Today the Rudd Government backed away from implementing their emissions trading scheme (the CPRS) until 2013, making a carbon price in Australia before then very unlikely. The CPRS had many flaws, but was far superior to there being no carbon price at all, and could have been changed later. The Rudd government was facing difficulties getting a carbon price through parliament, but there were two ways that it could have done so:

  • It could have negotiated with the Greens to implement an interim carbon tax, while the details of an emissions trading scheme are worked out later;
  • If could have used the CPRS legislation as the trigger for a double dissolution election, in which case the legislation could be put before a joint sitting of both houses of parliament.

Instead the government has decided that they dont want climate change to be an election issue, and the Prime Minister has hardly mentioned climate change in the past 3 months. This contrasts very strongly with his rhetoric last year. At Copenhagen, he gave a speech where he said:

When I arrive home at the end of this week, will I be able to sit down, look my children in the eyes and tell them in clear conscience that I did absolutely everything I could to achieve action to avoid dangerous climate change.

Because if we cannot, then we will have failed in our basic duties as leaders of our nations, as fathers and mothers of our children and custodians of our nations’ future.

The children of the world are watching.

They are listening.

And history will be the judge of each of us here today.

Now that the Copenhagen meeting is over, does this mean that history will no longer be judging our action on climate change? Will Kevin Rudd be able to look his children in the eye and say “I did absolutely everything I could to achieve action to avoid dangerous climate change”? History may well judge that Kevin Rudd has jumped the shark today.

Kevin Rudd has said (in defense of postponing the CPRS)
“The rest of the world is being slower to act on appropriate action on climate change.
“It’s very plain that the correct course of action is to extend the implementation date.”
In her paper ‘A Polycentric Approach for Coping with Climate Change’. Policy Research Working Paper 5095. World Bank., Nobel prize winner Elinor Ostrom said:
Given the severity of the threat, simply waiting for resolution of these issues at a global level, without trying out policies at multiple scales because they lack a global scale, is not a reasonable stance.

Ostrom has made it clear why it is unreasonable for individual countries to wait for the rest of the world.

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The Australian government is presently negotiating with the Liberal Party amendments to its proposed Carbon Pollution Reduction Scheme. The Age is reporting that one of the proposed amendments is to extend the period of specific caps on emissions from 5 years to 10 years, followed by a further 10 years of upper and lower bounds for Australia’s target (gateways). At present the governments policy is for 5 years of caps, followed by 5 years of gateways, but the legislation allows the government to set the gateways for as long as they want.

At present, for political reasons most countries are proposing emission reduction targets for the next ten years that are significantly weaker that what the science is suggesting. This will result in countries having to make very steep emission reductions after 2020, or the more likely outcome of dangerous greenhouse gas concentrations. For this reason the next round of commitments for industrialised countries should be for the 5 year period 2013-2017 rather than the 8 year period 2013-2020. There should also be a mechanism where countries can increase the ambition of their targets without having to renegotiate and re-ratify an international agreement.

It is Climate Dilemma‘s understanding that Australia would prefer a shorter commitment period for industrialised countries after 2012. Australia is also proposing a mechanism for increasing emission reduction commitments as part of its “schedules” approach to the legal architecture for a post-2012 agreement. The coalition’s proposal to lock in targets for 10-20 years would not be compatible with a shorter commitment period. It would be a serious barrier to Australia increasing its own mitigation ambition. This proposal will undermine Australia’s international negotiating position.

Update: Peter Wood has an opinion piece on this in The Canberra Times, October 28, 2009, Page 11.

The Australian opposition and Senator Nick Xenophon have commissioned a report from consultants Frontier Economics on the proposed Carbon Pollution Reduction Scheme (CPRS), and possible modifications. Opposition Leader Malcolm Turnbull has described it as a greener, cheaper, smarter ETS; Minister for Climate Change Penny Wong has stated “It is not a hybrid, it is a mongrel. It is not a credible alternative, it is a smokescreen.”

The main feature of this “intensity based” proposal is that the electricity generation sector is treated in a similar way to “Emissions Intensive Trade Exposed” industries are treated under the CPRS, firms are allocated a large amount of free permits based on their production, so if the amount of the good being produced is reduced, they receive less free permits. Under Frontier Economics’ proposal, electricity generators will receive a large amount of free permits provided that they continue to produce the same amount of electricity.

