Australia's carbon market challenge

Australian policymakers have big decisions to make given the prospect of low global carbon prices for a few years to come. So how should they respond?

Reuters Point Carbon

The European Union’s recent decision not to bolster credibility in its carbon market struck a chord in Australia’s political debate. Speculation about how it would impact on Australia’s price when it floats (or sinks) in 2015, and the knock-on effects to federal budget revenues resulted in a stream of media questions for the prime minister and the treasurer.

While there are signs that the public and business community are growing used to Australia’s carbon laws, the politicisation of the issue continues to make sensible public policy debates extremely challenging. With the election looming in September, this is unlikely to change any time soon.

It is worth saying upfront that greater short-term uncertainty around Australia’s carbon price is created by the threat of repeal under a Coalition government than the EU’s recent decision. Repeal is a tough road for the Coalition to take, but for an investor, decisions around the future of EU carbon markets pale against the prospect of doing business in a country that would be the first to dismantle a carbon market.       

That is not to say that the EU’s decision has not raised substantive questions around how Australian policymakers should respond to the prospect of low global carbon prices for a few years to come.

Policymakers could, of course, choose to ignore the situation as a short-term blip and decide it is better to avoid political interference in the market. At current carbon prices in Australia the economy has continued to grow and emissions in the electricity sector are falling.

Another obvious approach would be to increase Australia’s emission target. Even with stronger national ambition, Australia will likely remain a carbon price taker on global markets. Our demand, even with more ambitious targets, would likely have a marginal impact on global prices.

This – to a significant extent – decouples Australia’s emission reduction ambitions from the prices faced by liable entities. If Australia can increase ambition at little cost why would it not, given that the country has accepted that ambitious emission reductions are in its national interest?

Business could also find this scenario more attractive if it brought forward the shift from a fixed to floating carbon price.

However, this scenario risks undermining the domestic low pollution transformation now underway, unless key policies like the Renewable Energy Target are retained at full strength.

A different option would be to further limit the use of international units in the Australia scheme. If the limit was reduced from the current 50 per cent of a company’s liability to around 10 per cent, then the domestic carbon price would decouple from international markets. This would significantly increase carbon prices in Australia, drive additional domestic reductions, and support greater investment in the domestic offset scheme, the Carbon Farming Initiative.

The government could also consider delaying the link with the EU market and extending the fixed price period towards 2020. The upside of this is that it would give the EU time to get its house in order, while providing greater revenues to the Australian government and a stronger investment signal to projects that reduce emissions.

Regardless of the EU’s recent decision, the basic rationale for building the link between the two schemes remains strong. In the longer term, linked markets will be central to greasing the wheels of more ambitious global action. While these markets don’t reflect the long-term benefits of reducing emissions Australia will need to decide how it will boost global ambition and prepare its economy for the unstoppable transition to a carbon constrained world.

Not an easy decision in an election year.

Erwin Jackson is Deputy CEO, The Climate Institute.

This article was originally published by Reuters Point Carbon, Reproduced with permission.

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