26 Sep 2013

Axing the Tax: What's involved and what are the implications for business?

by Graeme Dennis, Brendan Bateman, Nick Thomas, Robyn Farmer

Until the repeal comes into effect, affected entities should continue to comply with the legal obligations imposed on them pursuant to the Clean Energy Act and associated legislation.

The new Government has stated that it won the mandate on its opposition to the Clean Energy Act's Carbon Price Mechanism, and plans to repeal it within six months of election. The direction is clear, but will the Government encounter calm seas on its journey, and how fiercely will its wake rock industry?

Exactly what will be binned?

The new Government has already commenced drafting the legislation to repeal the Clean Energy Act 2011 and its associated package of legislation, which establishes the Carbon Price Mechanism (CPM).

The Government has made it clear that repeal of the CPM also means the abolition of the:

  • Climate Change Commission – which was abolished on 19 September 2013;
  • Climate Change Authority;
  • Clean Energy Finance Corporation (CEFC) – however Low Carbon Australia (LCA) merged with the CEFC earlier this year, so the Coalition's policy regarding the LCA (see below) will need to be clarified given its commitment to abolish the CEFC; and
  • Energy Security Fund.

Furthermore, the existing assistance packages, such as the Jobs and Competitiveness Program (JCP), will be discontinued. Depending upon their terms, contracts already signed with the CEFC might remain enforceable, or might terminate.

The Clean Energy Regulator, LCA and the Australian Renewable Energy Agency will survive the cull.

The Government has signalled its continuing support for the existing Carbon Farming Initiative (CFI Scheme), and the National Greenhouse and Energy Reporting Scheme, with an amendment to permit opt-ins.

Obstacles to ambition

Any law to abolish or effectively nullify the Clean Energy package that passes the House of Representatives faces potential hold-up in the Senate, where the new Government does not currently have a majority, nor is it likely to with the new Senate after 1 July 2014.

Both abolition of the structures, and necessary amendment to avoid the core obligations, of the CPM require legislation to pass both Houses. The price of carbon units, the unit shortfall charge , and the liability thresholds, together with a default carbon pollution caps and carbon unit price ceiling for the flexible price period, are all hardwired into the Clean Energy Act 2011, and cannot be changed by regulation made by the Government. There is also potential for litigation if the Executive seeks to frustrate the activities of the CEFC prior to abolition.

Currently, it does not appear likely that current ALP or Greens senators will agree to repeal or neutralise the CPM. The ALP would support amending legislation for an earlier transition to the flexible price period (1 July 2014). This would have the effect of reducing prices sooner given the proposed linking with the EU-ETS. This, however, remains an unacceptable alternative to the Government intent on repealing even a floating carbon tax.

A special double dissolution election under section 57 of the Constitution, where the Governor-General dissolves both houses at once, can be used to resolve the deadlock in the event that the Senate rejects such a bill a second time (after a three month interval). It is noteworthy that there have only been six double dissolutions in Australian history, and only 50% have been successful for the Government. Further, there is scope for a constitutional challenge to a double dissolution, as the newly-elected senators will not yet have taken their seats.

In practice, based on the Parliamentary schedule with a double dissolution being possible in February 2014 at the earliest, such a risk for the Government may become politically unpalatable when the newly elected senators are due to take their seats on 1 July 2014 in any event. If the betting market (ie. the wholesale futures electricity market – see below) is anything to go by, the Government is unlikely to pursue a double dissolution option in advance of a potentially more malleable Senate becoming available from July next year.

That said, the Coalition will not have an outright majority in the Senate after 1 July 2014 either and is likely to rely on winning (or negotiating for) the support of six of the eight micro-party senators.

Market transition

The new Government will have to balance its political fervour with astute appreciation of the sensitivities of markets and industry, in order to mitigate the necessary disruption that unravelling the CPM will generate. Already carbon and other affected markets, like electricity, are plagued with uncertainty. The more notice markets are given of future regulatory arrangements, the better for market confidence.

