The European Commission and the Australian Government have recently announced an agreement to link the EU ETS and the Australian carbon pricing scheme.

The current Australian Scheme

Under the Australian carbon pricing scheme, a ‘liable entity’ which has a unit shortfall at the end of a given year will face a unit shortfall charge. The shortfall is calculated by reference to the number of ‘eligible emissions units’ surrendered by the liable entity for that year. There are three types of eligible emissions units: emissions units issued in Australia; carbon credits issued in Australia; and ‘eligible international emissions units’.

Interim link and final link

The essence of the linkage agreement is that ‘European allowance units’* will be prescribed as ‘eligible international emissions units’ and, subject to general limits on surrender, it will be possible from FY2015-16 onwards to offset liability under the Australian scheme using ‘European allowance units’. A general limit on the surrender of such units will apply in the first five years (1 July 2015 to 30 June 2020): in those years, up to 50% of liability may be offset by the surrender of such units. Thereafter, there will be no general limit on their surrender. A full ‘two-way link’ between EU ETS and the Australian scheme is proposed to be in place by 1 July 2018. The two-way link will mean that the price of carbon will be the same across the two regions.

Next steps

In order for the proposed agreement to go ahead the European Commission has agreed to seek a mandate from the Council to allow them to negotiate the treaty necessary to implement the proposals.

The Australian government already has a mandate. Legislation to give effect to the agreement has been introduced into the Australian Parliament. The Australian government has also agreed two principal changes to its current scheme to improve the compatibility of the two schemes:

  • The initially intended price floor ($15 per tonne) will not be implemented. This will increase flexibility in the Australian market and open up the road to linking the two systems. The price of Australian units will need to match the EU prices to ensure that the units are fully interchangeable.
  • A new sub-limit of 12.5% will be enforced for the surrender of eligible Kyoto units. This is to ensure that participants in the Australian scheme will not be able to satisfy their quota using too many of the cheaper Kyoto units.

Further changes ahead in EU ETS

The EU ETS scheme will also undergo some significant changes from January 2013. The revised Emissions Trading Directive provides for various changes including that:

  • there will be a centralised EU-wide cap on emissions which will be reduced each year;
  • the system of auctioning carbon allowances will play a more prominent role. The revised EU ETS Directive marks the end of free allowances for electricity production except in limited circumstances. Free allowances will be available for those industry sectors with significant risks of carbon leakage but will no longer be available for those without. In the energy sector, all allowances will be auctioned. It is expected that from 2013 half of all the allowances will be auctioned;
  • project credits from outside the EU under the Kyoto Protocol will be limited to no more than 50% of the reductions below 2005 levels required by the EU ETS.

The future of energy trading schemes

Currently the EU ETS has 30 participating countries. Airlines joined the scheme in 2012 and from 2013 the scheme will cover petrochemicals, ammonia and aluminium . EU ETS is also in discussions with Switzerland with regards to establishing a linked system. A fully integrated system means that units are completely interchangeable between the European and Australian systems so that those participating in one system can use units from another system in order to comply with their quota. Linking the EU ETS and the Australian scheme could also encourage the development of energy trading schemes in Asia and the Pacific and act as a key driver to reducing emissions.

Benefits of the link between EU ETS and the Australian scheme are likely to include costs reductions across the schemes as well as to increase market liquidity, stabilise the price of the units and to encourage global co-operation. The increased volume of members in the linked scheme will create a larger emissions market and greater opportunity.

*A ‘European allowance unit’ means an allowance (within the meaning of the European Union Greenhouse Gas Emission Allowance Trading Directive - Directive 2003/87/EC of the European Parliament and of the Council) issued by, or under the authority either of a country that is a Member State of the European Union or of a country that is not a Member State of the European Union but participates in the scheme for greenhouse gas emission allowance trading established by the Directive. It does not include an allowance issued in respect of aviation activities listed in Annex 1 of the Directive.