• The Carbon Pricing Mechanism (CPM) will commence on 1 July 2012
  • Around 500 companies will be required to acquire and surrender “eligible emissions units”
  • Eligible emissions units include carbon units (issued by the Government) and certain other carbon permits and credits (from international or domestic offset projects or from other countries’ trading schemes)
  • A carbon unit will allow the discharge of 1 tonne of CO2-e in a compliance year
  • The initial fixed price for a carbon unit will be $23
  • From 1 July 2015, the price of carbon units will be set by the market
  • Transport fuels and synthetic greenhouse gases will not be directly covered but in some cases an equivalent carbon price will be applied through changes to tax credits, excise and levies
  • Large fuel users may choose to opt-in to the CPM from 2013
  • The Government intends to impose a carbon price on heavy on-road transport from 1 July 2014
  • Various emissions will not be covered, for example agricultural emissions and emissions from legacy waste.  

Who is required to acquire and surrender Emissions units?

Generally, if an entity has ‘operational control’ over a facility that emits 25,000 tCO2-e or more in a compliance year, it will be a “liable entity” and required to acquire and surrender an “eligible emissions unit” for each tCO2-e emitted.

The following types of facilities may exceed this threshold:

  • stationary energy (eg power stations);
  • industrial processes (eg manufacturing);
  • waste management/disposal (eg landfill or waste treatment); and
  • active coal mines and oil and gas projects.  

A Liable Entities Public Information Database is being created progressively by the regulator. The current version of the Database can be accessed here.

Determining whether the threshold is exceeded

All ‘covered’ emissions will count towards the emissions threshold and, if the threshold is met, the obligation to surrender eligible emissions units. Covered emissions are the direct emissions from a facility (ie scope 1 emissions), other than certain excluded emissions.

Emissions from the following activities/sources are excluded:

  • the combustion of certain fuels that have been subject to customs or excise
  • the combustion of biofuels, biogas and biomass
  • agriculture and the land sector
  • closed landfills
  • decommissioned underground mines
  • certain synthetic greenhouse gases  

Emissions from legacy waste (ie waste deposited before 1 July 2012) will count towards the emissions threshold but are excluded from the obligation to surrender eligible emissions units.

It may be possible to transfer liability

A liable entity will be able to apply to transfer its CPM liability to –

  • another member of its corporate group; or
  • a person outside its corporate group who has financial control over the relevant facility.  

Natural gas is treated differently

Emissions from the use of natural gas are treated differently under the CPM, as the obligation to surrender eligible emissions units will generally fall on the natural gas supplier rather than the user of the gas. In these situations, the natural gas supplier will be a “liable entity” and the user of the gas will not be required to surrender eligible emissions units for the emissions from the gas (although these emissions will count towards their emissions threshold).

The general exception is where the natural gas is for use in the operation of a large gas consuming facility, in which case the liability must be transferred from the supplier to the recipient of the natural gas.

Who is in ‘operational control’ of a facility?

Generally, the person who has “operational control” of a liable facility will be required to surrender eligible emissions units for that facility.

A person will have operational control if s/he has authority to introduce and implement any or all of the operating, health and safety and environmental policies for that facility.

Where a facility is operated by an unincorporated joint venture and two or more persons may satisfy the ‘operational control’ test, the CPM liability for that facility must be allocated between the joint venture participants in proportion to their respective interests in the facility.

On the other hand, where it is possible to identify the person in ‘operational control’ of a facility operated exclusively for a joint venture, the CPM liability may be voluntarily transferred to and allocated between the joint venture participants in proportion to their interest in the facility (subject to certain conditions).  

What is an eligible emissions unit?

Eligible emissions units are:

  • Carbon units - Carbon units will be issued by the Government under the Clean Energy Act 2011 (Cth) and either sold, auctioned or given away.
  • Australian carbon credit units (ACCUs) -ACCUs will be issued by the Government under the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) for certain greenhouse gas abatement and sequestration activities in the agricultural, land use and legacy landfill sectors in Australia
  • Certain international offsets and permits - The international offsets that will be eligible include certified emission reductions (CERs), emissions reduction units (ERUs), and removal units (RMUs), issued under the Kyoto Protocol. Also, it is intended that the CPM will be linked to other trading schemes in the future, eg the EU Emissions Trading Scheme and/or the NZ Emissions Trading Scheme. This will enable liable entities to use international permits to meet their obligations under the CPM (subject to certain limitations).  

How much will a carbon unit cost?

A price on carbon will be introduced in two stages:

  1. From 1 July 2012 – 30 June 2015 – the price of carbon units will be fixed by Government (the fixed price period).
  2. From 1 July 2015 onwards – the market will determine the price of carbon units (the flexible price period)  

Fixed price period

Initially, the Government will sell carbon units for $23, and in some cases, issue free carbon units. The price of carbon units will increase to $24.15 in 2013–14 and $25.40 in 2014-15 (reflecting a 2.5% increase in real terms).

Liable entities will be entitled to purchase as many carbon units as they need to satisfy their obligations under the CPM.

During this period, carbon units may not be banked (ie. kept for future years) and generally must be surrendered in two parts during a compliance year (in a similar way to payment arrangements for corporate taxes).

Although liable entities may surrender ACCUs during this period, they can only do so to acquit up to 5% of their obligation[1].

