Emissions trading and what it means for Australian businesses

The federal government's long awaited plan on emissions trading was recently announced, with an increase on spending by $627million. The 'cap and trade' system will see government determining limits on greenhouse gas emissions and issuing tradable emissions permits.

In a recent interview with Sustainability Matters, the task group spoke about emissions trading and what impact it will have on businesses in the future:

• What was your role in establishing a task group on emissions trading?

  On 10 December 2006, the Prime Minister announced the establishment of a joint government-business task group on emissions trading.

  The task group consisted of Dr Peter Shergold (chair), Mr David Borthwick, Mr Peter Coates, Mr Tony Concannon, Dr Ken Henry, Mr Russell Higgins, Ms Margaret Jackson, Mr Michael L'Estrange, Mr Chris Lynch, Mr John Marlay, Mr Mark Paterson and Mr John Stewart.

  The task group was supported by a joint government-business secretariat.

• Why is it necessary to establish a task group?

  The Prime Minister's Weekly Radio Message of 28 May 2007 noted that:

  "It is fundamental to any response both here and elsewhere that a price is set for carbon emissions. This is best done through the market mechanism of an emissions trading system. That is why, last December, I established a joint government-business task group to advise on the form an emissions trading system might take in Australia. That report will be received by the government this week. The decisions to be taken on this issue will be the most crucial economic decisions facing Australia in the next decade. It is essential that we strike the right balance. Skilled and careful economic management is required."

• What type of emissions trading scheme is the government keen to establish?

  While the government has not yet announced its response to the details of the Report of the Task Group on Emissions Trading, the Prime Minister has announced his support for Australia to "move towards a domestic emissions trading system, that's a cap and trade system beginning no later than 2012" during a speech on 3 June 2007.

  The task group report recommended an emissions trading scheme with the following features:

  • A long-term aspirational emissions abatement goal and associated emission pathways to provide a context for community efforts
  • An overall emissions trajectory that commences moderately below 'business as usual' projections (so that the market establishes a low initial price for carbon), but which progressively stabilises and then allows for deeper emissions reductions over time
  • Maximum practical coverage of all sources and sinks, and of all greenhouse gases

  • A mixture of free allocation and auctioning of single-year dated emissions permits that:

    • Provides an up-front, once-and-for-all, free allocation of permits as compensation to existing businesses identified as likely to suffer a disproportionate loss of value due to the introduction of a carbon price
    • Ameliorates, through free allocation, the carbon-related exposures of existing and new investments in trade-exposed, emissions-intensive industries until key international competitors face similar carbon constraints, but which also provides ongoing incentives for abatement and adoption of industry best practice

    • Allows for the periodic auctioning of the remaining permits, with revenues used, in the first instance, to support the emergence of low-emissions technologies and measures to improve energy efficiency (and, as the scheme matures, revenue might be directed towards households and business)

• A 'safety valve' emissions fee designed to limit unanticipated costs to the economy and to business, particularly in the early years of the scheme, whilst ensuring a continuing incentive to abate
• Recognition of a wide range of credible domestic and international carbon offset regimes

• Capacity, over time, to link to other national and regional schemes in order to provide the building blocks of a truly global emissions trading scheme.

Why is emissions trading more flexible than carbon tax?

The task group report noted that the case for using either an emissions trading scheme or a carbon tax in preference to other forms of intervention is very strong. The task group is of the view that there are some policy objectives that are best addressed with emissions trading, and therefore considers that this should be the key instrument to deliver emissions reductions over time.

The key benefit of emissions trading is its focus on the ultimate environmental objective - namely, reducing emissions to a point that mitigates the effects of climate change. As such, emissions trading may provide greater long-term policy credibility, as the community can see the direct link between the policy instrument and the desired environmental objective.

An emissions trading scheme also possesses more options to link with global developments in a carbon-constrained environment. It can provide the capacity to access abatement opportunities at least cost internationally. The task group report noted that the primary policy instrument being used by other countries for carbon pricing is the development of emissions trading schemes.

Some countries with carbon levies have moved these into the emissions trading schemes. Whilst a carbon tax can theoretically interact with international emissions trading schemes, it might be more difficult to gain other countries' acceptance of an Australian carbon tax model.

Will it require full regulation by the government?

There are a number of policy options available to governments to achieve emissions reductions. Market-based approaches, such as emissions trading, have the potential to deliver least-cost abatement by providing incentives for firms to reduce emissions where this is cheapest (ie, whenever abatement is cheaper than the emissions price), whilst allowing the continuation of emissions where they are most costly to reduce.

In contrast, traditional regulatory approaches normally require affected parties to achieve specified outcomes irrespective of the individual costs, so there is little incentive to innovate or to do more than is absolutely necessary for compliance.

That said, market-based mechanisms such as an emissions trading scheme do require a legislative basis to mandate emissions reductions.

