EU Carbon Link Presents Political, Price Risks for Australians

Australia handed control of its carbon price to a partner with more ambitious climate targets when it agreed to link with the European Union market, according to a partner at Baker & McKenzie LLP.

“Australia’s price will be influenced by the market where the reduction target is the highest in the world,” Martijn Wilder of Baker & McKenzie, the Sydney law firm, said in an Oct. 10 interview. “If EU prices go much higher, say 30 euros, then the Australian government will be placed under a lot of pressure by industry to revisit the linking arrangements.”

Benchmark European Union carbon prices have plunged 74 percent since reaching a record high of 31 euros ($40) a metric ton on April 21, 2006. The European Commission in Brussels has proposed temporarily curbing supply of allowances sold at auctions starting next year to help deal with a supply glut. Australia announced on Aug. 28 it would allow its emitters to buy EU permits to comply with a cap-and-trade system scheduled to begin on July 1, 2015.

Linking the two markets “changes everything,” Hugh Bromley, an analyst at Bloomberg New Energy Finance in Sydney, said in an Oct. 10 report. Australian emitters will buy fewer international offsets under the United Nations’ Clean Development Mechanism, more domestic offsets under the country’s Carbon Farming Initiative, and more EU allowances following the link-up, he said.

‘Significant Change’

“This is a significant change that will fundamentally shift the economics of the Australian market,” Bromley said in the report. New Energy Finance forecasts that the price of carbon permits in Australia may rise to about A$26 by 2020, up from A$20 in the first year of cap and trade.

While EU permits are likely be the main driver, Australian emitters are likely to “bank” permits over the next several years, and prices there may trail those in Europe through 2020, he said.

Even with delayed supply, EU permits will only reach 8.50 euros a ton in 2013 and 9 euros on average in the eight years through 2020, according to an Oct. 11 forecast by Trevor Sikorski, an analyst in London for Barclays Plc. EU carbon for December rose as much as 4 percent to 8.32 euros today on the ICE Futures Europe exchange in London.

The bloc is also seeking more permanent fixes to its glut, which could boost its prices further, Wilder said, citing analysts.

Linking to Europe gives Australian emitters access to futures so they can hedge carbon-price risks should they want to, the Australian Department of Climate Change and Energy Efficiency said Oct. 12 in an e-mailed response to questions. The linkage enhances “the long-term carbon price signal for businesses, irrespective of whether or not businesses hedge future carbon price risk in advance.”

Climate Targets

The department didn’t immediately comment on what it would do should EU prices surge.

Australia has committed to reduce carbon pollution by 5 percent from 2000 levels by 2020 irrespective of what other countries do, and by as much as 25 percent depending on the scale of global action. The EU has pledged to cut emissions by at least 20 percent in the two decades through 2020 and as much as 30 percent.

Under the linking plan announced in August, Australia will allow its emitters to use international allowances including EU permits and UN Certified Emission Reductions for as much as half of their compliance needs, tightening the specific limit on UN offsets to 12.5 percent from 50 percent.

Floor Scrapped

The nation agreed to scrap a floor price of A$15 ($15.24) a metric ton that was set to take effect in 2015. EU carbon for 2015 traded today at 9.20 euros, or A$11.63, reducing costs for Australian emitters compared with the disbanded floor.

The two regions will start a partial link of their carbon markets by July 2015, allowing Australian companies to purchase EU allowances immediately for future compliance. Negotiations for the permanent two-way link would start once the commission gets a mandate to begin discussions on it from member states, the department known as DCCEE said.

“We are handing over control of the carbon tax, which in effect will determine Australia’s electricity prices, to Europe, which will have no interest in the flow on impact to Australian businesses and families,” said Greg Hunt, climate spokesman for Australia’s opposition Liberal party.

The leader of that party, Tony Abbott, has pledged to end what he says is a “toxic tax” that will raise prices in Australia and eliminate jobs as mines are forced to close or relocate, should he win office at elections to be held next year.

The regulatory uncertainty in Australia and Europe helps explain why carbon trading is off to a slow start in Australia, said Baker & McKenzie’s Wilder.

“Three years is a long time away,” he said.

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