Cheat sheet: Carbon trading in Australia and beyond
Westpac IQ asks three experts to explain how carbon markets work and unpack the reasons for the rapidly rising demand in Australia for high-integrity carbon offset schemes.
The heat is on Australian corporations to reduce carbon emissions where they can, and to offset them when they cannot. But how do carbon markets work and what impact do they have on efforts to address climate change?
Carbon trading is a market system designed to reduce greenhouse gases, especially carbon dioxide, that contribute to global warming. Effectively, carbon markets put a price on pollution, as companies buy carbon credits to offset their impact on the planet.
Two types of carbon markets exist. In Europe, a government-run compliance emissions trading market legally obliges companies to account for their emissions; while many other countries run voluntary markets in which carbon credits are traded on an opt-in basis, allowing polluters to offset their emissions by paying for carbon sequestration or emissions avoidance projects.
Hugh Grossman, executive director of carbon markets research firm RepuTex Energy, describes the current Australian market – a hybrid mix of predominantly voluntary trading with a small component of compliant trading – as “compliantory”. However, following the ALP’s election win, the local market is expected to transition to a compliance trading framework.
There is rapidly rising demand in Australia for high-integrity carbon offset schemes as companies seek to reduce net carbon emissions.
Australia’s compliance regime is known as the Safeguard Mechanism and requires large emitters, or companies that have facilities with annual emissions beyond 100,000 metric tonnes of carbon dioxide equivalent to buy Australian Carbon Credit Units (ACCUs) to offset emissions that exceed the baseline quotas.
Grossman says the price of ACCUs, which are issued by the Clean Energy Regulator (CER) under the Australian Government’s Emissions Reduction Fund (ERF), has increased dramatically in the past year as high-emitting companies have worked to hedge against their future emissions liabilities by accumulating ACCUs through voluntary trading.
Many companies are also beginning to favour ACCUs over international credits because, as the Australian Energy Council notes, they are “considered high-quality credits due to the stringent processes the CER has in place when issuing”.
What is the state of the Australian carbon credits market?
In short, it has been in turmoil recently, following a decision to allow landholders and other businesses with contracts to sell carbon credits to the Australian Government under the ERF to break those deals and sell them at a higher price on the secondary market. That decision sparked a price plunge for ACCUs earlier this year.
“So, Australia is going through some turbulence at the moment,” says Christophe Denoux, Head of Sustainable Trading, Westpac. “Big corporates who buy ACCUs are assessing what it means for their strategy going forward.”
Nevertheless, prices of ACCUs have increased significantly compared with just over a year ago, rising from about AUD18.75 in March 2021 to a peak of more than AUD56 in January 2022 before dropping after the ERF announcement.
Following the election of the Albanese Government in Australia in May, the spot price of ACCUs jumped to AUD35.50 a tonne, up from AUD30 just before the polls opened.
There are expectations that the new government may overhaul climate and energy policy, with Labor committing to a 43 per cent reduction in greenhouse gas emissions from 2005 base levels by 2030. The strong performance of Greens candidates in the election is also seen as giving the new government a mandate on climate action that could benefit carbon credits.
Are global carbon trading markets effective instruments for decarbonisation?
“That’s the billion-dollar question,” Denoux says. “The voluntary carbon market is relatively new, so it’s early days. And the compliance markets have been operating for about 20 years in Europe and it’s still unclear if they have had a meaningful impact on reducing pollution.”
The United Nations’ Emissions Gap Report 2020 suggests that despite a brief reduction in emissions, the world’s emissions trajectory is still on the rise and likely to exceed the constraints on global temperature targeted by the Paris Agreement. It found that since 2010 greenhouse gas emissions had risen 1.4 per cent on average a year.
Australia and other countries should be moving to a regime in which carbon offsets and the purchase of carbon credits should be the last resort as part of any decarbonisation strategy, says Ceri Binding, Head of Utilities & Direct Investment at Westpac.
“Ultimately, they should be used to offset the residual emissions that corporations can’t otherwise avoid, reduce or offset because of technology constraints,” she says. The focus should be on sustainable technologies and actions that stop emissions in the first place.”
Denoux agrees. “You should try everything else in your power to reduce emissions, for example by sourcing 100 per cent of your electricity from renewables,” he says.
Why have integrity issues plagued carbon trading, and is that changing?
Carbon trading initiatives have a chequered history, with big polluters often being accused of backing ‘greenwashing’ projects that have little positive impact on the environment.
There has been criticism, too, that many power, industrial and aviation companies, for example, have received ‘free allowances’ that limit their need to pay for every tonne of their emissions.
Denoux says companies in the voluntary carbon trading space have, in the past, often been influenced more by the price of carbon offsets than their quality. “But internationally we’re seeing a flight to quality, where buyers are becoming savvier and moving away from cheap carbon offsets to avoid criticism of greenwashing.”
Binding suggests corporations should always try to go over and above carbon credit verification standards.
“At Westpac, we apply an overlay of quality to verified carbon credits and also identify if there are credit types that add greater value from a community and broader environmental perspective,” Binding says. “Our approach has evolved over time as our knowledge of the market – and opportunities to have a greater impact – have grown.”