So if I was to own a brown coal fired power station, I would have less incentive to close it down or generate less electricity, but I would still have an incentive to find ways to make it burn brown coal with less emissions. This will reduce the amount of opportunities to reduce emissions, and increase the cost of reducing emissions. This would increase the carbon price, but Frontier Economics’ modelling assumes that Australia would be part of a well linked global carbon market, and so assumes that the carbon price is completely exogenous. This is why Australia imports more permits from overseas. In practice this would likely mean that we buy more CDM credits, whose additionality properties are questionable.

There is no problem with credible international permits. As far as the earth is concerned, it does not matter where emissions reductions occur. The problem with the Frontier Economics proposal is with why there will be more purchases of international permits. More international permits will be purchased because it will be harder and more expensive to reduce emissions in Australia.

Another problem with shielding the electricity generation sector is that if all countries did this, there will be far less opportunities for emissions reductions, the global carbon price will be much higher, and emissions reductions will be more expensive. Also, by shielding the electricity generation sector, the impact on electricity prices is reduced, dramatically reducing the incentive to reduce electricity usage. The approach in the CPRS to provide payments to households that would offset the effect on prices of the CPRS is much more sensible.

The modelling not only assumes that the carbon price is exogenous, it also assumes that it has no volatility (it increases in real terms by about 4% per year), and there is no uncertainty about what it is. The report therefore has nothing to say about whether an ETS, carbon tax, or hybrid approach (with price ceilings, price floors, or both) is preferable. However, a complex CGE model of the Australian economy is not neccessary to answer this question. The results of Roberts and Spence (1976) and subsequent studies strongly suggests that a hybrid approach with ceilings and floors is the best way of managing this uncertainty.

One more problem with the Frontier Economics report is that it describes its approach to the electricity generation sector as being similar to that proposed in the Waxman-Markey bill that is presently before the US Senate. This is nonsense. Waxman-Markey allocates a large amount of free permits to electricity retailers, who must pass on these benefits to customers, but not in the form of cheaper electricity — payment to customers would not depend on how much electricity they use. The approach of Waxman-Markey is closer to the CPRS, both do not reduce the incentive to decrease electricity usage. The Frontier Economics approach completely distorts this incentive.

Elsewhere: Comments by Ben Eltham at New Matilda, Bernard Keane at Crikey, Robert Merkel at Larvatus Prodeo, Joshua Gans at Core Economics, Andrew Bartlett.

Update: Harry Clarke states “Turnbull’s attempt to give them more to ease electricity prices is not good economics. Make consumers bear the higher prices and give them generalised tax relief. Capture the sought after substitution effects you want but offset the impoverishing income effects.”

Update: Stephen Howes and Frank Jotzo in the Sydney Morning Herald state “Frontier’s modelling fails to establish its claim that it would deliver cheaper mitigation. In fact, it suggests the opposite.”

Frontier’s modelling fails to establish its claim that it would deliver cheaper mitigation. In fact, it suggests the opposite.

The Carbon Pollution Reduction Scheme legislation was introduced into Parliament on Thursday May 14, 2009. This legislation includes new measures that were announced on May 4, which includes a delay of a year before firms must purchase permits. Below are some of the changes to the bill compared to the Exposure Draft Legislation.

The object of the act has been changed, with the addition of 4(a) to Section 3 of the legislation:

(4) The third object of this Act is: (a) if Australia is a party to a comprehensive international agreement that is capable of stabilising atmospheric concentrations of greenhouse gases at around 450 parts per million of carbon dioxide equivalence or lower—to take action directed towards meeting Australia’s target of reducing net greenhouse gas emissions to 25% below 2000 levels by 2020;

The government’s has announced policies (not in the bill) for what it would expect of developing and developed countries before agreeing to a 25% reduction:

The Government will adopt a 25 per cent target only as part of an ambitious international agreement involving comprehensive global action capable of stabilising greenhouse gases in the atmosphere at 450 ppm CO2-e or lower. Such a comprehensive and ambitious agreement must meet following conditions:
1. comprehensive coverage of gases, sources and sectors, with inclusion of forests (e.g. Reducing Emissions from Deforestation and forest Degradation – REDD) and the land sector (including soil carbon initiatives (e.g. bio char) if scientifically demonstrated) in the agreement;
2. a clear global trajectory, where the sum of all economies’ commitments is consistent with 450 ppm CO2-e or lower, and with a nominated early deadline year for peak global emissions no later than 2020;
3. advanced economy reductions, in aggregate, of at least 25 per cent below 1990 levels by 2020;
4. major developing economy commitments to slow growth and then reduce their absolute level of emissions over time, with a collective reduction of at least 20 per cent below business-as-usual by 2020 and a nominated peak year for individual major developing economies;
5. global action which mobilises greater financial resources, including from major developing economies, and results in fully functional global carbon markets.

