March 2009

We turn our attention to the issue of scheme caps (Part 2, Section 14 of the Carbon Pollution Reduction Scheme Exposure Draft Legislation) and gateways (Part 2, Section 15 of the Exposure Draft Legislation). The legislation states that the regulations must set a scheme cap for five years or more into the future; and may set a scheme gateway, with upper bounds and lower bounds for the scheme cap for the financial year beginning on July 2015, and any later financial year. This is slightly different to what is stated in the White Paper, which is that “the Government intends to provide up to 10 years of gateways beyond the minimum five years of certain Scheme caps, taking into account progress in international negotiations” (Policy decision 10.3).

There are two issues here. Firstly, are the caps and gateways that are in the government policy (the White Paper) appropriate? Secondly, is the framework for caps and gateways (the Exposure Draft Legislation) appropriate? Let us focus on the second issue.

Suppose for a moment that there was a comprehensive international agreement that not only reduced greenhouse gas emissions, but also reduced emissions in an optimal way. Reducing emissions in an optimal way would take into account the climate science, as well as the costs of mitigation and damages from climate change. The economics of climate change suggests that we should do our best to avoid even a low probability of potentially catastrophic outcomes1. The science, according to the NASA climate change scientist Dr James Hansen, suggests that if we maintain carbon dioxide concentrations of 450 ppm or more, for sufficiently long, the Earth would be pushed toward an “ice-free state”, and “the passing of climate tipping points and dynamic responses that could be out of humanity’s control”. Hansen therefore recommends that “an initial CO2 target of 350 ppm, to be reassessed as effects on ice sheet mass balance are observed, is suggested”2.

What sort of emission reductions are required to stabilise CO2 levels at 350 ppm or less? For any particular target, there is more than one trajectory to that target, and more than one way of allocating emissions between countries for any particular global trajectory. Most studies that have been done so far have focused on higher stabilisation targets, but there have been some that have included trajectories that stabilise at 350 ppm CO2. One of the more recent studies has OECD countries reducing their emissions by 5.17% per year3. No one has modelled in any detail (as far as the author is aware) what the mitigation costs of stabilisation at 350 ppm or less of CO2 are. However, there have been studies that suggest that the cost of stabilising at 450-500 ppm CO2-e of greenhouse gases are low.4

If optimal international cooperation on reducing greenhouse gas emissions was achieved, Australia could have reductions in emissions allocations of over 5% per year. This may be expensive, but an approach that is optimal globally is likely to have net benefit for Australia, more so than for most other countries. It would not in in Australia’s interest to rule out such a possibility.5

  • what the science is saying about the climate situation,
  • Australia’s high per-capita emissions,
  • Australia’s high historical emissions,
  • and Australia’s high capacity to reduce emissions or pay for emissions reductions because of its high per-capita GDP,

it is not appropriate to rule out any level of emissions reductions beyond 2015, and certainly not for an unlimited amount of years into the future. It is appropriate to have an upper bounds on Australia’s emissions for years beyond 2015, but not lower bounds. Part 2, Section 15 of the Exposure Draft Legislation should therefore be changed to reflect this issue. This could be easily achieved by removing paragraphs 2(b) and 3(b) from Section 15 of the legislation.

There are also problems with setting weak targets five years in advance: The targets for 2010-2013 are extremely weak, with the 2010-2011 target probably being greater than the amount of emissions. When combined with the 5-15% target range, there will probably be a very low carbon price. The only thing that is likely to prevent the price from collapsing is the banking of permits. It could also be argued that flexibility in emissions reductions could facilitate unforeseen international circumstances, either in the science, or in negotiations. Being able to tighten targets within shorter time-spans could also facilitate voluntary measures to reduce emissions. It is therefore recommended that Section 14 of the legislation is changed so that instead of an exact cap being set for five years, a gateway of upper and lower bounds is set for five years.

It could be argued that measures that reduce the certainty of the scheme cap provide uncertainty for investors. This is true in a limited sense, but there is also severe risk and downside uncertainty on impacts from climate change, there are uncertainties in the damage function. There is uncertainty in international negotiations. There are uncertainties in what carbon price will be required to achieve a certain level of emission reductions. There are uncertainties in the costs of emission reductions. There is uncertainty in whether the targets specified by the Australian government will be sufficient to drive sufficient to drive investment in low emission technologies. Some of these uncertainties could be managed by price based approaches, such as by having a floor on the permit price.

Measures that shift risk and uncertainty from investors to the climate are not appropriate any more, and may not be credible. This is particularly the case when it comes to measures that are not consistent with international cooperation on reducing emissions. This is because a world with poor cooperation on climate change policy is a far more uncertain world than a world where good cooperation is achieved.

