The carbon emissions ‘cap and trade’ scheme – a second read

I reported earlier on press releases describing the carbon trading report here. I have now had a chance to go through some of the actual report (here) myself. This is my second read – I’ll probably end up making a third and a fourth. The report (and particularly its chapter 7) interest me. I think it is a very important and well-reasoned document.

Some of the reactions by the Coalition’s foes to the proposed ‘cap and trade’ scheme have been predictable – John Quiggin argues that the ‘main implication of this report is that we should have got started on all this ten years ago (or at least, back in 2003 when he states Howard killed the idea) and that we’ll now have a more costly adjustment path than if we had acted sooner’. Well, maybe, but at least a decent proposal is on the table.

The Labor Party itself argues that the plan is discredited because Howard is ‘poll driven’ – this is a particularly foolish example of the motives fallacy. This issue is whether the plan is a good one or not.

Finally, The Age points out that the plan will increase energy prices – well, yes, that is what it is trying to do given that most of our energy supplies are carbon-based. It is trying to increase prices so people will use less of such fuels and energy suppliers will have incentives to search for less carbon-intensive technologies.

For all the hyperbole about John Howard’s restricted vision on climate change, Australia has committed to restrain its emissions to 108% of its 1990 levels to 2012. Because of much reduced land clearing it is one of the few countries likely to meet its Kyoto target.

I think there is a lot in the emissions trading plan that is very good and that the cynicism of many commentators is unwarranted.

It is a very broadly-based carbon trading system that is better than the defect-ridden European trading scheme and the less useful schemes advanced by State governments in Australia. All the big polluters (900 power stations, aluminium smelters, oil refineries, large factories) are captured. Paul Kelly describes it as an innovative scheme that other countries should imitate. The breadth of the scheme reduces the cost to the economy of meeting specific emission targets.

The scheme would cover 80% of total emissions and 55% of emissions outside of agriculture and waste disposal which would not be covered.

It moves toward taking action before the rest of the world does so – a decisive advance. It also sets up a debate between the inept heavy-handed State-based schemes which see centralized government promotion of renewable technologies such as wind and solar replaced by a market-driven approach which provides incentives for energy-entrepreneurs and energy-consumers to come up with economically efficient solutions. The plodders in the Victorian Government (particularly Thwaites) with their irrational policies are criticizing the scheme – their sensitivity is justified because they will be well and truly caught with their pants around their ankles. The comments of the ACF on the need for an a priori commitment to renewables are foolish.

The plan has been criticized for moving slowly. This is difficult to understand since the targets will not be decided until next year. Given the resource-orientation of our exports and the likelihood that carbon-intensive industries will immediately just move offshore if Australia makes unilateral large cuts I think caution here is warranted. It is pointless to destroy our major industries if the only effect is to drive such industries to countries where they will not be subject to emission controls. Moreover the case for being cautious is strengthened by the broad base of the scheme.

Features of the report:

1. Unlike the Labor Party posturing it recognizes the real costs of the measures to be adopted. It recognizes the need to cut carbon emissions and that this will cost us. It therefore stresses the need for a cautious response at least initially.

Australia’s economy is built on extractive natural resource industries. We need deeper emissions cuts with time but should be careful, not cavalier, with these.

2. The report takes it as a premise that we need to create a more certain policy environment where we spell out what we will do. Currently many investments are being deferred because of lack of certainty. The issue is to address the uncertainty concerns of the power sector and other areas of industry. This is one of the reasons for needing to act now.

Thus we need forward projections of desired emissions cutbacks and a forward carbon price that will help business plans.

3. Unlike other approaches (e.g. the State Labor governments) this is a market-driven approach not one that involves picking future energy sector winners. Markets will decide the energy sector winners (not governments) and markets will determine a market for offsets such as forest plantations.

Picking winners will impose unnecessary economic costs if market-based procedures can select the cost-minimizing ways of reducing emissions targets.

4. The last point raises the issue of offsets generally. Australia creates 1.2% of the world’s emissions but has vast biodiversity resources which offset these omissions. This is an important contrast to Europe, China and Japan.

5. Our emissions-intensive exporters should not lose business to overseas competitors who face no emissions control. This would hurt us and achieve nothing in improving the global environment. Indeed given that our own emissions-intensive industries are world’s best practice, off-shoring these activities might lead to a deterioration in the global environment.

6. Exploring new technologies and seeking greater international co-operation on climate change should continue to be central, auxiliary policies.

7. The greatest efficiency in reducing the costs of emissions cutbacks would occur through international emissions trading schemes. This seems a long way off however. Our scheme should be flexible enough to integrate with a future global scheme.

8. Agriculture and waste disposal would initially be exempted but should be brought into the scheme as soon as ambiguities in computing emission levels and in measuring the sector’s contributions to carbon offsets is clarified. It is important that agriculture be rapidly brought into the scheme since it can contribute to the market for offsets. It can already operate in the offsets market.

9. After setting long-term emission goals and desired emissions trajectories, some emissions permits would be distributed in 2012 as an initial once off free distribution providing compensations to existing businesses which suffer asset value losses (this is essentially the BCA plan) as a consequence of emissions trading. Additional contracts would be auctioned. This is sensible and improves political acceptability. The free permits would be dated and would last for 10 years or more. Other permits would be issued for 5 years.

A ‘safety valve’ emissions fee will allow accommodation of unexpected costs during the first few years of the scheme. This fee would be set a bit higher than the expected price of a traded permit and would apply to firms emitting more than their quota to encourage compliance with the quota. This fee would prevent unforeseen demands for quotas driving emission costs to levels that would damage industry.

10. Quotas could be ‘banked’ or carried forward but quotas could not be borrowed to meet current commitments. This promotes efficiency and flexibility.

11. Revenues from auctioned quotas and emission fees would be channeled in low emissions R&D and to address market failures which limit the uptake of improved energy efficiency technologies. So there is hypothecation provided the revenues are not wasted.

There are a host of other interesting details such as seeking efficient markets. The nitty-gritty details of the scheme are presented here. A very good read.