30 November, 2011

 

In brief:

 

The Federal Parliament has passed legislation to establish an Australian carbon pricing scheme, which will operate initially like a carbon tax, with a fixed (but increasing) carbon permit price, and will then transition into a cap and trade scheme after three years. 

 

How does it affect you?

 

• The Clean Energy Act 2011 (Cth) and associated legislation establishing a national carbon pricing scheme has been passed into law. The scheme will operate in two phases: a fixed price phase commencing 1 July 2012, followed by a floating price phase commencing automatically on 1 July 2015.

 

• The scheme will cover emissions from the stationary energy, industrial processing, resources and waste sectors. Entities that have operational control of a facility that emits more than 25,000tCO2-epa in greenhouse gas emissions from activities covered by the scheme will be required to surrender carbon units to cover those emissions. Natural gas suppliers will be liable for the greenhouse gas emissions embodied in the gas that they supply.

 

• Certain liquid fossil fuels will be excluded from the carbon pricing scheme. However, an effective carbon price will be applied to these liquid fossil fuels used by some businesses and industries (but not by households) through changes to the fuel tax credit and excise/customs duty regimes. An effective carbon price will also be applied to certain synthetic greenhouse gases that are excluded from scheme coverage through changes to import and manufacturing levies applicable to those gases. Emissions reductions in the agricultural and land sectors (which will not be covered by the scheme) will be encouraged through the Federal Government's Carbon Farming Initiative.

 

• Emissions-intensive trade-exposed industries and coal-fired power generators will be eligible to receive assistance, primarily in the form of free carbon units. In addition, the Government will seek to negotiate to buy out some 2,000MW of Australia's most emissions-intensive coal-fired power generation, and will provide loans and other measures to ensure stability in electricity supply markets.

 

• Liable entities will need to consider how they allocate liability under the carbon pricing scheme within their corporate group or within the unincorporated joint ventures of which they may be members. This will require a consideration of both statutory and contractual liability and cost transfer and allocation mechanisms.

 

• Entities that supply or purchase emissions-intensive or energy-intensive goods or services will need to consider whether their existing contractual arrangements provide for the pass through of costs associated with the carbon pricing scheme and will need to take into account the allocation of such costs when negotiating future contracts. It is highly desirable that contractual provisions for the pass through of carbon pricing scheme costs are tailored to the particular transaction and include appropriate incentives designed to minimise those costs.

 

• Directors of liable entities should put in place strategies to manage their companies' liabilities under the carbon pricing mechanism, including by implementing appropriate purchasing and hedging strategies and through the implementation of effective compliance programs.

 

• Listed companies should consider whether they are now required, under the ASX Listing Rules and the Corporations Act 2001 (Cth), to disclose to the market the likely impact of the carbon pricing scheme on their operations.

 

Overview of the carbon pricing scheme

 

The fixed and floating price phases

 

The carbon pricing scheme will operate in two phases: a three-year, fixed price phase from 1 July 2012 to 30 June 2015, moving to a floating price phase on 1 July 2015. In both phases, liable entities will be required to acquire and surrender carbon units equivalent to their annual emissions from activities covered by the scheme.

 

In the fixed price phase, the carbon price will commence at $23/tCO2-e (for 2012-13), increasing to $24.15/tCO2-e (for 2013-14) and $25.40/tCO2-e (for 2014-15). In this phase, the Clean Energy Regulator will sell to liable entities an uncapped number of units at the applicable fixed price, which will be automatically surrendered by those entities to meet their liability and cannot be traded or banked for future use. While international units (such as certified emissions reduction units generated under the Kyoto Protocol Clean Development Mechanism) will not be able to be used to acquit liabilities under the scheme during the fixed price phase, an entity will be able to acquit up to 5 per cent of its annual liability during this phase by surrendering Kyoto Australian carbon credits generated under the Carbon Farming Initiative. A limited number of carbon units with a vintage year that occurs during the floating price phase will be auctioned during the fixed price phase so as to enable the establishment of a forward price curve.

 

In the floating price phase, the Government will set annual caps on the number of carbon units to be issued in each year and the price of those units will be determined by the market forces of supply and demand. The exception is that, for the first three years of this phase, there will be a carbon unit floor price of $15 (for 2015-16, increasing to $16 for 2016-17 and $17.05 for 2017-18), and a carbon unit ceiling price of $20 above the 'expected international price'* (which will increase by 5 per cent per annum in real terms). This collar is intended to minimise the price volatility that may otherwise ensue upon the switch to the full market trading of carbon units under the floating price phase. As under the fixed price phase, liable entities will be able to acquit their liabilities under the carbon pricing scheme using Kyoto Australian carbon credits from eligible projects under the Carbon Farming Initiative – but, unlike for the fixed price phase, there will be no limit on the number of such carbon credits that may be used for this purpose. In addition, international units** will be able to be used to acquit carbon pricing scheme liabilities up to a maximum of 50 per cent of a liable entity's carbon unit surrender obligation. Carbon units issued for the floating price phase will be able to be banked without limit, and liable entities will be able to 'borrow' such carbon units from one vintage year in order to meet up to 5 per cent of their liability for the immediately preceding vintage year.