1Weitzman (2009), On Modeling and Interpreting the Economics of Catastrophic Climate Change, The Review of Economics and Statistics, 91(1): pp. 1—19.

2Hansen et. al. (2008), Target CO2: Where Should Humanity Aim? The Open Atmospheric Science Journal, 2, pp. 217—231.

3Meinshausen (2006), Multi-gas Emissions Pathways to Meet Climate Targets, Climatic Change, 75, pp. 151—194 — p. 166.

4McKinsey Global Institute (June 2008), The carbon productivity challenge: curbing climate change and sustaining economic growth

5There are huge barriers to this level of international cooperation, but it is not unheard of. The Montreal Protocol on Substances That Deplete the Ozone Layer achieved a level of cooperation that was not far from optimal, this is discussed in Barrett (2003), Chapter 8.

The Carbon Pollution Reduction Scheme is likely to rule out net emissions reductions of more than 15% of 2000 levels by 2020 (Part 1, Section 3 (4) of the Exposure Draft Legislation). This reduces the likelihood of any international agreement that stabilises greenhouse gas levels at 550 parts per million or less, because it rules out Australia playing its proportionate part in emissions reductions.

It has been suggested in the Treasury modeling that the 15% target is consistent with global stabilisation of greenhouse gases at 510 ppm, but this is unlikely to be true. This modeling claims that the CPRS -5 and CPRS -15 “multi-stage” scenarios are more realistic than the Garnaut “contraction and convergence” scenarios because the multi-stage scenarios assume that different countries start taking on emissions reductions at different times1. But there is another difference, the CPRS scenarios assume that when a group of countries start making emission reductions, they all do so at the same rate relative to the reference scenario. Because emission reductions do not relate to per-capita emissions, this is unlikely to be perceived as equitable by developing countries and low per-capita emitters, and therefore unlikely to be an approach that would be accepted by developing countries.

The Garnaut scenarios are based on all countries eventually converging to the same per-capita emissions allocations in 2050. After 2050 different countries may have different gross amounts of per-capita emissions, but they are allocated the same number of permits per person. Is a convergence date of 2050 likely to be acceptable as part of an international agreement? In his Targets and Trajectories Supplementary Draft Report, Garnaut stated

A relatively gradual convergence to equal per capita allocations, with the year 2050 proposed by the Review, could be seen in developing countries as developed-country-biased, as it perpetuates for some time the current unequal patterns of use of the atmosphere. What is outlined is probably at the limits of acceptability to developing countries—it demands a modest departure from developing countries’ current emissions growth path in the short term, and strong deviations in the medium term.

It is important for Australia to be flexible on issues that relate to equity, including whether an agreement is based on per-capita emissions, and the convergence date for an agreement based on per-capita emissions. This is because it is more likely that a large number of countries will agree to an international environmental agreement if it is perceived to be equitable.3 For Australia, a developing country and a high per-capita emitter, to not be flexible on equity issues that favour high per-capita emitters, would undermine the likelihood of a comprehensive international agreement that reduces greenhouse gas emissions.

There is also the possibility that an international agreement is reached that is not consistent with Australia’s targets. Australia would then have two choices: It could accept the agreement and change its targets; it could not accept the agreement and face the consequences of being perceived to be a free-rider. The CPRS White Paper argues for scheme caps and gateways because they provide certainty to investors4, but they do not provide certainty if there is a risk that Australia will have to change its targets in order for it to participate in an international climate agreement.

Because Australia should be flexible on the issue of contraction and convergence, and the convergence date, international scenarios with an earlier convergence date should be considered. This should include a 2040 convergence date and a 2030 convergence date. Ball-park estimates5 suggest that a convergence date 10 years earlier (i.e. 2040 instead of 2050 or 2030 instead of 2040) would require Australia to have its 2020 emission allocation reduced by 8-16%.

1Treasury (2008), Australia’s Low Pollution Future – The Economics of Climate Change Mitigation, Page xi.

2Garnaut (September 2008), Targets and Trajectories – Supplementary Draft Report, Page 14.

3See Barrett (2003), Environment and Statecraft – The Strategy of Environmental Treaty-Making, pp. 299-301, for a game theoretic discussion on why fairness is perceived to be important by participants in a cooperative outcome.

4Department of Climate Change (December 2008), Carbon Pollution Reduction Scheme – Australia’s Low Pollution Future (White Paper), Chapter 10.

The Carbon Pollution Reduction Scheme (CPRS) is the centre-piece of the Rudd governments climate policy. It aims to reduce Australia’s emissions to between 5 and 15% of 2000 levels by 2020. It involves setting a cap (but not a strict cap) on emissions, and distributing permits that can be traded. Some of these permits will be auctioned, some will be handed out for free. Firms will also be able to purchase an unlimited amount of international permits to meet their obligations. Permits will be treated as property rights, so if Australia wishes to reduce its emissions by more than the specified targets, then firms will have to be compensated.

