In brief - Any carbon costs you pass on must be accurate and verifiable
Businesses must review their contractual rights and obligations concerning the pass-through of carbon costs or they could be left with an unacceptable share of costs in July 2012.
'Change in law' clauses may not cover carbon tax costs
Many companies assume that they can pass on the costs of the carbon tax under the standard 'change in law' clauses in their existing contracts and pro-formas. They could be in for a nasty surprise when the carbon price legislation takes effect next year.
'Change in law' clauses allow prices to be adjusted where there has been a major regulatory change. Typically, they only kick in where the change could not have been reasonably anticipated at the time of contract. Carbon price reforms may not fit into this category because they have been expected for some time.
Furthermore, 'change in law' clauses often only cover situations where reforms require payment of a particular fee or charge. This might cover large carbon emitters who are required to purchase carbon units or pay a shortfall unit charge. However, it excludes every other downstream business saddled with higher input costs, whether through rising electricity and gas prices or more expensive carbon-intensive products and raw materials.
Calculate your carbon tax costs carefully
Unsurprisingly, we have seen a spike in interest by businesses for specific carbon pass-through clauses to be incorporated into new contracts. This is something that all businesses should be doing if they are going to be affected by the carbon price.
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 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 that they don't end up with a windfall. This is fundamental to ensuring that any resultant contractual price adjustment is able to be assessed and administered.
It is also a key compliance point, given that the ACCC has been given $12.8 million in funds and a clear directive from the government to crack down on businesses that claim price increases based on grounds that are not reasonable and substantiated. Such claims are likely to be in breach of the Australian Consumer Law (a schedule to the Competition and Consumer Act 2010) and could result in penalties of up to $1.1 million.
Finally, given that 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 that it is operating as intended. In some cases this might involve an appraisal by an agreed third party expert.
Carbon pass-through clauses must interlock with other contract clauses
A big mistake is to assume that carbon pass-through clauses exist in a vacuum. It's tempting to call your lawyer and say: "Give me a pass-through clause which will protect me and which I can put into my contracts".
The reality is that the carbon pass-through clause should dovetail with a number of other key clauses:
- the payment clause, so that it is clear how and when the adjustment will be effected
- the notification clauses, so that adjustments are notified promptly
- the dispute resolution clause, because you don't want to have to go to a three-arbitrator arbitration in the event of a dispute, when in reality an expert appraisal would be much more appropriate
- any joint venture provisions; there are special rules under the Clean Energy Act for joint venturers
- any clauses dealing with National Greenhouse and Energy Reporting (NGER) requirements, since that information can assist to price the carbon tax attributable to the project
Sharing of costs and risks may be in everyone's best interests
In the case of existing long-term contracts, 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 their market power to negotiate amendments in their favour. But even so, businesses should still question whether it is in their longer term interests to insist that their suppliers and contractors take on 100 per cent of the risk.
Could this jeopardise the viability of a strategic relationship, or lead to undesirable shortcuts being taken? It may well be that some sharing of the costs and risks is in everyone's best interests and can achieve better commercial relationships for all parties along the supply chain.
Elements of a first-rate 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
- integrate the clause into the contract to avoid inconsistencies and ensure smooth contract administration
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.