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Focus: EU linkage and other carbon pricing scheme amendments

27 November 2012

In brief: The Federal Parliament has passed legislation to allow Australia's carbon pricing scheme to be linked with the European Union emissions trading scheme from 1 July 2015, and to make significant amendments relating to the treatment of natural gas, the fuel opt-in scheme and the auctioning of carbon units. Partner Grant Anderson and Law Graduate Albert Yu report.

How does it affect you?

  • Newly passed legislation will facilitate the linking of the Australian and European Union emissions trading schemes. From 1 July 2015, this linking will allow EU allowances to be used, either directly or indirectly (through 'shadow' units), to satisfy up to 50 per cent of a liable entity's annual Australian carbon pricing scheme liability. However, only 12.5 per cent of an entity's annual liability will be able to be satisfied using Kyoto Protocol units.
  • The legislation also removes the floor price that was to apply for the first three years of the floating price phase of the Australian carbon pricing scheme. Accordingly, liable entities may wish to start stocking up on relatively cheap EU allowances and Kyoto Protocol units that they can bank for use during the floating price phase.
  • As a result of these changes, the fuel tax credit reduction that is applied to certain liquid fossil fuels to reflect an effective carbon price will now be calculated for the floating price phase by reference to a weighted average of the Australian carbon unit and Kyoto Protocol unit prices.
  • The legislation makes provision for the coverage of emissions from natural gas that is combusted in sub-threshold facilities. However, the activation of these provisions, which will impose such liability on the relevant natural gas supplier, is dependent on regulations being made and such regulations will not take effect until 1 July 2013 at the earliest.
  • A GST joint venture operator will be able to be a designated opt-in person for the fuel opt-in scheme, which is intended to come into operation with effect from 1 July 2013.
  • The number of carbon units that can be auctioned in advance in certain circumstances has been increased, so as to facilitate the establishment of a forward carbon price curve.

Background

As discussed in our previous Client Update, on 28 August 2012 the Federal Government announced its plans to link Australia's carbon pricing scheme with the European Union (EU) emissions trading scheme from 1 July 2015. In addition to providing for this linking (as well as future linkages with other foreign emissions trading schemes), the legislation that has been passed makes significant amendments to the Clean Energy Act 2011 (Cth) (the CEA) relating to the treatment of natural gas, the fuel opt-in scheme and the auctioning of carbon units.

Amendments to facilitate linking with EU emissions trading scheme

One-way linking

While the Australian carbon pricing scheme is to be linked with the EU emissions trading scheme from 1 July 2015 (the commencement of the floating price phase for the Australian scheme), this linkage will initially only be one-way, in the sense that EU allowances will be able to be used in the Australian scheme but Australian carbon units will not be able to be used in the EU scheme.

In this regard the Clean Energy Legislation Amendment (International Emissions Trading and Other Measures) Act 2012 (Cth) (the Principal Amendment Act) provides for two possible methods of linking the Australian carbon pricing scheme with the EU emissions trading scheme.

The first method is by the direct linking of the Australian and European registries. For this purpose, EU allowances are included under the Australian carbon pricing scheme as 'eligible international emissions units',1 and so can be used by liable entities under the Australian scheme to acquit their Australian carbon liabilities.2 The Clean Energy Regulator (the Regulator) has the power to facilitate the direct linkage of the Australian and European registries if there is an international agreement or arrangement that provides for their linking.3

The second method of linking is indirect linking. This is effected by the issue of 'Australian-issued international units' (AIIUs). Under this method, an entity can buy EU allowances (or other prescribed foreign units) and exchange those units for an equal number of AIIUs.4 Those AIIUs can then be used by liable entities to satisfy their Australian carbon liabilities.5 Yet-to-be-made regulations will regulate the disposal of foreign units in exchange for AIIUs.6 However, in so far as EU allowances are concerned, it appears that this is likely to involve the entity transferring EU allowances into an account opened by the Commonwealth within a EU registry, and the Regulator issuing a corresponding number of AIIUs into the Australian registry account of the transferor or its nominee.7 This form of indirect linkage does not require any international agreement or arrangement with the EU, nor does it require any action on the part of the EU. Also, it can be used to facilitate Australia's linkages with other emissions trading schemes, such as the New Zealand emissions trading scheme, if the Australian Government wishes to do so.8