 

Critical to the operation of the floating price phase is the establishment of annual scheme caps and targets. The Government has announced a 2020 emissions target of at least 5 per cent below 2000 levels, and has increased its 2050 emissions target from 60 per cent to 80 per cent below 2000 levels. A new independent Climate Change Authority will be established to advise the Government on the annual scheme caps, which will be set on a five-year rolling basis. The Authority will be required to recommend annual scheme caps for 2015-16 to 2019-20 by 28 February 2014 and the Government will be required to table regulations setting out the first five years of scheme caps by 31 May 2014 (if the Government does not adopt the Authority's recommendations, it will need to table its reasons for this before Parliament). Every year the Authority will need to recommend, and the Government will need to promulgate by regulation, a scheme cap for the compliance year five years out.

 

The initial scheme legislation will provide for five years' worth of 'default' scheme caps, consistent with the 2020 emissions reduction target of 5 per cent below 2000 levels, which will apply if the scheme cap regulations are disallowed by either House of Parliament or are not made. A similar mechanism will apply for the subsequent year scheme caps, should regulations establishing those scheme caps be disallowed.

 

The Climate Change Authority will also be empowered to make recommendations about Australia's longer-term emissions reduction trajectory. Given that some commentators believe that the conditions for Australia adopting a 2020 emissions reduction target of 15 per cent below 2000 levels have already been met, it will be interesting to see what these recommendations are.

 

Understandably, there is not much detail about future linkages with carbon schemes in other countries or about what types of international units could be allowed under future regulations. However, the Federal Government has disclosed that it is discussing the possibility of linking the carbon pricing scheme with the New Zealand Emissions Trading Scheme and the European Emissions Trading Scheme during the floating price phase. Linking the Australian scheme with similar schemes is a very significant issue. On the one hand, access to lower cost emissions reductions in other countries will provide liable entities with a more cost-effective way of meeting their obligations, and the Treasury modelling of the scheme certainly assumes that Australia will have to buy a substantial quantity of international units to meet its 2020 emissions reduction target. On the other hand, the use of such emissions reductions will depress the Australian carbon unit price and diminish the revenue that the scheme raises, being revenue that is necessary to provide assistance to households and industry, and to invest in low-emissions technologies.

 

Carbon pricing scheme coverage and exclusions

 

Covered gases and sectors

 

The carbon pricing scheme will cover the emission of four of the six Kyoto Protocol greenhouse gases (carbon dioxide, methane, nitrous oxide and perfluorocarbons) from the following economic sectors:

 

• stationary energy (eg electricity generation);

 

• industrial processing (eg aluminium smelting);

 

• fugitive emissions other than from decommissioned coal mines (eg emissions from the extraction of coal, oil and natural gas); and 

 

• emissions from landfill waste and waste water treatment (with an exemption for emissions from legacy waste, ie landfill waste deposited before 1 July 2012).

 

Non-covered gases and sectors: land-use, agriculture and forestry

 

Agricultural emissions and land sector emissions will not be covered by the carbon pricing scheme. Moreover, biosequestration will not be eligible to create carbon units under the scheme. These exclusions are justified on the basis that the Government's Carbon Farming Initiative is intended to stimulate carbon biosequestration and greenhouse gas emissions reduction in the land and forestry sectors. Under this initiative, farmers and other land holders will be able to create tradeable carbon credits that are either Kyoto-compliant (eg as where they relate to forests established since 1990 on cleared land) or non Kyoto-compliant (eg as where they relate to soil carbon sequestration or crop management). As stated above, Kyoto Australian carbon credits will be able to be surrendered to acquit liabilities under the carbon pricing scheme. Moreover, the Government has adopted Professor Garnaut's recommendation that it should purchase at least some non Kyoto-compliant carbon credits (it will spend $250 million over six years for this purpose). This is necessary because, in the absence of such support, there is likely to be a considerable price differential between these two kinds of carbon credits and this could render unviable projects that would generate non Kyoto-compliant carbon credits.

 

Non-covered gases and sectors: liquid fossil fuels

 

Subject to the opt-in mechanism (discussed further below), the other major exclusion from the carbon pricing scheme is certain liquid fossil fuels (including petroleum, diesel, liquefied natural gas and liquefied petroleum gas). However, these fuels will face an effective carbon price, to be applied through changes to the system of fuel tax credits and fuel excise/customs duties effective from 1 July 2012. Under these arrangements, an effective carbon price will be applied to:

 

• liquid fuels for business transport (other than in the agriculture, forestry and fisheries industries), including liquid fuels used in the domestic aviation, shipping and rail sectors;

 

• liquid fuels used for non-transport purposes (eg diesel used for power generation); and

 

• compressed natural gas, liquefied natural gas and liquefied petroleum gas used for off-road transport and non-transport uses.

 

Ethanol, biodiesel and renewable diesel will remain unaffected. The effective carbon price will be applied through periodic adjustments to fuel tax credits and excise/customs duties – annually during the fixed price phase and every six months (based on the average carbon unit auction price over the previous six months) during the flexible price phase. The Productivity Commission is to conduct a review of fuel excise arrangements and will examine the merits of moving to a regime based explicitly on the carbon and energy content of fuels. This review was reportedly secured by the Greens in exchange for supporting the exemption of transport fuels used by households and light vehicles from exposure to an effective carbon price.

