Forecast ACCU prices under the Climate Solutions Fund – High road or the low road?

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In late February the Australian Government announced an additional $2 billion in funding for the Emissions Reduction Fund (ERF), rebranding the scheme the Climate Solutions Fund (CSF).

The additional funding tranche for the ERF could provide $200 million over 10 years, bringing total investment to $4.55 billion (bn) since the commencement of the scheme. Funding will be conditional on the return of the Government at the upcoming federal election, with the Australian Labor Party (ALP) proposing to scrap the framework should it form government.

Below we take a closer look at Australian Carbon Credit Unit (ACCU) pricing dynamics under ERF I, and model possible pathways for price formation under the CSF (ERF II). Specifically, we look at the role of the Clean Energy Regulator in collapsing the current ERF market, and simulate future ACCU price dynamics should the scheme’s benchmark (or celling) price be more efficiently deployed to unlock higher cost abatement projects.

Current ACCU price dynamics under the ERF

The first tranche of the ERF has contracted to purchase 193 million ACCUs via 477 contracts, with around $1.8 billion of the government’s $2.55 billion funding tranche currently committed (approximately $226 million remaining for future contracting).[1]

As shown in Figure 1, ACCUs contacted under the scheme have fallen from highs of 47 to 51 million over auctions 1 to 3 (2015 to 2016), to under 4 million at auction 8 (2018). This slowdown in contracting reflects the low price environment in the ERF, with early auction rounds contracting many existing projects (particularly those transitioning from the former Carbon Farming Initiative), while modest prices in latter rounds have failed to incentivise the participation of higher cost abatement activities.

As a result of lower contracting rates, the total value of contracts committed at each auction event has fallen from $660 million at auction one to $45 million at auction eight. On current rates, the remaining funding ($226 million) is therefore unlikely to be fully committed even after another 4 to 5 auction rounds – or 2 to 3 years (semi-annual schedule).[2]

Figure 1: ACCUs contracted by ERF auction (ERF 1)

Figure 2: Annual ACCU issuance to ERF contracted projects by project type. Forecast from FY19.


Source: RepuTex Energy, 2019; Clean Energy Regulator.

Has the Regulator caused the contracting collapse?

The Regulator purchases emissions reductions in the ERF through a carbon abatement purchasing process. The Regulator contracts abatement at a price determined through a ‘pay-as-bid’ reverse auction.

Eligible bids are ranked by the price offered, with the lowest price bid ranked first and the highest bid ranked last. In determining which eligible bids are successful, the Regulator selects bids to a point that ‘offers the best balance between the principles of purchasing at the lowest cost and securing the highest volume’ – by applying a confidential variable volume threshold and assessment of bids.

All bids are subject to a benchmark (or ceiling) price, with bids above this point not considered by the Regulator. Along with the variable volume threshold, the benchmark price therefore provides the Regulator with a device to control ERF contract price rises, by excluding higher priced abatement from the market.

While the Regulator withholds the value of the benchmark price from the market, its impact as a price signal is felt by market participants. For example, in our modelling of Auction 8 , shown in Figure 3, an assumed benchmark price of between $15 and $16 enforces an ‘invisible’ cap on the amount the Regulator is willing to pay for ACCUs at an auction.

Figure 3: RepuTex modelled bids and outcomes at ERF Auction 8.

Source: RepuTex Energy, 2019; Clean Energy Regulator

Coincidentally, this has maintained ERF abatement prices at a politically palatable level, below $15. In doing so, the constraint on higher priced abatement has caused participation to collapse – seen from Auctions 5-8 in Figure 1 – with the low price ceiling preventing ERF contract prices from unlocking higher cost abatement projects, while eroding market sentiment, as bidders sit on the sidelines or wait for more favourable – and transparent – prices in the secondary market.

Repairing a collapsed ERF market

The impact of a $2 bn top up on ACCU prices – High road or low road?

Should additional funds be made available to the ERF/CSF, the role of the Regulator in capping contract prices (via the benchmark price) will be critical to ACCU price formation, and the success of the ERF in again contracting abatement.

Below we model the impact of two benchmark price scenarios on future auction outcomes under ERF II:

  1. Current approach – the continuation of a low contract price cap and low price environment from ERF I into ERF II; and
  2. Higher benchmark price – Eased restrictions on the participation of higher cost abatement and improved market sentiment.

As shown in Figure 4, should a low benchmark price continue under the second phase of the ERF (referred to as ERF II), modelling indicates that abatement contracting from indicative auctions 9 through 16 is likely to remain small (light blue bars), contracting around 3 million ACCUs at each event, similar to contracting levels at the eighth ERF auction.

Under such a scenario, average prices would remain consistent with ERF I, around $12 per tonne, keeping average (disclosed) prices low, but continuing to constrain the participation of abatement projects slightly higher up the cost curve – particularly land sector activities like soil carbon and plantation forestry, as well as industrial projects such as source separated organics, commercial buildings, and wastewater.

In this scenario, just $300 million of funding is modelled to be contacted over 8 future auction events, purchasing 25 million tonnes of emissions reductions (Figure 5).

Figure 4: Forecast ACCUs contracted under ERF 2.0 – High road versus low road scenarios

Source: RepuTex Energy, 2019; Clean Energy Regulator

Should the Regulator ease restrictions on the participation of higher cost abatement – allowing contract prices to rise toward $20 per tonne – modelling indicates that the handbrake on ERF contracting would be released, with a higher price environment contracting around 100 million tonnes over 3 auctions (orange bars).

Figure 5: Total ACCUs contracted under ERF 2.0 – High road versus low road scenarios


Source: RepuTex Energy, 2019; Clean Energy Regulator

As a result, the success of the government’s ERF/CSF scheme – and future ACCU price dynamics – rests with the Regulator, with the continued deployment of a low contract price cap likely to continue to limit abatement contracting, while the more efficient deployment of a higher price cap may unlock higher abatement levels, and better support Australia’s longer term emissions reduction target.

 

[1] Around $476 million has already been paid for ACCU deliveries.

[2] For example, in 2017-18 the Regulator contracted 14.62 million ACCUs at a cost of about $194 million, however, 10.6 million ACCUs – worth approximately $126 million – were lost to terminated and lapsed contracts. An annual ERF drawdown rate of just $68 million.

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