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Australia – Pass Through Of Carbon Costs.

13 November, 2013

 

Legal News & Analysis – Asia Pacific – Australia – Environment 

 

Centennial Mandalong v Delta Electricity [2013] NSWSC 1505


WHAT YOU NEED TO KNOW

 

  • Coal mine operator Centennial Mandalong (Centennial) was granted a declaration in the New South Wales Supreme Court to enable it to pass through a portion of the carbon costs it incurred from the operation of its coal mine to its customer Delta Electricity (Delta) under the terms of a supply agreement between the parties.
  • The key issue in dispute between the parties was whether carbon costs incurred by Centennial were attributable to coal sold by Centennial and purchased by Delta under the supply agreement.
  • The Court considered that in order to be attributable to coal sold and purchased by Delta, it was necessary to establish a sufficient connection between the carbon costs and the sale and delivery of coal.
  • The Court examined the relationship the parties sought to achieve through the supply agreement and the nature of the carbon costs incurred by Centennial and concluded that a sufficient connection existed.
 

WHAT YOU NEED TO DO

 

  • Consider the impact of the decision in light of your contractual pass through rights, particularly where those rights require that a cost or charge be “attributable to” particular conduct or circumstances.
 

Overview Of Decision

 

Centennial and Delta are parties to a supply agreement under which Centennial agrees to sell a fixed quantity of coal to Delta. Centennial also has an option to supply additional quantities of coal to Delta. It is a term of the supply agreement that at least 85% of the coal required to be delivered under the agreement is mined from the Mandalong mine operated by Centennial.

 

As a result of the operation of the Clean Energy Act 2011 (Cth) (Clean Energy Act), Centennial was liable to pay carbon costs with respect to greenhouse gas emissions arising from its coal mining activities at the Mandalong mine. A dispute arose between the parties as to whether, having regard to the relevant terms of the supply agreement, Centennial could pass some part of those costs on to Delta.


In one of the few decisions that have been handed down regarding the Clean Energy Act, McDougall J of the NSW Supreme Court held that Centennial was entitled to pass through carbon costs to Delta on the basis that these were attributable to coal sold by Centennial and purchased by Delta under the supply agreement.1 As to the method of dividing the overall carbon cost liability between Centennial and Delta, McDougall J observed that this should be done by a “pro-rating mechanism”, but left it to the parties to work out a mechanism, failing which, the matter would be referred to an expert for determination in accordance with the terms of the supply agreement.


Centennial’s Liability To Pay Carbon Costs


The Clean Energy Act imposes liability for the direct emission of covered greenhouse gases from a “facility” on the entity with “operational control” of the facility. These terms have a technical meaning under the Clean Energy Act.
As the entity with operational control of the Mandalong mine, Centennial was a liable entity under the Clean Energy Act with respect to the covered greenhouse gas emissions from the facility, including coal seam gases released as a result of the production of coal.

 

The major coal seam gas produced by the operation of the Mandalong mine is methane, which is a greenhouse gas for the purposes of the Clean Energy Act.
As a liable entity, Centennial was required to purchase and surrender sufficient eligible emissions units to meet its liability under the Clean Energy Act, or face a unit shortfall charge under the Clean Energy Act.

 

The Supply Agreement

 

How Was The Price Of Coal Determined Under The Supply Agreement?

 

The price charged for coal supplied under the supply agreement was the sum of two components: a contract price component per tonne of coal, adjusted for changes in CPI; and a government charges component per tonne of coal.


The supply agreement enabled either party to require the amount of government charges per tonne of coal to be reviewed. Centennial sought to pass through part of its carbon costs to Delta pursuant to this review procedure, on the basis that such costs were government charges attributable to coal sold by Centennial and purchased by Delta under the agreement.


Are Carbon Costs “Government Charges”?


Under the supply agreement, government charges were defined as “all charges, taxes…royalties and other levies imposed on or payable by [Centennial] under any statute … to the extent attributable to coal sold by [Centennial] and purchased by [Delta] under the [supply agreement]”.


It was common ground on the pleadings that the cost of acquiring and surrendering eligible emissions units or paying a unit shortfall charge under the Clean Energy Act fell within the definition of “government charges”. The key issue in dispute was whether these costs were attributable to the coal sold and purchased under the agreement.

