February 2011

The multi-party climate change committee has announced more details about carbon pricing in Australia. The approach is to have an initial fixed-price, and then to later transition to an emissions trading scheme. This is more-or-less the approach that I described in January 2010 here. A big advantage of the fixed-price approach is that there will be information about the effect of a carbon price on the economy and Australia’s emissions before Australia’s target is set.

Recent government projections suggest that Australia would need to reduce greenhouse gas emissions by  160 million tonnes of greenhouse gases per year by 2020 to reduce emissions to 5 percent less than 1990 levels, and by 270 million tonnes of greenhouse gases per year to reduce emissions to 25 percent less than 1990 levels. There is no politically feasible way to do this without a price on greenhouse gas emissions.

A carbon price works because if emission reductions are cheaper, there is an opportunity to make money from reducing emissions. It becomes like picking up a $100 bill from the ground. Now markets don’t work perfectly, and I might not pick up some of those bills (for example, due to an informational failure, I might not see some of them) but I’ll try hard to pick up as many as I can. Without a carbon price, this incentive is not there.

One argument used against carbon pricing is that it will increase the price of petrol or electricity, which is unpopular. But money raised from a carbon price can go back to households, and this is exactly what is planned. Petrol and electricity from fossil fuels will cost more, which will provide an incentive to use less, but we will get more than that back through paying less taxes, or through cheques in the mail. And we will get these cheques in the mail regardless of how much petrol or electricity we use, so the incentive to reduce emissions will remain.

Polluting industries will argue for assistance, and will have an incentive to exaggerate costs from a carbon price in order to bolster their case for assistance. But every dollar spent on assistance to industries will be one less dollar available for assistance to households. This is something that voters need to consider when greenhouse gas emitters make the case for assistance.

There is a string case for not all carbon price revenue to go to industry and households. Greenhouse gas emissions are an international problem, and carbon price revenue could be used to fund cost-effective emission reductions overseas and adaptation to the impacts of climate change. Technology advances could lower the cost of emission reductions, so there is a case for some carbon price revenue to be used for funding research and development. And the carbon price does not address emissions from agriculture, and probably not from land use, so there is a case for some of the money raised to provide incentives to sequester carbon in ecosystems.

Some key details:

  • The scheme would commence with a fixed-price in July 2012, this fixed price would increase by a fixed percentage each year.
  • After three to five years, the scheme would transition to a flexible price emissions trading scheme. The agreement does not specify any details about whether the emissions trading scheme would have measures such as price floors, price ceilings, or allowance reserves.
  • At least 12 months before the end of the fixed price phase, there would either be a decision on a 2020 target, or a decision to extend the fixed price phase. Issues that could be considered when deciding whether to extend the fixed price phase include: the state of the international carbon market; international developments in carbon pricing; Australia’s internationally agreed targets and progress towards meeting them, including whether they have been incorporated into a binding legal agreement; the fiscal implications of any on-budget purchases of internationally allowances that may be required to comply with any international emissions target; potential impacts on the Australian economy; and implications for investment certainty.
  • The scheme would cover emissions from energy, transport, industrial processes, fugitive emissions (methane leaking from things such as coal mines), and emissions from non-legacy waste (methane leaking from landfills). Agriculture would not be covered and sources covered under the proposed Carbon Farming Initiative would also not be covered.
  • The communiqué notes that “Options to provide economic value to activities which store or reduce carbon in the land sector could potentially include the use of Kyoto-compliant credits in the carbon price mechanism or alternative funding arrangements for the land sector.”
  • During the fixed price phase, international offsets will not be able to be used for compliance (although international allowances could potentially be purchased by the Australian government). During the flexible-price phase offsets could be used, with criteria concern quality and any other restrictions yet to be determined.
  • Many other matters, such as what to do with carbon price revenue, are still to be determined.

The details are below. The proposal is for an initial fixed price transitioning to an emissions trading scheme. I’ll write some analysis on this later.

Carbon price agmt release 240211

MPCCC Carbon Price Mechanism Final

Update: More analysis here.

The journal Energy Policy has recently published a paper by my colleague Frank Jotzo and myself:

Wood, P.J., Jotzo, F., Price floors for emissions trading. Energy Policy (2011), doi:10.1016/j.enpol.2011.01.004

The paper (as well as this blog) proposes that one way that a price floor could be implemented is for emitters to pay an additional fee or tax per tonne of emissions. The carbon price is then equal to the sum of the ETS permit price and the extra fee. The UK government has proposed to introduce a carbon price floor via this approach, and has been engaging in consultations. The proposal is the reform the Climate Change Levy so that it functions like a carbon tax. Because the UK is part of the EU ETS, firms would also pay for EU permits, and so the effective UK carbon price will be equal to the sum of the Climate Change Levy and the EU ETS permit price.

The discussion paper includes three different “illustrative carbon price scenarios” of £20/tCO2, £30/tCO2 and £40/tCO2 which is somewhat more ambitious than likely to be proposed for the carbon price in Australia, or the price floor that was proposed in the Waxman-Markey Bill.

Because most EU emissions are determined by the EU ETS, the direct effect on global emissions is likely to be minimal. Emissions in the EU are determined by the cap. If the whole EU ETS had a price floor, and the floor price was met, then that would reduce total EU emissions; but when a single country has a price floor, overall emissions are unchanged. For this reason Climate Strategies has made the important point that the UK should embed its policy in a strategy to strengthen EU emission reduction targets.

What the UK proposal does do is provide ‘learning-by-doing’ on carbon pricing, which provides valuable information to other jurisdictions that may consider a carbon price. A UK price floor proposal is consistent with a polycentric approach to climate change. It also provides much more certainty about the carbon price for investors in emission reductions. By eliminating the risk that the carbon price will go below a particular level, the cost of investing in emission reductions is significantly less.

The UK proposal has attracted a storm of controversy. It will mean that polluters will have to pay more, and steel-makers have already started to complain. This is to be expected – if firms can shape government policy to reduce their costs, then their investment in shaping policy could have a huge payoff. This is why rent-seeking is such a big issue in climate policy.

What was less expected was the opposition from two environment groups: the WWF and Greenpeace (presumably the UK branches of these organisations). They have claimed in a media release that because a price floor will raise electricity prices, and nuclear generators do not have significant emissions, their profits will increase, which will make a “mockery of the Coalition government’s stated opposition to any form of public subsidy for nuclear” and “this is yet another taxpayer handout to a failing nuclear industry.”

Any carbon price will increase the profitability of nuclear energy, just like it will increase the profitability of renewable energy or energy-efficiency. A carbon price is technology neutral and the claim that it is a subsidy or taxpayer handout for the nuclear industry in completely ridiculous. This proposal is good policy and the WWF and Greenpeace should be supporting it rather than attacking it.

For more on price floors, see http://climatedilemma.com/2008/07/19/making-the-polluter-pay-prices-quantities-or-both/