As the market digests the Australian Government’s decision to defer its proposed emissions trading scheme until well after the next election, Mallesons Partners Louis Chiam and Scott Farrell examine the policy changes and reflect on the implications for emitters, the low carbon sector and carbon markets.
The Australian Government’s recent announcement to defer implementation of its emissions trading scheme has, not surprisingly, attracted its fair share of media attention. Legislation for the Government’s Carbon Pollution Reduction Scheme (CPRS), which had been some two and half years in the making (longer if you include the earlier State-based proposals) and would have covered nearly 80 per cent of Australia’s greenhouse emissions and placed a carbon cost across virtually the entire Australian economy, has now been deferred until at least 2012.
Just as the CPRS would have been a very significant reform, so its deferral is relevant to every business from greenhouse gas emitters through to carbon markets and low carbon technologies.
In the wake of an inconclusive United Nations climate conference in Copenhagen and the implosion of a political deal to pass the enabling legislation, the Government’s CPRS had been in limbo for six months. At a doorstop at the Nepean Hospital at Penrith on 27 April, the Prime Minister outlined the Government’s new policy. The Government remains committed to a minimum five per cent reduction in Australia’s greenhouse emissions by 2020 and continues to believe an emissions trading scheme is the best way to get there. However, in light of domestic political circumstances and an uncertain international outlook, the Government will “extend the implementation date” to at least the end of 2012.
The Government had intended to secure passage of the legislation in late 2009, with CPRS to start on 1 July 2011. However, the legislation, which lacks the support of either the coalition opposition parties or the cross-bench senators, has now been deferred for at least two years.
The underwhelming results of the 2009 United Nations conference in Copenhagen and ongoing uncertainty surrounding the fate of the Kyoto Protocol after it expires at the end of 2012 are both well-known. However, the last fortnight has seen two separate but related international developments.
First, the wheels fell off a major bipartisan climate change initiative in the US. In the wake of the Waxman-Markey cap-and-trade scheme’s failure in the US Senate, three Senators - Democrat John Kerry, (moderate) Republican Lindsey Graham and independent Joseph Lieberman – had been jointly developing a fresh piece of climate change and energy legislation. Press speculation suggested the draft bill incorporated a cap-and-trade scheme for electricity generation and a carbon tax on the oil and gas industry.
The three Senators had been poised to launch the legislation on 26 April but, in a dramatic reversal, Senator Graham withdrew from the negotiations on 24 April, claiming Democrat proposals to deal with controversial immigration reforms ahead of the energy bill meant he could no longer participate in the energy bill. As a result of Senator Graham’s withdrawal, the bill has been postponed, with no date set for its return.
Meanwhile Mexico and Germany attempted last week to re-inject some urgency into the United Nations process, convening a three day meeting outside Bonn. In an effort to address some of the perceived shortcomings of the Copenhagen conference, the meeting (or Petersberg Dialog, as it is officially known), involved representatives from 45 selected countries including the US, China, India, the UK, Australia and Brazil, and was designed to establish a framework and timetable for negotiations leading up to the next United Nations climate conference in Cancun, Mexico, starting in November this year.
Not surprisingly, while some progress was made on specific projects, the meeting made little headway towards a new global protocol. In comments at the conclusion of the meeting, the German environment minister claimed the talks had “broken the ice” on these discussions. There is clearly a long way to go before any global deal emerges.
If there is a lesson to be learned from the recent history of climate policy in Australia, it is that any prediction is likely to be wrong. So with that caveat, here are our thoughts on some possible scenarios and their impacts.
The Government has indicated that it would not seek to reintroduce an emissions trading scheme until 2012 at the earliest. This has two important implications.
First, it suggests the Government would not look to put the CPRS legislation to a joint sitting of Parliament following a double-dissolution election, which must be called prior to August this year. In these circumstances, even if the Government were to reintroduce the CPRS, it is difficult to see a straightforward political solution to ensure passage in the Senate. The coalition remains opposed to an emissions trading scheme and the Government has not been able to strike a deal with the cross-bench senators. It seems unlikely that the political dynamics will be altered dramatically any time soon.
