Act now to manage carbon tax costs

With the carbon tax legislation kicking in next July, businesses wanting to pass on carbon costs are being urged to review their contractual rights and obligations now to ensure they are not left carrying an unacceptable share of the cost burden, says a leading energy and resources lawyer.

According to Julian Mellick, senior associate in the energy and resources team at CBP Lawyers, companies which assume that their ability to pass on the costs of the carbon tax is protected by standard ‘change in law’ clauses in their existing contracts could be in for a nasty surprise.

“’Change in law’ clauses allow prices to be adjusted where there’s been a major regulatory change. But they are unlikely to be very helpful on the carbon tax because they typically require the change to be ‘not reasonably anticipated’, which is hardly the case since these reforms have been expected for some time.

“Also, the clauses often only cover situations where reforms require payment of a particular fee or charge. While the large carbon emitters who are directly liable for the tax may fall into this category, every other downstream business saddled with higher input costs - whether they be rising electricity prices or more expensive carbon-intensive products and raw materials - would be left out in the cold,” Mellick said.

Mellick urges that all businesses should consider whether it is in their interests to incorporate specific carbon pass-through clauses into their new contracts.

“When tailoring a carbon pass-through clause, companies should consider the scope of the costs that may be passed on, such as whether both direct and indirect costs are covered as well as any incidental compliance costs.

“There should also be transparency, equity and accountability around how those costs are calculated. For example, companies should have to substantiate their price increases and only be allowed to pass through ‘net costs’ after their carbon tax liability is offset by any government compensation or free permits, so they don’t end up with a windfall.

“Finally, given the regime will move from a fixed price to a fluctuating market price in 2015, the contract should also include a process for assessing the carbon cost pass-through mechanism every couple of years to ensure it’s operating as intended.

In the case of existing long-term contracts, Mellick recommends that businesses consider negotiating amendments to deal specifically with how the costs and risks of the carbon tax should be allocated between the parties.

“There’s no doubt that certain suppliers and contractors may now find themselves locked into contracts where they are unable to pass on higher costs. Dominant parties may seek to rely on the muscle of their market power to negotiate amendments in their favour. But even so, businesses should still question whether it’s in their longer term interests to insist their suppliers and contractors take on 100% of the risk. Could this jeopardise the viability of a strategic relationship, or lead to undesirable short cuts being taken? It may well be that some sharing of the costs and risks is in everyone’s best interests and could achieve better commercial relationships for all parties along the supply chain.

“If they have not already done so, all companies should now be reviewing how the carbon tax will affect their bottom line and be taking steps to ensure their contractual arrangements protect them as far as possible from undue commercial risks. With the legislation now a done deal, there’s no longer any excuse for inaction,” Mellick added.

Elements of an effective carbon pass-through clause:

• Ensure there is an appropriate allocation of the risks and costs associated with the carbon tax/price between contracting parties
• Consider the scope of costs that can be passed through such as whether direct and indirect costs are covered and how any fines or penalties are to be dealt with
• Include incentives for suppliers to minimise their carbon costs through the adoption of emission reduction strategies or acquisition of well-priced permits
• Ensure there is transparency, equity and accountability in how the pass-through costs are determined
• Provide for a periodic evaluation of the carbon costs pass-through mechanism over the contract term
• Incorporate a cost-effective and efficient dispute resolution process to sort out any disagreements. 

For more information about energy, renewables and resources, please see the website of CBP Lawyers