The Carbon Pricing Mechanism (CPM) is a mechanism by which businesses pay a charge for each tonne of carbon pollution they emit each year.  The following industries will be covered by the CPM:

• Stationary energy
• Industrial processes
• Fugitive emissions (but excluding those from decommissioned coal mines); and
• Emissions from non-legacy waste (waste deposited after the scheme starts)

Affected businesses will pay the charge by purchasing a carbon unit (permit) for each tonne of carbon pollution emitted and surrender these to the government either yearly, or half-yearly if they emit greater than 35,000 tonnes.

The CPM will be divided into two stages.  From 1 July 2012, there will be a fixed price stage, whereby businesses will pay a fixed charge per tonne of carbon emissions.

From 1 July 2015, the mechanism will shift to effectively change to a market based system, whereby carbon units are tradable on an emissions market and the price of a carbon unit is “floating”. The floating system is called a ‘cap and trade’ emissions trading scheme, and a minimum floor and maximum ceiling will be set for the price of a carbon unit.

How does the first (fixed) stage of the CPM work?

The first stage starts on 1 July 2012 and ends on 30 June 2015.  During the first stage of the CPM, affected businesses will be charged a fixed price per tonne of carbon emissions.  The initial price will be $23 per tonne of carbon, increasing by 2.5% in real terms per year, over the next two years. As such, the fixed price for a carbon unit has been set at:

The fixed carbon price will be imposed by the Clean Energy Regulator
issuing carbon units (ie permits to emit a tonne of carbon pollution)
for a fixed charge to affected businesses. These carbon units issued
during the fixed stage will have a “vintage” year allocated to each
unit, which prevents the banking of carbon units to later periods.

What emissions are caught by the CPM?

The CPM will cover 4 of the 6 Kyoto greenhouse gases. These have been identified as:

1. carbon dioxide
2. methane
3. nitrous oxide
4. perfluorocarbon

These are also covered by the introduction of the National Green
Energy Reporting Act 2007, which was effective from 1 July 2008.

Will I be subject to the Carbon Price Mechanism?

The government has continually announced that only the “top 500
Australian polluters” will be liable for a price on carbon under the
CPM.  If you are not one of these, then you will not need to pay a
charge for carbon under the CPM.

I am not one of the top 500 polluters.  How will my business be impacted?

Although the scheme will only require approximately 500 of the
country’s biggest emitters to purchase and surrender carbon units for
their greenhouse gas emissions, many other businesses are likely to be
impacted in several ways.

Most businesses are likely to experience the indirect effects of
increased prices on many production inputs and general business
expenses, as suppliers subject to the CPM are likely to pass on their
carbon price burden to their customers, in the form of increased prices.

In conjunction with the scheme, there will also be changes to the
Fuel Tax Credit system. The effect of these changes is to reduce the
Fuel Tax Credit available and apply an “effective carbon price” on the
use of certain fuels.  As these changes are not confined to the same top
500 polluters, they will directly impact many more Australian
businesses from various industries that are currently eligible for fuel
tax credits. This is explained further below.

The degree to which any particular business experiences increases in
its cost structure will depend on a number of factors, in particular,
the amount of energy it expends in its operations, its exposure to
transportation costs and the proportion of its domestic inputs and
production compared to its imports.

Is it a tax?

Although the CPM has a similar effect to levying a tax on carbon
emissions during its initial fixed stage, it is not technically a tax.

Each carbon unit is a separate asset issued by the Clean Energy
Regulator and paid for by emitters.  A carbon unit is considered to be
an item of personal property and as such it is not a tax.

During the second stage of the CPM, these units are able to be traded on the market with other businesses.

The cost of acquiring the carbon units will be deductible to
business; however the timing of the deduction will be similar to trading
stock in that the amount of the deduction will be limited to the
proportion of the carbon units surrendered/traded.

Taxpayers will be assessable on revenue account on amounts they are
entitled to receive on ceasing to hold a unit.  Free carbon units
granted to certain emissions intensive industries which are not required
to be surrendered can be sold back to the Regulator or traded, at which
time that income will be assessable.

Thanks to Grant Thornton for this summary

At the heart of the Scheme is emissions trading, in which the Government sets a limit on how much carbon pollution industry can produce, and then the Government sells permits up to that limit, creating an incentive to look for cleaner energy options. Companies can buy and sell permits from each other depending on how much they value them.

See our earlier post for details of how a general emissions trading scheme works

The Government intends that revenue raised from the selling of permits will be used to help households and business (see below).

