Carbon in Electricity Prices
Incorporating a carbon cost into future electricity prices and contracts is relatively straight forward. The generators have a new variable cost. The pool price will reflect this new variable cost, and hedges/swaps will reflect the new forward price estimates and cost bases. It should all flow reasonably smoothly and new forward prices should emerge soon.
However incorporating the cost of carbon into existing electricity contracts will be much harder. It is not as simple as increasing the hedge price by the seller's emissions factor. Swaps are financial derivatives independent of the seller and the seller's emissions intensity. In addition, not all contracts are written with generators (some are with the ASX or banks). The differences in potential emission factors that could be applied are very large (as much as double).
As a result we can anticipate many contract discussions and disputes around this very material issue.
We may see some guidance from government in the future on what the new authorities deem to be 'appropriate' mechanisms for inserting carbon into existing contracts.
Companies do not necessarily have to be a passive price taker in this process. They should understand their contract choices and obligations and lobby for the outcome that suits their business.
Very low European prices
The EUA price today is around EUR$12-$13. And the Certified Emission Reduction (CER) price is around EUR$8-9. If trading was active today the Australian carbon price would most likely collapse to $10-$15.
This may not be an acceptable outcome for the government. Governments have shown previously that they will intervene in environmental markets if the outcome is not what they'd hoped. The Australian scheme includes 50% use of overseas credits, however this may not be enough to stop a price collapse. We may see the government revisiting the rules on use of overseas allowances.
The tree planting cap
Tree planting is available in Australia today for $20/T. The scheme proposes full inter-changeability with Carbon Farming Initiative (CFI) tree planting credits. This means that the carbon price is unlikely to ever go much above $20. There is essentially an unlimited ability to plant trees and make CFI credits at around $20 in Australia. If emitters are allowed to use as many of these credits as they like, there is no logical reason to ever pay over $20 for auctioned carbon units.
In short, as the legislation is currently designed:
At $20 the scheme effectively becomes a reforestation scheme
Emissions reduction projects for industry over $20/t will probably never be triggered
The fixed price of $23, $24.15 and $25.40 is likely to drop to $20 once trading starts
The carbon price will never rise to a level that will trigger major generation change
We may see the government change the rules around accepting CFI credits.
$15 floor price when overseas prices are lower
The operation of the $15+ auction floor prices, when overseas credits are trading below $15 (as they are currently) is unclear. The draft legislation states that a bid will not be accepted below the floor price. (p 126 of draft legislation)
Under this scenario, it is possible that half the Carbon Units (CUs) will never receive bids. Liable entities will use overseas credits for ½ the requirement and the demand for the local CUs will be very depressed, resulting in low prices.
A floor price is fine in concept but quite problematic in application. The challenge for the government is that the logical solutions of watering down the floor price, or stepping back from global intergration, are not consistent with the principle of letting the market clean up pollution at the lowest cost.
For more information on the bills, the process and the timetable the government is following go to the Clean Energy Future website.
Issues for business to consider now:
Business should consider taking the following steps:
Obtain new future energy price forecasts incorporating the carbon impact, to assist with planning, budgeting and modelling.
If your business is a large electricity user you can influence the price increase in current contracts potentially resulting in large savings. For example the difference between the three potential emission factors (state-based, national or retailers’-own) may equate to a 100% difference in the cost increase.
If your business is a large gas user you should take steps to understand the impact on gas prices of a carbon cost and manage the pass through accordingly.
If you are a large organisation, you may need assistance to manage the risks associated with trading derivatives.
Investigate the opportunity to use cheap tree planting credits to offset your business' liability in the first three years of the carbon price scheme, and in future years when trading commences.
Investigate taking advantage of the very low overseas carbon prices to obtain low cost credits for the trading period after 2020.