The government also recently announced that it will set up an independent panel to review the integrity of the Australian Carbon Credit units (ACCU). The review will take six months with the panel expected to provide its report to the government by 31 December 2022.
How are carbon markets driving technology investment and innovation?
In markets such as Europe and the United Kingdom, Grossman says green hydrogen – that is, hydrogen produced using renewables-powered electrolysis – is seen as a sustainable means of fuelling industries such as transport.
“The EU ETS creates a market signal to unlock technology and, more importantly, drive investment into those new technologies and to then reduce emissions,” he says.
In Australia, by contrast, Grossman believes a “policy malaise” has discouraged industry from investing in different technologies. With such a large land mass, he asserts there is strong opportunity in Australia for nature-based carbon sequestration projects.
There is great potential for direct air capture projects, he says, referring to an emerging technology that involves using chemical reactions to pull carbon dioxide out of the air and then store it.
“It’s very expensive now, but a lot of companies, including Microsoft, are funding such projects because they think in 10 to 20 years’ time direct air capture will be an important part of the solution.”
Eyes are now on the actions of the new Australian Government, following previous pledges from Anthony Albanese to embrace carbon capture and storage technologies and back additional funding support for renewable energy innovation.
What role can businesses play through carbon trading and other measures?
Farmers, businesses, governments and others can run projects that earn ACCUs for emissions avoidance, or through carbon removal initiatives that capture carbon dioxide from the atmosphere and lock it away in plants, soils, oceans, rocks, saline aquifers and other means as part of sequestration activities.
Australia has an opportunity to become a significant global supplier of carbon credits, Binding believes. Through carbon credit purchasing and other sustainability measures, businesses have an opportunity to help the planet and avoid the worst impacts of climate change, she says.
“Carbon credits can deliver more than emissions reductions. We have large swathes of natural environment that have been degraded over time and the carbon credit market provides a chance for us to address that issue, the loss of biodiversity and to support our regional communities.”
Westpac has long taken the lead in this space and has been carbon neutral since 2012. The bank has also committed to source the equivalent of 100 per cent of its global electricity consumption through renewables by 2025.
What is a specific Westpac project in the carbon credits space?
Westpac is the largest buyer of ACCUs in Australia. One project has been to purchase carbon credits from savannah fire-management projects in Arnhem Land, in the Northern Territory, as part of the bank’s continued support for Indigenous-owned businesses.
The initiative allows for the burning of savannah during the colder months of the year, which, in turn, reduces the risk of major fires during summer.
What is the role of carbon offset developers?
They act as aggregators and retailers between project developers seeking to develop nature-based solutions – such as a carbon sequestration project on a farm – and any buyers.
Denoux says developers help those wanting to produce carbon credits to understand the potential of their land and manage projects for them. “They usually charge a commission between 20–30 per cent, which is quite high. But it’s pretty tough and bureaucratic if you’re a farmer and you’re trying to get a project off the ground by yourself. So you may need those developers.”
Westpac partners with customers to provide practical risk management and financial solutions with carbon trading. Why is the bank focusing on carbon forwards, rather than the spot market?
If a bank sells carbon units on the spot market, the transaction typically settles within days, whereas a ‘carbon forward’ could see ACCUs delivered at certain dates over a 10-year period, for instance. Denoux says the emphasis is moving to carbon forwards because companies are trying to lock in the price of their carbon credits.
“It’s driven by the big corporates wanting to remove the uncertainty of finding the right type of carbon credit unit and the uncertainty around the price.”
What’s next for Australia’s carbon trading market?
Australia’s carbon offset certification schemes, including Climate Active, a carbon neutral certification scheme administered by the Australia Government, are undergoing a review.
Australia is also set to overhaul its carbon market by launching an online exchange where brokers, companies and individuals can buy and sell ACCUs on a platform run by the Clean Energy Regulator.
“If we get a more centralised clearing house, we will automatically see an improvement in price discovery and price transparency,” Grossman says. “That will improve new product development and the barriers to entry will be much lower.”
What is on the horizon for carbon markets globally?
For Australia, Grossman thinks the big question is the impact of expected changes to the Safeguard Mechanism, and how the local market will transition to a compliance scheme, aligning industrial emissions with net-zero.
“The Australian market is about to take a significant step forward in its development, as it transitions from a voluntary to compliance driven regime. The pace, and scale of industrial decarbonisation will be a key driver of local prices and market development” Grossman says.
Internationally, Binding expects more debate on carbon removal credits (from projects, such as re-vegetation and carbon capture, that focus on removing emissions that are already present in the atmosphere) versus carbon avoidance credits (from projects that reduce likely emissions such as renewables and avoidance of deforestation).
The latter are opposed by some groups such as the Net-Zero Banking Alliance, but Binding believes they can play a key role in protecting native vegetation and habitats such as the Amazon rainforest, the world’s largest carbon sink.
“I think the role carbon credits can play in restoring natural capital will be one of the most significant topics in the next five years relating to carbon markets,” she says.
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