Australia's LNG nuclear bomb

The LNG export boom will make it virtually impossible for Australia to meet the government’s carbon emissions reduction target.

The high price of gas in Australia has made replacing coal-fired power stations with gas uneconomic and “fugitive emissions” from the LNG plants mean that reducing overall emissions within Australia by 5 per cent by 2020, as government policy states, will require much bigger cuts in other industries.

Tony Abbott will have to either drop the promise to cut emissions by 5 per cent or the promise to repeal the carbon tax – both together will be impossible without massive government spending under the proposed “direct action” policy of paying companies to reduce emissions.

Actually previous government policy was for a 15 per cent reduction in emissions if the rest of the developed world also took action on climate change. That’s happening, so the 15 per cent would have applied.

The Coalition said it would match Labor’s emissions reduction target, but the figure of 15 per cent doesn’t seem to appear in its policy – only 5 per cent.

Anyway, not trying to reduce carbon emissions at all would put Australia at odds with the rest of the world, including China and the US, and endanger trade agreements, so the prime minister and Treasurer Joe Hockey will be, or at least should be, desperately hoping that the Senate never allows the repeal of the emission trading scheme legislation, so it’s not exactly a broken promise – at least they tried.

Before the Charter of Budget Honesty it used to be routine for incoming governments to declare things were much worse than anyone thought, so that all bets are off on election promises.

Now, with the introduction of the PEFO (pre-election fiscal outlook) there has to be a Commission of Audit to provide the nasty surprise that allows the breaking of expensive promises.

In essence, Australia’s LNG export boom and high domestic gas prices will make it very difficult for the Coalition to get re-elected if it sticks to current policies.

The cost to the budget of climate change direct action, plus paid parental leave, disability insurance, education funding and rapidly rising health costs would lead to an even greater structural deficit than currently exists ($28.8 billion according to economic consultancy Macroeconomics).

The emissions trading scheme currently in place would eventually produce revenues to the government of up to $10 billion a year. It’s understood Treasury has estimated the eventual cost of the Coalition’s direct action plan at $10 billion.

That’s a $20 billion turnaround and makes climate change a “nuclear bomb” in the federal budget, as Professor Ross Garnaut says and as he puts in his book Dog Days, it would end up “distracting the government and the polity from the great economic challenges facing Australia”.

Like Australia, the United States has enjoyed a huge boom in gas supplies by exploiting smaller and tighter reservoirs – in their case in shale, in ours coal seams.

However the US banned LNG exports and is now allowing them on a case-by-case basis, resulting in a collapse in the domestic gas price to about a third of what it was. The result is wholesale replacement of coal-fired power stations – new and existing -- with lower carbon emitting gas.

In Australia, export pricing has led to a huge increase in the domestic gas price despite the big lift in available supply, with the result that gas is still uneconomic as a replacement electricity fuel for coal.

Wind and solar are also too expensive to replace coal: gas is, or at least should be, the only viable substitute in the medium term.

Add to that the fugitive emissions from the gas liquefaction plants and Australia’s LNG export industry is likely to be a big net cost to Australia, not a benefit, especially in the early years while the capital cost of building the plants is written off in depreciation against taxable profits.

All the extra costs to the budget that have been promised – direct action, parental leave, NDIS, education and health – seem to lead inevitably to a budget crisis just beyond the current forward estimates of four years.

It will be very interesting to see how the Commission of Audit led by Tony Shepherd deals with all of this, and in particular whether they try to properly cost the Coalition’s direct action policy.

That might be awkward, especially if the audit reveals that the government will have to make big cuts to welfare, health and education spending in order to fund the reduction in carbon emissions.