Markets and industry need as long a lead-in time as possible in order to reposition contracts to exclude the cost of carbon. The introduction of the CPM provided over six months from the passage of the bill to the start of the first compliance period. The commencement of the CPM on 2 April 2012 (like many other price relevant announcements, such as the budget, tax changes, and energy-price regulatory determinations) provided a transitional period before becoming effective. This gave each affected business time to cater for the impact of the foreshadowed changes in its pricing structures, compliance policies, and emissions reduction measures for the financial year ahead. A similar transitional period will be needed to change these positions – this affects other supply chain participants as well as liable entities under the CPM.

As an illustration, power retailers typically build their portfolio from a mix of self-generation, spot market purchases, exchange-based hedges and over-the-counter hedges. The price impact of the CPM may already be locked in for periods following 1 July 2014, as:

  • not all wholesale power purchases are on contracts that allow for an immediate adjustment of the carbon price. Some over-the-counter power price futures contracts do not allow any adjustment in the price for carbon (buyers pay a fixed price to leave the carbon risk with the seller), and others adopt a fixed price inclusive of carbon until the end of June 2015;
  • exchange-based hedges on the ASX24 (which presently sells derivatives up to the end of June 2017) are based on the spot price of power, inclusive of all costs (including carbon), and so a retailer which has already bought these forward hedges for a price assumed to include carbon in FY2015 will see no reduction in its effective power price cost, even if the carbon price mechanism is abolished before FY2015. Currently the price for FY2014-15 wholesale electricity futures contracts continues to factor in a price on carbon despite the result on September 7. However, it appears that the cost of carbon has halved in light of the political uncertainty; and
  • bilateral power purchase agreements may have fixed the customer's price as a carbon-inclusive price, with the retailer accepting the risk of movements in input costs.

Such trading strategies are commonly used to protect the energy retailer from future price rises and to deliver fixed costs to customers.

So an immediate fall in power prices may not be achievable (without casualties) after abolition of the tax. The Government's proposal to penalise businesses that do not pass through the benefit of the repeal , if implemented immediately on abolition of the CPM, would effectively leave the industry between a rock and a hard place – by penalising the energy industry whether or not the price of carbon that is unavoidably incurred is passed through to customers.

Effective date for repeal

Issues surround the effective date for the repeal or amendment of the CPM:

  • a transitional period is valuable to enable procedural and financial repositioning, as discussed above;
  • it may be unfeasible to terminate the CPM during a compliance year. Carbon units are currently regulated financial products, are personal property and have a market value, particularly for businesses receiving assistance under the JCP. Indeed, if the experience of the first compliance period is any measure, units issued to eligible industries under the JCP will be quickly converted to cash. This will become more pronounced in respect of JCP units issued in September 2014 if there is any risk of scheme repeal. For government, this potentially means money going out the door without the option to generate revenue from the sale of units;
  • any changes which reduce the domestic incentive to acquire carbon units, will certainly reduce the value of the personal property in the units, and may give rise to a litigation for compensation on just terms under the Constitution; and
  • if the commencement date is made retrospective, ie. to 1 July 2014, this will have a significant disruptive impact on markets and industry, whose contracts may not allow price reopeners for the retrospective period. For example, electricity generators prepare spot market bids in advance of the trade date. While bids can be changed, to an extent, on the day an abolition Bill is passed, spot market purchases that are inclusive of carbon cannot be retrospectively altered. So, the cost of carbon in such trades will remain within the supply chain.

So, if the CPM is repealed during the 2014-15 financial year, it may be the most prudent course to delay the actual abolition until 30 June 2015. A combination of the timing of obligations under the CPM, allocation of JCP compensation, and market hedging in the energy sector all means that if the CPM is not repealed well in advance of 1 July 2014, not only will business need to meet its obligations for FY2013-14, but also for FY2014-15 (at the higher fixed price) given the likely difficulty in adjusting a repeal other than from a financial year basis. Ironically, if the existing scheme does continue into the final higher fixed priced year, the Government's budget will get a substantial boost.

Until the repeal comes into effect, affected entities should continue to comply with the legal obligations imposed on them pursuant to the Clean Energy Act and associated legislation.

We would be very happy to help you prepare submissions to the Government in response to public consultation on the implementation of the Direct Action Plan, or to provide advice on the impact of the intended repeal of the CPM on your business.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.