 

Non-covered gases and sectors: biofuels and biomass combustion

 

Emissions from the combustion of biofuels, biogas and biomass (including emissions from the combustion of methane from landfill facilities) are excluded from coverage by the carbon pricing scheme.

 

Non-covered gases and sectors: synthetic gases

 

Finally, hydrofluorocarbons and sulphur hexafluoride will be excluded from the carbon pricing scheme. However, they will be subject to an effective carbon price through changes to existing import and manufacturing levies applicable under the Ozone Protection and Synthetic Greenhouse Gas Management Act 1989 (Cth). These levies will be adjusted annually to reflect the prevailing carbon unit price. The Government has also foreshadowed the introduction, by 1 July 2013, of incentives for the destruction of waste synthetic greenhouse gases, including ozone depleting substances, recovered at end of life.

 

'Opt-in' mechanism for fuels

 

The legislation provides for a scheme to be established by regulations (such regulations being intended to be made before 15 December 2012) under which a 'designated opt-in person' can assume liability for the potential greenhouse gas emissions embodied in taxable liquid fossil fuels. Where this occurs, there will be no carbon-related reduction in the fuel tax credits available for the fuel. A person will be eligible to be a 'designated opt-in person' where that person is a member of a GST group that is entitled to fuel tax credits, is a participant in a GST joint venture that is entitled to fuel tax credits or is itself entitled to fuel tax credits, and the fuel is subject to the fuel tax credits regime.*** This approach is intended to provide substantial flexibility, as the entity with operational control over the facility in which the fuel is used, or who purchases the fuel, will not invariably be the entity that is entitled to the fuel tax credits available for the fuel. The opt-in arrangements will only apply for fuel that is acquired, manufactured or imported from 1 July 2013.

 

The Government has indicated that it intends to consult on the detailed design of the opt-in scheme.

 

Liable entities

 

It should be noted that liable entities under the carbon pricing scheme are not limited to corporations, but extend to (among others) trusts, state governments (including their departments and authorities), state-owned businesses and local councils. Putting aside the fuel opt-in scheme, there are two categories of liable entities:

 

• entities that are liable for direct greenhouse gas emissions; and

 

• entities that are liable for the potential greenhouse gas emissions embodied in natural gas that is supplied or used by them.

 

Entities with operational control over above-threshold facilities

 

The first category of liable entities is those that have operational control over facilities (ie activities) that emit 25ktCO2-epa or more of greenhouse gas emissions that are covered by the carbon pricing scheme (a lower threshold of 10ktCO2-epa applies to landfills that are located close to large landfill facilities).

 

Liability for the covered emissions of such facilities is imposed on the entity that has 'operational control' over the facility. An entity will have operational control over an activity where it has the authority to introduce or implement operating, health and safety, or environmental policies for the activity or (if more than one entity has such authority) the entity has the greatest authority to introduce and implement operating and environmental policies for the activity. Determining which entity has operational control over a facility often entails a degree of judgment – yet the financial consequences of this determination are significant.

 

While the entity that has operational control over the emitting facility will have the initial carbon liability, it is possible to restructure that liability by transferring it to:

 

• a member of the same corporate group; or

 

• a person outside the corporate group who has 'financial control' over the facility.

 

This transfer is effected by the Clean Energy Regulator issuing a 'liability transfer certificate' for the facility, which it can only do with the agreement of both the liability transferor and the liability transferee.

 

Special provisions also apply for unincorporated joint ventures:

 

• Where the joint venture is managed by an operator who has liability for the facility's emissions (because it has operational control over the facility), that liability can be transferred to the joint venturers in proportion to their joint venture interests with the agreement of the operator and the joint venturers and the approval of the Clean Energy Regulator. Such a joint venture is referred to as a 'declared designated joint venture'.

 

• Where the joint venturers (as opposed to any operator) collectively have operational control over the facility, liability for the facility's emissions is imposed directly on the joint venturers in proportion to their joint venture interests. Such a joint venture is referred to as a 'mandatory designated joint venture'.

 

However, the following issues relating to the joint venture provisions need to be borne in mind:

 

• Where a joint venture is a declared designated joint venture, if a joint venturer fails to pay its unit shortfall charge for more than three months, then the Clean Energy Regulator must (having first provided notice to the other joint venturers) revoke the declaration of the joint venture if that charge is not paid by the following 1 July. The effect of such a revocation is that liability for the facility's covered emissions reverts to the operator.

 

• The participants in a mandatory designated joint venture must notify the Clean Energy Regulator of the existence of the joint venture, failing which they will be liable to a monetary penalty.

 

• Joint venturers must notify the Clean Energy Regulator if the joint venture ceases to be either a mandatory or a declared designated joint venture.

