Correcting Combet and Hunt on climate policy

This is a follow-up to an article by climate change minister Greg Combet and the response piece from Coalition climate spokesperson Greg Hunt.

The federal government’s decision to initiate a fixed carbon price for Australia as a precursor to joining a global emissions trading system in 2015 was sensible at the time, in view of the immaturity of the EU Emissions Trading Scheme as a fully-functioning market system. It was sensible because the evidence of the effectiveness of ETSs is thin on the ground.  Perhaps a little history will help clarify.

Claims that ETSs are the most efficient way to reduce carbon dioxide emissions are based on a scheme enacted in the US in 1995 to reduce sulphur dioxide (SO2) emissions from US coal-fired power stations. The success message is a 51 per cent reduction in emissions over a 13-year period. What was notable about the program was that it was legislated after the failure of more than 70 pieces of legislation to regulate SO2 emissions due to high estimated costs. Whilst there was much fanfare that the ETS reduced emissions at less than expected costs, a few observations need to be made:

-- A group of researchers from Massachusetts Institute of Technology (MIT) found that the reduced costs of the program could not all be attributed to an ETS, and that benefits from the decrease in the price of low-sulphur coal (facilitated by decreased rail costs that allowed the transportation of low sulphur coal to generators generally reliant on high-sulphur coal) and efficiencies from scrubber technology played a substantial role in cost reductions;

-- Permits to emit SO2 were given free to generators;

-- There is no evidence that the SO2 program resulted in significant innovation other than efficiencies from implementation of scrubbers;

-- Germany, when faced with the same requirement to reduce SO2 emissions a decade earlier in 1983, regulated emissions standards based on technology guarantees provided by the technology providers. So, whilst the German program cost more per tonne of SO2, it achieved 84 per cent emissions reductions in a 10-year period when the technology was still in its infancy. Effectively, the US program reaped the cost benefits of Germany's early action.

Based on the US SO2 program that allowed governments to drop the ugly tax word associated with environmental policy, the US required that global emissions reductions be driven by ETSs in subsequent United Nations Framework Convention on Climate Change negotiations. Europe, on the other hand, had many successful implementations of both emissions standards and environmental tax regimes and was understandably keen to pursue a carbon tax instead. How ironic that the US proceeded to drop out of the UNFCCC negotiations whilst the EU implemented the EU ETS in deference to US requirements.

The EU ETS has now been in operation since 2005, and eight years later (the same amount of time that it took Germany’s performance standards to reduce SO2 emissions by 84 per cent) shows little environmental benefit. The Europeans claim that the ETS was the first-of-a-kind, a pilot, and ravaged by a global economic slowdown, but cannot refute that it has been unsuccessful in reducing emissions and has not resulted in significant technological innovation.

What the implementation has proved though is that a successful implementation is heavily-dependent on a rigorous framework and allocations of permits that intend abatement rather than an apologetic attempt at dealing with the problem. With governments afraid of being accused of picking winners and leaving all risk to the market, investors and innovators have little certainty when facing decisions that have consequences many decades into the future. And as economists Avinash Dixit and Robert Pindyck showed in 'Investment under uncertainty' that when uncertainty prevails, the logical thing to do is wait; hence the lack of progress on both abatement and innovation as a result of the EU ETS.

Australia’s power system is amongst the highest emitters of CO2 in the world, and even China emits less CO2 per MWh than Australia. Continuing to source power largely from coal has left Australia open to the potential for a seismic shock to its power system and as a result its economic system. Our modelling of the electricity system in 2035 for the report “Delivering a competitive power system: The challenges, the scenarios” indicates that failing to diversify the power system will render Australian electricity less competitive and less resilient in future decades. The power industry needs to start a measured program of diversification in its fuel sources to avoid the pitfalls that befall any person, company or nation that puts all their eggs in one basket.

As the government is committed to shifting to sustainability using market mechanisms, a relatively high carbon price is required to fund and promote diversity. Calls to link Australia’s carbon price to the EU ETS today so that we can gain the benefit of cheap carbon emissions, fail to understand the benefits associated with funding innovation and diversification, and lock Australia into a future vulnerable to sudden unpredictable change as a result of dependence on coal.

Rather than being concerned with the impact on future government revenues, discussion about linkage to the EU ETS should be focussed on policies’ ability to reduce emissions, encourage diversity in fuel sources, and focus investment in innovative solutions like storage and grid management in an environment of very low carbon prices. For now, Greg Combet should be considering steering clear of linkage to volatile emissions markets that will undermine innovation and investment to reduce carbon dioxide emissions.

Greg Hunt’s cynicism about the effectiveness of an international ETS is well-founded and his proposal for an Emissions Reduction Fund is not a bad idea of itself but $300 million a year to buy back carbon from power stations that emit about 200 million tonnes of carbon dioxide per annum is sadly laughable when considering the size of the problem. Without a significant funding mechanism, any buyback scheme will be relegated to tweaking efficiency. The challenge facing Australia’s power industry is to fund a shift away from a vulnerable coal-based electricity system today to an affordable, diverse, resilient system in the future.

If the government or the Opposition is serious about facilitating a shift to a secure power system fit for the future, they should stick with a local carbon price and seriously consider holding back on linking to the EU ETS.

John Foster is Professor of Economics, Director of the Energy Economics and Management Group, and Global Change Institute Renewable Energy lead at The University of Queensland.