Smarter tools needed as market matures

Emissions of greenhouse gases in Australia are slowly tracking lower, but with about 434 million tonnes of carbon dioxide equivalent sent into the atmosphere in the year to September 2024, there is still a long way to go to meet the Australian Government’s targets.[1]

To push emissions to 43% below 2005 levels by 2030, it reformed the Safeguard Mechanism first legislated in 2016, setting declining emissions baseline limits at Australia’s largest industrial facilities. If a facility produces more emissions than its baseline, it must surrender Australian carbon credit units (ACCUs) or newly created Safeguard Mechanism Credits to offset those excess emissions.

The participants in this huge exercise – including entities able to sequester emissions – are trading an invisible commodity. They will need greater transparency as the carbon market grows, attendees at the ASX discussion heard.

If Australia is to transition to non-polluting sources of energy to replace coal and gas, investors and developers will need liquid markets to manage risk.

Supporting role for derivatives as emissions baselines decline

As part of Australia’s commitment to the Kyoto Protocol, the Clean Energy Regulator (CER) maintains the Australian National Registry of Emissions Units (ANREU), which records transfer of ownership. The CER also runs the ACCU and Safeguard Mechanism schemes.

Carbon Market Institute CEO John Connor says the volume of ACCUs traded surpassed $1 billion in 2024, and about 18.8 million ACCUs were issued in 2024[2]. The market is maturing, but growth will accelerate as the baseline emissions decrease until 2030. The CER has prepared for growth by launching a new and modern unit and certificate registry to replace the aging ANREU. It is clear that fit-for-purpose, modern infrastructure is required to facilitate market innovation and scalability.

Carbon market participants need certainty if they are to hedge and manage risk. Derivatives markets have the potential to generate additional liquidity. Case in point is the ASX core electricity markets which can trade up to six times the physical equivalent of the electricity market. To manage liquidity and achieve better price discovery, the carbon market needs a reliable forward curve.

ASX is committed to improving price transparency in carbon and renewables markets, recently launching a suite of Environmental Futures products. The products provide a forward looking price curve out to 5 years, helping investors and developers to understand and manage their price risk.

The CER has also been working with ASX on a proposed spot carbon exchange model, which contemplates utilising existing ASX infrastructure, including its clearing and settlement services.  

The CER released ‘Enabling deep, liquid, transparent and accessible carbon markets in Australia’ discussion paper on 11 October 2024, and sought stakeholder feedback on market needs and priorities for the establishment of new infrastructure, including a modern registry, and test the feasibility of the proposed spot carbon exchange model. 

An exchange model must support market liquidity and improve transparency and standardisation, while providing clients with robust risk management. The benefits of a reliable exchange model are clear, but there are legislative limitations governing ACCUs and fundamental exchange market principles that need to be considered to make it effective, says CER Principal Economist Georgina Prasad.

“We needed a model where you could facilitate the trade with the legal title outside the ANREU, so we developed a beneficial interest of trading an ACCU on the exchange. There will also be some tensions around balancing market liquidity and fungibility, because there are several methodologies that underpin ACCUs.” Prasad says.

Connor gave an example from a recent trip to Darwin. Indigenous communities earn credits through ‘cool burning’, a traditional method where preventative burning is performed earlier in the season to avoid more voluminous emissions from later, hotter burns. “Indigenous ACCUs trade at a premium in the market, partly through the compliance but also under the voluntary market,” Connor says.

The baseline measures used in the Safeguard Mechanism were reformed in 2023, increasing compliance obligations on covered entities. The reforms took effect in the last financial year with full results to be released mid-April. The transition to the Australian carbon market from a voluntary market driven primarily by a government Emission Reduction Fund into a compliance market. “That’s really meaningful in what it does to support and develop a market,” ASX General Manager, Product Management, Markets, Daniel Sinclair says.

The government is expecting about 30 million ACCUs will be issued in 2030, which Sinclair says would make Australia one of the largest providers of carbon credits in the world. “We have a unique position on the supply side, if we can get it right,” he says. “We see an important role for derivatives, acknowledging the contribution they play internationally and the fact we are moving into a compliance market.”

The global carbon market is worth about US$950 billion, says Sinclair, quoting research by the London Stock Exchange[3]. “Looking at the breakdown of volume, we can see that the majority of this is transacted via derivatives, specifically futures.” [4]

“Carbon markets have been around for over 30 years however it is only relatively recently that they have become mainstream,” Sinclair says. “In Australia, we are going through a transition from a voluntary market to a compliance market. As the predominant local derivatives exchange, we feel ASX has an important role to play in developing the right products to help scale carbon and renewables markets as well as supporting our customers in navigating the energy transition.”

As the Australian carbon market grows, propelled by the certainty of the Safeguard Mechanism, derivatives will facilitate trade. ASX’s suite of physically deliverable environmental futures contracts – ACCUs, large-scale generation certificates (LGCs) and New Zealand units (NZUs) – are deliverable against the relevant registries.

“These futures products are a mechanism to help compliance entities manage surrender obligations, but they can also be used by developers and other entities with exposures to hedge their risk,” Sinclair says.

Methodology stratification

In the ACCU market, stratification classifies projects by methodology, such as reforestation, soil carbon, and industrial abatement. Differences in risk, verification, permanence, and co-benefits create price variations, with high-integrity nature-based credits often commanding a premium over perceived lower-integrity or higher-risk methods.

This stratification of the ACCU market creates a challenge to building a liquid centralised exchange market, Sinclair acknowledges. But he says similar dynamics are found in other global commodity markets and it is not insurmountable. For a carbon futures market to grow, though, it will benefit from pooling liquidity around a standardised specification with relative method integrity and co benefits transacted as a differential to the underlying futures market.

ASX’s carbon futures product views ACCUs as a generic commodity, where any methodology can be delivered and surrendered.

“For the market to really scale and to be successful, we have to pool liquidity to a centralised point. This requires a level of standardisation,” Sinclair says. From a compliance market perspective, the CER views all ACCUs equally, he says. “You can surrender any method, so long as it is a certified ACCU.”

This logic is adopted by ASX, with all ACCU methods eligible for futures delivery.

Standardisation does not mean that a counterparty has to take delivery of something they didn’t want.  Futures provide users with the flexibility to hedge price risk without having to take physical delivery.

“For example, a buyer of an ACCU future has the option of going to delivery or closing out their position on market prior to the futures expiry. If the buyer takes delivery and they get a human-induced regeneration method, but what they really wanted was a savanna burning method as part of their portfolio, they have the option to switch that method out in the Over the Counter (OTC) market. Similarly, if the buyer chooses to close out their futures position prior to contract expiry, they still can use the OTC market to source a savanna burning method for surrender,” Sinclair says.

For Australia to reach its target of 82% renewable energy by 2030, annual completions of clean generation projects between 2026 and 2030 will need to increase by 240% above levels between 2020 to 2022, according to a 2023 Clean Energy Council report.[5]

Investors and developers need certainty if they are to access the finance required to transition to net zero emissions. A dynamic and deep carbon futures market completes the picture.

Sources

[1] Quarterly Update of Australia’s National Greenhouse Gas Inventory: September 2024, Department of Climate Change, Energy, the Environment and Water

[2] Quarterly Carbon Market Report December Quarter 2024, 14 March 2025, Clean Energy Regulator

[3] Global carbon markets value hit record $949 bln last year - LSEG, 13 February 2024, Reuters

[4] EU carbon markets 2024, 7 October 2024, ESMA

[5] Bridging the gap to 82% renewable eletrctricity generation by 2030, August 2023, Clean Energy Council