Key Points:

The Carbon Price Mechanism reflects many key design elements of the Carbon Pollution Reduction Scheme, but there are some key changes.

While the nomenclature may have changed, the Carbon Price Mechanism (CPM) announced on Sunday 10 July by Prime Minister Gillard, as part of the Clean Energy Future package, reflects many key design elements of the Carbon Pollution Reduction Scheme dumped in February 2010.

What's been carried over from the CPRS

The "Clean Energy Future" package (aka the Carbon Price Mechanism or CPRS 2.0), contains the following same elements of the original CPRS:

  • an unconditional 5% target for emissions reduction by 2020 based on 2000 levels, with the option to increase to 10-25% depending on international developments;
  • broad sectoral coverage – stationary energy, transport, industrial processes, non-legacy waste and fugitive emissions will be covered. Agriculture and land use will be excluded. There will be no phasing in of sectors over time unlike the NZ ETS and EU ETS;
  • a carbon price will be set based on an emissions trading scheme;
  • there will be an initial transitional period, during which time permit prices are fixed;
  • liability threshold generally remains 25ktCO2-e of direct (scope 1) emissions, except for certain waste facilities where the threshold will be 10ktC02-e;
  • compensation in the form of a free allocation of permits to emissions intensive and trade exposed (EITE) activities;
  • auctioning of permits during the flexible price phase;
  • assistance to households; and industry adjustment assistance, particularly for the stationary energy sector.

And what's new about the Clean Energy Future package

While some of us may ask "why didn't the Greens just support the CPRS in the first place?", there are sufficient changes to keep us interested and give the Greens excuses. Some of the more significant changes include:

  • an increase in the 2050 emissions reduction target from 60 to 80% in line with recent commitments by the UK and Germany;
  • a fixed date for transition to an emissions trading scheme. The scheme will transition from fixed price to a market on 1 July 2015;
  • a price floor and ceiling when the scheme moves to the trading phase, at least for the first three years;
  • the liable entity for direct emissions from a facility will generally be the person with operational control over that facility, not the ultimate Australian holding company, thus avoiding the "parent trap" scenario that existed under the CPRS;
  • additional assistance for "gassy" coal mines, LNG projects and steel manufacturers;
  • transport fuels excluded from the carbon price mechanism, but with an equivalent price achieved through changes in fuel tax credits and excise, but only for heavy transport including aviation;
  • the number of greenhouse gases covered by the CPM reduced from six to four – carbon dioxide, methane, nitrous oxide and perfluorocarbons remain covered, with synthetic greenhouse gases to be regulated under separate legislation;
  • more assistance to the stationary energy sector, particularly brown coal-fired generation, including payments for closure;
  • establishment of an independent Climate Change Authority, chaired by former Reserve Bank Governor Bernie Fraser, to advise on pollution caps, levels of assistance/compensation and linkages;
  • reduction in international linkages, at least in the initial phases, with no international trading during the fixed price period, and requirement to meet at least 50% of scheme obligations with domestic permits or credits during the first five years of the trading scheme.

The Government estimates that whereas the CPRS achieved 80% coverage of national emissions, the CPM will capture 50%, and other measures such as adjustments to fuel excise will increase coverage to 60%. Parts of the package however, have not been approved by the MPCCC, including the proposed cuts to fuel tax credits for heavy road transport, and additional assistance to coal mines and steel making.

In addition, the CPM comes gift-wrapped with a number of complementary measures to assist the renewable energy and energy efficiency sectors, and to justify the change in name (heaven forbid that it be described as a "carbon tax").

What's the price?

Permits during the three year transitional period will have a fixed price of $23, increasingly annually by 2.5% in real terms. Assuming a CPI rate of 2.5%, permits will cost $24.15 in 2013-14, and $25.40 in 2014-15. Treasury Modelling indicates that this will have a 0.7% impact on CPI, less than the 2.5% increase at the time of the introduction of the GST.

After the transitional period, the price will be determined by the market, however, to provide price stability, certainty and to appease some interests groups, the Government has agreed to both a "price floor", and a "price ceiling" for at least the first three years of the scheme.

The floor price will be set at $15 and increase each year by 4% in real terms. The price ceiling will be set at $20 above the expected international permit price, rising 5% pa in real terms.

Who is liable?

This is where there appears to have been a significant departure from a key design element on the CPRS. Under the CPRS, as with reporting obligations under NGERS, Australian parent companies of operators of facilities that emit more than the threshold were liable to surrender permits. Buried on page 105 of the Clean Energy Future package, the liable entity is stated to generally be the person with operational control of the facility, that is the operator. This is the same position adopted in the EU ETS.

If this is ultimately translated into the proposed legislation for the scheme, this will overcome what we described as the "parent trap" where liability sat with the Australian parent company, with the carbon price potentially unable to be passed through under existing supply contracts.

For unincorporated joint ventures, where the majority interest potentially assumed 100% liability under the CPRS with similar impediments to carbon price pass through or recovery, there is also a proposed sensible change. Where no one person has operational control of a facility under an unincorporated joint venture, the liability for emissions is spread between the joint venture participants in proportion to their interest in the facility.

With the omission of transport fuels from the CPM, the Government estimates that it has cut the number of liable entities from 1000 to about 500, with the largest 50 entities making up 75% of the CPM liability.

The scheme will also allow the operator of the facility to transfer its liability to another member of its corporate group, a person outside the group with financial control of the facility, or to participants in an unincorporated joint venture.

What's the cap?

Although during the transitional period there will be no limit on the number of permits the Government can issue, in order for the scheme to move to a free(-ish) market in 2015, the annual emissions cap will need to be set, thus quantifying the number of permits likely to be available.

The Government intends to announce the first five years' worth of caps in 2014. Each year thereafter, the cap for the fifth year will be announced to maintain five years of known caps at any given time.

When setting the caps, the Government must consider, among other things, the recommendations of the Climate Change Authority (CCA). The CCA will also make recommendations on indicative national trajectories and long-term emissions budgets, and provide advice on whether national targets are being met. Voluntary action by individuals, such as voluntary cancellation of permits or Greenpower purchases, will be considered in setting scheme caps.

Compensation

In addition to the compensatory measures to assist emissions intensive and trade exposed activities exposed to a carbon price, the Government also proposes additional assistance for the coal, steel-making and stationary energy sectors. There is also a raft of measures to compensate middle-low income households from the effects of the carbon price, mainly through changes to tax and benefits systems.

However, one of the more significant changes is the exclusion of fuel from the CPM, and any reductions to the fuel tax credit regime limited to the heavy transport sector. Agriculture, fisheries and forest sectors will not be subject to any reduction in fuel credits.

Where to from here?

The Government proposes to release draft legislation for comment before 31 July 2011, and introduce legislation into Parliament to give effect to the scheme before the end of 2011. The commencement date of the scheme remains 1 July 2012, as announced in February this year.

Whether the Government can get the legislation through Parliament within this time-frame, or at all, is dependent on a number of variables. Unlike the experience with the CPRS, the risk for the Government lies in the House of Representatives, not the Senate, now that the Greens hold the balance of power in that chamber.

Clearly the MPCCC's objective has been to ensure that agreement will equate to support from the independents and Greens in both houses for the legislation. Independent MPs Tony Windsor and Rob Oakeshott, who were on the MPCCC, have stated that they will vote for the legislation if it is consistent with the agreement announced on Sunday. Independent MP Andrew Wilkie has also recently expressed his support. That said, there are some elements of the package that do not have MPCCC support, including cuts to fuel credits for heavy road transport, and additional assistance to the coal and steel sectors. These, however, are unlikely to be fatal to the package.

While the Opposition will do its best to turn independents in the House of Representatives, the chances of legislation passing must be considered very likely, absent any sudden by-elections.