One imagines that Minister Combet got some fairly firm assurances from EU Climate Commissioner Hedegaard that the EU would be moving decisively to implement policy measures to shore up the price of EUAs.
Otherwise the announcement on Tuesday that Australia would start from 1 July 2015 with one-way (and then, from 2018, two-way) linking with the EU Emissions Trading Scheme (ETS) is a much bigger political gamble than it appears.
By all accounts the Australian government’s decision to establish bilateral linking with the EU ETS – and by political necessity drop the $15 floor price – is clever policy. It positions our ETS firmly as part of the global carbon market which will be a useful hedge against counter-arguments by the Opposition in 2015 that we’re ahead of the rest of the world. It should provide increased liquidity in our ETS given the much larger EU market.
And with a 12.5 per cent ceiling on CERs from CDM projects in developing countries, it should leave room for domestic CFI projects to compete just below the EUA price, while still giving Australian liable entities access to lowest cost abatement under the CDM.
But it is policy with some risks – albeit perhaps ultimately more political than economical.
It relies heavily on the EUA price trending upwards by the time we move to a floating price mid-2015 because the political bet here is that the EUA price becomes the de facto $15 floor price on the assumption that the EUA price increases over the next few years. However, all the best analysis suggests that this won’t happen unless the EU Commission intervenes to reduce supply to increase the EUA price.
The forward price for December 2015 EUAs is currently €9.73 (A$11.72) and Deutsche Bank’s EU carbon analysts central forecast is for EUAs to rise to €11(A$13.25) in 2015. Assuming Connie Heddegaard can get the EU set-aside and other policies across the line, then the EU carbon price could be on track to reach €20-25/t by 2020, implying a price of €15/t ($18.15) in 2015.
And this is why Minister Combet presumably had some strong assurances from Connie Heddegaard that the EU could come through with its policy measures to help lift the EUA price.
Of course, if the EUA price does not recover by 2015 and beyond, that is not bad news to Ausralian liable entities – in fact, access to lowest cost abatement is something Australian emitters have been strongly pushing for. CFI project developers, on the other hand, would be negatively affected if the EUA price were too low to make those projects economically viable. CER developers would presumaby be less impacted with a lower-than-expeted EUA price because the margin between lower-cost primary CDM projects and the secondary market should be large enough to allow CERs to continue to find demand in the Australian market.
But does all of this really worry the Australian government now? Let alone in three years’ time? The biggest risk would seem to be that the budget doesn’t balance because revenues from the Australian ETS end up coming in much less than the Treasury modelling has projected at an Australian carbon price of $29 in 2015. But again, aren’t the short-term political gains from linking with the EU and removing the unpopular $15 floor price greater than any political consequences from budget shortfalls in 3 years’ time?
For short-term political expediency, fast-tracking bilateral linking with the EU ETS is very clever policy. Even more so when you consider that it can even keep the Greens happy where the downside risk to the policy is a lower-than-expected prices. While Christine Milne has lent her party’s support on the basis that linking would see the Australian price continue to rise – which would hopefully see more investment in renewable energy and clean technologies – it seems the Gillard Government will be able to rely on the Greens’ optimism on economic recovery in Europe and policy intervention by the European Commission the get the EU linking policy over the legislative amendment hurdle.
So whether the EUA price increases or remains depressed it seems linking the Australian ETS to the EU ETS could be a political winner either way.
Paul Curnow is a Partner in Baker & McKenzie’s Global Environmental Markets Practice