Compensatory changes

The Government announced a range of compensatory arrangements and transitional measures:

· To offset the initial price impact on fuel associated with the introduction of the Scheme, the Government said it would cut fuel taxes on a cent-for-cent basis (this will include fuel used by heavy vehicle road users). The Government will review this measure after one year.

· For rural and regional areas, a rebate will be provided equivalent to the excise cut for businesses in the agricultural and fishing industries for three years.

· Transitional assistance will be provided in the form of a share of free permits to the most emissions-intensive trade-exposed activities.

· The Government also proposes to provide a limited amount of direct assistance to existing coal-fired electricity generators.

· Payments will be increased, above automatic indexation, to people in receipt of pensioner, carer, senior and allowance benefits and to provide other assistance to meet the overall increase in the cost of living flowing from the Scheme.

· Assistance will be increased to other low-income households through the tax and payment system to meet the overall increase in the cost of living flowing from the Scheme.

· ‘Middle-income households’ will also get assistance to help them meet any overall increase in the cost of living flowing from the scheme.

Tax and accounting aspects

The Green Paper says ‘discrete provisions of the income tax law’ would be developed to provide generally the same tax treatment to permits purchased by taxpayers who are carrying on a business or other income-earning activity as would occur under existing legislation. Other tax aspects include:

· the cost of acquiring a permit would be deductible at the time the permit is acquired. If the permit is banked, the effect of the deduction would be deferred until the time the permit is surrendered or sold;

· any proceeds received on the sale of a permit would be treated as assessable income;

· the value of free permits would be included in the taxpayer’s assessable income in the year the permits are received; and

· Scheme transactions would be treated under the normal GST rules.

1. The government sets emission reduction targets in line with their protocol and other commitments.
2. Businesses in sectors covered by the emissions trading scheme, whose greenhouse gas emissions are above
   a threshold, report those emissions to the government.
3. The government uses its own short-term and long-term emission reduction targets, and emissions data from
   business, to allocate free emission permits and / or auction emission permits to businesses whose greenhouse gas emissions are above a threshold (known as scheme participants). Emission permits represent a right for the holder of the permit to emit a specified amount of greenhouse gas emissions during a specified period of time. The limit or cap on the number of permits allocated creates the scarcity needed for a trading market to emerge.
4. If a scheme participant’s net emissions (gross emissions less activity that reduces emissions, such as the purchase of approved carbon offsets) at the end of a year is likely to be less than that allowed by the permits they hold, the participant can sell their excess permits to other scheme participants, or bank them for future use.

If the net emissions are likely to be more than the emission permits allow, a participant can: attempt to purchase approved carbon offsets; and / or reduce their emissions, for example by deploying more energy efficient technology; and / or attempt to purchase unused emission permits from other scheme participants.

If the participant is still unable to reduce their net emissions to equal the emissions allowed by the permits they hold, then the participant will have to pay an emissions fee to the government.

Example

Companies A and B both emit 100,000 tonnes of CO2 per year. The government allocates companies A and B emission permits that allow them to emit 95,000 tonnes a year each. Both companies must find ways of reducing their CO2 emissions by 5000 tonnes to meet the permit allocations.

Each permit represents a right to emit one tonne of CO2. The market price for each permit is $10.00. Company A calculates that if it invests in more efficient means of production the cost of reducing its emissions is only $5.00 per tonne, which will reduce its emissions by 10,000 tonnes. As reducing emissions is $5.00 per tonne cheaper than purchasing emissions permits from other scheme participants, company A decides to invest in improving its efficiency and reduce its emissions to 100,000 tonnes. This leaves company A with 5000 excess emission permits for the year that it can either sell to other scheme participants or bank for future use.

Company B is in a different situation as it has already done a lot to reduce its emissions by investing in low emissions technology. It has worked out that the cost to further reduce its emission is $15.00 per tonne. As the cost of reducing its emissions to 95,000 tonnes is greater than the cost of buying 5,000 emission permits, company B decides to purchase 5,000 permits from another scheme participant, so that it holds sufficient permits to cover its emissions for the year (100,000 tonnes).

Company A sells its 5,000 excess permits to company B for at the market price of $10.00 per tonne. For company A, it has spent $50,000 to reduce 10,000 tonnes of emissions and has made a gain of $50,000 on the sale of 5,000 excess permits to company B. Company B has saved $25,000 on what it would have had to otherwise spend, but for the emissions trading scheme.

The total emissions from company A and company B has reduced from 200,000 tonnes of CO2 to 190,000 tonnes.

From the CPA Australia publication EMISSIONS TRADING AND THER RELATED POLICY INITIATIVES