Is it important for Australia to be aligned with international emissions trading schemes and if so why?

The task group report noted that international carbon markets are expanding as countries adopt emissions trading or other arrangements that introduce a carbon price into their economies. Links are likely to develop between these diverse arrangements, but the pace will be uneven.

A way will need to be found to engage developing countries in a manner that allows them to balance their economic growth ambitions with the global imperative to reduce emissions.

Australia has a chance now to design a domestic emissions trading system that is sensitive to our particular economic interests, including the determinants of our international competitiveness, and that will provide further opportunities to engage the international community.

Will there be a cost to businesses?

The task group noted that the economic cost of an emissions trading scheme depends critically on the cap placed on emissions. To an important extent, the cost of any such scheme can easily be adjusted over time by appropriately setting the cap - indeed, that is one of the benefits of an emissions trading scheme relative to other less efficient policy instruments.

Estimates available both domestically and internationally suggest that the costs of restraining emissions through a price signal can be kept modest and can also be consistent with ongoing strong economic growth, though the total costs rise with more ambitious levels of abatement. These estimates also serve to underline the significant uncertainty that currently exists in the range of predicted impacts on economic growth, suggesting that further analysis is needed before a final decision is taken on any short-term emissions cap or long-term aspirational goal.

What is the Clean Development Mechanism?

The Clean Development Mechanism (CDM) was established under the Kyoto Protocol. Countries that have taken on emissions targets under the Kyoto Protocol can use the CDM to fund greenhouse gas emission reductions in developing countries and in return receive credits that they can use towards meeting their emissions targets.

The task group has supported the use of international offsets in Australia's emissions trading scheme, however the report has suggested that credits could be generated from a broader range of activities (than currently allowed under the CDM) provided they were credible.

What would be the best way to design an emissions trading scheme in Australia that encourages participation from all sectors of industry?

The efficiency and fairness of a national abatement effort will be increased if all sectors contribute to greenhouse gas reductions. The task group report recommended that exclusions be only considered due to compelling practical considerations, particularly the lack of accurate and/or cost-effective ways of measuring and verifying emissions.

Following these principles, there is a strong case for all energy (including transport), industrial and fugitive emissions to be included. However, measurement uncertainties and compliance costs suggest that agricultural and land use emissions be initially excluded. The task group report recommended that waste be further investigated during the detailed design phase to determine whether it can be practically included in the scheme.

Eventual inclusion of all sectors in the emissions trading scheme, or imposition of alternative policies, should remain a fundamental policy principle.

What are the long- and short-term benefits for emissions trading both in Australia and internationally?

After careful consideration, the task group report concluded that there are benefits, which outweigh the costs, in early adoption by Australia of an appropriate emissions constraint and using emissions trading to meeting this constraint at least cost. Some short-term benefits of adopting such a constraint are:

• Enhanced business certainty - there is evidence that investment in key emissions intensive industries and energy infrastructure is being deferred and the development of a clear and coherent national framework for dealing with carbon constraints will improve the business environment.
• Position Australia for international developments - adopting an Australian cap and emissions trading scheme ahead of comprehensive global action would demonstrate Australia's clear and continued commitment to making a fair contribution to the overall global response. It would also enable Australia to engage early with major emitters and key developing countries and to respond flexibly to the broad range of possible international developments.

In the longer term, it is widely acknowledged that the use of new and presently immature low-emissions technologies (along with the more widespread use of existing technologies) will be needed to deliver deep and sustained emissions reductions. It is also becoming increasingly clear that many low emissions technologies will require a carbon price signal to make them competitive. The introduction of an emissions trading scheme can play an important role in motivating development and deployment of low emissions technologies.

Is Australia slow to implement such policies?

The task group concluded that, on balance, there would be benefits in the Australian government now setting a post-2012 constraint on emissions.

Australia accounts for only around 1.5% of world emissions. Any actions to reduce our own emissions will do little to address climate change unless they contribute to developing a global solution. While there is an increasing level of activity within and between nations, at this stage it is unclear what burden-sharing approach will be capable of attracting support from the international community. In the judgment of the task group, Australia's commitment to assume a post-2012 constraint would underscore our willingness to help construct a post-Kyoto international framework. We need an approach to climate change that is environmentally effective, economically efficient and equitable, and delivers early and effective engagement between both developed and developing countries, particularly the large emitters.

An Australian emissions trading scheme, with a carbon price set by the market, would improve business investment certainty. This is particularly the case for projects with a high degree of carbon risk. There is growing evidence that investments are being deferred due to uncertainty about the future cost of addressing climate change. Without a clear signal on future carbon costs, these investments will not be optimised. There is a risk that a higher carbon profile will be locked in for the life of the capital stock. Emissions trading would improve Australia's business investment environment and strengthen the incentives to develop low-emissions technologies. It would promote the long-term behavioural changes necessary to ensure a smooth transition to a carbon-constrained future.