There has also been a very minor modification to the sections of the legislation that deal with scheme caps and gateways (which describe how Australia will set its trajectory), with the addition of sub-sections 14 (7) (relating to the caps) and 15 (6) (relating to the gateways):

14 (7) If: (a) regulations are made for the purposes of this section; and (b) on a particular day (the tabling day), a copy of the regulations is tabled before a House of the Parliament under section 38 of the Legislative Instruments Act 2003; then, on or as soon as practicable after the tabling day, the Minister must cause to be tabled before that House a written statement setting out the Minister’s reasons for making the recommendation to the Governor-General about those regulations.

Subs-section 15 (6) is identical to 14 (7) except that it applies to a different section of the legislation. This changes are extremely minor and do not address the serious problems with this aspect of the legislation that I have raised before.

The most significant changes to the legislation relate to how the price cap (fixed price permits) will work, which is in Section 89 of the legislation. In the first year of operation, 2011-2012, the price of carbon will be set at $10 per tonne CO2-e — in this year the CPRS will function like a carbon tax; between 2012-2013 and 2015-2016, the government will issue fixed price permits that will initially be at $40, and increase by 5% above the CPI in subsequent years. As well as everything being shifted back by a year, the method in which the fixed price permits is set is slightly different. Previously, the price was set precisely in the legislation, and increased by 7.5% each year.

Australia’s Prime Minister, Kevin Rudd, has announced some changes to the proposed carbon pollution reduction scheme legislation. In short, this is what is being proposed:

  1. The scheme will be delayed until July 2011;
  2. In 2011-2012 the carbon price will be set at $10/tonne and there will be an unlimited amount of permits;
  3. Emissions trading will be begin proper in July 2012 — I don’t know if there will be any price caps or floors after July 2012.
  4. There will be “recession buffer” where industries eligible for assistance at the 60% rate “would receive a 10% buffer for a finite period”, while those eligible at the 90% rate “will receive a 5% buffer for finite period”.
  5. The 5%-15% target reduction range will be kept unless an agreement consistent with 450ppm CO2-e is agreed to, in which case Australia will agree with a 25% reduction on 2000 levels.
  6. Some token measures that enable households to buy and cancel permits — something that they probably would be able to do anyway.

Some of the fine print on how the targets will work is here.

I’ll reserve my final opinion until I see whet the new legislation looks like next week, but it does seem like overall it is a slight improvement. There is stuff in the scheme that is unfortunate, such as the delay, the $10 carbon price in 2011-12, and the extra 5-10% free permits to emissions intensive industries. But the targets for 2010-11 and 2011-12 in the White Paper were so weak that I wouldn’t have been surprised if the carbon price was less that $10 in those years anyway. The 5-10% extra free permits to emissions intensive industries won’t affect the overall target, but is an equity issue and a waste of taxpayers money.

In my opinion the conditional target is more important than the unconditional target, because that is what makes the most of a difference for international cooperation. The willingness to go beyond 15% emission reductions is very good news, the government has partially fixed what was the worst problem with the CPRS. Unfortunately a 25% reduction for Australia would only consistent with 450 ppm CO2-e that was very generous to Australia, and unlikely to be acceptable to developing countries, low per-capita emitters, and countries responsible for low amounts of historical emissions — in other words Australia would be getting a “special deal”, which is similar to free-riding. What Australia should be doing is be willing to accept a reduction of at least 25% by 2020 as part of an agreement consistent with a stabilisation target of 450 ppm CO2-e or less.

One way to respond to this development would be to put on the table proposals that have not been on the agenda so far. A steadily increasing price floor should be at the top of the list, as should be overhauling the scheme caps and gateways approach for setting the target (too inflexible), and the ability of firms to buy an unlimited amount of CDM credits (which have additionality problems). Only a steadily increasing price floor will drive the investment in renewable technologies that we need.

On whether the legislation should be passed, I would be very reluctant to pass it unless something was done about the scheme caps and gateways approach to setting the trajectory. The problem with the gateway approach is that the minister can set lower (and upper) bounds on Australia’s emissions forever. It is not appropriate for the minister to set any lower bound for emissions, let alone forever.

My submission to the Senate Select Committee on Climate Policy is here. Here is the abstract:

This submission is on the Australian Government’s Exposure Draft Legislation for the implementation the Carbon Pollution Reduction Scheme (CPRS), and Australia’s climate policy in general.

