Australia’s carbon price time bomb

Australia’s carbon price, presently fixed at $23/tonne, is the subject of many political talking points. The most important (and perhaps most confusing) disagreement is over whether or not the carbon price is effective. The Labor government and the Greens, who designed the policy, claim the carbon price is already cutting emissions, pointing to reports that the Australian electricity sector’s emissions intensity (emissions per economic output) has decreased since the carbon price came into effect last July. The Liberals, who want the carbon price abolished, claim Australia’s emissions will continue to rise under the policy, pointing to government modeling showing it will merely offset emissions overseas. So who’s right?

Both arguments have some basis in reality. It is true that changes are beginning to occur in Australia’s electricity sector: renewable energy generation is increasing, electricity demand is falling, coal-fired generators are closing, and, yes, the carbon intensity of electricity decreased 7.6% between June and September 2012. But there are several caveats. Firstly, keep in mind the carbon price only applies to emissions within Australia’s borders; there are no restrictions on Australia’s fossil fuel exports, its largest and fastest-growing contribution to climate change. Secondly, reductions in emissions intensity are generally far less impressive than they sound, as emissions intensity tends to fall automatically. Between the year to September 2011 and the year to September 2012, the actual reduction in Australia’s electricity emissions was only 2.8%, and only 0.5% for total emissions. (UPDATE 15 April 2013: Newly released data show Australia’s total emissions fell 1% between July and December 2012.) Thirdly, it is unclear how much is due to the carbon price and how much to the pre-existing Renewable Energy Target (RET). Fourthly, far from being a “python squeeze” as claimed by the Liberals, the carbon price contains time bombs set to go off in 2015 when it is scheduled to become an emissions trading scheme (ETS), which will stop the present emissions reduction in its tracks and allow emissions to rise instead.

As currently designed, the ETS phase will lock in a meaningless target of a 5% emissions reduction by 2020, actively limiting emissions cuts. Any future attempt to strengthen the target could be legally challenged as an acquisition of property rights. Voluntary actions will be counted only five years after they occur, if ever. Fortunately, the Caps and Targets Review by the independent Climate Change Authority (CCA), currently getting underway and due to report in February 2014, offers an opportunity for concerned citizens to indirectly persuade the government to adopt a more ambitious target. However, the Australian Industry Group (AIG) is lobbying to bring forward the ETS transition, which would mean bypassing CCA.

Even worse, polluters will be allowed to meet this target with effectively unlimited international offsets, both from other cap-and-trade schemes like the EU ETS, and from baseline-and-credit schemes without emissions caps like the Kyoto Protocol Clean Development Mechanism (CDM). According to the latest government projections, Australia’s domestic emissions will increase 11% by 2020. Problems with international offsets include that they may not represent real emissions cuts (especially those coming from baseline-and-credit schemes), will displace domestic decarbonization, and will unfairly shift the burden of meeting Australia’s target to other countries, at a time when everybody needs to get to zero emissions as fast as possible.

This gaping loophole looks likely to be compounded by the fact that international carbon prices have crashed to levels measured in cents rather than dollars. Unless international prices recover, imported permits will cause the Australian carbon price to also crash, undermining any remaining incentive to decarbonize (and a proposed carbon floor price that could have acted as a brake has been cancelled). Even if they do recover, polluters are allowed to buy international permits now at the current price and use them later.

These time bombs are not the only problems with the carbon price. There are other flaws which are already hampering emissions cuts in the fixed price period. The carbon price, currently raising $8 billion in annual revenue, is working against $13 billion in annual fossil fuel subsidies, including $4 billion in carbon price compensation. Through complex interactions, the time bombs threaten to exacerbate these existing flaws.

The compensation arrangements include the Jobs and Competitiveness Program, handing out $3 billion per year in free carbon permits to industries defined as “emissions-intensive trade-exposed” (EITE), with the highest-polluting EITEs getting 94.5% of their permits for free, diluting the carbon price to $1.27/tonne for those companies. 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. Low international carbon prices increase the chances of EITE companies being overcompensated. 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. These absurd levels of compensation are guaranteed in law until at least 2017 with the government required to give three years’ notice of any changes.

The other main plank of the compensation is a $1-billion-per-year Energy Security Fund for coal-fired electricity generators, also mostly in the form of free permits. The only condition for a generator to receive compensation is that it continues to operate, effectively an incentive to stay open for years. This fund has actually made the generators more profitable than if there had been no carbon price, contributing to the failure of another fund intended to pay for the closure of 2,000 MW of coal-fired generation. If the Energy Security Fund continues, windfall profits to generators will reach $2-5 billion by 2016. Again, the lower the international carbon price, the higher those windfall profits will be.

Although the above analysis paints a bleak picture, the carbon price is not beyond repair. Its defects can be rectified, and must be soon if the policy is to drive decarbonization in the long term. The time bombs must be fixed before they go off, by setting much deeper emissions targets with zero international offsets allowed, and reinstating the floor price. Alternately, if it proves politically impossible to dismantle the time bombs before 2015, the fixed price period could be extended. The government should decide by 2015 to stop compensating EITE industries from 2018. The free permits for coal-fired generators and other fossil fuel subsidies should be immediately cut. New policies (eg. feed-in tariffs, an increased Renewable Energy Target, a new plan to close coal power plants) should be introduced to further accelerate decarbonization. Finally, Australia needs to broaden its attention from cutting its domestic emissions and start also phasing out its fossil fuel exports.

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