 

• In the case of both declared and mandatory designated joint ventures, the Clean Energy Regulator will make a determination as to the joint venturers' percentage interests in the facility, which will determine their share of the facility's carbon liability. These percentage interests are intended to represent the joint venturers' respective shares of the economic benefits of the facility and so replacement determinations will need to be sought where joint venture interests change or are transferred. Provisions enabling the Clean Energy Regulator to issue both back-dated and forward-dated declarations of participating percentage determinations should assist joint venturers in keeping their shares of the facility's carbon liability in tandem with their actual joint venture interests.

 

• Where the composition of a declared designated joint venture changes (in the sense that an existing member quits the joint venture or a new member joins it), it will be necessary to seek a new declaration of that joint venture and a new participating percentage determination for it.

 

It should also be noted that the joint venture provisions do not apply in the following circumstances:

 

• Where one joint venturer has operational control over an emitting facility (eg because it has sufficient voting power to unilaterally introduce and implement operating and environmental policies for the facility). In such a case, the facility's carbon liability will rest with that joint venturer and that joint venturer will need to rely on contractual arrangements with the other joint venturers to be reimbursed for, or indemnified against, the other joint venturers' shares of the associated costs.

 

• Where the structure takes the form of a partnership rather than an unincorporated joint venture. Where operational control over a partnership's emitting facility is with an operator, the operator cannot transfer that liability to the partners in proportion to their partnership interests.**** Where operational control rests collectively with the partners, the partners must nominate one of their number to bear all of the carbon liability for the facility. In these cases, the liable entity will need to enter into contractual arrangements with the (other) partners for it to be reimbursed for, or indemnified against, the costs associated with the (other) partners' shares of that liability.

 

Liability for natural gas supplies

 

Under the legislation, a person who supplies natural gas to another person through a natural gas supply pipeline will be liable for the emissions embodied in that natural gas where it may reasonably be expected that the other person will use some or all of the natural gas. That liability may, however, be effectively transferred to the purchaser where the purchaser quotes an obligation transfer number (OTN) in relation to the supply of the natural gas:

 

• where the natural gas is used in the operation of a 'large gas consuming facility' (ie a facility that produces 25ktCO2-epa or more of emissions from the combustion of natural gas) the purchaser must quote, and the supplier must accept, the purchaser's OTN – in such a case, the entity that has operational control over the large gas consuming facility (who may not be the OTN holder) is liable for the emissions resulting from the combustion of the natural gas;

 

• where the natural gas is used in the operation of a large facility that is not a large gas consuming facility (ie a facility that produces 25ktCO2-epa or more of covered emissions), the natural gas supplier will be liable for the emissions embodied in the natural gas unless the natural gas is purchased under an OTN, in which case the entity that has operational control over the large facility is liable for all of the covered emissions of the facility (including those resulting from the combustion of natural gas) – in these circumstances, the quotation and acceptance of the purchaser's OTN is voluntary, and the purchaser will generally only be entitled to quote an OTN if it also purchases gas for a large gas consuming facility; and 

 

• where the natural gas is used in the operation of a small facility (ie a facility that produces less than 25ktCO2-epa of covered emissions), the natural gas supplier will be liable for the emissions embodied in the natural gas unless the natural gas is purchased under an OTN, in which case the OTN holder is liable for those embodied emissions – again, in these circumstances, the quotation and acceptance of the purchaser's OTN is voluntary, and the purchaser will generally only be entitled to quote an OTN if it also purchases gas for a large gas consuming facility.*****

 

An entity that purchases natural gas in bulk for use within its corporate group, where that entity does not itself use that natural gas or have operational control over a facility, is entitled to purchase any natural gas using an OTN (so long as some of the natural gas it purchases is for use in a large gas consuming facility). While it remains the case that a natural gas supplier can refuse to accept the quotation of an OTN where the natural gas is to be used in a facility that is not a large gas consuming facility, it is expected that natural gas suppliers will (in practice) accept the quotation of an OTN where the natural gas is being purchased in bulk for facilities that include a large gas consuming facility. To do otherwise will result in considerable complexity: it would be necessary to distinguish between gas purchased for use in large gas consuming facilities and gas purchased for use in other facilities, with the former being priced on a carbon-exclusive basis and the latter being priced on a carbon-inclusive basis.

 

Industry assistance

 

The carbon pricing scheme includes a number of measures designed to provide assistance to those industry sectors that are likely to be particularly adversely affected by the introduction of a carbon price. Two of these measures entail the provision of free carbon units to affected industry participants. Given that there is unlikely to be much of a market for carbon units issued during the fixed price phase, and that carbon units with a fixed price phase vintage will be cancelled in the following February, those entities that receive a free allocation of such units under these measures will be able to realise their value by selling them back to the Clean Energy Regulator at the applicable (discounted) fixed price.

 

Jobs and Competitiveness Program

 

There is a risk that the carbon pricing scheme will adversely affect Australia's international competitiveness by imposing on those industry sectors that compete in global markets costs they cannot recover because their output is sold at a world price. These costs may take the form of the costs of acquiring the carbon units that are required to cover their emissions and/or the increased costs of energy-intensive or emissions-intensive inputs that they use.

 

In order to provide some assistance to these 'emissions-intensive trade-exposed' (EITE) activities, the carbon pricing scheme incorporates a Jobs and Competitiveness Program (the JCP) under which free carbon units will be allocated to these industry sectors. Under this program:

 

• the highest emissions-intensive activities (ie those for which emissions exceed 2,000tCO2-e/$m in revenue or 6,000tCO2-e/$m in value-added), such as aluminium smelting, will receive free carbon units sufficient to cover 94.5 per cent of their average emissions initially (ie for 2012/13), decreasing at the rate of 1.3 per cent per annum; and

 

• moderately emissions-intensive activities (ie those for which emissions are between 1,000 to 2,000tCO2-e/$m in revenue or 3,000 to 6,000tCO2-e/$m in value-added), such as the production of glass containers, will receive free carbon units sufficient to cover 66 per cent of their average emissions initially (ie for 2012-13), decreasing at the rate of 1.3 per cent per annum.

 

The emissions covered by this assistance are not just direct greenhouse gas emissions from the covered activities but also indirect emissions attributable to the consumption of electricity, and the production of steam and natural gas (for use as feedstock), used in those activities. This ensures that the assistance gives some relief for increases in the prices of electricity, steam and natural gas which will occur as a result of the imposition of a carbon price.

 

In recognition of Australia's substantial LNG reserves and the fact that LNG can be combusted with significantly less greenhouse gas emissions than coal, LNG producers will receive an additional allocation of free carbon units to the extent this is necessary to ensure that they receive sufficient free units to cover 50 per cent of all the emissions associated with the LNG production process (ie extraction, production, transport and energy use in compression).

 

The Productivity Commission is required to conduct regular reviews of the operation of assistance arrangements under the JCP, the economic and environmental efficiency of those arrangements, and the impact of the Clean Energy Act and associated provisions on EITE industries. These reviews are required to occur during 2014-15 (the final year of the fixed price phase), 2015-16 (the first year of the flexible price phase), 2017-18, and every successive five-year period beginning 1 January 2019.

 

One of the things that will be considered during this review is whether the assistance arrangements should be altered so as to move to Professor Garnaut's suggested model where the assistance is to be based on the gap between the world product prices for the relevant activities that are expected with a global carbon price and those that are expected with only an Australian carbon price. The adoption of such a model would significantly reduce the assistance available to EITE activities.

 

While the reports from the Commission's reviews will not determine future changes to assistance arrangements, they are expected to be highly influential. The Government has made a policy commitment that any changes to assistance arrangements that adversely affect industry will not come into effect within the first five years of the scheme (ie before 1 July 2017) and will be accompanied by at least three years' notice. However, the Act merely requires that the Minister 'have regard to' the most recent Productivity Commission review when amending the JCP.

 

Coal-fired electricity generation

 

In recognition of the significant impairment of the value of coal-fired electricity plant that will result from the imposition of a carbon price, $5.5 billion worth of assistance will be provided to emissions-intensive coal-fired electricity generators (ie those with an emissions intensity of more than 1tCO2-e/MWh of electricity). This assistance, which will take the form of cash in the first year (2012-13) and free carbon units in subsequent years, will be provided in equal annual instalments over the five-year period to 2016-17. The ongoing provision of this assistance to a generator will be conditional on:

 

• the capacity of the generation plant not being reduced unless the market operator certifies that such a reduction in capacity will not have an adverse impact on power system reliability or because the generator replaces that capacity with lower emissions-intensity capacity.

 

• the generator preparing a clean energy investment plan outlining the plans (if any) it has to invest in new generation capacity, measures to reduce the energy intensity of its generation plant, research and development of clean energy technology, and energy efficiency opportunities.

 

The Government will also seek to negotiate the closure, by 2020, of around 2,000MW of the most emissions intensive coal-fired electricity generation (ie generation the emissions-intensity of which is greater than 1.2tCO2-e/MWh). Expressions of interest in relation to five eligible generators were received in October 2011: the Hazelwood, Yallourn and Energy Brix power stations in Victoria, the Playford power station in South Australia, and the Collinsville Power Station in Queensland. The Government hopes to enter into closure contracts by 30 June 2012. It will be important that this buy-out is managed in such a way as to ensure that sufficient replacement capacity is on hand to avoid undue increases in electricity prices as a consequence of supply constraints.

 

In order to alleviate the potential financial stress on coal-fired electricity generators as a result of the imposition of a carbon price, an Energy Security Council will be established to make recommendations as to any assistance (eg in the form of loans) that the Government should provide to help those generators to refinance their existing debt or to purchase carbon units on a forward basis, during the fixed price phase, for use in the flexible price phase.

 

Steel Transformation Plan

 

Under the Steel Transformation Plan Act, which also passed the Senate this week, the Government will allocate $300 million over four years to encourage investment in the steel industry in low-emissions and energy efficiency technologies.

 

Coal Sector Jobs Package

 

The Government proposes to provide assistance of $1.3 billion over six years to gassy coal mines, ie those the fugitive emissions of which account for more than 0.1tCO2-e/ton of saleable coal, to cover 80 per cent of their fugitive emissions above this threshold. In addition, the Government proposes to allocate assistance of $70 million over six years (in matched grants) to assist the coal mining sector to introduce emissions abatement technology.

 

The Coal Sector Jobs Package is a 'government only' measure that is currently not supported by the Greens, meaning there is some doubt as to whether the proposed assistance will materialise. Uncertainty associated with this assistance is exacerbated by the absence of any Bill before Parliament containing an appropriation of the funds promised under the package. It is expected that the mooted assistance would therefore be provided by way of a standard budgetary appropriation (though this could also be opposed in the Parliament).

 

Clean Technology Program

 

In order to assist in the adoption of the low-emissions and energy efficiency technologies, the Government is committed to providing:

 

• $800 million over seven years (by way of 1:3 in matched grants) to manufacturing businesses that consume over 300MWhpa of electricity or 5TJpa of natural gas, or that are otherwise covered by the carbon pricing scheme; and

 

• $200 million over six years (by way of 1:3 in matched grants) to food processors and metal forges/foundries.

 

In addition, the Government will provide $200 million over five years (by way of 1:1 in matched grants) to support business investment in research and development for renewable energy, low-emissions and energy efficiency technologies.

 

What you should do

 

The carbon pricing scheme is a far-reaching economic reform that will affect a range of businesses. While only 500 businesses are expected to be directly liable under the scheme, the imposition of a carbon price will increase the cost of energy-intensive and emissions-intensive inputs (such as electricity, gas, aluminium, steel, glass and cement) that are used by many businesses. Overall, this is expected to increase the CPI by 0.7 per cent initially and a further 0.2 per cent when the scheme transitions from its fixed price phase to its flexible price phase.

 

Determination and structuring of liability

 

For those businesses in sectors that are covered by the carbon pricing scheme, it will be necessary to determine whether they are directly liable under that scheme (see above section on liable entities). Entities that are directly liable will need to decide how to manage their carbon liability – that is, to which company within their corporate group the liability should be allocated, how that liability is to be acquitted (eg the strategy that is to be adopted to enable the acquisition of the necessary carbon units in the most cost-effective way) and whether the costs associated with that liability can be passed through to customers.

 

Participants in, and operators of, unincorporated joint ventures should scrutinise relevant contracts to determine which party or parties are to be liable under the scheme by default. Where liability for a facility's emissions falls on the operator of a joint venture (because it has operational control over the facility), the parties should consider whether to transfer the operator's liability to the joint venturers in proportion to their joint venture interests and, if they decide to do so, seek to be approved by the Clean Energy Regulator as a declared designated joint venture. Where liability falls on the joint venturers, the parties will be part of a mandatory designated joint venture and should, accordingly, be aware of their respective liabilities and obligations.

 

In addition to considering how to structure their carbon pricing scheme liability, entities that are eligible for industry assistance, eg under the JCP or the coal-fired electricity generation assistance package, should be aware of the information that they will need to provide, and the procedures that they will need to follow, in order to qualify for such assistance.

 

Of course, the carbon pricing scheme will also present significant opportunities for companies to improve their competitive position by managing their emissions intensity and energy consumption, and for companies in low-emissions industry sectors, such as gas-fired and renewable energy generation. As part of assessing the impact of the carbon pricing scheme, it is important that companies look not just at the risks, but also the opportunities.

 

Pass through of carbon costs

 

Both directly liable entities, and other entities that (while not directly liable under the carbon pricing scheme) supply or purchase energy-intensive or emissions-intensive goods or services, should review their existing contracts to determine the extent to which they will be able to pass through (or resist the pass through) of costs associated with the carbon pricing scheme. There are two pass through mechanisms that are commonly included in contracts:

 

• change in tax clauses; and

 

• change in law clauses.

 

Despite the carbon pricing scheme commonly being referred to as a 'carbon tax' it is not, in fact, a 'tax' but an emissions trading scheme (albeit one that operates as a fixed price unit scheme for the first three years). Accordingly, it should not be assumed that a supplier will be able to rely on a change in tax clause to pass through to its customers the costs it incurs under the carbon pricing scheme. Having said this, change in tax clauses sometimes extend to 'levies, charges and imposts' and, depending on the context, it is conceivable (although by no means certain) that at least a fixed carbon unit price might be regarded as coming within these terms.

 

While the introduction of the carbon pricing scheme will clearly constitute a change in law, change in law clauses are not necessarily ideally suited to the pass through of costs associated with a scheme such as the carbon pricing scheme. The first reason for this is that change in law clauses are predicated on being able to identify an upfront and once-off cost adjustment arising from a legal obligation that can be spread across the price for the relevant goods or services for the remaining term of the contract. However, at least during the flexible price phase, it will be very difficult to predict the carbon unit price for more than a few years in advance, which will mean that a once-off adjustment to the price of the goods or services is likely either to over or under compensate the supplier for the costs it incurs under the carbon pricing scheme in purchasing carbon units. The second limitation of a typical change in law clause is that, because it assumes that a change in law will result in a given cost for pass through, it provides little incentive for the supplier to manage that cost. However, under the carbon pricing scheme, a liable entity will be able to manage to some degree the cost of the carbon units that it is required to surrender. For example, the supplier will be able to hedge against the carbon price by the forward purchase of carbon units.

