A sensible cap and trade scheme for national carbon emissions?

The PM’s taskforce recommends a cautious start to carbon emissions trading by 2012 with carbon caps being initially set generously to take into account impacts on the economy. If the report is adopted (how could it not be at this stage of the election cycle?) it will be a shift for JWH who has previously rejected emissions trading and greenhouse reduction targets.

Kevin Rudd has pledged to start emissions trading by 2010 and has set a long-term emissions reduction target of 60% on 2000 levels by 2050. The report is cautious about this type of target, warning of the prospect of significant economic losses if cuts are set too stringently.

The complete report will be released today here. (Update it is here).

The claims I record here about the report come from the press and from an excellent interview with Grant King (managing director of Origin Energy) on Lateline last night. The transcript is available - note that interviewer Tony Jones didn’t understood that the market will determine the carbon price with a cap and trade’ scheme not the government.

The report advocates a flexible ‘cap and trade’ which is a version of the standard ‘tradeable permits’ model beloved of resource economists. Quotas on emissions are set and assigned in some way with trade in these quotas allowing them to settle into areas of the economy where cuts would otherwise be expensive to make. The idea is to encourage those who can cut back on emissions cheaply to do so and for those who find it more expensive to use a quota. This then meets emission targets at lowest community cost.

As an environmental economist I think this scheme has much to recommend it. I also suspect that the price at which quotas trade will be lower than expected as the limitless creativity of capitalism discovers innovative new ways to cut emissions. Initially anyway prices will be relatively low – perhaps $30 per tonne of CO2 – because quotas will be generous. But even as quotas are tightened I suspect carbon prices will rise by less than is expected. At above $30 per tonne Grant King forecasts that carbon emissions by 2020 will be back at around year 2000 or 2010 levels.

Already the AFR suggest the report will be criticized because of its failure to commit to deep initial cuts. The difficulty here is that firms, such as electricity generators, may want to know early on what the costs of carbon will be in order to sensibly plan their investment expansion decisions – a long-term predictable regime is what industry requires. That more stringent quotas will be established in the future provides firms with partial information and the report apparently provides forecast carbon prices as a consequence of the scheme and this is useful information. Some firms have achieved certainty by negotiating special deals with state governments at the expense of the rest of the community.

A valuable feature of the report is that it suggests an international consensus on trading is a long way off so Australia should go it alone and not wait for the rest of the world. The world's major emissions markets now are in Europe. Trading schemes can also be domestic, such as in some US states, or global, as envisaged under the Kyoto Protocol. The report suggests that the Australian scheme should be flexible enough to link up with a future international scheme.
The report suggests some politically sensitive sectors of the Australian economy, such as agriculture, should be exempt. This is ill-advised. Agriculture is an important source of carbon emissions and should be treated as with any other industry. The world’s 1.5 billion cattle contribute as much to global warming as do its 900 million cars.

The report sees Australia as needing all available low-emission energy options (solar, wind, hydro, geothermal, "clean" coal and nuclear) to achieve the large reductions in CO2 emissions required to deal with global warming. Picking winners should be avoided in this respect.
The taskforce report says revenue raised by the emissions trading scheme will initially fund new technologies designed to develop low-emission energy sources. In a second phase, revenue raised will be returned to business and households, which will face higher energy costs as a result of the new price imposed on pollution.

A big issue is how the cap will be distributed whether it will be auctioned off and so on. It is also important to know the period over which the contracts will prevail – will they be annual or will they be very long-term pollution rights that operate for decades? My view is that giving them away to current large polluters to offset their losses is not the way to go. Many non-polluting groups in the community (including consumers) will be hit by higher energy prices as a consequence of pricing carbon so that in terms of distributive justice all should share in the benefits conveyed in owning a quota.