12 Jun 2014

The long arm of carbon pricing: your long-term supply contract might allow costs to be passed on

by Brendan Bateman

If you're a party to a long-term supply contract, this decision reinforces the need for you to carefully consider its wording to determine if carbon pricing costs can be passed on.

Contracts entered into many years before the commencement of the carbon pricing mechanism under the Clean Energy Act 2011 (Cth) may nevertheless enable sellers to pass costs associated with emissions captured under that scheme through to the purchasers, as Delta Electricity found out.

On 6 June 2014, the NSW Court of Appeal in Delta Electricity v Centennial Mandalong Pty Limited [2014] NSWCA 178 upheld two decisions which effectively permitted Centennial to pass on a significant portion of its liability under the carbon pricing scheme for methane emissions from the production of coal at its Mandalong mine to Delta Electricity.

The issues under the coal supply agreement

The principal issue in the case related to the construction of a clause in a coal supply agreement entered into in 2002, which Centennial argued entitled it to trigger a mechanism to adjust the price for coal supplied to Delta on account of the introduction of the carbon pricing mechanism.

A secondary dispute focused on the sources of emissions liability referrable to the extraction of coal supplied under the agreement.

Under the agreement, Centennial was obliged to supply a particular tonnage of coal annually, which Delta was obliged to purchase. The total amount of coal supplied under the agreement to Delta's Vales Point power station represented approximately 85% of coal produced at Centennial's Mandalong mine.

Clause 12 contained the relevant provisions concerning the price payable for the coal supplied. The price had two components:

  • the contract price per tonne adjusted for CPI quarterly; and
  • a government charges component per tonne.

Essentially, the government charges component was defined as all charges, taxes, royalties and other levies imposed on or payable by Centennial under any statute "to the extent attributable to the coal sold by [Centennial] and purchased by [Delta]" under the agreement. The adjustment mechanism in the contract permitted either party by notice to advise the other party that it required the amount of the government charges component per tonne to be reviewed.

Centennial gave notice to Delta of its intention to increase the cost of coal supplied as a consequence of the introduction of the carbon price. Delta disputed Centennial's entitlement to do so. Centennial then went to the NSW Supreme Court for its view.

Charges, taxes, royalties and other levies "attributable to the coal"

In the first instance decision, Justice McDougall determined that the words "attributable to" required some form of connection between the charge and the coal sold by Centennial. As a result, the clause was intended to pick up government charges that, inter alia, were related in a rational way both to the production of coal and the cost of production of coal. No direct, immediate or obvious connection was needed; essentially only some form of causation, such as a contributing cause, was sufficient.

In view of the fact that the emission of methane was an inevitable consequence of coal mining, Justice McDougall considered that the carbon pricing charges were a necessary or integral part of the production of coal. This was a sufficient connection between the charge and coal supplied under the agreement. The amount of the charge to be passed through should be determined based on a pro rata basis to the coal supplied to Delta.

As for the sources of methane emissions which could be said to be part of the production of coal, Justice McDougall preferred a broad understanding of the activities involved in mining coal. Accordingly, emissions associated with incidental activities in the production of coal such as pre-draining of mined areas, construction of roads, the stockpiling of coal and the injection of captured methane into goafs, were all found to be sources of emissions, and liability for them under the carbon pricing mechanism could be passed on to Delta on a pro rata basis.

Carbon price based on coal supplied or means of production?

Delta's principal ground of appeal was that the carbon price was not attributable to the coal supplied, but to the emissions of methane by Centennial in the operation of the mine itself.

The Court of Appeal unanimously dismissed Delta's appeal. It found that Delta effectively was trying to substitute the notion of "attributability" with "imposition". The issue was not whether the charge was imposed on coal supplied to Delta, but whether the charge was attributable to that coal. The concept of attributability did not mean "is imposed on", but something broader, including notions of "referrable to" or "ascribed to". There did not need to be an exclusive causal connection between the charge and the coal supplied.

It also upheld Justice McDougall's finding on connection. There was a sufficient connection if the charge was referable to a necessary incident of the production of coal supplied to Delta. As methane emissions were caused by an integral part of the mining process, the charge imposed on those emissions by the Clean Energy Act is "attributable to" the coal supplied for the purposes of the clause in the agreement.

Finally, the Court of Appeal also agreed with Justice McDougall that the carbon charges on emissions referrable to the disputed sources were caught by the clause. This was because those charges are referrable to emissions caused by incidental measures necessary to extract the coal supplied to Delta or, in the case of stockpiles, imposed by reference to the total production of coal irrespective of whether it was in fact stockpiled.

Check the wording of any long-term supply contract

If you're a party to a long-term supply contract, this decision reinforces the need for you to carefully consider its wording. There might be a possibility that costs associated with the carbon pricing mechanism can be passed through, even if that liability does not directly attach to the goods supplied but the means by which those goods are produced. This continues to be relevant as long as the carbon pricing mechanism remains in force.

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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.