Some desired design features of

Australia’s policy response to the

greenhouse challenge

Australian Industry Greenhouse Network

Rod Sims
Director, Port Jackson Partners Limited; and
Expert Adviser to the MPCCC
23 March, 2011

Parliament House, Canberra

 SUMMARY MESSAGES

1. Australia has a difficult challenge in reaching the around 25% against

BAU emission reduction target by 2020 (and this target has bipartisan
support)

2. A market-based approach should be the dominant policy mechanism

to reach this challenging target

3. The design of the market mechanism is key; much will depend on

aligning our actions with international efforts

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 The science is calling for large and immediate reductions in world emissions

ATMOSPHERIC CONCENTRATIONS OF GREENHOUSE GASES

PPM 1,500 No mitigation

550 ppm
1,300
450 ppm

1,100

900

700
Immediate, large
On a BAU basis will be
change required from
500 1000 PPM before 2070
current trajectory

300
1990 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 2100

* Kyoto gasses and CFCs only

Source: Garnaut Climate Change Review Update, paper 5, page 9

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 On a BAU basis 70% of emissions will come from developing countries by 2030

GLOBAL BUSINESS AS USUAL EMISSIONS SHARES BY REGION, 2000 TO 2030

Per cent
~ 50% emissions now from
developing countries

100

90
Other OECD
Transition
80
EU
70
USA
60

50 Other
40 Developing
30

20
India

10

0
2000 2005 2010 2015 2020 2025 2030
China

Source: Garnaut Climate Change Review, Global emissions Trends, 2011, page 31

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 Australia’s -5% target is in fact around 25% against BAU; and a target of -25% is -40%
against BAU

AUSTRALIA’S EMISSIONS TRENDS, 1990 TO 2020 Bipartisan support for ~24%

reduction against BAU by 2020

750

700 Abatement challenge

+ 24%
650

600

550 108% of 1990 level

Mt C02-e

500 2000 level

450

- 5% - 160
400

350 - 15%
1990 1995 2000 2005 2010 2015 2020
- 216

Kyoto - 25%
period - 272

Note: Trajectories to the 2020 target range are illustrative, they begin in 2011-12 at 108 per cent of 1990 levels (consistent with Australia’s Kyoto
protocol first commitment period target) and assume a straight line reduction to the target

Source: Australia’s emissions projections, Department of Climate Change and Energy Efficiency, 2010, page 8

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 The bipartisan around 25% reduction target is a major challenge for Australia

NATURE OF EMISSION REDUCTION CHALLENGE

Bigger challenge than tariff reform Example issues

• Unilateral action not in our interest
• Preventing a problem, not creating a gain
• Need to believe the economics and the science
• Likely harder eventual transition
• Change the way we produce or use steel, cement,
agriculture, etc
• Nuclear, hydro aside no feasible low emission, base
load electricity generation options yet available
– But large emission reduction gains possible by
moving to gas-fired generation

• Lose our current comparative advantage in low

priced (non export linked) coal-fired electricity

• Solar panels, energy efficiency, wind farms will not

suffice

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 At a high level there are 3 ways to meet the challenging ~25% BAU target
HIGH LEVEL ALTERNATIVE APPROACHES
Approach
1. Use R&D incentives to gain the needed
breakthroughs
2. Have the Government determine where/how the
emission reductions will come
3. Use a market-based mechanism
23 March 2011
Comment
• Requires taxpayer funding
• Governments likely to have a large role in “picking
the winners”
• Most important, this approach alone gives no
incentive to use the new technology (e.g. solar
energy likely never be competitive with coal without
carbon price)
• Someone must pay; either general taxpayers or
specific sectors of community
• Government picks winners (e.g. solar panels)
• No greenhouse reduction action other than what the
Government decides
• Let the market decide on lowest cost emissions
• Requires belief in markets, much like the belief
needed for tariff reform
– And relative price changes usually drive larger
than expected behaviour change
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 Advantages of an ETS over a carbon tax

PREFERRED MARKET MECHANISM

Mechanism Comment

• Carbon tax • Investors cannot be sure how the tax rate

– Fix price, not abatement will move in future
• Harder to establish forward price to guide
investment decisions
• Harder to allow full purchase of overseas
offsets
– Risk that Australian price get out of
alignment with world prices

• ETS • With full banking, borrowing (as with CPRS)

– Fix abatement, not price will get forward curve
• Easier to allow full purchase of overseas
offsets (as with CPRS)
• Investors can judge where international
targets/prices will go

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 Ultimately the burden of emission reduction will fall on society as a whole

WHO PAYS?