Second, even if a CPRS Mark II were passed into law at a later date, there would be a considerable time lag before the formal start, to allow affected businesses adequate time to prepare for the scheme. In CPRS Mark I, which benefited from detailed Government-Industry liaison that ran well ahead of the legislative timetable, the Government implicitly allowed a lead time of 18 months from legislation to start date. By the time of any CPRS Mark II, much of that corporate knowledge will have seeped away, making implementation even more challenging.
As a result, we think it is unlikely any new CPRS would commence before July 2014 and it is easy to see this slipping well into 2015 – an effective window of four to five years.
The compliance sectors, comprising industries such as power generation, manufacturing and mining that were to be “covered” under the CPRS, face a quandary. On the one hand, they have considerable certainty that there will be no CPRS in the short term. However, the prospects of investing in a major new plant or refurbishing existing facilities are more complicated. These assets are typically very long-lived (over 20 years) and the investment environment beyond year five remains murky. The climate pendulum has swung decisively in recent time against policies such as an emissions trading scheme. But the pendulum will inevitably swing back to some extent and, given both the Government and the coalition advocate action on climate change; it would be a brave decision to bank on a no-carbon-price outcome.
Similarly, any long-term carbon-intensive supply contract, for example, to purchase gas, electricity or chemicals, still needs to anticipate, and clearly allocate, any future carbon costs. While much of the legal “software” in the market today is based on the CPRS, this is likely to give way, in favour of a return to the more generic “change in law” clauses that were common four or five years ago (or perhaps a blend of the two).
However, one implication is clear – businesses facing a complex investment are better making the decision sooner rather than later. A five year window will assist many business cases and you never know how long the window will be open.
It is easy to be pessimistic about the future for the low-carbon sectors. The CPRS delay will, naturally, adversely affect a number of businesses set up to take advantage of a carbon price. Some industries will now defer the purchase of new technology, reducing demand for low-carbon products. Similarly a number of offset projects such as forestry or land use projects, will not be able to sell credits into an Australian compliance market and will have to rely instead on the less liquid voluntary market.
However, the CPRS was never the sole influence on this sector. For example, renewable energy generators will continue to benefit from the enhanced mandatory renewable energy scheme, which is expected to have such a strong impact on electricity prices that the Government has established a compensation scheme for some affected (large) electricity users.
The extended deferral of the CPRS has called a halt to the development of Australia’s carbon market. The core of such market was to be trading in Australian Emissions Units created under CPRS. Without the CPRS, there is nothing to trade. We had seen that it was possible to engage in carbon trades before the CPRS came into effect, as some such trades have been entered into. However, the length of the deferral and the uncertainty around CPRS implementation makes further trading very unlikely. Accordingly, the work done by the Australian market to develop standard documentation for carbon trading and carbon derivatives is now likely to be put “on-the-shelf” to be recalled when needed at a future time.
Of course, trading in international units by Australian entities can continue. However, the absence of the CPRS gives rise to some interesting implications for this:
the CPRS was to provide for certain international carbon units to be regulated as financial products under the Australian Corporations Act. Without the CPRS, there is no such prescribed financial market regulation of international units in Australia, although derivatives in respect of international carbon units will be subject to the same regulation as other derivatives;
the CPRS was to provide that certain international carbon units were to be treated as property for the purpose of some Australian laws, such as those relating to bankruptcy. Without this, the treatment of those units for some Australian law will not be as clear; and
to some extent the industry discussions which led to the development of Australian carbon documentation may “echo” through future negotiation of international carbon trading documentation with Australian counterparties. The Australian documentation was based on international standards and provisions relating to domestic issues, such as taxation, may still be needed.
In addition, the possibility of a CPRS may still need to be reflected in other current trading documentation, particularly for transactions which relate to carbon-intensive industries, such as electricity. Unfortunately, the additional uncertainty created for the CPRS by its deferral has not made the crafting of these sorts of provisions any easier.
A final question is whether we will see the return of the Australian “voluntary” markets, which found it difficult to attract attention in an environment dominated by the CPRS. Businesses will no longer be able to rely on CPRS permits as their carbon contribution, possibly heralding the re-emergence of the carbon-neutral business. Likewise, at the retail level, some consumers (presumably those who choose to pay more for renewable energy) will be willing to pay a premium for a carbon neutral product.