Emissions trading vs Carbon tax

Monday, 16 March 2009  Opinion Pieces

The debate in Australia and elsewhere between emissions trading and a carbon tax continues. And risks missing the point - Governments around the world to date have largely proven incapable of delivering effective emissions trading schemes or carbon taxes, write Dr Regina Betz and Dr Iain MacGill from the Centre for Energy and Environmental Markets at the Australian School of Business.

Yet failure can not be an option. So we need to establish a political environment that is commensurate with the climate challenge, and a robust climate and energy policy framework that doesn't rely on any single policy for success.

The Federal Government's announced 2020 target of emission reductions of between 5% and 15% from 2000 levels would represent an inadequate contribution towards effective global action. The UNFCCC meeting in Bali over a year ago highlighted the necessity of developed countries committing to emission reductions of at least 25% by 2020. Our government argues that a more appropriate measure of effort is per-capita emission reductions and that our high population growth should be factored in. And they have it half right. Likely the only basis for agreed global action is per-capita emissions.

The problem is that it is absolute per-capita emissions that are relevant rather than per-capita emission reductions. And Australia's per-capita emissions are amongst the highest in the world. For example, the proposed 5-15% Australian reduction represents less than half the emission reduction commitments of the EU for 2020 despite Australia having over twice the per-capita emissions. Also, other key countries many not agree that continuing population growth is an argument for lower national emission reduction targets. China, for example, considers it's population control measures to have been a particularly effective contribution to their climate mitigation policy.

Many developed countries of course haven't yet committed to 2020 targets at all, and Australia's position might therefore be considered progress. Unfortunately, it could be interpreted internationally as a commitment that we are not prepared to deliver our fair share of global emission reductions to 2020, and that we consider ourselves entitled to higher per capita emissions than any other country in the world. This is not the right starting point for policy development at home or internationally. The primary policy instrument for achieving these national targets is intended to be the emissions trading through the Carbon Pollution Reduction Scheme (CPRS). Note that such policy approaches are still somewhat experimental. The most significant scheme to date is the EU ETS, and its performance during it's first phase 2005-7 was underwhelming. It would appear to have had only a limited impact on emissions. It was, however, remarkably successful in extracting money from energy end-users and delivering it as windfall profits to large emitters - a truly perverse climate policy outcome.

The EU does now, however, have significant emission reduction targets and is now working hard to improve the scheme for it's third phase starting in 2013. Note also that this scheme only emerged after failed efforts in the EU to introduce energy taxes.

The proposed Australian CPRS clearly incorporates some lessons from the initial EU debacle. Unfortunately, however, it looks to be a backwards step from the EU design in key regards. The CPRS design includes the creation of formal property rights to emissions, borrowing provisions, an initial price cap, large subsidies to major emitters, unlimited use of what are increasingly questionable international emission reduction credits from the Clean Development Mechanism, effective exclusion of some key sectors such as petrol from carbon prices over an initial period and voluntary forestry opt-in.

Given the possible effects of the global downturn on Australian emissions and the impact of other policies such as Australia's 20% renewable energy target it's unclear whether any significant change of Australia's energy sector will be driven by the CPRS up to 2020. If this is the case, emissions trading is likely to be the wrong policy.

It is difficult to ensure a scheme's effectiveness if the target represents only a small reduction from what is an inherently varying and uncertain large number - yearly Australian emissions. Such targets have flow-on effects on carbon price and volatility that adversely impact investor certainty in undertaking low emission investments - the price may fall to zero if the target is too weak as was seen in the first phase of the EU ETS.

There are also very significant participation costs for participants given the monitoring, reporting, verification and trading requirements within the scheme. Is it worth imposing such costs if you're not asking these market participants to actually do anything significant about their emissions for at least the next 10 years? And will the cashflow generated by the scheme do anything truly useful in transitioning the Australian economy, or see energy consumers paying more for Business-As-Usual?

Furthermore, the proposed CPRS will provide significant subsidies to large emitters through free permits. These subsidies go well beyond even those proposed in the earlier Green Paper - an estimated 25% or more of all emissions from so-called Energy Intensive Trade Exposed (EITE) industry potentially increasing to 45% in 2020. The chosen approach is perverse -emissions intensive industry will be subsidised to remain or even establish itself in Australia even if there would be lower global emissions should they locate in other countries with cleaner energy supplies. Furthermore, some of Australia's most polluting coal-fired power stations will be freely given almost 6% of the total permits over the first five years of the scheme. All of these free permits represent a lost opportunity to move financial flows towards creating a less carbon-intensive Australian economy.

In all these regards the weak proposed Australian targets for 2020 undermine the case for the CPRS. There are other policy options that don't involve such a significant reporting and compliance burden, can direct cashflow only to activities that reduce emissions while not locking in subsidies to large emitters. It might be argued that emissions trading with a soft start will still provide a framework for stronger efforts later. Perhaps. However, the history of these types of policies is that poor initial design choices can prove very hard to get rid of, and so-called transitional arrangements create a sense of entitlement that can be hard to remove. The Government's flawed scheme design doesn't inspire much confidence in this regard.

Transforming the Australian economy for a carbon constrained world will almost certainly require a price on carbon amongst many other policy interventions. Emissions trading or carbon taxes are both options and have their strengths and weaknesses. However, weak targets and emissions trading are almost certainly a poor mix. Given apparent political realities at present, as reflected in the Government's chosen national targets and flawed CPRS design, a comprehensive set of targeted policies addressing specific emissions reduction opportunities might therefore prove a more effective and efficient policy response for now. Such policies would include regulation and targeted taxes on key emitters and energy consumers, and directed cash flows to support energy efficiency and low-carbon supply-side investments. A broad suite of policies are going be required regardless, and we don't yet appear to have the necessary governance in place to either establish national targets consistent with the climate science and global equity considerations, or implement an effective CPRS.