Australian’s carbon market comes under scrutiny ahead of federal election

How well is Australia's carbon market operating? More importantly, how is the market helping the country achieve its stated goal of net-zero emissions by 2050?

The questions have prompted heated debates in recent weeks, with the next federal election expected to be held in less than two months' time.

The ruling Liberal-National coalition trumpeted the government-sponsored Australian Carbon Credit Units' (ACCUs') decarbonization advantages. Government data shows over 18 million ACCUs are to be issued in 2022, up from 17 million ACCUs in 2021 and 16 million ACCUs in 2020. Each unit represents a metric ton of carbon emissions either stored or avoided, Australia Energy Minister Angus Taylor suggested.

The federal Clean Energy Regulator (CER) said that 2021 was a record year for the carbon market in terms of liquidity and pricing. A total of 7.5 million ACCUs changed hands, compared with 3.4 million transacted in 2020. Spot prices rose from A$16.60 ($12.40) to A$51 through the year.

But the rosy picture was recently tainted by Andrew Macintosh, the former chair of the ACCU mechanism's integrity committee, who said there are serious "governance flaws" in Australia's carbon market.

Based on the current market design, qualified entities earn ACCUs from the CER by operating projects that reduce or avoid GHG emissions. The carbon credits are generally sold to the government-run Emissions Reduction Fund (ERF) via auctions, as well as to voluntary, speculative or compliance buyers in the secondary market.

Macintosh, who had chaired the Emissions Reduction Assurance Committee under successive coalition governments in 2015-2020, said 70%-80% of the ACCUs are issued to projects related to avoided deforestation, human-induced regeneration of native forests, and the combustion of methane from landfills.

"All of the major emission reduction methods have serious integrity issues, either in their design or the way they are being administered," said Macintosh, who is a law professor at the Australian National University.

"People are getting ACCUs for not clearing forests that were never going to be cleared; they are getting credits for growing trees that are already there; they are getting credits for growing forests in places that will never sustain permanent forests; and they are getting credits for operating electricity generators at large landfills that would have operated anyway," he added.

The CER has already spent A$1 billion ($750 million) on purchasing ACCUs and has contracts to purchase a further A$1.6 billion, Macintosh said. "By issuing ACCUs for these low-integrity abatement projects, the regulator is throwing good money after bad and undermining Australia's ability to meet its long-term emission reduction targets."

While attacks on the carbon market's integrity—often from Australian nonprofits—are not uncommon, such accusations from a leading emissions expert in the election year has the potential altering future market development, observers said.

"To have such a senior figure come out with such claims was a significant development," consultancy Demand Manager CEO Jeffery Bye told S&P Global Commodity Insights' Net-Zero Business Daily. "It will be interesting to see where this goes—at the moment, the claims are a little esoteric for the general public, but this could shift in an election year if the opposition runs a campaign on the matter."

In response to Macintosh, the CER said the ACCU issuance has "rigorous assessment processes" underpinned by decarbonization methods of "high integrity." But Australia's main opposition parties were quick to lambast the government over the alleged integrity issues.

The Greens party has referred the allegations to the Auditor General while calling for a full, independent inquiry into the claims, and its leader Adam Bandt described the market scheme as "another rort [dishonest practice] from a terrible government."

In an interview with Australian Broadcast Corp., Chris Bowen, Labor's climate change and energy spokesman, promised to launch a review of the carbon market over integrity and other issues like biodiversity if his party wins the federal election.

"I have concerns with the scheme … I will want an independent advice giving me and Australian people the confidence," Bowen said.

Market reform

Separately, the Australian government has revised the ACCU scheme in a way that proved to be unpopular among some market participants.

The CER announced 4 March that ACCU project developers can pay a fee to exit their fixed delivery contracts with the government and sell their credits to private buyers in spot trading. The rule change does not affect optional contract holders, who can sell their ACCUs to either the government or the private sector.

In the past, the developers had to pay a penalty called buyers' market damages (BMD) capped at their contractual prices to terminate their fixed delivery contracts.

With over 75% of the government's fixed delivery contracts priced under A$13 per ACCU, well below the spot price in recent quarters, the CER said the new rule would lead to an "orderly process" as project developers exit their contracts without "reputational risks."

But ACCU spot prices dropped from A$50/mt on 3 March to A$35.4/mt on 4 March following the announcement, government data showed. Demand Manager said ACCUs recently traded at A$31/mt.

The rule change came out of the blue and could release up to 100 million ACCUs at a value of up to A$2.4 billion to the private sector over the next decade, according to the Carbon Market Institute.

"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," the trade group's CEO John Connor said in a statement. "The government needs to be clear about the intended use and timing of … the exit payments."

According to the CER, the exit fee will be calculated by multiplying the contract price by the quantity of ACCUs to be released. Bye said the current spot ACCU price will thus represent the minimum value to incentivize the exits of contracted parties, plus some administrative expenses and risks premiums in the secondary market.

"From the government's perspective, this achieved a few goals—it dropped the price of ACCUs in the private market for corporate Australia to meet carbon neutrality goals and it effectively turned the ERF program from a cost base potentially into an income source, allowing them to extend the life of the ERF without the need for budget support," Bye said.

Election advances

In October, Australia joined almost all other industrialized nations by committing to net-zero emissions by 2050. But the government has kept its interim target of cutting emissions by 26% to 28% from 2005 levels by 2030, despite having projected that the country is on track for a reduction of 30-35%.

The Labor promises a 43% reduction by 2030 partly via strengthening the Safeguard Mechanism—and experts said the party could effectively usher in a cap-and-trade system for emissions if it wins office.

Introduced by the coalition government, the Safeguard Mechanism sets baseline emission levels for Australia companies with Scope 1 emissions of more than 100,000 mt of CO2-equivalent and allows major emitters to acquire ACCUs to offset their excess emissions.

But critics said that the scheme has limited decarbonization effects because the current administration has been too willing to raise the baselines, that the emitters seldom need carbon credits.

"A change in government could create a baseline and credit system that increases accountability for Australia's biggest emitters each year, which is anticipated to create more certainty around ACCU offset demand growth," said Bret Harper, research director at Melbourne-based energy consultancy RepuTex.

"This will depend on how the election numbers play out and whether parties have the numbers in enact the climate policies they have laid out or whether these may have to be negotiated with other parties," he added.

If the coalition remains in power, Bye said Australia could continue the path of "privatization of carbon abatement" by establishing rules that limit demand for carbon credits from regulated emitters and promote voluntary purchases.

"Such a path is politically more achievable since it does not rely on 'the big stick' of regulation, however it would in all likelihood not be sufficient to meet the deep cuts required," Bye said.

Posted 29 March 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.