With all this talk of taxes being ‘terminated’ and an ‘invisible substance’ in a ‘so-called market’, observers could be forgiven for thinking our leaders are taking their cues from Hollywood action flicks when it comes to Australia’s policy response to climate change. And amid the twists and turns, the over-acting and the mounting body count, the suspense is rising over how this story ends as the federal election looms. 

In this article, Gadens cuts through the political spin and sets out what industry stakeholders need to know about recent announcements and the practical realities that will face our lawmakers.

The Government’s decision last week to bring forward the emissions trading scheme (ETS) by one year to 1 July 2014 was one of the worst kept secrets in Canberra.  If the announced changes become law – something which is far from certain – liable entities and industry stakeholders will have to adjust quickly to a ‘cap and trade’ ETS by this time next year. 

The outlook as to what Australia’s policy response to climate change will look like by the end of the year remains terribly uncertain for investors, liable entities and carbon market participants such as banks.  This uncertainty may well continue after the election, particularly if the result is close and an incoming Government has difficulty claiming a ‘mandate’ in respect of amending legislation. 

In the meantime, in addition to considering the impact of the Coalition’s proposed Direct Action scheme, industry stakeholders need to prepare for an ETS (with the potential for an expedited commencement next year).  Under the current ETS model, movements in international carbon prices and decisions of EU lawmakers will soon have a direct financial impact on Australian businesses and prudence would dictate that this be factored into any business or investment strategy.   

What you need to know about the proposed changes

The key aspects of the proposed changes announced by the Government last week can be summarised as follows:

  • Australia will move to a "cap and trade" emissions trading scheme where the carbon price is set by the market on 1 July 2014 (instead of the current legislated commencement date of 1 July 2015);
  • After considering advice from the Climate Change Authority, the Government will set a pollution cap defining the amount of covered emissions that will apply in 2014-15, consistent with Australia’s emissions reduction target (under the current fixed price period there is no cap on emissions);
  • Liable entities will be able to access international permits, including permits from the European Union Emissions Trading Scheme (EU ETS), and unlimited access to units generated under the Carbon Farming Initiative;
  • The Australian carbon unit price is expected to move in line with the carbon price prevailing under the EU ETS (Treasury is forecasting that the current fixed $24.15 price will drop to $6 under the ETS if it commences on 1 July 2014 under the new proposal); and
  • Compensation under the Jobs and Competitiveness Package for emissions-intensive trade-exposed (EITE) industries and the Household Assistance Package for low income families in 2014-15 remains unchanged.  This assistance was based on the $25.40 fixed price for 2014-15 and it has not been adjusted despite the expected drop in the fixed carbon price to $6 as we move to an ETS). 

Therefore, if the changes are implemented and if the carbon price does drop to $6 for 2014-15 (in line with Treasury forecasts) then low income families and EITE industries will receive a windfall from the compensation payments.  This price assumption by Treasury is the basis for the Prime Minister’s claims that the announced changes will ease cost of living pressures and support businesses. 

  • The revenue gap from moving from the fixed price to a floating price a year earlier than planned and maintaining the current compensation levels is estimated at $3.8 billion (also based upon Treasury forecasts in respect of the EU carbon price in 2014-15).  The Government has announced a number of savings measures in the budget to account for this shortfall.  More details on these budget changes can be found on the Treasurer’s website here.

Back to the future – the tricky politics of ‘tax’ and the end of fixed price schemes

In March this year, Gadens foreshadowed the current move to expedite the commencement of the ETS as an available option for a political ‘fix’ (please click here for details).  We set out the practical difficulties that an incoming Coalition government would face in unwinding the relevant Clean Energy legislation and honouring the promise to ‘axe the tax’.  We noted the attractiveness of expediting the ETS in light of the increasingly vocal support from business groups after, the collapse in international carbon prices and following last year’s legislative reforms in respect of the EU link and the removal of the $15 carbon price floor.  

