Flawed Lima sets the stage for target tension

Reputex Market Insider

Over the past fortnight the eyes of the global community have been focused on the Lima climate conference, which, much like its predecessor ended without any real progress towards a global agreement.

The Lima conference had a largely simple goal – to agree to the scope and schedule for the Paris agreement in December 2015, yet historical divisions once more came to the surface with developed and developing economies split on many of the details of a future agreement, notably the legal form of any 2015 text.

As in past conferences, developing markets fear that any future agreement will require them to set more ambitious emissions targets, while developed economies, which have produced most of the world's emissions, argue that the time is nigh for global action, particularly from larger economies China and India.

The final outcome in Lima, which can be read in full here, waters down an earlier draft version by deleting any review of country pledges, along with a technical review of financial support for developing countries.

On point analysis – Lima agreement

– Nations will be required to create “Intended Nationally Determined Contributions,” or INDCs, to the United Nations by March 31, 2015, to show how they will meet their stated emissions target.

– The text requiring INDCs has been watered down following pressure from China, against the EU's wishes. INDCs “may include” details such as base years and yearly targets. This text has been amended from “shall provide” under a former draft, indicating that Paris could at worst be a statement of offers to cut emissions, and little else.

– Donations to the Green Climate Fund to support developing nations cut their emissions and adapt to climate change surpassed $10 billion.

– A 37-page document was created that will form the basis of a negotiating text for Paris next year, largely in ‘multiple choice' form.

The state is set for 2015 ... and Australia's role

Despite its failure to reach a clear outcome on the big issues – which few had realistically expected – the Lima conference provides a pathway to Paris, with diplomatic discussions to continue between the major players as the international community seeks to avoid another disappointing outcome on climate policy.

Domestically, Australia's emissions ambition will be closely scrutinised as part of that pathway, with a new emissions reduction target expected to be announced in the first half of 2015.

The setting of the domestic target will come under the added pressure of a Special Review by the Climate Change Authority as to whether Australia should introduce an ETS, with part one of the review, due for release by June 30, 2015, to focus specifically on what future emissions reduction targets Australia should agree to.

Should the government fail to meet expectations, the CCA's report will place significant pressure political pressure on the government, with the review coming at the formal request of Minister for the Environment, Greg Hunt, albeit as a result of lobbying from the Palmer United Party.

The Environment Minister has been notably absent from the global policy dialogue, sidelined from attending the Lima conference, due largely to the Prime Minister's desire to ensure Australia does not overreach on the international stage, with Foreign Minister Julie Bishop joined in Lima by Minister for Trade, Andrew Robb, a climate conservative.

As the first half of 2015 approaches, how the government manages to balance its conservative view on climate change with its stated objective of committing to “strong” greenhouse gas emissions cuts will be a key watch – for both the domestic market, and the international diplomatic community.

Domestic update – wheels begin to turn on ERF

Domestically, the wheels have begun to turn in the lead up to the first Emissions Reduction Fund auction in March 2015, with the Department of Environment and Clean Energy Regulator releasing draft regulations and a draft contract, representing the first of a series of updates to be released ahead of the first auction.

As the first auction approaches, the key issue for many proponents in deciding whether to participate in the ERF will be the price that the regulator is willing to pay for emission reductions, with the setting of the benchmark price to have significant implications for contract prices and ACCU supply.

In establishing the parameters for setting the benchmark price, the regulator has confirmed that the ERF will not seek to meet Australia's 2020 emissions target, but will simply seek to ‘buy as much abatement as it can with the funds available', meaning that the scheme will operate without a clear quantitative purchasing target.

We analysed this dynamic in our latest Market Update ‘Setting the ERF Benchmark Price', with findings indicting that a high benchmark price will result in a de facto ‘market driven' ACCU price forming. Such an approach is likely to incentivise widespread participation from industry, with modelling indicating that competition would create a large gap between the average price of abatement and the benchmark price.

Notably, as we explored in our latest Analyst Update, over multiple auctions, the average bid price is likely to converge on maximum, not minimum price expectations as proponents inflate their bids to seek out the clearing price, rather than reflect the underlying cost of abatement projects.

This may not be an ideal outcome for the government, but it is good news for proponents, with more acceptable project economics likely to be on offer for those who roll the dice in early auction rounds.

The RepuTex Market Insider publication is a monthly review of the key events and activity shaping the Australian emissions markets. It was originally published by RepuTex under its Australian emissions markets research service. For more information please click here.