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Carbon trading: companies play the waiting game (1)

Carbon trading: companies play the waiting game (1)

Australian companies nervously await the release of the framework legislation for the Carbon Pollution Reduction Scheme - now just a matter of months away. No doubt it's an exciting time to be a…

Australian companies nervously await the release of the framework legislation for the Carbon Pollution Reduction Scheme - now just a matter of months away. No doubt it's an exciting time to be a climate change lawyer in Australia.

The Federal Government's Carbon Pollution Reduction Scheme Green Paper, released in July, outlined the basic structure the scheme is likely to take and clarified a number of important issues. It confirmed, for example, that the scheme will have "maximum practical coverage" which will include the transport sector. Agriculture will be initially excluded, but with the intention that it be brought in at a later date, and forestry can be included on an "opt in" basis.

The paper also confirmed that in contrast to the European Union's Emissions Trading Scheme (ETS), permits will be auctioned off from the get go, subject to some exceptions.

But many of the nuts and bolts of the scheme have been left to the legislation. For example, the paper hinted vaguely that "strongly affected industries" will receive a "limited amount of direct assistance", but many questions remain about the type and extent of this assistance. The absence of any real detail on this point is undoubtedly a reflection of the controversy surrounding the notion of the government compensating coal-fired power plants and the issue has been the subject of intensive lobbying.

Another issue that's sparked the attention of many Australian companies is the Green Paper's indication that "emissions-intensive trade-exposed industries" will receive assistance in the form of free permits.

It indicated that some companies will receive free permits covering 90 per cent of their emissions, while others will receive permits covering 60 per cent - depending on their emissions intensity. The paper's suggestion that up to 30 per cent of all permits will be earmarked for such industries has provoked a mad scramble among industries groups trying to justify why they fall under the "trade-exposed" umbrella, or should otherwise be compensated or exempted from the scheme.

Key players in the LNG industry, for example, have claimed they will incur significant costs as a result of the scheme which will threaten the industry's international competitiveness, and they are calling for the industry to be excluded from the scheme. However a number of parties, including JP Morgan energy analyst Mark Greenwood, contend that these claims are significantly overstated.

Freehills partner John Taberner confirmed that the issue has been a source of anxiety for many companies. "One of the central concerns of many people is what a 'trade-exposed industry' is. How do you qualify that? What should be the degree of assistance to such an industry? For how long should it last? And so on," he says.

Allen Arthur Robinson partner Grant Anderson agreed that the 'trade-exposed industry' definition is one of the big concerns for clients, [especially] for those companies who will likely miss out on a free allocation. "And then you've got those who might be in the 90 per cent category saying 'We need 100 per cent' ... and you've got people in the 60 per cent category saying 'We should be getting 90 per cent'. It's certainly a very important area," he says.

Obviously a major concern for companies is what the price of permits will be - something that can't be determined until emissions trajectories have been released by the Government and the initial emissions cap has been set. Although forward trading in permits has already commenced on a small scale - the AGL Energy/Westpac trade being the first - Baker & McKenzie partner Paul Curnow believes that the real action will start once the Government's White Paper (setting out the trajectories) is released at the end of the year.

"A lot of our clients are now making submissions to government and putting their positions forward," Curnow says. "A lot of them aren't at the stage where they're doing transactions yet. We expect that's going to change post-White Paper."

Freehills solicitor Jason Johnston agrees that Australia is unlikely to see an active market in forward trades of permits until there is greater price certainty.

"Until you know the actual overall cap on emissions and therefore, how many permits there are likely to be, the market won't be able to set a meaningful price," he says. "The ASX is keen to provide a platform for these types of forward trades ... and certainly as we get closer to certainty about the cap there will be a greater likelihood of forward trades in permits."

Taberner added: "It's probably not likely to occur in any event before the legislation is at least released in draft form."

Anderson believes that the price of permits in any forward trades is likely to be reasonably low, because of the inherent risks of forward trading under a scheme that is not yet operational.

"I'd have thought that buyers are going to be saying 'Well, because of the price uncertainty, we'd expect a price that's pretty low'," he says. "The ultimate risk is that the scheme doesn't go ahead, so presumably you'd need to provide that to the extent any monies have been paid, they'll be repaid.

"The other risk, which is not so dramatic, is what happens if the seller can't actually obtain the units. Now it's a fairly low risk, but again you'd need mechanisms that would deal with that possibility."

Whatever the eventual price, Taberner says that an important consideration for companies affected directly or indirectly by the scheme is how and whether they will be able to pass those costs through.

"An issue we have found clients to be really concerned with is how the cost will be passed through and the cost of acquiring and acquitting permits in existing contracts, particularly long-term ones. The flipside of that is that if you're the recipient of a cost pass through, how can you make sure that you're not being shafted?" he says.

Another worry for companies is whether there will be relative permit price stability once the scheme is operational. This is particularly pertinent when considering the experience of the EU ETS in its first phase, where the price of permits nosedived from a high of 30 ($53) in 2006 to practically nothing by the end of 2007.

However Curnow, Taberner, Johnston and Anderson all agree that, because of a range of factors, the price of permits in the Australian scheme is likely to be less volatile.

For a start, permits under the EU scheme were significantly over-allocated, largely because, for the most part, it was left to industries and EU member states to determine what they would require. However in Australia, the risk of this occurring is far smaller because most permits will be auctioned from the start.

"[In the first phase of the EU scheme] there was an over-allocation and the problem was that the market didn't realise there was an over-allocation until half way through the first period," Curnow explained. "Then, when they released all the imagery data, everyone suddenly realised that the market was long and the price went to zero - as it should."

Anderson added: "[In the first phase of the scheme EU] the information about the true position leaked out in a fairly uncontrolled manner and that led people to losing confidence. So it's an unusual event and I wouldn't have thought that would be replicated in Australia."

And even in the second phase of the EU scheme, Curnow explained, lessons have been learned and things are looking far more stable.

"There are indications that [the EU market] is going to be short [in the second phase]. The caps have been tightened and the European Commission has played a much stronger role in challenging member state caps," Curnow says.

The Australian Government has also indicated that all Australian permits will be infinitely bankable - meaning they won't lose their value at the end of each phase of the scheme. This is in contrast to the EU ETS, where permits from the first phase could not be used in the second phase and therefore became worthless as the first phase drew to a close.

Johnston also believes that Australia has the benefit of being able to learn from the EU experience. Unlike in the EU, the scheme won't be a plunge into the unknown.

"A reason for the price instability in the EU scheme was simply the fact that it was the first and no-one had any experience," Johnston says. "We have their experience to draw on and, I think it's fair to say, a far more rigorous process of assessment and design of this scheme."

Curnow concurred: "I think the EU scheme gets a bad rap in that first phase because people forget it was a pilot phase and it was very much always explicitly set up to be 'learning by doing'. As a result, member states weren't as rigorous in their cap setting."

Still, Anderson believes local companies will tread carefully when the scheme comes into force. "In any sort of new scheme people tend to be cautious, so I suspect people will tend to hold onto their units rather than trade them where they need them for compliance purposes," he says.

"I think the other thing is, because you can bank these units - if the starting price is low - people will be inclined to bank them. They'll get them at a low price, tuck them away, and wait until the price increases and that's when they'll start trading.

The government is scheduled to release draft legislation for Australia's Carbon Pollution Reduction Scheme in December.

- Zoe Lyon

>> For the latest news, views and analysis of issues affecting in-house lawyers, check out Lawyers Weekly's dedicated in-house site www.lawyersinhouse.com.au

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Carbon trading: companies play the waiting game (1)
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