However, in a remarkable turn of events, it is Kevin Rudd as Prime Minister and not an incoming Coalition government, who has enthusiastically taken up the mantle as ‘tax terminator’ and moved to end the fixed price period.   The decision owes much to the success of the Coalition campaign against the ‘carbon tax’.

In the Prime Minister’s attempts to reframe the discussion over climate change policy in the lead-up to the election to focus on emissions trading, he is unlikely to emphasise the fact that his original scheme, the Carbon Pollution Reduction Scheme (which had Coalition support under Malcolm Turnbull) had implemented the recommendations of Professor Ross Garnaut by also including a fixed price period not dissimilar to the current ‘carbon tax’. 

The impact of the election on the future of Australia’s response to climate change

In light of the recent announcement of the Government’s intention to bring forward the ETS by one year, industry stakeholders now have to adjust to at least three broad potential outcomes:

Click here to view table.

As we can see from the above table, if Labor is successful in obtaining a majority of seats in the House of Representatives at the federal election then the only real uncertainty in terms of broad policy direction is whether the ETS will commence on 1 July 2014 (under amending legislation) or 1 July 2015 (under the existing legislation). 

If the Coalition is successful in the federal election, only an outright Senate majority would provide absolute certainty in respect of its ability to repeal the existing carbon price legislation and replace it with its Direct Action scheme.  Otherwise, the cooperation of the other parties and respecting the ‘mandate’ of an incoming Government will be needed.   In our next update, Gadens will analyse the Coalition’s Direct Action policy and compare this to the current law and proposed offering from the current Labor Government. 

For current purposes, and until a repeal of the carbon price by an incoming Coalition Government is assured, industry stakeholders should keep informed about international developments in carbon markets and consider implementing risk mitigation and hedging strategies in anticipation for an ETS becoming operative within the next two years.   Whilst there may be considerable risks, the currently depressed price of international carbon units could create significant opportunities for savvy investors including Australian liable entities. 

The impact of the EU link and update on the rescue package

The package of reforms linking Australian and the European emissions trading schemes was passed with little fanfare late last year, however, the announcement to bring forward the ETS means that this package of amendments should be closely scrutinised by Australian businesses affected by the carbon price.  Gadens has explained the key amendments in a previous update (click here for details).

Following the recent announcement by the Prime Minister, the existing timetable for establishing an inter-registry link with Europe now needs to be significantly accelerated.  The only indication that we currently have that this is occurring is a twitter post by the EU Commissioner for Climate Action, Connie Hedegaard: 

“Great to see (Kevin Rudd) strongly committed to emissions trading – now being advanced to 2014 – speeding up ETS linking discussions (with) Australia”.

The list of issues requiring further policy detail continues to grow, and the detailed mechanics of the registry link with the EU system and how this is expected to be achieved in time for commencement in less than a year is perhaps the biggest piece missing from the ETS puzzle and the Government announcement. 

Whilst an ETS brings more emissions certainty – in the form of a strict cap on emissions – Australian companies will no longer have the luxury of certainty over the price of carbon.  Forecasting the price of international and European units over the coming years (as Treasury has done in its modelling) is little more than educated speculation based on a series of assumptions.  Treasury forecasts the price of European Union Allowances (EUAs) to leap from $6 in 2014-15 to $38 by 2020.  This increase is based upon the success of a number if EU Parliamentary processes in shoring up the scheme and tightening emissions targets.  Other assumptions also relate to the economic outlook improving across Europe and therefore driving demand.

In the short term, hopes for inflating prices and the survival of the EU scheme are pinned on the European Parliament approving a temporary rescue package known as ‘back-loading’ to remove some of the over-supply of credits in its market as a way of temporarily shoring up prices and restoring confidence in its market.  Longer-term structural changes to the scheme are also being contemplated.  For more information on these reforms to the EU ETS (please click here).

Since our last update on the rescue plan, some further tentative progress has been made, with the EU Parliament voting in favour of a legislation change which provides the EU Commission with a mandate to find agreement with EU governments.  Whether this can be achieved in the current economic circumstances and with several key European nations opposed to the changes is another matter entirely.