Pricing carbon: More carrot, less stick

Later this week two business meetings to discuss a carbon price have been scheduled by the federal government. One is being held under the auspices of the Parliamentary Committee on Climate Change and the other has been convened by Greens deputy leader Christine Milne.

This process is unlikely to lead to a meaningful result for the simple reason that only the Greens want to see a sufficiently high carbon price emerge – everyone else will be pushing for a price and policy mechanism that will have little effect on Australia's carbon emissions.

The default position for a country that makes most of its export earnings selling thermal and coking coal, and which produces most of its baseload electricity burning black and brown coal, is to do nothing about carbon emissions.

To appease the large number of people who are concerned about carbon emissions and climate change, this do-nothing government strategy includes some high profile announcements about climate change programs and numerous committees exploring the problem. 

This was exactly the strategy undertaken by the Howard government. The joint announcement of the US and Australia this past weekend to provide insignificant funding for renewable energy and carbon capture technologies is much of the same; do nothing but make it appear as though progress is being made.

There are only four key aspects of any carbon price policy – the actual price of carbon that emerges, who is liable to pay, how much compensation is given to liable entities, and what the government does with the balance of revenue generated from the new regulations.

If your goal is to de-carbonise the Australia economy, and not just provide window-dressing policy that disguises the fact that nothing is actually happening, then the most important features are the carbon price that emerges and the level of compensation. If the price is too low, the compensation too high, or both, then no one has the financial incentive to invest in the important structural changes required to lower our carbon emissions.

Michael Fraser, the head of energy giant AGL, recently announced that a price of $30 per tonne of carbon was the minimum level required for the energy sector to invest in meaningful de-carbonisation of baseload energy production. A review of the Australian economy's carbon abatement cost curve produced by McKinsey suggests that this minimum price should be closer to $40 per tonne of carbon.

It is hard to believe that the process now underway by the federal government will lead to a carbon price above $20 per tonne of carbon. A safe bet would be a price that emerges at around $10 per tonne of carbon. Anything less than the key threshold price is a complete waste of time as it adds real costs to our economy and leads to no real changes in our carbon emissions.

Compensation is the other key variable capable of undermining the principal objective of lowering our carbon emissions. Regardless of the actual carbon price, if large carbon emitting companies are given compensation equal to the majority of their carbon price liabilities then, again, no real investment in lowering our carbon emissions will occur.

Richard McIndoe, the Managing Director of TRUenergy, recently suggested that his company should be compensated for any losses to the value of their brown coal power plants in Victoria that resulted from the introduction of a carbon price. 

Compensating TRUenery is a bad idea that creates a giant moral hazard for any government.  Creating a precedent that gives companies the right to be compensated for the loss in asset values that results from the promulgation of new regulations would have us paying James Hardie to stop producing asbestos. 

The more rational approach is to allow TRUenergy's high-carbon emitting assets to rapidly depreciate in value so the company will shut them down and then use the carbon price revenue to provide them with capital to build gas-fired power plants and large-scale renewable energy.

There is no question that we need companies like TRUenergy to help us de-carbonise our energy supply. What is crucial is the new carbon price policy and the means by which it incentivises key companies to invest in de-carbonisation.

Introduction of a carbon price through new regulations is an example of major ecomomic reform with staggering implications for the Australian economy. We must ensure that the carbon price is sufficiently high to drive real investment in lower-carbon energy and to keep compensation as low as possible.

If Treasury can be persuaded not to use the new revenue for non-decarbonising activities, then the real opportunity lies in making it available to those companies with the technology and energy resources to lead the way. 

We can introduce a robust carbon price and raise the enterprise value of leading energy companies in Australia. Nothing else will make any real difference.

Michael Molitor is the CEO of CarbonShift Advisory Pty Ltd and a Visiting professorial fellow at the UNSW Climate Change Research Centre. He has no commercial relationships with any of the companies mentioned in this article.