Taylor walks away from Emissions Reduction Fund, carbon prices to plunge

Federal energy and emissions reduction minister Angus Taylor has effectively walked away from the Coalition’s flagship climate policy, conceding that the Morrison government may not actually purchase any further carbon abatement under its flagship Emissions Reduction Fund.

Taylor and the Clean Energy Regulator, announced on Friday that they would allow the release of carbon abatement projects from fulfilling their government contracts and instead sell their credits on the more lucrative open market.

The move was hailed by the government media as a potential windfall for carbon farmers, but industry analysts warn it could have a devastating impact on carbon prices, and threaten investment in large scale abatement projects, such as the carbon capture and storage projects the Morrison government hopes it will support.

The Emissions Reduction Fund has been the centrepiece of the Coalition’s otherwise lacklustre climate change policies, with more than $4.5 billion allowed to the fund to buy emissions reductions from projects that avoided land clearing, revegetated land, or cut emissions from landfill sites.

To date, the fund has entered into contracts to purchase around 230 million tonnes of emissions abatement.

But the Morrison government’s latest move puts these reductions – and its ability to achieve its 2030 emissions reduction targets – into doubt.

As was foreshadowed by RenewEconomy in December, the Clean Energy Regulator faces a major problem that arises due to surging open market prices for Australian Carbon Credit Units (ACCUs) and the effect of a term included in the carbon abatement contracts signed between the federal government and offset projects under the Emissions Reduction Fund.

Under a term of the ‘fixed price’ abatement contracts – which cover the vast majority of abatement purchased under the Emissions Reduction Fund – offset projects are allowed to default on the contract – by failing to hand over their emissions reduction targets to the government – provided they pay a penalty to the Clean Energy Regulator.

The contractual penalty, called “buyer’s market damages”, is designed to provide funds for the Clean Energy Regulator to purchase replacement offset units, at the expense of the project failing to deliver on its contract, as a form of insurance to ensure replacement offsets can be secured.

According to the terms of the carbon abatement contracts, the maximum extent of the damages payable is fixed at the agreed offset price under the contract. For most contracts under the Emissions Reduction Fund, this falls within the range of about $12 per tonne.

This is well below the current open market price for ACCUs – about $47 per tonne – and so there is a clear incentive for offset projects to default on the contract and sell their ACCUs into the more lucrative open market, even after the penalty is taken into account.

The Clean Energy Regulator announced on Friday that it would facilitate projects to exit from their contracts for periods of six months at a time while still enforcing the payment of the buyer’s market damages.

“The initiative will be open to all compliant fixed delivery contract holders who are in good standing with the Clean Energy Regulator,” the regulator said in an update to ERF participants.

“Initially, delivery milestones falling due from 4 March to 30 June 2022 will be offered an administrative option not to deliver those ACCUs to the agency on payment of an exit fee. Later delivery milestones will also be provided this opportunity in a staged manner.

“Contract holders will be required to pay an exit fee to be released from their delivery obligations. The exit fee will be calculated by multiplying the contract price by the quantity of ACCUs to be released.”

“This is similar to existing contractual clauses in carbon abatement contracts, but will occur in a streamlined fashion without the legal and likely reputational risks of non-delivery or default.”

While the announcement from Taylor and the regulator – that the government will facilitate projects to exit their contractual obligations – will be welcomed by the offset projects, there is caution about the potential for perverse outcomes and unintended consequences.

Being able to exit from these contracts will likely prove profitable for abatement projects, which are now looking at selling their ACCUs in the open market for around double their originally contracted price.

It will also be popular for both carbon traders and corporate emitters that can now access a substantial supply of ACCUs previously locked away under contract.

Several carbon market analysis have told RenewEconomy that carbon credit prices may slump as a result of the change – which have already fallen in recent weeks. But analysts indicated that ACCU prices could hit a floor of around $24 per tonne, the minimum price where it makes sense for abatement projects to walk away from their contracts.

The Carbon Market Institute warned that the impact of the Morrison government backing out of the market for carbon abatement could be a source of significant uncertainty for participants in Australia’s fledgling carbon market.

“While we welcome that the release will be staged and that exit payments will be used for ‘emission reduction measures’, we are concerned about the message this sends to the market about the ability for government intervention without transparent and public consultation at any point in time, if market dynamics change,” Carbon Market Institute CEO John Connor said.

“The Government needs to be clear about the intended use and timing of how the exit payments will be recycled and should have linked this to stronger corporate investment requirements under strengthened Safeguard Mechanism responsibilities and stronger national emission reduction commitments.”

Connor stressed the need for the Morrison government to consult with the industry about the changes.

“We urge the Government to commit to proper public consultation on these and any further changes, and commit to stronger policies for Australia to reduce overall emissions by 50 per cent by 2030, including a strengthened Safeguard Mechanism,” Connor added.

The acknowledgement from Taylor that the government will support the contractual defaults is not a new position – it was an option baked into the contracts it signed with carbon offset projects.

“These changes are entirely consistent with the Coalition’s longstanding policy of supporting voluntary action to reduce emissions. Our policies are incentive-based – they expressly rule out taxes or mandates, and will not impose higher costs on households, businesses or the economy,” Taylor said in a statement.

However, it does see the Morrison government yet again stepping away from direct involvement in emissions reduction policy, instead allowing the ‘voluntary’ market – driven by major corporate emitters making their own commitments to cut their emissions in the absence of a meaningful national mechanism to cut emissions.