This submission is primarily concerned with two issues. Firstly we shall look at the issue of achieving international cooperation to reduce greenhouse gas emissions. We shall examine how this relates to the targets in the CPRS, and the approach for choosing targets, based on “scheme caps and gateways”. This relates to items (1) (c) and (1) (d) of the terms of reference.

Secondly we examine the issue of what is the best instrument for a carbon price signal. We conclude that an emission trading scheme with a “price floor” is the most appropriate policy for Australia. This relates to items (1) (a) and (1) (d) of the terms of reference.

Summary of Recommendations

We have two key recommendations.

  1. To not set a lower bound for Australia’s emissions after 2015. We therefore recommend the removal of paragraphs 2(b) and 3(b) from Section 15 of the Exposure Draft Legislation.
  2. To introduce a floor in the carbon price. The price floor could be implemented by either altering Section 129 of the Exposure Draft Legislation, or by altering Section 103 of the Exposure Draft Legislation.

The proposed Australian Carbon Pollution Reduction Scheme is a policy that seeks to reduce greenhouse gas emissions by introducing a price on carbon. Possible policies for carbon pricing include cap and trade schemes, carbon taxes, and hybrid approaches. Cap and trade schemes involve setting the quantity of emissions, with this quantity and the market determining the carbon price; carbon taxes involve setting the carbon price directly, with the market determining the amount of emissions. Hybrid approaches can usually be thought of as cap and trade schemes but where there is either a minimum price – a price floor, a maximum price – a price ceiling, or both.

The CPRS is a cap and trade scheme, but there is a transitional ceiling on the carbon price (Section 89 of the Exposure Draft Legislation). This ceiling will be phased out by 2015. While this ceiling exists, the emissions cap can always be exceeded by firms buying permits that are at the value of the price ceiling. To this extent the CPRS has similarities to a carbon tax.

One of the main arguments in favour of cap-and-trade is that international negotiations are based on a “target-and-timetables” approach. Emissions trading (on a national scale) has the advantage that there is much more certainty that a given target will be reached. This increases the credibility of targets under international negotiations, more so than a carbon tax.

There are other advantages to a carbon tax. If the cost of mitigation is lower than expected, then there will be more mitigation with a carbon tax. There will be no limit to the amount of low cost mitigation that occurs. Under a carbon tax, voluntary measures that reduce emissions will add to Australia’s total emissions reductions.

A emissions trading scheme with a price floor has many of the advantages of a carbon tax and many of the advantages of a cap and trade scheme.

There are two ways that the CPRS legislation could be modified so that a price floor is introduced:

  1. The price floor can be maintained by having firms pay an extra fee when they surrender their permits, based on the amount of their emissions. The carbon price then becomes equal to the sum of the permit price and the extra fee. This could be achieved by altering Section 129 of the Exposure Draft Legislation.
  2. The price floor could be maintained by having a reserve price when permits are auctioned. This could be achieved by altering Section 103 of the Exposure Draft Legislation.

The approaches to introducing a price floor above are different to what was discussed in the Garnaut Review. The Garnaut Review considered and rejected a mechanism for introducing a price floor by having the government buy back permits. The Garnaut Review did not consider the approaches examined above.

If a price floor was introduced, changes may also be needed to be made to the legislation with regard to international trading of permits. If a price floor was introduced, what price should it be set at? There are two possible approaches to this:

  1. One approach would be to set it so that it is relatively low, but is high enough to mean that the amount of low cost emissions reductions is not limited, and high enough to provide some certainty to investors in low emission technologies. Under this approach, the emissions cap would be expected to be the main policy that drives emissions reductions.
  2. Another approach would be to have a significantly higher price floor, that is close to the social cost of carbon. Under this approach, the price floor is likely to be what drives emissions reductions. Under this approach the main role of the emissions cap is to provide certainty that a given target will be achieved, and add credibility to international negotiations.

If the role of the floor price was merely to provide insurance against the carbon price being exceptionally low (as was the case in the EU ETS during 2006 and 2007), it would not be necessary – there are better mechanisms from preventing this, such as banking, and making sure that there is scarcity when setting the cap. The idea of setting the floor price to be equal to the social cost of carbon is that the floor price has just as important a role as the permit price in driving emission reductions. There is a good chance that the slope of the marginal cost function of mitigation is higher than the slope of the marginal benefit function over short time scales, which suggests that the floor price will be a better driver of emission reductions.

Another issue with carbon pricing is how much should the price floor increase each year? An appropriate choice may be to have the price indexed by a discount rate of 4%, which is the discount rate used in Treasury modeling.

For more on why we need a price floor, see also: