiative.
  2. During the floating price phase, a liable entity can also meet its scheme liabilities by surrendering an unlimited amount of Kyoto-compliant Australian carbon credit units that are issued under the Carbon Farming Initiative.
  3. On 19 July 2013, the Minister requested the Climate Change Authority to undertake a special review for this purpose; the Authority's report is due by 28 February 2014.
  4. The opening auction price for these auctions will be set at 80 per cent of the European Union allowance price.

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