As is the case for carbon units, AIIUs can be ordered by a court to be relinquished for fraud.9 Accordingly, the provisions on the relinquishment of AIIUs substantially mirror the CEA provisions on the relinquishment of carbon units10 except that, instead of relinquishing the required number of AIIUs, it will be possible to transfer to the Commonwealth an equal number of 'substitute units' (ie Australian carbon units or Kyoto-compliant Australian carbon credit units that are issued under the Carbon Farming Initiative).11 In addition, the Government may make regulations that set out the conditions on which AIIUs may be cancelled by the Regulator, eg as where an indirect link is to be replaced by a direct link.12

A qualification to the use of EU allowances in the Australian scheme is that allowances issued in respect of aviation activities will not be able to be surrendered to satisfy Australian carbon liabilities.13 This is because EU aviation allowances can only be used for compliance by aircraft operators that have a liability under the EU scheme, and may therefore trade at different prices to other EU allowances.14

Two-way linking

A two-way link between the Australian and EU schemes – which will allow liable entities under the EU scheme to acquit their scheme liabilities by surrendering Australian carbon units – is targeted to take effect from 1 July 2018, providing that a treaty establishing the two-way link can be successfully negotiated between Australia and the EU. The detail of any such treaty has yet to be developed, but it will be important to have adequate provisions in the treaty to protect Australia's national interest. For example, under the treaty, the Federal Government could sensibly retain the ability to delink the Australian carbon pricing scheme from the EU scheme if there is sustained volatility in the prices of EU allowances, or if the EU scheme adopts rules or links to another scheme and those rules or that linkage adversely affects the Australian carbon pricing scheme. Similarly, the Federal Government might wish to preserve the right to accept cheaper international emissions units into the Australian scheme irrespective of whether the EU scheme imposes tighter restrictions on their use in the EU scheme.

Limits on the use of foreign units in Australian scheme

The use of EU allowances under the Australian carbon pricing scheme will be subject to the existing overarching 50 per cent limit on the surrender of foreign units to meet a liable entity's annual carbon pricing scheme liability for the floating price phase of the scheme15 – that is, until 1 July 2020, a liable entity will only be able to satisfy up to 50 per cent of its annual Australian carbon pricing scheme liability using EU allowances.16

However, the Government will also be able to impose additional limits on the use of other foreign units (as prescribed by regulation) if it wishes to do so.17 In this regard, the legislation itself provides that Kyoto Protocol units (such as certified emissions reductions from Clean Development Mechanism projects)18 will only be able to be used to acquit up to 12.5 per cent of a liable entity's annual Australian carbon pricing scheme liability.19 Unlike the 50 per cent limit,20 this 12.5 per cent limit will not sunset on 1 July 2020, although it may be changed by regulations after 1 July 2020.21

If a liable entity under the Australian carbon pricing scheme surrenders more international emissions units than are permitted under any of these prescribed limits, the entity will be taken to have surrendered the excess units for the subsequent financial year.22 In addition, if a liable entity exceeds both the specific 12.5 per cent limit on Kyoto units and the general 50 per cent limit on foreign units, the 12.5 per cent limit is to be applied before applying the 50 per cent limit in calculating that excess (unless there is a Ministerial order to the contrary).23

Removal of the carbon floor price

A corollary to linking the Australian and EU emissions trading schemes is the removal of the Australian scheme floor price, which was also announced by the Government on 28 August 2012. This floor price was to apply for the first three years of the floating price phase (1 July 2015 to 30 June 2018), commencing at $15 for 2015-16 and rising to $17.05 in 2017-18. While the floor price has been removed, the Government has retained the accompanying three-year price cap, which is now to be $20 above the expected price for EU allowances in 2015-16 and is to escalate at 5 per cent pa in real terms over the subsequent two years.24

In order to sustain the floor price, it was necessary to require liable entities that used foreign units to satisfy their Australian carbon liabilities to make a 'top up' payment when they surrendered those units. The calculation of this top up payment has proven to be problematic, but this issue has now disappeared, along with the floor price.25

Despite the removal of the floor price, the reserve charge amount on auctions has been retained.26 The reason for this is that such a reserve price is not intended to act as a price floor but rather to minimise administrative inconvenience by enabling carbon unit auctions to commence at a realistic price.27

Fuel tax credit adjustments

Emissions from the combustion of certain liquid fuels28 are not currently subject to direct carbon liability, and instead face indirect carbon liability, which is imposed primarily by reducing the fuel tax credits (FTCs) that would otherwise be available in respect of them by reference to a 'carbon reduction'.29 Before the amendments made by the Principal Amendment Act, from 1 July 2015 the carbon reduction was to be based on the average carbon unit auction price for the preceding six-month period ending on 31 May or 30 November (as the case may be).30 However, as a result of the amendments, the carbon reduction will now be based on a 'per-tonne carbon price equivalent' for each of these six-month periods.31 Broadly speaking, the per-tonne carbon price equivalent is a weighted average of the price of Australian carbon units and the price of Kyoto Protocol units32 that can be used in the Australian carbon pricing scheme,33 and is based on the assumption that the price of Australian carbon units will be the same as that of EU allowances.34 It is calculated as the sum of:35

  • the reference price for Kyoto Protocol units for the relevant six-month period, as determined by the Regulator using a methodology specified by Ministerial order, multiplied by the surrender limit for those units (12.5 per cent);36 and
  • the average carbon unit auction price for that six-month period adjusted for the surrender limit (87.5 per cent),

but is capped at the applicable average carbon unit auction price.37

Natural gas amendments

The Principal Amendment Act introduces some significant changes to the treatment of natural gas supply and use arrangements for the purposes of the carbon pricing scheme. The changes are intended to 'maintain competitive neutrality by supporting the complete coverage of natural gas under the carbon pricing mechanism over time'.38

Under the existing provisions of the CEA, which establish the primary natural gas liability regime, carbon liability for the emissions embodied in natural gas,39 which may be either imposed on the natural gas supplier40 or transferred to the purchaser where the purchaser acquires the natural gas under an obligation transfer number,41 only arises where there is a 'supply' of the natural gas, ie a supply by way of sale, exchange or gift.42 Moreover, for there to be such a supply, the natural gas must be withdrawn from a natural gas supply pipeline.43 There is a 'withdrawal' of natural gas where (among other things) the natural gas exits from a point on a pipeline in relation to which the natural gas supplier will ascertain the amount of that natural gas supplied to a person for use.44

A self-contracting end user will typically take delivery of the natural gas at an inlet point on a pipeline and then arrange for its transportation to a point at which it withdraws the gas for its own use. While there will be a sale of the gas by the natural gas supplier to the end user at the inlet point, there would be no 'supply' of the gas to the end user under the primary natural gas liability regime because the natural gas supplier does not ascertain the withdrawn quantity of natural gas at the exit point (ie there is no withdrawal). This does not matter where the natural gas is combusted in an above-threshold facility45 because the emissions from that combustion will attract liability under the carbon pricing scheme as direct emissions.46 However, where the self-contracting end user combusts the natural gas in a sub-threshold facility, there would be no liability for those emissions under the primary natural gas liability regime. It is largely in order to impose liability in these circumstances that the Principal Amendment Act provides for the establishment of an 'own-use' notification scheme.47

The application and operation of the own-use notification scheme will depend upon regulations being made that actually establish the scheme, and so the enactment of the Principal Amendment Act does not itself result in the scheme coming into operation. Instead, the earliest time at which such a scheme can come into operation is from the beginning of the 2013-14 financial year.48 The own-use notification scheme will apply where the use of the natural gas does not attract either direct emissions liability (because it is combusted at a sub-threshold facility) or embodied emissions liability (eg because there is no supply or withdrawal of the natural gas).49 It will therefore be necessary for regulations to be made that modify the circumstances in which there is a 'natural gas supplier', and in which (and when) a 'supply' of natural gas is to be considered to occur.50 This will enable the scheme to apply to 'supplies' of natural gas that would not be 'supplies' under the primary natural gas liability regime.

