As the federal government considers major changes to its climate policy framework, including crediting Safeguard Mechanism facilities for emissions below their baselines and a long-term emissions target ahead of COP 26, the long-run price of Australian Carbon Credit Unit (ACCU) offsets remains a key signal for investment in large-scale emissions abatement, and a benchmark for price formation of potential new Safeguard Mechanism Credits (SMCs).
In particular, the Paris Agreement is a key driver of our long-term offset price expectations, with the long-run price underpinned by the cost and availability of external offsets to meet a 1.5-2°C carbon budget between 2015-50.
In this outlook, we model Australia’s long run carbon offset price from 2020-50 to achieve and maintain carbon neutrality. Analysis considers a Base Case target trajectory consistent with current policy (‘low’ offset price forecast). Scaled-up target scenarios are also considered, including net-zero emissions by 2040 and 2050, reflecting ‘high’ and ‘medium’ offset price scenarios in line with the Paris Agreement.
As policymakers and large-emitting companies seek to make informed long-term decisions to reach net-zero emissions, modelling provides an important reference point for future investment and policy decisions and the development of the carbon market under more aggressive action on climate change.
Australian carbon price flatlines on thin volumes
The Australian Carbon Credit Units (ACCUs) spot price has fallen 9 per cent calendar year-to-date, reaching $15.80/t in June, down from $17.28/t on 1 January. With trading activity quieting considerably through the COVID-19 period, ACCU prices have held flat in June, with small trades at $15.80 since mid-May, reflecting soft voluntary spot demand and a wait-and-see strategy from ACCU holders in anticipation of further Commonwealth purchases.
The spot price is now trading at a 2 per cent discount to the ERF average price, the first discount for the spot price relative to the ERF average price, due to a $1.97 increase (14 per cent) in the March 2020 ERF average price from July 2019.
This is likely to open limited arbitrage opportunities for contracted sellers under the ERF, who may buy ACCUs in the secondary market below their ERF contract prices, enabling immediate delivery to the Commonwealth for a profit.
Where to next under current policy?
We expect any further decreases in the ACCU spot price to be limited, with prices forecast to increase over the next three years. Potential remains for new appropriations to the Commonwealth’s Climate Solutions Fund to stimulate increased public sector investment, albeit from record low contracting rates, towards 10 to 17 million ACCUs per annum. Combined with increased state-level appetite for premium ACCUs and lags in new ACCU issuance, annual demand may for the first time outpace supply, resulting in price increases. This is also being reflected in early forward activity, with a trade of 50,000 ACCUs agreed with an option to buy in December 2021 at $18.50.
Given most ACCU generating projects continue to be vegetation based, with long-term crediting periods, a repeat of the market imbalance experienced under the initial ERF remains likely, whereby contracting successfully drives some project development, but leads to inelastic long-term supply of ACCUs.
While the Climate Solutions Fund may defer an anticipated decline in ACCU demand, a surplus of ACCUs is forecast to continue to accumulate. As a result, under current policy we estimate long-term ACCU prices to fall back toward historic lows, with the market almost inevitably becoming oversupplied in the absence of a long-term source of industry demand.
Net-zero emissions by 2050 achievable with $30/t offset price
Our Base Case offset price forecast reflects a ‘current policy’ pathway for ACCU prices from 2020-30 in line with stated policy commitments. In practice, national policy is expected to change over time as Australia moves towards net zero emissions under the Paris Agreement. As a result, while our Base Case ACCU price trajectory is an accurate depiction of offset prices under current policy, it should be considered a ‘low’ price scenario, reflecting an assumed ‘lowest possible’ policy effort.
Without defining a specific policy mechanism, we model an Alternative Case which assumes the long-run ACCU price tends towards the marginal cost of external abatement from sequestration to meet net zero emissions by 2050, equivalent to a 2°C target trajectory.
Modelling applies a ‘carbon budget’ methodology, calculated from global carbon budgets equivalent to a 67 per cent chance of limiting temperature rise to 2°C, or 14.0 Gt CO2/e between 2015 and 2050. Effort sharing is assumed to be apportioned across all sectors of the economy, whereby sectors that can completely decarbonise with current technologies, such as Electricity and Buildings, do so. Where a sector does not have enough emissions reductions available, such as the Agriculture, Industry and Transport sectors, it is assumed to rely on a corresponding number of ACCU offsets to achieve net-zero emissions.
Given the short timeline and large scale of required emissions reductions, external offsets are assumed to be acquired to fulfil each sector’s abatement task in place of assumed ‘breakthroughs’ in future technologies. This reflects the immediate timeline for required investment, along with the relative cost of external offsets from commercial land-sector offsets, which are forecast to be the cheapest form of large-scale abatement rather than emerging technologies, such as carbon capture and storage (CCS). In particular, CCS is unable to scale up fast enough to achieve the negative emissions we estimate are needed over the next seven to eight years.
Should Australia’s emissions reduction ambition be scaled up to be compatible with a 2°C pathway, outcomes indicate a modest increase in ACCU prices is possible, with pricing growing to $30 in 2050, averaging of $23 over the period.
Over this timescale, the longer period to 2050 (relative to the 1.5° timeline of 2040 in the next section) is critical for the decadal scale of carbon forestry required to offset a modest amount of residual emissions. We anticipate these emissions to be around 100 Mt in 2050, or approximately twice the current amount of national sequestration.
Offset prices in excess of $100/t to meet a 1.5° goal by 2040
Should Australia’s emissions reduction ambition be scaled up to be compatible with a 1.5°C scenario, reaching net-zero emissions before 2040, the size of the ambition coupled with the short timeline for achieving emissions reductions drives much more substantial demand for external abatement.
Under such a scenario, Australia would face a carbon budget of just 7 gigatons (Gt) between 2015 and 2050. Having already emitted around 3 Gt between 2015 and 2020, significant investment will therefore be required for Australia to maintain net-negative emissions from 2035-2050 in order to align with a 1.5°C budget by 2050.
In this scenario, all sectors (except Buildings and Electricity) are modelled to create demand for offsets, particularly more expensive soil management and tree planting activities than are necessary in a 2°C scenario. This causes the long run offset price to rise steeply in a more ambitious 1.5°C scenario, reflecting reduced time for the land sector to ‘ramp up’ traditional sequestration efforts, and the limited timeline for the emergence of technological advancements in ‘expensive to abate’ sectors. Under such a scenario, by 2050, much more substantial demand for carbon sequestration leads to offset prices well in excess of $100/t.
Even at higher offset prices, the widescale deployment of emerging technologies such as carbon capture and storage (CCS) is not expected to be possible in time to avoid required immediate large-scale investment in land-sector sequestration activities.
The RepuTex Team
Australian Electricity Markets
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