On 4 March 2022, the Minister for Industry, Energy and Emissions Reduction announced changes to Emissions Reduction Fund (ERF) fixed delivery contracts. Current holders of fixed delivery contracts will now be able to pay an exit fee to be released from fixed delivery obligations to the Commonwealth under a new initiative being offered by the Clean Energy Regulator.
Why are changes to fixed delivery contracts being introduced?
The market for Australian carbon credit units (ACCUs) is undergoing significant change and ERF contracting is changing to meet the needs of this dynamic market.
Since early 2021, Australia's carbon market has seen a strong increase in demand for ACCUs resulting in material increases in ACCU prices. Spot market prices of ACCUs have increased from $17 at the start of 2021 to $50 on 3 March 2022 - approximately a 200% increase. Market participants have noted increases in private sector demand but also tight liquidity in the ACCU market which has contributed to the run up in prices.
Over 75% of the abatement held by the Government under fixed delivery contracts is priced under $13 per ACCU, well below current market prices. To date, fixed delivery contract holders have met their delivery obligations with 13 million ACCUs supplied in the last financial year alone and deliveries across the contract portfolio are tracking 6% ahead of schedule.
Fixed delivery contracts include provisions for buyer's market damages (BMD), capped at the contracted price, that must be paid to the Government for undelivered abatement. At current high prices it may be financially advantageous for many fixed delivery contract holders to not supply ACCUs to the Government and sell their abatement on the private market, even after paying BMD. If a widespread disorderly exit from fixed delivery contracts occurred, this would cause a large volume of ACCUs to become available to the carbon market leading to price volatility and investment uncertainty.
The new initiative will allow fixed delivery contract holders to be released from delivery obligations in a transparent and orderly process.
Should parties seek to cease fixed contract deliveries outside of the above initiative, BMD will be sought as per existing contractual arrangements including the recouping of the Clean Energy Regulator's costs (as per contract terms).
How will the initiative work?
The initiative will be open to all compliant contract holders who are in good standing with the Clean Energy Regulator. Fixed delivery contract holders will have the flexibility to sell their ACCUs for higher prices on the private market without breaking contractual obligations.
Holders of fixed delivery contracts who opt-in will be required to pay an exit fee to be released from their contractual 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.
Contract holders will be eligible to be released from fixed delivery milestones falling due within six-month windows, between 1 January and 30 June, and 1 July and 31 December each year. This approach intends to reduce the risk of price impacts on the ACCU market by moderating the rate at which supply is released. It also provides fixed contract holders clarity about when their milestones will be eligible and time to pay the exit fee.
The first window open will be for delivery milestones falling due between 4 March 2022 and 30 June 2022 with the window for milestones between 1 July 2022 and 31 December 2022 to follow soon thereafter.
There will be a 2-stage process to be released from delivery obligations:
- Application and conditional approval: Contract holders will be eligible to apply to be released from eligible delivery milestones ahead of each window. If found eligible, the Clean Energy Regulator will provide conditional approval, an invoice for the exit fee, and payment instructions.
- Exit fee payment and milestone cancellation: The exit fee must be paid by the delivery milestone due date. When payment is confirmed, the delivery obligation will be cancelled.
The 2-stage approval process is designed to provide contract holders with confidence in undertaking third-party transactions prior to making their exit fee payment to the Clean Energy Regulator.