Unfortunately, because the CPRS wants to provide “certainty for investors”, it locks many of the bad decisions in, making it extremely difficult to improve later. In effect, this shifts risks from investors and firms to the taxpayer, future generations, and the environment. Below are some problems with the CPRS, as described in the White Paper:

  1. The CPRS pretty much rules out Australia accepting emissions allocations that correspond to reductions in emissions of 15% or more by 2020. This is effectively using “precommitment” to attempt to rule out Australia’s participation in an international agreement that is equitable and comes anywhere near what the science says we need to do (Policy Position 4.2).
  2. The fact that there is a “gateway”, that rules out net emissions reductions that are greater than a particular level in 10 years after the gateway is set is not appropriate. Given what the science is saying about the emergency that we are in, it is not appropriate to rule out any level of emissions reductions. There are also strong equity arguments for this. Australia’s high historical and per capita emissions, and capacity to invest in reducing emissions are all arguments for allocating low amounts of emission allocations to us. Australia should be flexible when it comes to equity in international negotiations and any form of “gateway” undermines this (Policy Positions 10.1-10.14).
  3. Land clearing and logging native forests have significant emissions that are not dealt with, but carbon sink forests attract an offset. At relatively low carbon prices, it will be more profitable to manage plantations as carbon sinks than use them for wood. This will increase the demand for native forest timber, increase native forest logging, and increase total emissions (Policy Position 6.22). Because deforestation and native forest logging is not addressed, the CPRS could also promote the burning of native forest biomass (Policy Position 6.14), because emissions from such activities are “zero rated”.
  4. Emissions permits are treated as a property right, rather than a compliance instrument. This makes it much more difficult to improve the CPRS, because firms will have to be compensated. It is also totally inappropriate for the present government to create property rights that infringe on the rights of future generations (Policy Position 8.1).
  5. The absence of a price floor means that public goods from activities such as home insulation, developing new technologies, voluntary measures and so on are not realised. Instead more permits are freed up for big emitters. The CPRS should have a price floor, otherwise it would be better to replace it with a tax. The price floor (or tax) should increase each year by a certain amount (e.g. 4%).
  6. The 5% unconditional target is far too weak (Policy Position 4.2).
  7. Exact yearly targets are set 5 years in advance and cannot be tightened (Policy Position 4.4). The targets for 2010-2013 are extremely weak, with the 2010-2011 target probably being greater than the amount of emissions (Policy Position 4.5).
  8. There will be a price cap on permits, so the emissions cap can be exceeded by firms buying more permits at a price of the level of the cap (Policy Positions 8.9—8.12). According to the White Paper:
    • The scheme will have a transitional price cap for the period 2010–11 to 2014–15.
    • The level of the price cap will rise in real terms by 5% per year.
    • The level of the price cap will be set at $40 commencing in 2010-11.

    From an environmental perspective, the Carbon Pollution Reduction Scheme has the same disadvantage that a carbon tax has, there is no real cap on emissions. It has none of the advantages that a carbon tax has. The Carbon Pollution Reduction Scheme is not a cap-and-trade scheme, because there is not a strict emissions cap. It is a hybrid between an emissions trading scheme and a carbon tax – but it is not a very good hybrid.

  9. Much money is being squandered on assistance to emissions intensive industries (EITEs – Chapter 12, coal fired generators – Chapter 13, gassy coal mines). The coverage of assistance to “emissions intensive trade exposed” industries has been expanded to include industries that made the most noise, such as liquefied natural gas. Rentseekers have been rewarded. There will also be $3.9 billion dollars (assuming a $25 carbon price) in free permits handed out to coal-fired electricity generators. This is money that could have been invested in low emission technologies, reducing emissions from deforestation or forest degradation, or assistance to low income households. Instead it does nothing more than line the pockets of shareholders.
  10. The large amounts of assistance to polluting industries have meant that there much less funding available for compensating households. The distribution of assistance to households is strange, households with incomes of less than $20,000 are given less assistance than households with incomes between $20,000 and $120,000. Newstart recipients will recieve $14.20 more per fortnight; people on the minimum wage will recieve $14.95 more per fortnight.

There are some good things about the design of the CPRS. The coverage is greater than the EU ETS. Less permits are handed out for free than with the EU ETS. If the issues above are addressed, then we will have a well designed emissions trading scheme that could be used to efficiently make deep emissions reductions. If Australia put together some good carbon pricing policies, then these policies could be adopted elsewhere.

Update: The exposure draft legislation Carbon Pollution Reduction Scheme Bill 2009 is now available from the Department of Climate Change website here.