Observation Conclusion

• All taxpayers pay for R&D grants

• Electricity users pay for solar panels

• Need to find lowest cost abatement
• With a carbon price mainly consumers pay

– Either firms can pass on the cost

– Or they cannot, i.e. EITEs; but then need

shielding to prevent leakage

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 Most independent commentators did not support the CPRS, often using strange logic

CPRS ISSUES

CPRS criticism Response

• A 5% reduction target is too “soft”, easy to reach • Around 25% reduction against BAU will be hard to
meet

• Allows free permits to the “big polluters” • Assistance mainly aimed at EITEs
(companies that make steel, cement, electricity, – See next page
…)

• Simply churns the money • It provides compensation while still sending the
appropriate price signal

• Means action by households simply helps “big • Fails to understand that we all benefit from least
polluters” cost abatement
– Aim is to transition the economy, not inflict pain on
Australian companies

• Allowing the overseas purchase of offsets • Also fails to understand that we all benefit from
removes the pressure for action in Australia least cost abatement, and that those generating
emissions still pay full carbon price and have strong
incentive to reduce emissions
– As Ross Garnaut says, trading is essential for
23 March 2011 Australia
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 Perhaps the most heated debate was over compensation to EITEs

Note – largest criticism of EITE

compensation not matched by equal
COMPENSATING EITEs
criticism of the highest cost abatement
measures

Alternative approaches Comment

• Any compensation amounts to a return to • Does not recognise carbon leakage argument;
protectionism flawed position in economic logic

• Need a clear principle (Ross Garnaut); • Assumes world will move to significant reduction in
compensate to offset only for loss from world not emissions
having an equivalent carbon price to Australia – And does not want to encourage investment in
declining activities

• Help companies transition; either to new • Governments sometimes provide such assistance
technology or out of economy to “oil the reform wheels”

• Ensure Australian companies do not suffer • More cautious approach, until the actions of others
significant disadvantages against competitors are clearer
until others do act
Under any approach, EITE assistance should be
removed once other countries adopt commensurate
measures

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 There is now a renewed effort to achieve a carbon price, but the approach creates some
additional issues

WHERE ARE WE NOW?

Current position Issues

• Government, Greens both want a carbon • Will Greens, Government agree on the
price but cannot agree on the targets that remaining issues to bring in a carbon price?
must underpin any ETS – E.g. EITE, electricity arrangements; level
of carbon price?

• Unclear future of many of the

“complimentary” (or substitute?) measures

• Initially more difficult to allow access to

• 3-5 year fixed price international offsets

• Moving then to ETS i.e. a hybrid model • Raises investment certainty issue

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 Allowing any access to international offsets is more difficult with a fixed price

INTERNATIONAL OFFSETS

ETS Fixed carbon price

• CPRS allowed access to international • Fixed price will not have regard to overseas

V
offsets which provided an effective floor to prices
the carbon price
– That is, the ETS carbon price would move • If allowed access to international offsets,
to match the international price and these were cheaper than domestic
– Most would, however, likely buy their price, most would buy overseas
permits off the Government – Government would then lose the revenue
needed for compensation; or need to
lower the “fixed” price

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 The hybrid model raises the issue of investment certainty

INVESTMENT CERTAINTY – THE ISSUE

CPRS Hybrid model

• Had banking and borrowing, and so clear • Know price for 3-5 years but what is the
forward price price after that?

V
– And had longer term target “gateways”
– Without knowing targets this may be very
• Had access to international offsets, so difficult to assess
could rely on being in line with overseas
prices

• Companies could make assessments of

future prices much as they do when
investing in, say, new copper mines

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 We must find a solution to the issue of investment certainty within the hybrid model

INVESTMENT CERTAINTY – FINDING A SOLUTION

Possible solutions? Comment

• Allow the 3-5 year fixed price to continue in • BUT this could see a price in Australia higher than
some way world prices; and a government-set price can be
changed

• Pre specify the future target as a default • BUT we have a hybrid model because the parties
mechanism cannot agree the targets

• After 3-5 years allow full access to international
offsets whether or not there is an ETS
• Puts pressure on Government to set ETS targets
• Has advantage that companies can invest based on
their interpretation of international events and so
likely world prices, rather than level of domestic
caps; but is this sufficient?

Key principle: Investment certainty comes NOT from a known price but from known
and trusted rules and institutions, and from having some reference to
international prices about which investors can form judgements

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 Stepping back, we need to keep in mind what we are solving for

KEY GREENHOUSE GOALS – ONE VIEW

Goals Comment

• Make an economy-wide start to reducing carbon • If large change is ultimately needed it will be useful
emissions to begin now

• Do so at least cost • Requires a market based mechanism

• Not be seen as a drag on world efforts
• If Australia’s actions do contribute to building a
world response (and they must at least to some
extent), then it is likely that the world wants to see
us move
– A modest carbon price should meet this goal

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 Given these goals, we should be guided by some key policy principles

SOME POSSIBLE PRINCIPLES

• Allow a carbon price to substitute for most other “complimentary” measures; particularly the high cost
measures

• Explicitly link Australian steps to those taken by most other emitters

– Do not assume now what steps the international community will take in future (relevant to the EITE
compensation issue)
– Helps the economics and the politics

• Maximise linkages to other carbon markets

• Seek a modest start to this difficult challenge

– Avoid the “catch 22” of “the longer we leave it the larger the initial steps we must take”; but large steps
are harder to sell politically, so we take no substantive action
– Instead we introduce appealing but very high cost measures (e.g. solar panels) that cannot address the
problem but which raise costs considerably, and without any compensation

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 SUMMARY MESSAGES

1. Australia has a difficult challenge in reaching the around 25% against

BAU emission reduction target by 2020 (and this target has bipartisan
support)

2. A market-based approach should be the dominant policy mechanism

to reach this challenging target

3. The design of the market mechanism is key; much will depend on

aligning our actions with international efforts

23 March 2011 Port Jackson Partners Limited 18