Jurisdiction - Australia
Reports and Analysis
Australia – Linking Carbon Pricing Mechanism To The European Union Emissions Trading System.

10 November 2012

  

Legal News & Analysis – Asia Pacific – Australia – Environment

 

In brief
 
  • On 28 August 2012, the Government announced major changes to Australia’s Carbon Pricing Mechanism (“CPM”). Australia’s CPM will link to the European Union Emissions Trading Scheme, initially through a “one way” link from 1 July 2015, followed by a full “two way” link by 1 July 2018. As part of the linking arrangement, the Government announced it would not proceed with the implementation of the price floor and it would introduce a sub-limit of 12.5% on the use of eligible Kyoto units. The legislation implementing these policy changes was introduced into Parliament on 19 September and is expected to become law in November 2012. 
  • These changes have significant implications for the energy and resources sectors in Australia, and present many new opportunities that liable entities in those sectors can take advantage of now, to minimise the cost of their compliance with the CPM. Liable entities have access to a broader and deeper market from which to source abatement. The Australian unit price will track the European price, and as this is currently trading at a low price (around 8 euros), but is expected to increase in the future, liable entities that purchase European units at current prices are likely to be at an advantage when the flexible price period starts in 2015-6. Liable entities that receive free permits under the CPM can also take advantage of the spread in price between units from the Clean Development Mechanism (“CERs”) and Australian permits, and use CERs to meet up to 12.5% of their liability, while selling or banking surplus freely allocated  ustralian permits. Overall,  the cost of complying with the scheme will be less than what it would have been under the floor price arrangements, at least in the short-medium term, particularly for those liable entities that take advantage of the current opportunities.
 
Implications and opportunities for the energy and resources sector in Australia

 

The Government’s announcement on 28 August 2012 that the Australian Carbon Pricing Mechanism (“CPM”) will link to the European Emissions Trading System (“EU ETS”), initially through a “one-way” link, from 2015, is significant for Australian liable entities, carbon market stakeholders, and for the broader international
carbon market. It presents particular opportunities for the energy and resources sector in Australia.
 
An initial “one-way” link will enable Australian liable entities to use European units (“EUAs”) to meet up to 50% of their annual liability. This is until a full two-way link is established, which will enable Australian units to be used by European liable entities in the EU ETS. 
 
What was announced?
 
In summary:
 
  • Australia’s CPM is linked to the EU ETS. This will occur in stages; from 1 July 2015 Australian liable entities will be able to meet up to 50% of their liability with EUAs, and from 1 July 2018, Australian units will be able to be used in the EU ETS when a full “two way” link will commence; 
  • the price floor will not be  implemented;
  • a quantitative restriction of 12.5% on the use of eligible Kyoto units within the overall 50% annual limit on the surrender of international units by liable entities; and
  • the price ceiling will be set by reference to the European unit price. 
 
So what does it mean for the Energy and Resources Sector in Australia?
 
International trading opportunities
 
The removal of the floor price means that Australian liable entities will no longer have to pay a surrender charge on international units. This presents significant opportunities in the current carbon market environment. It enables liable entities to purchase eligible international units, while both CERs and EUAs are at record low prices, for use in the CPM from 2015-2016. There is nothing preventing Australian liable entities from purchasing EUAs today and holding these units until they can be surrendered in the CPM. This can be achieved through existing registry accounts in the EU Registry, or through the establishment of a new account in the EU registry.
 
The low European prices are unlikely to remain for too long, as the European Commission is taking measures to increase the price over the short and long term. The upward momentum these developments will give to the price of EUAs means that the EU ETS and the Australian CPM may become linked at the bottom of the market for EUAs. This provides Australian buyers with an opportunity to acquire EUAs at prices significantly below the current floor price. While these units can’t be surrendered in Australia until 2015/16, if the price of EUAs increases between now and 2015, the current EUA price may be  significantly below the price compliance buyers will be required to pay on the market in 2015. This may provide liable entities with an arbitrage opportunity.
 
Purchasing international units (that is, CERs, ERUs and EUAs) minimises the impacts of any repeal of the CPM on Australian buyers, as these units will be able to be sold on the international market, in the event they can’t be used in Australia under a Coalition Government. There are, in any event, signs (although no formal policy) that a Coalition Government may allow companies to purchase some abatement internationally. Again this suggests there are good opportunities for companies to forward purchase these units, or options over them, now. 
 
A reduced demand for CER in Australia 
 
Units from the Clean Development Mechanism (“CERs”) will continue to play an important role in assisting liable entities to meet their obligations. While the new sub-limit of 12.5% on eligible Kyoto units will reduce demand for CERs by Australian liable entities, this is balanced with the need to safeguard the  Australian permit price from tracking the CER price. A number of opportunities exist to purchase CERs in the current market at record low prices (currently trading at A$1 to A$2).
 
There is likely to be a significant spread (of more than A$10) between the Australian permit and CER unit price. This gives rise to opportunities, particularly for liable entities in the energy and resources sector, that will receive a large proportion of units for free under the assistance programs. These entities can take advantage of the arbitrage potential that arises from this spread by purchasing up to 12.5% of CER units and selling or banking any surplus Australian permits for a higher price.
 
Implications for CFI and other domestic abatement in Australia
 
A main strength of the price floor was the certainty on return that it provided to Carbon Farming Initiative (“CFI”) investors. The initial floor price of A$15, increasing at 4% per year each year, would have set the price for Australian and CFI units. The removal of the floor will have implications for the price of Australian permits, including CFI units. The new sub-limit of 12.5% on eligible Kyoto units will mean that the Australian price will likely track the European price, instead of the CER
price. This makes the return on investment in CFI projects more volatile, but not necessarily less profitable. There have been concerns expressed about the impacts the current low prices in the EU ETS will have on the feasibility of CFI, and other emission reduction, projects in Australia. However, these concerns do not take into account the measures that the European Commission is taking to increase its carbon price in the short and longer term. The European unit price could be above the floor price if the Commission implements its proposals to increase the price.
 
The link with the EU ETS means that Australian carbon market stakeholders will need to be more informed about developments in the EU ETS as these will now have a direct impact on the price of Australian units.
 
Current opportunities
 
The Government’s announcements are expected to pass Parliament and become law in November. Businesses need to consider how these changes may impact them, and in particular consider:
 
  • contractual documentation for the trading of carbon units under the CPM;
  • the legal requirements for trading international units in Australia; and
  • purchasing European units and CER units, including setting up a registry account in the EU Registry.

 

 

For further information, please contact:

 

Jeff Lynn, Partner, Ashurst

jeff.lynn@ashurst.com

 

Katherine Lake, Ashurst

katherine.lake@ashurst.com

 

 

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