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Australia – Managing Carbon Cost Pass Through: Practical Insights From The First 100 Days.

 

10 November, 2012

 

Legal News & Analysis – Asia Pacific – Australia – Energy & Project Finance

 

In brief
 
  • Most energy and resource companies are now either is suing or receiving invoices that contain carbon pass through amounts.
  • In our experience, these invoices are quickly leading to purchasers triggering formal contractual dispute mechanisms, many of which are proving an inappropriate architecture for parties to work through the commercial, legal and often technical issues concerning the pass through of carbon costs.
  • The mechanics of pass through and ensuring transparency of the calculation and apportionment of carbon costs are proving just as important issues as the initial decision to accept or reject a pass through of carbon costs under a supply contract.
 
With the carbon pricing mechanism (the “CPM”) only four months old, most energy and resource companies are now either issuing or receiving invoices that contain an amount attributable to the pass through of CPM-related costs. In our experience,
these invoices are quickly, and often unnecessarily, escalating into disputes as purchasers push back on the payment of carbon costs that are often poorly explained or justified. In many cases, purchasers are forced into triggering contractual dispute mechanisms simply to gain clarity and transparency around how the pass through amount has been calculated.
 
This article provides some observations on the issues companies are grappling with in handling carbon pass through and some common themes surfacing in the market.
 
Is carbon pass through permitted under the contract?
 
The first, and perhaps most important, issue for parties to consider is whether the pass through of carbon costs is permitted under a contract. While some contracts contain a clear right to pass through carbon costs, many existing (and particularly older) contracts do not contain a specific carbon pass through clause and it
is common for suppliers to rely on a general change in law or change in tax clause to justify a carbon pass through. Ultimately, the right of a supplier to any pass through carbon costs will  depend on the precise wording of each contract, and our experience is that most suppliers are adopting (unsurprisingly) a bullish view about their rights in this regard.
 
The acceptance that carbon costs may be passed through under a contract is often the beginning rather than the end of the “carbon pass through” conversation. Parties often move quickly past a discussion about whether carbon costs may be passed through at all, to a focus on very practical issues like the quantum of costs passed through, how these costs are to be calculated and apportioned, the timing for payment and other similar “mechanical” issues. Our experience has been that many contracts do not provide an effective avenue for parties to pursue discussions regarding these issues without a supplier triggering a formal payment dispute under the contract. For the reasons we discuss below, it is becoming increasingly apparent that formal contractual dispute architecture does not provide the best framework for the resolution of these issues.
 
Is the amount of the pass through correct?
 
In many instances, parties to a contract have not engaged in substantive discussion about carbon pass through prior to the issue of the first carbon price inclusive
invoice. Where such engagement has occurred (for example where a supplier has issued a change event notice under a contract) the information provided by the supplier is often insufficient for a purchaser to form a proper view about whether to accept the proposed carbon cost pass through. The result is that when the first carbon price inclusive invoice arrives, many purchasers feel unable, in good faith, to accept it for payment.
 
Where an invoice does not provide the level of transparency as to the
methodology or mechanics of the calculation of pass through amounts
it is often difficult for purchasers to decide the best course of action. We have seen invoices where carbon costs have simply appeared in invoices with no explanation as to the method of calculation; in other cases there have been substantial inaccuracies in the calculation of amounts included. Even where explanatory material has been provided, it often lacks detail regarding calculations, the basis for adopting certain assumptions, and whether any free carbon units or other forms of government assistance have been considered.
 
This issue highlights the tension between a supplier’s desire to protect  commercially sensitive information regarding its operations and to deal quickly and efficiently with its invoicing function, and the desire for purchasers to ensure that any carbon pass through they accept accurately reflects the carbon footprint of the goods and services actually supplied to them in the period covered by the 
invoice. While a supplier will always want to ensure they are kept whole in relation to their carbon costs, a purchaser will be equally keen to ensure they are not providing their supplier with a windfall gain. In many cases the contract itself is not helpful because it does not provide any mechanics of calculation. In addition, while some pass through clauses require the supplier to pass through the cost of carbon units at a yearly market average cost or a least cost basis, many other contracts are
silent on such matters and place little discipline on the supplier to minimise its carbon costs.
 
Another contentious issue is the timing of pass through of direct costs. In most cases, cost pass through is occurring on a monthly basis in line with regular invoicing. While this manner of invoicing for carbon costs of carbon liabilities by the supplier, it does not reflect the obligation of the supplier to incur actual costs in meeting those liabilities. This raises the issue of whether the supplier is receiving a windfall gain by being “reimbursed” the full costs of purchasing and surrendering carbon units well before they are required to be acquired and surrendered under the Clean Energy Act 2011 (Cth). For example, in the first year of the CPM, carbon units are required to be surrendered by 15 June 2013 (for 75% of liability) and 1 February 2014 (for the remaining 25% of liability). This gives rise to a discussion about whether a purchaser ought to get a “time-value” discount for this effective prepayment of carbon costs.
 
Triggering dispute mechanisms and withholding carbon pass through amounts
 
While a purchaser grapples with whether to accept a pass through
and how the pass through amount has been arrived at, the time for payment of the invoice draws near. In many contracts, parties have less than 30 days to pay invoice amounts or trigger a formal dispute. In our experience, this is proving too short a time for an adequate exchange of correspondence and information in relation to the carbon pass through and purchasers are being forced to escalate the matter to a formal dispute under the contract, in order to preserve their rights, even where the sole objective is simply to learn how the pass through amount has been calculated.
 
A consequence of triggering a payment dispute for a purchaser is the need to consider whether to withhold payment of all or part of the invoiced amount. In many cases the contract will provide a mechanism for disputing an invoice and allow a party to withhold a disputed amount. However, in our experience, parties
can be reluctant to withhold amounts particularly where the contract allows for withdrawal or suspension of supply for non-payment of invoices or where the purchaser may be required to pay interest on a withheld amount if their claim is not upheld. On the other hand, the withholding of a pass through amount, particularly if substantial, tends to speed up the supplier’s response to the purchaser’s demands for further information or a meeting to discuss disputed issues. 
 
In many cases, energy and resource companies have long-established supply relationships that are crucial to the ongoing success of their business; in some cases markets are small or specialised. The supply relationship needs to be respected and a range of factors will play into a decision whether or not to trigger
a carbon cost pass through dispute. This decision must be taken after careful consideration of the legal and commercial issues.
 
The main issues arising
 
Many contracts (even those that include a carbon clause) do not provide for an adequate flow of information prior to the issue of an invoice containing a pass through of CPM-related costs. This is leading to purchasers being forced to trigger formal contractual dispute mechanisms to buy time to work through poorly explained or justified carbon pass through amounts. These mechanisms are proving an inappropriate architecture for parties to work through the commercial, legal and often technical issues involved.

  

For further information, please contact:

 

Jeff Lynn, Partner, Ashurst

jeff.lynn@ashurst.com

 

Meredith Gibbs, Ashurst

meredith.gibbs@ashurst.com

 

Ashurst Energy & Project Finance Practice Profile in Australia

 

Homegrown Energy & Project Finance Law Firms in Australia

 

 

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