Australia’s carbon price mechanism has become law. But how does it work? There are six key points:

1. Australia’s emissions trajectory

Australia has committed unconditionally to reduce its greenhouse gas emissions by 5% compared with 2000 levels by 2020. By 2050, emissions will be reduced by 80% compared with 2000 levels.

2. The annual cap on emissions

During the first three years (July 1 2012 to July 1 2015), when the price of carbon units is fixed, emissions will not be limited. Thereafter the government will set an annual cap. The extent of the cap will be based on the advice of the new Climate Change Authority (CCA).

The annual cap is set consistently with Australia’s downward emissions trajectory – it will get tighter as Australia’s emissions reduction targets go up. The number of carbon units issued each year will equal the scheme cap.

3. Entities covered by the scheme

Liable entities must surrender one carbon unit (to the new Clean Energy Regulator for each tonne of emissions for which they are liable. Liable entities are broken into three categories:

the person who has operational control of a facility from which 25,000 tonnes of CO₂e (these are all greenhouse gases covered by the legislation) are emitted annually

natural gas retailers

the person who has operational control of a landfill facility from which 25,000 tonnes of CO₂e are emitted annually.

Liable entities are only liable for Scope 1 (direct) emissions from:

the combustion of energy sources

fugitive emissions (such as from coal mines)

industrial process emissions

emissions from waste.

These emissions have been reported since 1 July 2009 under the National Greenhouse and Energy Reporting Act 2007.

Three types of eligible carbon units can be surrendered:

units issued by the Clean Energy Regulator

Australian Carbon Credit Units (ACCUs) issued under the Carbon Farming Initiative (CFI)

international units which are accredited either under the Kyoto Protocol or any successor to the Kyoto Protocol. The government may disallow any of these if it considers them ineligible.

The CCA will advise the government on the eligibility of international units. Eligible international emissions units cannot be surrendered during the fixed charge period. They can however be surrendered during the flexible charge period (from 1 July 2015), and can be up to 50% of the total emissions liability for that entity for the year.

The Carbon Farming Initiative lets Australia’s agricultural sector reduce emissions and create carbon credit units. Emissions reduction may happen by avoiding emissions in the first place, or by removing carbon from the atmosphere and storing it in soil or trees. The credits generated can be sold to liable entities both in Australia and overseas.

In the fixed charge period, a liable entity can surrender carbon credit units to meet 5% of its total emissions liability. In the flexible charge period, a liable entity can surrender as many of these units as it wants. A stringent shortfall charge applies for failure to surrender carbon units.

The carbon price mechanism does not apply to fuel. A carbon price is imposed on fuel through changes in fuel tax credits or changes in excise.

4. Issuing carbon units

The Clean Energy Regulator will issue carbon units. In the first three years of the scheme (1 July 2012 to 1 July 2015, the “fixed charge” years), carbon units will issued at a fixed charge of:

in 2012, $23/tonne

in 2013, $24.15/tonne

in 2014, $25.40/tonne.

The scheme then enters an emissions trading phase (known as the flexible charge years). For the first three years, a transitional carbon price ceiling and a floor will manage price volatility. Thereafter the price will be set only at auction.

Carbon units will be issued free to emissions-intensive trade-exposed industries (EITEs – these are industries which compete with industries in countries without a carbon price), coal-fired electricity generators and LNG projects.

Complex mathematical formulae calculate the number of units to be issued. Highly emissions-intensive EITEs will receive 94.5% of their carbon units for free. Moderately emissions-intensive EITEs it is 66%. This will be reduced by 1.3% a year. LNG projects will will get assistance at or above 50%.

The issue of free carbon units will be reviewed by the Productivity Commission. Units issued in the flexible charge years are tradable.

5. Information, monitoring, penalties, and reviews

The electronic Liable Entities Public Information Database must be kept open for public inspection. The Regulator can demand information from liable entities, who must keep records for five years.

Inspectors have monitoring powers. Strict civil and criminal penalties apply. CEOs are personally liable to pay civil penalties if they fail to take reasonable steps to prevent a contravention. The CCA will review the carbon price mechanism.

6. Compensation

$14.9 billion in household assistance will be provided. This assistance is to offset the price rises likely to be passed from liable entities to consumers.

Free units for emissions-intensive industries will cost $9.2 billion. Free permits to coal-fired generators, and the closure of highly polluting plants, will cost $5.5 billion from 2011-2017.

$1.3 billion from 2011-2017 will fund the Coal Sector Jobs Package. Clean energy and energy efficiency also receive government funding.