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.

Some sections of Australia’s business community (as well as the Abbott opposition) are concerned that we should not go ahead of the rest of the world on a carbon price. This ignores the fact that much of the rest of the world is already moving ahead of Australia on both carbon pricing in particular, and climate change mitigation more generally.

The Australian Financial Review (unfortunately paywalled) reported on Thursday September 16 that a number of CEOs have made the above argument. These include QBE Insurance CEO Frank O’Halloran who said “we ought to be patient and go with the other major developed countries around the world and not try to be the first cab off the rank”; Coca-Cola Amatil CEO Terry Davis who said “I don’t think we should lead the world”. The Australian Chamber of Commerce and Industry has claimed that “unilaterally imposing an emissions trading scheme has low business support”. Tony Abbott, who once said that climate change was “crap”, recently said that “a go-it-alone carbon tax in Australia would be an act of economic self-harm”.

One CEO who does not share this opinion is BHP CEO Marius Kloppers who has called for a carbon price to be introduced in Australia. The speech where Kloppers said this can be downloaded here (pdf). We will know whether Kloppers is serious when we find out whether Minerals Council CEO Mitch Hooke continues his scaremongering about a carbon price or not.

I will list below some of the climate action around the world that makes it impossible for Australia to “go-it-alone” on carbon pricing. The most comprehensive carbon pricing is in the EU ETS, where a carbon price partially contributed to emissions covered by the EU ETS falling by 11 percent in 2009.

Japan is presently drafting plans for an emissions trading scheme to come into effect from 2013. It will cover emissions from large emitters, include provisions for domestic and international offsets, and compensation for trade exposed industries. Japan already has a voluntary ETS in operation, and a mandatory ETS covering Tokyo.

South Korea, which does have commitments under the Kyoto Protocol, is also planning on introducing an ETS. Korea has already passed a ‘Basic Law on Low-carbon and Green Growth’, which mandates a cap on emissions. It is planning to pass further legislation to make this cap operational.

Although the United States has not yet passed national legislation, state-based approaches to carbon pricing are expanding. The Regional Greenhouse Gas Initiative is operating in ten states; eleven states in the US and Canada are developing the Western Climate Initiative and seven states in the US and Canada are developing the Midwestern Greenhouse Gas Accord. New Zealand now also has an emissions trading scheme. China has been dramatically reducing steel production in order to meet energy efficiency targets and has been driving down the costs of solar and wind power with its clean energy industries.

As was pointed out by Paul Gilding in Climate Spectator, “we are in as much danger of leading in action on climate change as we are of leading on indigenous health”. The risk for Australian Business is not that we will go ahead of the rest of the world on climate policy – it is already too late for that. The risk is that lack of climate policy and high Australian per-capita emissions will lead to our industries being frozen out of markets in the future.

Australian opposition leader Tony Abbott has launched a new climate policy. The plan states on page one:

Our policy will cost $3.2 billion over 4 years, while the ETS costs $40.6 billion over the first four years.

This is comparing oranges with apples. It is referring to the their policy spending $3.2 billion, and the ETS raising $40.6 billion from sale of permits (much of which will go back to households or polluters), but they are completely different things. And the “cost” of a policy is how much is spent on emission reductions, be it by firms, the government, or whatever. This has nothing to do with the amount of auction revenue in an ETS.

The Coalition does not appear to understand the difference between price and cost. Professor Ross Garnaut spelled out the difference at a public lecture at the ANU in November 2007:

Finally, it is worth differentiating between the price of carbon and its cost to the economy. The cost to the economy is not, as some have suggested, the carbon price set for emission permits. The “price” is not the cost – this has been a fallacy of the Australian discussion to date.

The cost to the economy is the expenditure on substitutes net of existing higher costs imposed through mandatory schemes. While carbon prices will rise over time, the cost of mitigation does not rise at the same rate. It could be more or less depending on expenditure on substitutes such as renewable energy development, increased costs of structural industry adjustment and improving energy efficiency.

But over time, the incremental cost of new energy sources applies to a smaller part of the economy; and continued technological and institutional improvement in supply of the new substitutes for the old high-carbon activities may bring down their cost, even when the carbon price is rising.