 

These limitations suggest that contract counterparties should consider negotiating amendments to their existing long-term contracts, or including in new contracts, tailored carbon pass through clauses that, for example:

 

• provide for the periodic assessment and pass through of carbon costs (eg every few years during the contract term);

 

• incentivise the supplier to manage the cost of its carbon units (eg by deeming the cost of units for pass through purposes to be an average long-term carbon price, which will encourage the supplier to hedge those costs) or provide for the purchaser to acquire units to acquit the supplier's liability (so that the purchaser is able to control the carbon costs that it bears); and

 

• properly take into account any free carbon units that the supplier receives or is entitled to receive for the emitting activities so that the supplier does not make a windfall gain out of the carbon cost pass through.

 

It is also important to be aware that the voluntary assumption of carbon liability — as will occur where a party takes a transfer of carbon liability under a liability transfer certificate, voluntarily quotes an OTN in relation to the purchase of natural gas supplied to it, or is declared to be a declared designated joint venture — might not trigger a change in law provision pass through because the liability is not being imposed by law but by the voluntary acceptance of that liability by the liability transferee.

 

Where the contract is not with an entity that is directly liable under the carbon pricing scheme, a cost pass through clause will typically not permit the pass through of increased input prices where that increase results from the imposition of a legal obligation to surrender carbon units that is imposed on an entity further up the supply chain. Nonetheless, a supplier may wish to provide for a price adjustment to reflect carbon-related input price increases. In these circumstances, the supplier can be incentivised to manage its upstream costs by the price increase being linked to the average input price increases of its competitors rather than its actual price increases. Given the once-off increase in CPI resulting from the carbon pricing scheme, the parties to the relevant contract may also wish to 'stagger' any CPI-indexed price increase across a few quarters.

 

The Government has flagged that, just as with the introduction of the GST, the Australian Competition and Consumer Commission will be empowered to investigate price gouging in the context of the pass through of carbon costs, and so businesses will also need to comply with yet-to-be-released pricing guidelines relating to this matter.

 

Finally, as discussed above, even though many liquid fossil fuels and certain synthetic greenhouse gases (hydrofluorocarbons and sulphur hexafluorides) are not covered by the carbon pricing scheme (unless they 'opt-in' to the scheme under the opt-in mechanism), an effective carbon price is to be imposed on them in certain circumstances through adjustments to the fuel tax credit and excise/customs duties systems and import/manufacturing levies. Participants in these industry sectors will therefore need to consider whether they are able to pass through such increased costs under their existing contracts and should provide for the pass through of these costs under new contracts. Because the imposition of the effective carbon price in these circumstances is achieved through changes in tax, a standard change in tax clause is likely to suffice for this purpose.

 

Continuous disclosure

 

Under ASX Listing Rule 3.1, once a listed company becomes aware of any information that would reasonably be expected to have a material effect on the price of its listed securities, it is required to immediately disclose that information to the Australian Securities Exchange. A failure to do so attracts sanctions under the Corporations Act (s674). During the course of the development of the carbon pricing scheme, various companies have made public statements that the imposition of a carbon price will cause them to close existing operations or not proceed with planned projects. Given that the carbon pricing scheme legislation has now been passed, these companies (and others that are likely to be materially affected by the carbon pricing scheme) will need to consider whether they should be making disclosures to the market regarding the likely effect of the carbon pricing scheme on their operations. This may be the case where, for example, the introduction of the carbon pricing scheme causes a revision in previously released forecasts in the order of 10 to 15 per cent.******

 

Liability of directors and officers

 

Directors are required to exercise their powers and discharge their duties with reasonable care and diligence.******* Accordingly, the directors of companies that are liable under the carbon pricing scheme are under a duty to ensure that the company has in place strategies to manage that liability, including by introducing lower-emissions technologies and processes and implementing purchasing and hedging strategies to mitigate the company's carbon costs.

 

In addition, the executive officers (ie directors and senior management) of a company that is liable under the carbon pricing scheme may be exposed to personal liability if the company fails to comply with the carbon pricing scheme legislation and that officer, being in a position to do so, fails to take reasonable steps to prevent the contravention. The implementation of an effective compliance and education program will be an important part of an officer's defence in such a case. This is in addition to the obvious benefit of a compliance program – which is to minimise the risk of any breach by a company of its carbon pricing scheme obligations in the first place. A key obligation is the annual surrender of carbon units to acquit the company's liability for a compliance (financial) year. During the fixed price phase, liable entities will be required to surrender units to cover 75 per cent of their annual emissions by 15 June of the compliance year, with a true-up surrender for the remaining units by the following 1 February. During the floating price phase, liable entities will be required to surrender units to cover 100 per cent of their annual emissions by the 1 February following the compliance year. A failure to meet the surrender obligations will attract a unit shortfall charge of 1.3 times the fixed price for carbon units during the fixed price phase and twice the average auction price for carbon units during the floating price phase.

