The recent outcome of a review of Australia’s carbon credit system by Professor Ian Chubb, which propose changes to the safeguard mechanism, form an important milestone for national carbon markets. The consensus reporting has coalesced around the potential for dramatic growth of the market and the inevitability of higher prices. These are worth considering in more detail.

Australian businesses are increasingly making net zero commitments. These will likely lead to an increased uptake of Australian Carbon Credit Units (ACCUs). But that doesn’t mean businesses should rush into buying them. It’s instead important for businesses to begin the journey of understanding Australia’s carbon market.

BCG believes corporates should dig into the detail of the markets and the policy, and frame their actions to make sure it aligns with their business model, capabilities, and the demands of their numerous stakeholders. But there are some nuances businesses should consider.

ACCU market among world’s most significant offsetting markets

Changes from the Chubb Review have solidified the ACCU market’s position as among the most significant and credible offsetting markets in the world.

The ACCU market is administered exclusively by the Clean Energy Regulator, an Australian Government body. The acceptance of the Chubb Review is an explicit endorsement of the ongoing integrity of the ACCU market. And, as a signatory to the Paris Climate Agreement, this creates direct links between the Australian carbon market and the country’s Nationally Determined Contributions (NDCs) to reduce emissions. This is a sovereign commitment, directly linked to the Paris Agreement.

This is also a bipartisan creation. By accepting the Chubb Review’s recommendations, the Labor Government has endorsed offsetting methodologies put in place by previous Coalition governments. By choosing to retain and refine the safeguard mechanism it is building on a scheme developed by a previous government. The Australian carbon market has many fathers and mothers, and as such is likely more durable than other constructs as a result.

The United States is an interesting counterexample. Under President Obama, the US was a signatory to the Paris Agreement and put in place the Clean Power Plan to reduce emissions from electricity generation. However, the following administration withdrew from the agreement and scrapped the plan. Participants in any US carbon market investments will need to constantly keep their eyes on the political winds.

Prices are not necessarily headed straight to $75 a tonne

Some in the market see the $75 price cap as an indication of the immediate direction of the market. Changes to the safeguard mechanism add demand for ACCUs. By 2030, safeguard mechanism facilities will have to either reduce emissions or buy offsets for ~50mt (CO2-e) per year. While this increase in demand will certainly support price, it is also necessary to consider supply.

  • In the 12 months to October 2022, over 17mt of ACCUs were produced.
  • 8.5mt, or less than half of those units, were retired. The market is in serious oversupply.
  • Inventories of ~20mt represent 2.3 years of current demand.
  • The changes to the safeguard mechanism will add approximately ~7mt of demand in 2023-24, rising to ~20mt of demand in 2025-26. At a high level, this is the point where demand will meet current supply and start to consume inventories.
  • In the last 12 months, 302 new projects were registered, up ~40% from the previous period, adding to potential supply.
  • It is reasonable to expect material growth in supply from new methodologies including soil carbon, carbon capture and storage, and blue carbon.

While we expect the market to tighten and push prices higher, it doesn’t seem justified in the next three to four years. The $75 price cap, ironically, removes the risk of a flare up in prices and could take some heat out of the market.

It is also worthwhile considering the marginal cost of new supply. To date, over 200mt of ACCUs have been auctioned into the Emissions Reduction Fund (ERF) at prices averaging ~$12.50/t. Even including some measure of cost inflation, the current price of ~$35/t may be sufficient to incentivise significant new capacity. Prices may eventually rise to the cap, but it might take a while.

There is clearly reason to be excited about the new policy. But it is possible that the market price for ACCUs has already anticipated these changes.

A market for all

Safeguard mechanism facilities will need to deal with the ACCU market. However, it doesn’t stop there. Any company with a carbon neutrality claim that is certified by Climate Active – a government-backed program – should seriously consider using ACCUs for some or all of their offsetting obligations. Stakeholders will want to see Australian offsets to Australian emissions.

Beyond the corporate sphere, individuals are beginning to invest in ACCUs for personal reasons. These investments can be direct, through ETFs, or through innovative platforms allowing fractional ACCUs down to a kilogram. These are small contributors to demand now, but we expect rapid growth.

As companies dig into the details to consider commitments, policies, and investments in the Australian carbon market, it is essential that they align their plans with their business model, organisational capabilities and controls, and purpose. In this volatile and growing space every opportunity will be met with some underlying risk. Australia now enjoys one of the most developed carbon markets in the world. The onus is on companies to best take advantage of it.

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