Where the own-use notification regime applies, the end user will be liable for the embodied emissions in the natural gas that is supplied to it51 unless the end user has given an own-use notification to the supplier that is accepted by the supplier. Where the end user gives the supplier an own-use notification that is accepted by the supplier, then the supplier will be liable for those embodied emissions.52 However, even then, the supplier's liability will be reduced, and the end user's liability will be correspondingly increased, to the extent the gas supplied to the end user is not actually used by the end user (the amount of the gas that is actually used by the end user being notified to the supplier by way of a follow-up notification that is given within 28 days after the end of the financial year in which the gas was supplied).53 The effect of the own-use notification regime is therefore to allow carbon liability to be imposed on the natural gas supplier for the emissions embodied in the natural gas that it supplies to an end user (in such a case, the supplier will wish to charge the end user a carbon-inclusive price for the natural gas).

Regulations will prescribe the circumstances in which end users will be obliged, or entitled, to give an own-use notification, and natural gas suppliers will be obliged, or entitled, to accept an own-use notification.54 Regulations will also prescribe the circumstances in which end users may give suppliers a follow-up notification.55

If an own-use notification is given and accepted, the new no-double-counting provisions in the CEA will apply to ensure that no carbon price liability arises for the direct emissions from combusting the natural gas covered by the own-use notification.56

The Department of Climate Change and Energy Efficiency has released a consultation paper on the regulations that could be made for the own-use notification scheme. This paper appears to favour there being both voluntary provision and acceptance of any own-use notification so that self-contracting end users and natural gas suppliers can reach their own commercial arrangements regarding the imposition of carbon liability.57

Fuel opt-in scheme

As stated above, certain liquid fuels face an indirect carbon price (rather than a direct carbon price) through adjustments to the fuel tax credits that may be claimed, and the excise or customs duty that is required to be paid, in respect of them. However, under the fuel opt-in scheme, it is possible for an entity to opt such fuel into the carbon pricing scheme (so that liability attaches to the embodied emissions in that fuel) where the entity, a member of its GST group or a co-participant in a GST joint venture is entitled to fuel tax credits in respect of the acquisition, manufacture or importation of that fuel.58 This entity is referred to as the designated opt-in person (DOIP).59 Where fuel is opted into the fuel opt-in scheme, there is no carbon-related reduction in fuel tax credits or carbon-related increase in excise or customs duties.

The Principal Amendment Act amends the CEA to expressly allow the joint venture operator of a GST joint venture to be the DOIP for the joint venture and accordingly bear direct carbon liability for the fuels used for the purposes of the joint venture.60 Previously, only joint venture participants could be the DOIP for a GST joint venture.

Exposure draft regulations that establish the fuel opt-in scheme have been released for consultation.61

Auctioning of carbon units

Relinquished units

Before the amendments made by the Principal Amendment Act, if carbon units were to be relinquished (ie compulsorily given up) during the floating price phase of the Australian carbon pricing scheme, the Regulator would be required to transfer the units to the Commonwealth relinquished units account and those units could be auctioned by the Regulator.62 This will no longer be the case. Instead, such relinquished carbon units will simply be cancelled (as is currently the case with carbon units that are relinquished during the fixed price phase),63 and the Regulator will be required to auction a corresponding number of additional carbon units.64

Increased limit on advance auctions

The Principal Amendment Act makes a number of changes to the auctioning of carbon units in circumstances where there are no regulations setting a carbon pollution cap for a vintage year. Before the amendments, the number of carbon units of such a vintage year that could be auctioned more than one year in advance in these circumstances was capped at 15 million each year.65 As a result of the amendments, this number will be increased to 20 million66 for each of the second and third years prior to the vintage year.67 The exception is for advance auctions of 2015-16 vintage carbon units;68 up to 40 million 2015-16 vintage carbon units will be able to be auctioned during 2013-14.69

In addition, where there are no regulations in place that set a carbon pollution cap for a vintage year, the Principal Amendment Act increases the number of carbon units of that vintage that may be auctioned in the first six months of the year before their vintage year from 15 million to 20 million.70 There is, however, no restriction on the number of carbon units that may be advance auctioned during the last six months of the year before their vintage year.

The next steps

Linking the Australian and EU emissions trading schemes means that Australian liable entities may wish to purchase relatively cheap EU allowances now in order to use them under the Australian scheme after 1 July 2015. Our alliance with Linklaters means that we can provide you with any assistance that you may require in this respect.

In addition, we have been providing detailed advice to clients on the operation of the primary natural gas liability regime, and so are well-positioned to advise you on implications arising from the proposed new own-use notification regime.

If you would like further information on any of these areas, please contact any of the people below.

Footnotes
  1. CEA, s5 (par (b) of the definition of 'eligible emissions unit'); Australian National Registry of Emissions Units Act 2011 (Cth) (the ANREU Act), s4 (par (e) of the definition of 'eligible international emissions unit' and new par.(c) of the definition of 'prescribed international unit').
  2. CEA, s133(1), (2), (5).
  3. ANREU Act, s21(1) (as amended).
  4. CEA, s5 (par (b) of the definition of 'eligible emissions unit'); ANREU Act (par (e) of the definition of 'eligible international emissions unit' and new par.(d) of the definition of 'prescribed international unit'), new ss 48A, 48C, 48D.
  5. CEA, s133(1), (2), (5).
  6. ANREU Act, new s48D.
  7. Explanatory Memorandum, par.1.73; ANREU Act, new s86A.
  8. Explanatory Memorandum, par.1.33.
  9. ANREU Act, new s66C.
  10. ANREU Act, new Divs 4&5 of Part 6B; CEA, ss 212-216, 275-276.
  11. ANREU Act, new s66E.
  12. ANREU Act, new s66A; Explanatory Memorandum, par.1.83. See also new ss 48E(2) and 57(2) which permit regulations to be made to facilitate the linking of the Australian carbon pricing scheme with other emissions trading schemes.
  13. ANREU Act, s4 (new definition of 'European allowance unit').
  14. Explanatory Memorandum, par.1.31.
  15. Foreign units cannot be surrendered for the fixed price phase of the Australian carbon pricing scheme.
  16. CEA, new s133(7E).
  17. CEA, new ss 123A(1), (6), 133(7)-(7G). This may be necessary as part of any future arrangement to link the Australian carbon pricing scheme to another emissions trading scheme: see Explanatory Memorandum, pars 1.7, 1.43.
  18. Other foreign units may also be prescribed for this purpose: CEA, new s123A(6)(b).
  19. CEA, new s123A(6), (8)(b). The imposition of this restriction, as well as the removal of the floor price (see below), was a condition of being permitted to link the Australian carbon pricing scheme to the EU scheme.
  20. CEA, current s133(7)(a); see new s133(7A)(a).
  21. CEA, new s123A(6)(b)(ii).
  22. CEA, new ss 133(7) & (7F), (7A) & (7E), (7G).
  23. CEA, new ss 133(7B)-(7D).
  24. CEA, new s111(5). Principal Amendment Act, items 70, 80, 107.
  25. See the discussion paper and stakeholder submissions for the price floor consultation. A consequential change is the repeal of the Clean Energy (International Unit Surrender Charge) Act 2011 (Cth).
  26. CEA, new ss 111(5), (6A). The Minister may specify the manner in which the reserve charge amount for an auction is to be calculated: see Clean Energy (Unit Issue Charge - Auctions) Act 2011 (Cth), new s8(4A).
  27. CEA, new s111(5), (6A); Explanatory Memorandum, par.1.125.
  28. Liquid petroleum fuel, LPG, LNG and CNG, where those fuels have been subject to customs or excise duty: see CEA, s30(2).
  29. See, eg, Fuel Tax Act 2006 (Cth) (the FTA), ss 43-5, 43-8. The exception is fuels for use in aircraft, which are subject to increased excise and customs duties.