 

Australian Financial Services Licence

 

Because carbon units will be 'financial products' for the purposes of the financial services regulatory regime under the Corporations Act and the Australian Securities and Investments Commission Act 2001 (Cth), entities that wish to trade in such units will typically be required to hold an Australian Financial Services Licence. While trading is likely to be limited during the fixed price phase, carbon units for the floating price phase will be auctioned during the fixed price phase, with the aim of creating a forward price curve. Accordingly, potential traders should consider applying for the necessary licence (or a modification of their existing licence if required) in preparation of the commencement of the carbon pricing scheme.

 

Possibility of repeal of carbon pricing scheme

 

The Federal Opposition's current policy is to repeal the carbon pricing scheme legislation should it win government at the next election, and not to pay compensation for any carbon units that have been issued but that would become valueless as a result of the scheme ceasing to exist. In order to repeal the legislation, the Opposition would need to win control of both the House of Representatives and the Senate (or would need to have the support of a majority of members in each of those Houses for the repeal of the scheme). The next election is due around November 2013, when only half of the Senate will be up for election.

 

If the Opposition were to win government but did not achieve a majority in the Senate, it might nonetheless be able to have the carbon pricing scheme legislation repealed following a double dissolution election. In order to achieve this, the House of Representatives would pass the repealing legislation, which would then be presented to the Senate. If the Senate rejects that legislation, the rejected legislation would need to be passed again by the House of Representatives after three months. If the Senate still rejects the legislation, the Government could hold a 'double dissolution' election, which means that all of the members of both the House of Representatives and the Senate are up for election. Assuming the Government is re-elected, the repealing legislation would then again need to be passed by the House of Representatives and presented to the Senate. This time, if the Senate rejects the legislation, the Government could convene a joint sitting of both Houses to consider the repealing legislation. At such a sitting, the repealing legislation is able to be passed by a majority of the joint sitting. Depending on the size of the Government's majority at the double dissolution election, the Government might win control of the majority of votes at the joint sitting because there are fewer members of the Senate than members of the House of Representatives, and the Government would have a majority of the House of Representatives.

 

The Opposition's declared position not to pay compensation for any carbon units that are rendered valueless as a consequence of the repeal of the carbon pricing scheme legislation is not so much of an issue for carbon units with a vintage during the fixed price phase because:

 

• to the extent those carbon units are issued to acquit scheme liabilities, they are automatically surrendered on payment for them, ie they are not able to be held and traded; and

 

• to the extent those carbon units are issued under an industry assistance scheme (such as the JCP), they are issued for free.

 

However, this is not so for carbon units that are issued with a vintage during the floating price phase. To the extent purchasers buy these units (including at advance auctions during the fixed price phase), the repeal of the scheme legislation and the failure to compensate those purchasers for this outlay will be commercially detrimental to purchasers. This risk will increase exponentially if the carbon pricing scheme legislation were to be repealed after the commencement of the floating price phase on 1 July 2015 because liable entities will need to purchase carbon units during this phase to acquit their scheme obligations and may well hold onto those units for some time before surrendering them. However, if the Opposition wins the next election, it would have sufficient time to have the scheme legislation repealed before 1 July 2015, even if its only option is the double dissolution election route described above.

 

While the Commonwealth Constitution requires the provision of just compensation where the Federal Government compulsorily acquires property, this constitutional protection would not apply to the repeal of the carbon pricing scheme legislation because, in such a case, the mere repeal of the scheme does not entail the Commonwealth acquiring any carbon units (or related property).

 

Footnotes

 

*By which the Government seems to mean the price of certified emissions reduction units under the Kyoto Protocol Clean Development Mechanism. The exact starting ceiling price will be set in regulations by 31 May 2014.

 

**Such international units include certified emissions reduction units (CERs) under the Kyoto Protocol Clean Development Mechanism, emission reduction units (ERUs) under the Kyoto Protocol Joint Implementation arrangements, removal units issued by a Kyoto Protocol country on the basis of land use, land use change and forestry activities and any other international units that the Government may allow by regulation (eg units from the European and New Zealand emissions trading schemes). However, there will be some quality restrictions imposed – for example, forestry CERs, nuclear CERs/ERUs, and CERs/ERUs from the destruction of trifluoromethane (HFC-23) or of nitrous oxide from adipic acid plants or from non-compliant large scale hydro electric projects, will not be eligible for surrender under the carbon pricing scheme.

 

***Similar arrangements apply for aviation fuel, where an effective carbon price is being imposed through increases in the excise and customs duties that apply to that fuel.

 

****While the operator may be able to transfer that liability to one partner (as an entity that has financial control over the facility) that is not the same as transferring proportionate liability to each partner.

 

*****The above description sets out the general position. Purchasers of natural gas as a feedstock or for the manufacture of LPG, LNG or CNG are also entitled to quote an OTN for their natural gas purchases. In such a case, while the OTN holder would notionally assume liability for the embodied emissions (and pay a carbon-exclusive price for the natural gas), that liability is entirely negated by the application of offset provisions.

 

******ASX Guidance Note 8, par.93.

 

*******Corporations Act, s.180.

 

 

For further information, please contact:

 

Grant Anderson, Allens Arthur Robinson

[email protected]

 

Fergus Green, Allens Arthur Robinson

[email protected]