 

Reasons For Decision

 

Were Carbon Costs Attributable To Coal Sold And Purchased Under The Supply Agreement?

 

Centennial submitted that the words “to the extent attributable to” did not impose a causal relationship and were allocative words directed to determination of the portion of any government charge that was for Delta’s account. It also submitted that what was required, for one thing to be attributable to another, was that there be some relationship or connection between them, that might be, but need not be, a causal relationship.
In the alternative, Centennial submitted that if it was necessary to demonstrate a causal relationship, such a relationship existed because:

 

  • the emission of methane was an unavoidable incident of the mining of coal for sale under the supply agreement; and
  • Centennial could not extract coal to sell to Delta under the supply agreement without producing emissions attracting carbon costs.
 

It was also argued that the government charge review procedure evidenced the parties’ intention to provide a mechanism whereby new government charges incurred by Centennial could be passed on to Delta. This was submitted to be a commercially sensible outcome, as Delta would be able to recoup such charges by increasing the price it charged for the electricity sold into the market.


Delta submitted that the carbon charges were not attributable to coal sold by Centennial to Delta. Rather, they were attributable to Centennial’s greenhouse gas emissions. Delta also argued that the phrase “attributable to” required a causal relationship to be demonstrated and that in this case there was no such element of causation, as the emission of seam gases was a consequence of coal mining and not a consequence of the sale and delivery of coal to Delta. Delta countered Centennial’s submission on the commercial sensibility of Delta passing on the cost, by arguing that Delta, as a reasonably small player in the national energy market, would be unable to influence the market price in such a way as would enable it to recoup increased costs.


Was There A Sufficient Connection?


McDougall J held that there was a sufficient connection between the carbon costs and the sale and delivery of coal under the agreement to render the former attributable to the latter. In reaching this decision, McDougall J considered that:

 

  • Centennial and Delta had sought to achieve a number of things by their agreement, including the quantity and source of the coal supplied and purchased, and certainty of price, with as little variation as possible. They achieved this by stating a base price and allowing for adjustment for two factors, changes in CPI and changes in government charges. On this analysis, the parties recognised that government charges may increase and Delta agreed to bear some of that risk, if such costs were attributable to the sale of coal by Centennial to Delta.
  • The phrase “attributable to” requires some form of connection; however, an understanding of the nature of the connection requires attention to the context in which the process of attribution occurs and, specifically, to why it is that one thing is required to be attributable to another.
  • In this case, the context includes the way in which the parties sought to ensure certainty of pricing, whilst at the same time recognising that there would be some external factors – specifically, government charges – that might have a direct impact on the mining of coal for sale to Delta.
  • Carbon charges and unit shortfall charges are a necessary, or integral, part of the cost of production of coal. This is because they are imposed (in this case) on the emission of methane which is formed and trapped as part of the process of “coalification”, and inevitably released as a result of the mining of coal.
  • On the facts of the case, there was an obvious link between coal production and the sale of coal, particularly as Centennial was required to supply coal mined from the Mandalong mine. That being so, the charges under the Clean Energy Act, which arise inevitably on the production of coal, can properly be said to be attributable to the sale of that which is produced.
 

How Were The Carbon Costs To Be Allocated?


Whilst McDougall J did not make binding orders as to the allocation of carbon costs, the decision does discuss how emissions should be quantified. McDougall J suggested that, in principle, the appropriate method to quantify the relevant emissions was to take the totality of the emissions that are caused by the process of mining in any given period and to prorate those emissions between the total quantity of coal produced in that period and the quantity sold to Delta. McDougall J also suggested that coal that does not meet the stipulated quality standards should be excluded from any calculations.

 

End Notes

 

1 Centennial Mandalong v Delta Electricity [2013] NSWSC 1505

 

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For further information, please contact:

 

Tony Hill, Partner, Ashurst
[email protected]


Jeff Lynn, Partner, Ashurst
[email protected]


Paul Newman, Partner, Ashurst
[email protected]


James Bruining, Partner, Ashurst
[email protected]


Natsuko Ogawa, Partner, Ashurst
[email protected]


Peter Limbers, Partner, Ashurst
[email protected]

 
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