The Australian Emission Reduction Fund or ERF, is the centrepiece of the Australian Government’s target to reduce Australia’s emissions in line with the Paris Agreement. It was launched in 2015 with an initial budget of $2.2 billion.
A subsequent top up was added called the Climate Solutions Fund, with an additional $2.55 billion to build on the success of the ERF to date. The ERF is called an auction system, but it’s really more like a blind tender for carbon farming project owners to sell Australian Carbon Credit Units (ACCUs). Pre-qualified carbon credit sellers commit to sell a volume of carbon credits at an offer price, with an agreed set of delivery dates which could be for a period up to 10 years from now. The Clean Energy Regulator (CER) then assesses the offers, and makes a decision on purchasing those it considers “good value”. At that point, the CER commits the contract, and the accepted offers become biding contracts.
Business-as-usual- what happened until now?
For the first nine ERF auctions, the Clean Energy Regulator has only offered “guaranteed delivery” contracts, where the buyer agrees to buy and the seller agrees to sell ACCUs on specified dates for the agreed price per ACCU. Across those nine auctions, the CER committed around $2.3 billion in contracts to purchase around 193 million carbon credits. That produces a rough average price per carbon credit purchased by the CER at just over $12/ACCU over the nine auctions. The delivery contracts under business as usual for the ERF Auctions 1-9 were all “firm delivery”. That is, the seller had to supply the agreed volumes to agreed dates, or face the risk of series contract breach fines. This added real risk for sellers entering into those contracts, and stopped them from seeking out better prices in the open market.
Auction #10: what’s new? Higher prices and financial product innovation
While the volumes purchased at this auction were down compared to Auctions 1-6, the volume contracted at Auction 10 was in-line with the smaller volumes contracted in Auctions 7-9. This smaller volume reflects a smaller number of new projects being registered since the last Auction, again a consistent trend over the last three Auctions. So what makes the results published by the CER (see results here) so interesting?
First, the price paid per credit. The average price paid across all contracts secured at Auction 10 was $16.14. This price is very close to $2/credit higher than the next best auction price (Auction 9) and $4/credit higher than the whole of scheme average price paid (~$12). This is really interesting outcome, as it is clear the Australian Government spend is much closer to recent prices paid in the spot market (see www.accus.com.au). This convergence of the spot price and the ERF contract price shows the CER is prepared to respond to the low number of new projects being registered by being prepared to offer more per credit to pull more new projects into the market and increase rates of carbon farming participation. We expect that the current spot and ERF contract price paid at Auction 10 is closer to representing the actual cost of abatement from new projects today.
Second, the CER has been really innovative with a new product offering in the market. Auction 10 represented the first time they offered an optional deliver contract. The basic form of this contract differs from the traditional fixed delivery contracts the ERF covered, in the optional delivery means the credit seller has the right to sell, but not the obligation to sell at the agreed price. The CER is obliged to buy if the seller wishes to sell. This is better known as a “put option” in other markets and really means that if a seller can find a better price in the market to sell at, they can take the premium market price. If no better prices are available, they always have the fall back of the CER contract sale. The CER options contract traded at a very small average discount of $0.21 to the fixed price contracts. This really increases flexibility for sellers at a pretty competitive price, and makes the CER a buyer of last resort, creating an effective floor to the carbon price for carbon farmers. Now, if we could just get the CER to move away from hosting all sales at Auctions and keeping the purchasing account open every day of the week like most financial product markets, we will really be getting somewhere with creating some real depth and potential for liquidity in the market for carbon farmers who are working to improve their natural capital.
We think the CER should really be congratulated in listening to the market participants and finding ways to increase participation rates, and look forward to their next advances!
Dr Tim Moore
6th April 2020