Europe represents the world’s largest and longest-established carbon market. The potential link between Australia’s carbon price and Europe’s emissions trading scheme (ETS) will require some key changes to the design of the Australian carbon price – changes that will have ramifications for the level of the price from 1 July 2015. It is expected that this link will further entrench the carbon price in Australia.

The processes behind the link

On 28 August 2012, the Federal Government and the European Commission jointly announced that they had agreed to link the Australian carbon price mechanism and the European Union (EU) ETS. The EU ETS operates across all 27 EU member states, as well as Norway, Iceland and Liechtenstein.

Under the agreement, ‘liable entities’ under either scheme will be able to use carbon units from either scheme to help meet their carbon liabilities.

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From 1 July 2015, Australian liable entities will be able to use EU allowances issued under the EU ETS; by 1 July 2018, a full two-way link will be established to also allow EU liable entities to use carbon units issued under the Australian mechanism.

To facilitate linking, a number of changes will be made to the design of the Australian carbon price, namely:

  • The $15 per tonne carbon dioxide equivalent floor price, which was to have been applied to the Australian carbon price from 1 July 2015 to 30 June 2018, will be scrapped
  • Between 1 July 2015 and 30 June 2020, a new sub-limit of 12.5 per cent will apply to the use of Kyoto units by Australian liable entities.

Kyoto units are certified emissions reductions (CERs) under the Clean Development Mechanism program applying to: emissions reduction projects in developing nations; emissions reduction units; and removal units. This means that while Australian liable entities will still be able to surrender eligible international emissions units to meet up to 50 per cent of their liability from 1 July 2015 to 30 June 2020, they will only be able to meet 12.5 per cent of their liability using Kyoto units.

The Australian Greens and key independent members of Federal Parliament have been consulted on, and have supported, these changes to the Australian carbon pricing scheme. Legislation to give effect to the changes was released for public comment and recently introduced into Parliament. The legislation is expected to be passed shortly.

Relevance for Australian business

Scrapping the floor price is intended to address a key industry concern that the Australian carbon price was set too high and out of step with the low EU and international price.

It will not affect the Australian fixed price between now and 30 June 2015 ($23 per tonne of carbon dioxide in 2012-13, $24.15 in 2013-14 and $25.40 in 2014-15).

Rather, the floor price will be removed with effect from 1 July 2015, which is the date the fixed-price phase of the Australian carbon price mechanism gives way to a flexible price phase under an ETS. In the flexible price phase, the carbon price applying in Australia will be influenced by the EU price.

That future EU price remains uncertain. While it is currently around $10 per tonne of carbon dioxide, European governments have indicated they may take steps designed to lift the EU price over the short and long term by releasing fewer units. Current forecasts indicate that the EU price will be around $15–20 per tonne of carbon dioxide by 2015. However, such forecasts are complicated by southern Europe’s continuing economic uncertainty.

While Australian liable entities will be able to use a proportion of cheap CERs to meet their carbon liability from 1 July 2015, the new sub-limit of 12.5 per cent will prevent CERs from being the predominant influence on the Australian carbon price. CERs are currently trading at less than $4 per tonne of carbon dioxide.

Immediate opportunities and implications for businesses

Australian liable entities can now take advantage of the current low prices for EU units and Kyoto units, and can buy them now for use under the Australian scheme from 1 July 2015.

Risks remain, however. There is still some uncertainty about the political future of the Australian carbon pricing mechanism, and the Kyoto Protocol’s future is uncertain beyond 2012.

It is very likely that the EU scheme will continue, and so there is a lower risk in buying EU allowances. Even if the Australian carbon price mechanism was changed or repealed in the future, EU allowances bought now will still retain value under the EU ETS.

International legal firms such as Freehills can assist businesses with undertaking necessary due diligence and acquiring EU and Kyoto units.

The removal of the price floor from 1 July 2015 will apply pressure to the viability of Australian Carbon Farming Initiative (CFI) projects, which can no longer be assured of the $15 per tonne carbon dioxide floor price that would otherwise have applied.

Further international ties

The Federal Government has stated that linkage of the Australian carbon pricing mechanism with other ETS programs will not stop at the EU. In particular, it is also pursuing links in the Asia-Pacific region, including New Zealand.

In doing so, the Government has recognised that an effective global market will reduce global and Australian abatement costs by ensuring that the cheapest abatement opportunities are pursued first, regardless of where in the world they occur.

A further consequence of the 28 August 2012 announcement is that the link with the EU ETS further entrenches a carbon price in Australia. This will likely make it more difficult for a Federal Government led by the Liberal Party and Nationals Coalition to repeal the carbon price if it wins government at the next election in late 2013.