By Hugh Grossman & Bret Harper of energy and environmental analysts RepuTex
Australia’s third Emission Reduction Fund (ERF) auction will take place on Apr. 27-28, with A$1.33 billion of the government’s A$2.55 billion funding tranche available (53% of all funding) for proponents to access over remaining auction rounds.
While on the surface, the first two ERF auctions appeared to be similar – contracting a comparable amount of Australian Carbon Credit Units (ACCUs) for a similar amount of money – analysis indicates that the second ERF auction was more competitive than the first, with a higher number of projects participating but a lower number of bidders signing contracts. Only one in three projects were successful at ERF II, with larger projects and more sophisticated bidders dominating, supplying around three quarters of all abatement contracted. This indicates that small projects disproportionately lost.
Notably, analysis indicates that firms that bid outside of our estimated “safe bid range” prior to ERF II were unsuccessful, with a large number of proponents estimated to have taken what they thought was a ‘conservative’ approach by bidding slightly under the average price of abatement of the first ERF auction ($13.95). Our modelling indicates that the large number of proponents bidding in this range led to the formation of a bid-stack ‘plateau’ driven by the regulator’s public price ‘signal’ from the first auction round.
Coincidentally this plateau is estimated to have been over the 50-100% range of eligible volume, however, the second auction was subject to a threshold not used in round one.
Did the new variable threshold have an impact at ERF II?
The introduction of the clearing threshold was most likely intended to make it more difficult for the largest bidders to manipulate each subsequent auction’s highest clearing price. However, it may also have had an unintended consequence for bidders who applied a simple logic, which prevailed at the second ERF auction:
• Less informed participants did not know how the clearing threshold would come into effect, but they did know the regulator was/is committed to contract the lowest 50% of abatement bid.
• They also knew the average price of the previous auction.
• Subsequently, a large number of proponents bid at, or just below, the previous weighted average price, forming our bid-stack plateau.
The unintended consequence of this bidding behaviour is that the significance of the new clearing threshold was not foreseen by many participants. For example, if the threshold was volume-based, the average price of the previous, lower-volume auction would have been a poor indicator or where the safe bidding range was. Alternatively, if the threshold was based on relative bid-price rises within the second half of the bid-stack, the price step that triggered the threshold may have been very small, driven by the aforementioned plateau.
Given that all bids at the same price level are contracted – and the large number of projects bidding within such a tight price range – this trigger would necessarily have been just A$0.05 or less. Subsequently, the perceived ‘safe’ strategy of “bidding the average price of the previous auction” (or slightly under) was destined to fail, particularly given the supply characteristics of the second auction.
Implications for the third ERF auction…
Because the threshold will be used again to determine the cut-off price, bidding the average price of the previous auction is likely to again be a high-risk strategy at ERF III. Such an approach is best viewed as a large gamble for little gain, particularly given that there may be only a small number of auctions left, and that contract prices may continue to go lower.
As noted, the next auction is shaping up to be highly competitive, with around 290 projects registered – an increase from auction one (260) yet slightly lower than ERF II (328). While the number of participants may be similar to earlier auctions, auction three will take its own unique shape, whereby the key to successfully competing for a contract will be to estimate the volume of ACCUs that new projects will supply to the auction, and the diversity of projects types. These factors, including the volume of ACCUs from low-cost projects, will be a key influence on the clearing threshold.
Notably, while forest regeneration, livestock, soil carbon and landfill projects have largely been successful to date, new efficiency and emission destruction projects (in sectors such as transport, mining, energy, and manufacturing) are likely to begin to play a bigger role in the ERF. In almost all cases, efficiency projects have a cost advantage over more rural projects, meaning efficiency projects can continue to compete as contract prices drop.
This, combined with the fact that half of the first tranche of ERF funding has been already been contracted – and the small number of remaining auctions – suggests that contract prices will again tend lower in the next auction. This continues the trend we saw from the first and second auctions, where contract prices dropped in line with the higher level of competition.
For proponents, this suggests that rather than gamble by bidding the ‘average price’ of the previous auction (which is a misleading “price”), the key will be to understand the evolving safe bidding range, which is dependent both on the amount of competition (ACCU supply) that is likely to participate in the next auction, and the way the clearing threshold will work.
Hugh Grossman is executive director of energy and carbon markets at RepuTex, and Bret Harper is associate director of research. Established in 1999, RepuTex has offices in Melbourne and Hong Kong, supported by a team of analysts with backgrounds in economics, commodities, policy and energy markets.