  30. CEA, s196; FTA, s43-8(1), (1A), (2). This average is calculated using the result of all auctions of carbon units of the vintage year in which the auction is conducted.
  31. FTA, new s.43-8(2)(a), (b). See the Excise Tariff Amendment (Per-tonne Carbon Price Equivalent) Act 2012 (Cth) which makes a similar change in relation to the calculation of excise (and therefore customs) duties in respect of aircraft fuels.
  32. Or any other foreign units that are subject to a surrender limit other than the general 50 per cent limit that applies to all foreign units.
  33. Note that the 'benchmark average auction charge', by reference to which the unit shortfall charge for the floating price phase is calculated, is not similarly amended but continues to be calculated by reference to carbon unit auction prices: see CEA, s114.
  34. See Explanatory Memorandum, p.7.
  35. CEA, new s196A(2).
  36. CEA, new s196A(5)-(8), (11); see also s196A(12)-(15) for different rules that apply in special circumstances.
  37. CEA, new s196A(4)(b).
  38. Explanatory Memorandum, par.2.9.
  39. As distinct from carbon liability for the direct emissions arising from the combustion of natural gas: see CEA, ss 20(1), (8), (9), 35(2), 55B, 56(1), 59(4), 60(4).
  40. CEA, s33.
  41. CEA, s35(1).
  42. CEA, ss 5, 33(1)(a), 35(1)(a).
  43. CEA, s 6(a); Clean Energy Regulations 2011 (Cth) (the CER), reg.1.10 – a supply of natural gas occurs at the time of such a withdrawal.
  44. CER, reg.1.9(1)(a)(i).
  45. A facility the covered emissions of which are 25,000tCO2-epa or more.
  46. See, eg, CEA, s20(1), (4), (5).
  47. Other potential scenarios, which also arise in the context of natural gas that is combusted in a sub-threshold facility, are where the natural gas is sourced from the wholesale market (there is no supplier) and where the end user owns the natural gas from production to end use (there is no supply).
  48. CEA, new ss 35A(6), 35B(2).
  49. CEA, new ss 35A(1)(b), (c), 35B(1)(c), (e); see also new s.35A(9).
  50. CEA, new ss 5A, 6(2)-(5).
  51. CEA, new s35B(1) (esp. s35B(1)(d)), (3), (4).
  52. CEA, new ss 35A(1) (esp. s35A(1)(d)), (2), (7), 64D(6), 64E(6).
  53. CEA, new ss 35A(2), (3), (4) (esp. s35A(4)(c)), 35B(1)(d).
  54. CEA, new ss 64A, 64B, 64E(1)-(3); see also new ss 64C, 64D, 64E(4), (5).
  55. CEA, new s64G; see also new s.64H. Natural gas suppliers will not be permitted to reject a follow-up notification: Explanatory Memorandum, par.2.49.
  56. See CEA, new ss 20(14)-(15), 21(8E)-(8F), 22(12)-(13), 23(9E)-(9F), 24(8E)-(8F), 25(7E)-(7F).
  57. CEA, s92A.
  58. In contrast, it appears that imposing such liability on the end user is the only possible option in respect of other scenarios referred to in footnote 47.
  59. EA, s92A(4).
  60. CEA, new s92A(4)(b).
  61. Department of Climate Change and Energy Efficiency, Australian Carbon Pricing Mechanism - Liquid Fuels Opt-In Scheme - Exposure Draft, 18 October 2012.
  62. CEA, current ss 112, 210(4).
  63. CEA, current s210(3); new s210(3).
  64. CEA, new s102(1)(e), (f). Current s112 has been repealed.
  65. CEA, current s101(1).
  66. CEA, new s101(1).
  67. Advance auctions of units are not able to be held more than three years in advance of the relevant vintage year, whether or not a carbon pollution cap has been prescribed for that vintage year: CEA, new s.101(3).
  68. CEA, new s101(1A).
  69. CEA, new s101(1B).
  70. CEA, new s101(2).

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