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Oct 12 2012

Reflections on carbon price amendments

Yesterday the Australian House of Representatives passed amendments to the carbon price. I’ve already posted my initial reactions to their content; here are some more thoughts based on further reflection, loosely organized by issue.

Background

Legislated last year after extensive negotiations between the Labor government, Greens, and independents, the carbon price is presently a $23 fixed price and in 2015 will become an emissions trading scheme (ETS). Unfortunately, it is full of holes that render it ineffective, including allowing companies to buy offsets from overseas, and handing out around $4 billion per year in free permits as “compensation” to polluters. Fortunately, the original policy also included, among other positive measures, a $15 floor price during the ETS phase for investor certainty and a plan to negotiate contracts for closure of 2,000 MW of coal power.

The new amendments, which were also negotiated by Labor and the Greens and will now progress to the Senate, do three main things: remove the floor price, limit offsets from Kyoto’s Clean Development Mechanism (CDM), and link Australia to the European Union emissions trading scheme (EU ETS). To summarize my earlier post about these changes: the removal of the floor price is bad because a low carbon price won’t drive the investment needed to decarbonize our economy; the limit on Kyoto offsets is good because it restricts one avenue for creative accounting; the EU link’s implications depend on decisions yet to be made in Europe and accounting rules yet to be agreed.

According to the Australian Financial Review, the legislation contains some extra changes in addition to those announced in August. These include:

  • Giving the Minister the power to limit the number and type of international permits (a positive step, if the Minister chooses to exercise the power).
  • Giving the Minister the power to set a reserve auction price (I’m not sure if this is a mechanism to prevent the carbon price from crashing, intended to prop up government revenue, or merely an administrative detail).
  • Increasing the number of permits that will be auctioned during the fixed price period (the amount seems small enough to be not very significant).

Offsets

The Government says it “stands behind” the Treasury modeling of the carbon price and refuses to redo it, which seems stupid when they’ve changed the policy that the modeling was based on. I would like to see the modeling redone to see how the changes are likely to affect what proportion of Australia’s target will be met by domestic decarbonization and what proportion “met” by overseas offsets. The original modeling projects domestic emissions will actually rise until the mid-2030s then fall back to today’s level by 2050, with the 2050 target of an 80% reduction being supposedly met by buying international emissions permits. Such an outcome would be utterly inadequate at a time when everybody needs to get to zero emissions as fast as possible.

Worse, I’ve recently realized there was nothing to prevent a far worse outcome than the modeling predicts. When the carbon price was first announced in July 2011, including a 50% limit on international offsets until at least 2020, I assumed it meant 50% of abatement relative to business as usual (which would have been bad enough). But in fact, as explained by Climate Spectator:

In effect this provision allows the Australian government to issue Australian carbon permits up to the emissions cap required to meet the 5 per cent reduction target, and then firms could emit double that amount through also acquiring international carbon credits. This would be entirely consistent with the requirement that firms can meet their liability with 50 per cent Australian carbon permits and 50 per cent international credits.

Australia’s domestic emissions could almost double by 2020 without breaching the 50% limit! The limit is effectively no limit at all; in practice offsets are unlimited. The Greens were either deluded or disingenuous when they trumpeted the 50% limit as “groundbreaking”.

How do the new amendments affect this grim picture? One thing that’s for sure is they make it more confusing.

First, it is important to distinguish between two types of international emissions trading: one the one hand, linking to schemes like the EU ETS which have an emissions cap like Australia’s ETS will; and on the other hand, offsets from other mechanisms which rely on estimates of “additionality”, how much a carbon credit supposedly lowers emissions relative to a business-as-usual baseline. The latter type, at the very least, is a breeding ground for creative accounting. The former type could hypothetically be relatively credible, if there are consistent and rigorous accounting rules to make sure apples are being traded with apples, though I’m skeptical. What is certain is that both types of international trading will prevent decarbonization in Australia, whereas we urgently need all countries to decarbonize their economies at home. And the Australian and European policies are both deeply flawed, so linking the two will allow them to contaminate each other with their flaws.

I’m not sure whether the 50% limit will apply to European permits, though it won’t make much difference if it does. Assuming no or minimal restrictions on emissions trading between Australia and Europe, the two will effectively function like one big emissions trading scheme with one cap. (By the way, Europe’s target is a 20% cut by 2020 relative to 1990, which might sound a bit better than Australia’s target of 5% by 2020, but Europe’s low carbon price shows it is similarly toothless.) In addition, an unknown number of offsets will be imported from mechanisms like the CDM, and perhaps from other national emissions trading schemes.

The Australian Government is talking to various other countries about linking to their respective schemes. (It is disturbing that Labor now seems to see this as the main focus, as opposed to accelerating domestic decarbonization; indeed Labor keeps cutting domestic climate policies.) Climate Change Minister Greg Combet says the Government does not want to link to uncapped schemes like New Zealand’s, which is superficially reassuring. Yet Combet does not seem to see any problem with allowing offsets from the uncapped CDM, and he also says Australia and Europe are talking to China, who certainly don’t have an absolute emissions cap. Australian companies will also be able to buy unlimited Australian land carbon offsets from the Carbon Farming Initiative (CFI).

As I understand, an Australian company will now be allowed to use up to 12.5% CDM offsets, and up to 50% total international permits (or I suppose up to 100% European permits, if the 50% limit does not apply), plus unlimited CFI offsets. Of course these percentages only apply to Australian companies; I am not familiar with the rules for European companies (though from memory I think the EU limits CDM offsets as well). My conclusion is that companies will still be allowed to emit in excess of the combined Australian-European emissions cap, let alone the Australian cap, by a very significant amount – although even this situation may be better than it was before the amendments, when there was no limit on CDM offsets.

All this makes it very complicated to figure out where the emissions cuts that Australia will claim as progress toward its own target are likely to physically occur, if they occur in the real world at all.

Price

The EU link, combined with the removal of the Australian floor price, means Australia’s carbon price will effectively be determined by decisions made in Europe. Currently the EU ETS is flooded with surplus permits, which have caused its carbon price to plummet to €8/tonne (AU$10/tonne). Another contributing factor is that Europe’s emissions have gone down because the economy has gone down, making its target easier to meet in the short term – but that low carbon price is not sending a long-term signal for decarbonization, so when the economy comes back up the emissions will come back up. European politicians are debating whether and how to rectify the situation, but so far coal-addicted Poland has vetoed all attempts to do so. Conflicting signals are coming out of the EU on whether it is likely to move to a more ambitious emissions target.

Labor and the Greens are confident the EU will fix their ETS and the European carbon price will recover. If so, it had better happen very quickly, because polluters are allowed to buy EU permits now at the current low price and “bank” them to use later. If the EU does not fix its scheme, Bloomberg New Energy Finance forecasts a European carbon price of AU$12 in 2015, $3 lower than Australia’s floor price would have been, which would save polluters $1 billion per year. And if Labor and the Greens are correct that the European price will be above $15 in 2015, it raises the question: what is the point of removing the floor price?

Complementary policies

Linking to Europe makes it even more important that we maintain and strengthen existing complementary policies like the Renewable Energy Target (RET), and introduce new ones, for example a national feed-in tariff, to drive decarbonization here in Australia. As pointed out by Renew Economy:

Because of their own frustration with the EU ETS, leading European economies have taken their own additional measures to effect a transition to a low carbon economy, and to ensure that they remain competitive with the Asian economies and their Asian counterparts, who are dominating the clean energy markets. England has introduced an additional carbon price for its energy sector, on top of a renewable energy target and generous feed in tariffs. Germany has accelerated its exit from nuclear and is pushing for the most ambitious transformation to a renewables-dominated electricity grid. Ireland, Spain and the Scandinavian countries all have supplementary measures to add to their low carbon opportunities.

Trade-exposed industry compensation

Officials from the Department of Climate Change and Energy Efficiency told the Australian Financial Review that the changes effectively increase the (already ridiculous) level of carbon price compensation to trade-exposed industries.

As I’ve written before, industries which the Government has deemed to be “emissions-intensive trade-exposed” (EITE) get $3 billion per year in free permits (supposedly to protect “jobs and competitiveness”). The highest-polluting EITE industries get 94.5% of their emissions permits for free, diluting the $23 price to $1.27. Note the 94.5% number actually refers to 94.5% of the industry average, so any company with emissions below its industry’s average could be overcompensated for its emissions. These absurd levels of compensation are guaranteed in law for at least five years, and the rate at which the percentage of free permits reduces is so meaningless that the total number of free permits could actually rise over time.

The combined effect of the changes made in the carbon price amendments further increases the chances that EITE companies will be overcompensated for their emissions – effectively being paid to pollute instead of paying to pollute. This is because EITE companies will now be able to buy CDM offsets at ridiculously low prices around AU$4 and make multi-million-dollar profits by selling their free permits at the higher Australian-European carbon price.

Coal power plants compensation

Meanwhile, the contracts-for-closure policy has been cancelled because coal-fired generators refused to accept the amount the Government was offering, saying they are still profitable despite the carbon price. Actually, they are now more profitable, because the Government is paying them $1 billion per year in cash and free permits as carbon price compensation (supposedly to protect “energy security”). Their compensation, combined with the cancellation of the floor price, has actually increased their value by up to $1 billion. The only condition for a coal-fired generator to receive compensation is that it continues to operate, effectively an incentive to stay open for years. All this reinforces what should have been obvious: the Government should never have decided to pay polluters to stay open while planning to pay them to close.

Yet yesterday, the House of Representatives voted down a Greens amendment to refer the generators’ compensation to a review by Productivity Commission (the Greens will try again in the Senate). Labor had the gall to call the Greens’ move a “breach” of last year’s climate policy agreement. What was Labor’s abandonment of contracts for closure, if not a breach? What was Rob Oakeshott’s abandonment of the floor price, if not a breach?

Business lobby arguments

Following the success of their campaign against the floor price, business lobby groups have shifted back to their original argument that the price should be lowered before 2015, which presumably would mean moving to emissions trading and setting a target sooner. It appears they are attempting to convince the Government to bypass the independent Climate Change Authority and lock in a weak emission target. It also illustrates their aggressive negotiating strategy: businesses got what they wanted, yet still they complain, while many environmentalists foolishly rhapsodize about changes with unclear implications.

Conclusion

Confused? Me too. One of my pet peeves about climate policies is that governments tend to make them near-impossible for an average citizen to understand – and yet we will all be affected by whether they are effective at preventing catastrophe, or merely employ creative accounting to produce an appearance of change.

To ensure a higher carbon price and strong domestic action in future, both Australia and the EU should increase their emissions targets, limit trading between each other, and ban all international offsets as South Korea and California have done. Australia should also bring back its floor price, indeed strengthen it; cancel or phase out polluter compensation as soon as possible; announce a replacement plan to close coal power plants; increase the RET; and introduce new climate policies additional to the carbon price. The Government must resist campaigns by business lobby groups to further weaken climate policies.

Most immediately, I urge readers to sign this petition by Environment Victoria to withdraw the compensation for coal power plants.

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