Once the carbon price is in place, what should the government focus on next to reduce emissions in an economically responsible manner?
The first step is to make this system work. The scheme contains a number of mechanisms for adjustment over time as international circumstances change.
The first is the linking to international markets, which occurs in 2015, and which will link our carbon price to international carbon prices, with a floor for the first three years.
The second is the adjustment of the targets. There are automatic mechanisms established within the policy for targets to be adjusted in line with international developments. At the centre of the mechanisms will be the advice from an independent climate change authority. Targets recommended by the authority will have to be considered by the parliament of the day. One would expect that if the authority develops standing within the polity, if it establishes a strong reputation for independence and professional strength, then its recommendations will be highly influential.
The aim is that it will attain the sort of status that the Reserve Bank of Australia holds. Its recommendations, like those of the Reserve Bank, can be overturned by the government of the day, but the standing of the authority should ensure that it won’t be easy to overturn them without good reason.
The third of the automatic mechanisms is the review of assistance for industries exposed to emissions intensive trade, which will be conducted by the Productivity Commission. The first review will be in 2015. This will ensure that assistance will be adjusted in line with developments in carbon pricing in other countries.
I would add that two financing mechanisms established within the scheme will have their own independent boards. The success of the financing authorities will depend on the work done by those boards. We need appointees to the boards to be people of integrity and professional strength. I hope that the boards place a strong focus on support for innovation in low emissions technologies, because it’s innovation in research, development and commercialisation of new technologies that has a legitimate claim on public resources.
Beyond setting a carbon price and putting this scheme in place, what should the government be doing next?
Beyond the carbon pricing arrangements, some other mechanisms that are already in place will be influential for a period. In the energy sector, the renewable energy target remains important. It’s important partly because there will be uncertainty about carbon pricing for some time.
One can’t avoid the reality that some political leaders have said that they would like to remove carbon pricing. For as long as that is a risk, then the renewable energy target is in the front line of adjustment in the energy sector.
The current legislation, which requires renewable energy to provide 41,000 terawatt-hours per annum of electricity by 2020, was supported by both sides of Parliament and continues to hold the support of both sides.
On that point – the Coalition under Tony Abbott looks likely to win the next federal election. What do you make of Mr Abbott’s vow to roll back the carbon price, and what are the effects of that pledge on business right now?
I’m no authority on what’s likely to happen in Australian politics. The simple fact that there is such contention within the Australian parliament does necessarily mean that uncertainty raises the supply price of investment to any industries and any processes that would receive incentives for investment from the carbon price.
What impact will the carbon price have on household electricity costs over the next two years?
There are four components of electricity prices. One is the generation of power – wholesale prices. It is the wholesale prices that are affected by the carbon price. The second is the cost of transmission along the high voltage lines. The third is the distribution of electricity from those high voltage lines into households around the suburbs. The fourth is the cost of retailing the power – the cost of advertising and managing relations with customers.
If you take as the base the time when the current regulatory framework was introduced back in 2006, wholesale prices in real terms will have increased hardly at all even after the carbon price comes into effect tomorrow. Yet electricity prices to households have increased enormously. The price increases since 2006 to next week are almost entirely the result of big increases in the cost, in real terms, of distribution to households, transmission and retail relationships.
Wholesale prices with carbon pricing are a good deal lower than we thought they would have been a couple of years ago. The modelling I did for the 2008 Review, and Treasury’s modelling in 2011 of the current policy package, suggest that carbon pricing alone could be expected to add about 10 per cent to household electricity bills. Detailed work by various regulatory bodies around Australia suggests that actual price increases from carbon pricing alone will be nearly – but not quite – that much.
Overall, wholesale electricity prices after Sunday will be a good deal less than 10 per cent above levels of two, let alone five and six years ago. This is because they have been pushed lower by the oversupply of wholesale power. We’re finding that that oversupply is leading to especially low prices in the wholesale market, so that’s offsetting the upward pressure of carbon pricing on wholesale prices.
Why do we have that surplus? There are several factors. One is the power that’s coming from renewable sources, such as household solar and wind energy, and a couple of years of good rain means we’re getting more from hydro-electricity at the moment.
The second reason is that demand hasn’t grown nearly as strongly as anticipated, mainly as a result of the large increase in household electricity prices every year since the current regulatory arrangements were put in place 2006. In addition, people may have become more aware of the environmental as well as private economic value of using less electricity.
The high exchange rate and the resulting diminution of growth in the manufacturing sector, especially energy-intensive parts, are also contributing to an easing in demand, and therefore to the electricity surplus.
From July 1, we’ll get another burst of price increases from transmission, distribution and retail. Plus we’ll get almost a 10 per cent upward contribution from the carbon price, offset by downward pressure on the wholesale price due to oversupply.
When we look forward, we can expect another increase of between 1 and 2 per cent from carbon pricing in each of the next two years. What the overall increase in household electricity prices over the next two years will be depends mainly on whether we’ve had strong reform of regulatory arrangements. Only regulatory reform can stop the relentless increase in electricity prices that has been going on since 2006. Electricity price will just keep going on, carbon price or no carbon price, unless there is reform of the regulatory system.
European carbon prices dropped over the past year. How do you think the Australian pricing plan stacks up against overseas pricing?
In most countries carbon pricing is not the main way emissions are being discouraged, and is not the main way in which climate change mitigation is imposing costs on households and consumers.
For example, the United States has been strengthening regulation of various kinds. The regulation of emissions from motor vehicles and the new power generation emissions regulations announced by the Environmental Protection Agency a couple of months ago will impose very substantial costs on households and businesses, but not through carbon pricing.
Even in Europe, the emissions trading scheme at the moment is nowhere near the main source of cost increases from climate change mitigation. You only look at a small part of the story if you compare explicit carbon prices through emissions trading schemes or carbon taxes across countries.
The job of comparing the total effect of mitigation policies is actually a complicated one, as the 2011 report of the Productivity Commission reveals. The costs of Australia’s mitigation effort will be around the middle of the pack of developed countries after Sunday, despite the fact that the European emissions trading price has fallen to low levels.
Since the release of your Climate Change Review a year ago, how would you rate action by the US and China towards emissions reductions?
More has been done over the past year than my report anticipated. In the United States, the most important developments are the strong regulations on emissions that have been introduced by the Federal EPA, especially for motor vehicles and electricity generation.
Developments include sharpening of environmental regulation of coal-based power regulation in a number of important states. They include the legislation of an emissions trading scheme in California, which will take effect from January 1 next year. Another important factor reducing emissions has been the fall in gas prices over the past year to very low levels, which has increased pressure for contraction on coal-based power generation.
The United States administration has gone further than it has previously gone to express commitment to its target placed before the United Nations Convention on Climate Change at Cancun at the end of 2010. That commitment is to reduce emissions by 17 per cent between 2005 and 2020.
The United States government has also been calling on countries to take their Cancun targets seriously. So all in all, the US scene looks stronger than it did at the time of my report.
In China, my report drew attention to the very large investment that was being made in low emissions technologies, and the very rapid growth in the use of virtually the whole range of low emissions technologies, including nuclear, solar, wind, bio-mass, and hydro-electricity. Increased scale has been bringing costs down rapidly for all of these sources of electricity – for China, and through the reduction in the costs of equipment, for the rest of us as well.
On hydro-electricity, there’s still quite a lot of underutilised hydro-electric capacity in China, especially in the west and south-west where the rivers tumble out of those great mountains.
Over the past 12 years, the most important developments have been the development and release of the programs through which China will seek to meet its ambitious target of reducing the emissions intensity of production by between 40 to 45 per cent between 2005 and 2020.
We have been able to see the stunning scale of the budgetary commitments to the low emissions technologies and energy efficiency through which China seeks to implement in five-year plan emissions targets.
Two other developments are of special note. The Fukushima tragedy in Japan in early 2011 caused China to put its ambitious nuclear energy program under review. Those reviews have been completed and safety standards have been strengthened, but within those stronger safety standards there’s been a re-commitment to rapid expansion the nuclear power industry.
The most surprising of developments in the past year has been the introduction of pilot emissions trading schemes in five cities and two provinces – which have a total population many, many times that of Australia – with a view to seeing how they work in the Chinese context. Statements have been made that these may be generalised as national emissions pricing schemes.
The general effect of all of these developments on the ground in China has been to strengthen confidence that it will be able to meet those ambitious targets for reducing emissions intensity.
Ross Garnaut is a Professorial Fellow in Economics at the University of Melbourne.