The surrender charge on international units in the Australian ETS

On 8 November 2011, the Australian Senate passed the Clean Energy Future package of 18 bills without amendment. Among other things, these bills introduce carbon pricing arrangements for Australia, starting with a fixed-price regime from 1 July 2012 and moving to a floating-price emissions trading scheme from 1 July 2015.1 The Clean Energy Bill includes provisions for a ‘price floor’ in the emissions trading scheme. This is a minimum carbon price established by setting a reserve price in the auctions of emission allowances. The emissions trading scheme also allows liable entities to comply by surrendering international units, such as Certified Emission Reductions. However, the use of international units could potentially undermine the price floor, if the price of such international units is low. A top-up fee, referred to as a ‘surrender charge’, is therefore contemplated to be payable if the price of the relevant international unit is below the price floor. Provision for this surrender charge is made in the legislation (see Appendix for selected provisions).

The Australian Department of Climate Change and Energy Efficiency approached the Grantham Research Institute at the London School of Economics for advice about the interaction of the price floor and the use of international units. At a meeting in London on 1 December 2011, along with representatives from Climate Bridge and Vivid Economics, researchers from the Grantham Research Institute addressed various options for the design of the ‘surrender charge’, and assessed the various design options in terms of their ability to meet the objectives of the Australian carbon pricing mechanism. Subsequent discussions and input has been provided by members of the Grattan  Institute in Australia. The conclusions of this analysis are presented in this Policy Paper. The core conclusion is that the ‘surrender charge’ should be equal to the floor price minus the 1-month moving average price of secondary (i.e. issued) international units as revealed on a transparent, liquid market (rather than by reference to private bilateral trades), calculated at the date of surrender of the international unit.2 Shortly after this meeting, the government released a discussion paper entitled Price floor for Australia’s carbon pricing mechanism: Implementing a surrender charge for international units (the Discussion Paper). The Discussion Paper sets out four options for implementation. The recommendation in this Policy Paper most closely corresponds to Option 3 of the Discussion Paper. This Policy Paper provides an overview of the basic economics of international units (section 2.1) and carbon price floors (section 2.2) before presenting the economic theory of their interaction (section 2.3). We then describe some design options for the ‘surrender charge’ in section 3. Our recommended design for the surrender charge, and supporting reasons, are presented in section 4.