International permits and offsets may not be used to meet CPM obligations during this period.

If a liable entity fails to surrender the required number of carbon units during this period, an emissions charge will be imposed. The emissions charge will be 1.3 times the fixed carbon unit price.

Flexible price period

During this period, the CPM will operate as a ‘cap and trade’ scheme.

The Government will set a cap on the amount of greenhouse gases that may be emitted from the facilities covered by the CPM during each compliance year. In setting the cap, the Government will consider Australia’s greenhouse gas reduction targets and international climate change obligations (amongst other things).

The Government will auction the number of carbon units that is consistent with achieving that cap (taking into account the allocation of free units under the industry assistance schemes). The policies, procedures and rules for auctioning will be set out in regulations which are due to be released shortly. The Government has confirmed that it will advance auction future vintage units and there will be advance auctions of flexible price units during the fixed price period. It is expected that the first auction will take place at the beginning of 2014.

Carbon units may also be traded on the secondary market.

As the price of carbon units will be heavily influenced by the number of units that will be available, the Government will announce each annual cap five years in advance, with the annual caps for the first 5 years of the scheme to be announced by 31 May 2014. Notably, there is no requirement to provide an indication of longer term caps.

In order to provide a safety valve against price spikes and plunges and provide more certainty for investors and liable entities, there will be a price floor and a price ceiling for the first three years of this period and possibly longer. The price floor will be $15 (rising by 4% in real terms each year) and the price ceiling will be set at $20 above the expected international price for 2015-16 (rising by 5% in real terms each year).

There will be no limitation on banking carbon units during this period. However, liable entities will only be able to borrow carbon units from future years in limited circumstances.

During this period, there is no limit on the use of ACCUs to meet CPM obligations.

Eligible international offsets or permits can be used during this period subject to certain qualitative and quantitative restrictions.  In particular, until 2020 liable entities must meet at least 50% of their obligations under the CPM with domestic units or offsets.

If a liable entity fails to surrender the required number of eligible emissions units during this period, the emissions charge will be double the average price of carbon units for the relevant compliance year.

Treatment of fuel emissions

Although emissions from the combustion of fuel are effectively excluded from the CPM, an equivalent carbon price will be imposed in certain circumstances through changes to the fuel tax regime.

This will apply to:

•certain transport activities, including domestic aviation and shipping, rail transport and some  off-road transport use of liquid and gaseous fuels; and •the non-transport use of liquid and gaseous fuels, for example diesel generators. Large fuel users will be entitled to opt-in to the CPM from 2013 if they would prefer to manage their carbon liabilities through the acquisition and surrender of eligible emissions units rather than paying the carbon price through the fuel tax regime.

Also, the Government intends to impose a carbon price on heavy on-road transport from 1 July 2014.

What are the tax implications?

The income tax law has been amended to include specific provisions dealing with registered emissions units. These provisions will provide for a rolling balance method of accounting, similar to trading stock, for income tax purposes.

The cost of acquiring a registered emissions unit will be deductible and the proceeds from selling the unit will be assessable. The deduction for the cost of acquiring units will, however, be deferred until the unit is surrendered, sold or otherwise disposed of. The deferral is achieved by including in assessable income the difference between the value of units on hand at the start and end of the income year.

In the first year, taxpayers will be able to elect to value their units at either actual cost, FIFO (first in, first out) or market value. If no election is made, the FIFO cost method will apply by default. There are limitations on changing methods.

Emissions units will be deemed to have a market value in a number of situations including in non-arm’s length transactions, and where units are issued for free as part of an assistance arrangement. Special rules also apply to transfers of units to or from a foreign account (i.e. if they are on a foreign register).

Where an entity surrenders a unit for a purpose unrelated to producing assessable income, the deduction for the cost is effectively reversed by including in assessable income an amount equal to the amount deducted for its acquisition.

Regular transactions involving emissions units will be GST-free. However GST rules will apply to transactions involving financial derivatives of emissions units and the payment of grants of government assistance and other transactions under the carbon pricing mechanism.

Who will administer the CPM?

The Clean Energy Regulator will administer and enforce the CPM as well as the National Greenhouse and Energy Reporting scheme, the Renewable Energy Target and the Carbon Farming Initiative.

The Clean Energy Regulator is lead by Chloe Munro, who was previously the Chair of the National Water Commission, and commenced operations on 2 April 2012.

The Regulator will publish a series of guidance notes and application forms relating to the CPM and associated schemes on its website.

The Climate Change Authority will provide independent advice to the Government on carbon pollution caps, the performance of the carbon price and other initiatives. Former Reserve Bank Governor and Treasury Secretary Bernie Fraser will be appointed as Chairman of the Authority, which will be made up of experts with a particular focus on climate science, economics, climate change mitigation, emissions trading, investment and business.

The Climate Change Authority will begin operation in July this year and will undertake a number of reviews going forward, including a review of the Renewable Energy Target (by 31 December 2012) and a review of the CPM (by 31 December 2016).

The Productivity Commission will review industry assistance under the Jobs and Competitiveness Program and the Coal Sector Jobs Package, review the impact of carbon price on industry, review fuel excise arrangements and report on actions taken by other countries to reduce greenhouse gas emissions.