What would a quick transition to ETS really mean?

The Earth

(Original article from The Age) Carbon Tax v European ETS

​Thursday 04 July 2013

The newly minted Rudd government may bring forward the date at which the Gillard carbon tax converts to an ETS, currently legislated for 1 July 2015.  What would an earlier transition to an ETS, linked to the European system, mean for the community, business and global warming? 

It is probable that the logistical/technical issues of transitioning earlier would be impractical or at least fraught with difficulties (ref Greg Combet).  If an ETS was linked to the European scheme and the price there remained low (around $6 per ton), one of the major difficulties for the government would be that income from issuing ETS permits would be substantially lower than that allowed for in the budget for the carbon tax ($23 per tonne in FY2013 and rising).  This budget shortfall could be averted by applying a floor price – in which case the resulting ETS would just be the current carbon tax but with window dressing, a different name and very substantial logistical and bureaucratic technical difficulties.  

Although technically different, an ETS and carbon tax aim to achieve similar objectives by applying a market mechanism.  An ETS sets a limit on pollution (a supply constraint) and allows the market to determine the price.  A carbon tax sets a price for polluting and allows the market to determine demand (which equals supply).  If the parameters of each system are set consistently, each will result in the same price and demand (ie volume of pollution).  But parameters need to be set in advance of the period in which they are effective.  Accordingly, these parameters are based on projections.  The problems with the European ETS, principally a price which is too low to have any meaningful effect, arose primarily because the key parameters (essentially the volume of permits) were set based on a projection that did not allow for the GFC.  This is not a criticism of the projections – not many people saw the GFC coming.  But it explains why the scheme is so ineffective and the price is so low.

An argument for transitioning to the ETS earlier than currently legislated is that it would be cheaper.  This is manifestly true, in the short term, given that the carbon tax would be around $25 and the ETS cost would be about ¼ of this.  But this is cheaper in the same sense that buying a 5l can of fuel is cheaper than buying a 20l can of fuel.  Each is a can of fuel.  But the useful content is different by a factor of 4.  Similarly, a $25 carbon price buys much more real abatement than $6.  And the policy objective is surely real carbon abatement and not just “anything so that we can be perceived to be doing something”?  Changing to an ETS and linking with Europe would be very similar to retaining the carbon tax but reducing it to $6 per tonne – but a lot easier. 

But what is the effect of a carbon tax at $6 per tonne? 

The effect on consumers?  A lower carbon tax might flow through to lower prices for electricity and goods heavily dependent on electricity for their production.  But this assumes that carbon intensive generators would pass on such reductions in their costs.  Is this likely?  Government control/monitoring is likely to be necessary to ensure such behaviour – as it was, to ensure price increases were not excessive, when the tax was introduced.  Assuming that the compensation package, including lower personal taxes, which was based on a higher carbon price, is not changed, the net result to individuals, would be lower prices.  It is likely that such changes in prices would be imperceptibly small.  And such lower prices would be offset by the cost of higher taxes/lower services in other areas which would be necessary to make up for the carbon tax revenue foregone by the government.  (TANSTAAFL – There ain’t no such thing as a free lunch.)

The effect on businesses not liable for the carbon tax?  The effect is essentially similar to that for consumers – generally imperceptibly lower input prices but with the possibility of higher taxes to make up for foregone government revenue.

The effect on businesses liable for the carbon tax?  Lower costs, much of which might flow through to higher profits.

The effect on global warming?  Carbon pricing can affect short term production decisions and thereby change short term CO2 production.  So a lower carbon price should increase, perhaps by only a small margin, CO2 emissions.  But the main policy imperative for a carbon tax, or any carbon abatement policy, is to affect long term investment decisions and transformation of the community/economy to a cleaner future.   For example, any serious policy response to global warming must result in construction of no new fossil fuelled power stations.  Decisions on investments with 30 to 50 year lifetimes are based on all the future circumstances of such investments, including explicit carbon costs to be borne by the investors.  If investors perceive the Australian government to be taking a token rather than meaningful approach to global warming and expect this to continue well into the future, they should factor lower future carbon prices into their decision making processes.  This would result in, for example, more coal fired power stations rather than better/smarter grids, energy conservation measures, renewable power etc.  On the other hand, if investors perceive that the government and community generally are supportive of action to address global warming, they will expect explicit carbon pricing to rise steeply over time.  With such perception, investors would not invest in fossil fuel burning power stations but in the vast of array alternative technologies and options that already provide a pathway to a cleaner future.  Combined with the coalition’s climate policies, which provide no incentive for economy wide transformation, the effect on global warming of the government implementing a lower carbon price is likely to be further delay in the clearly required transformation of the Australian, and global, economies to a clean future.

 The effect on the government’s political standing?  With appropriate spin and emphasis of the (possible) lower costs to consumers, higher profits to generators, and omission of the need to fund the revenue shortfall, there may be some short term political gain, relative to the “ban the carbon tax” alternative, in switching to a lower carbon price.  But the government’s credibility in terms of having a serious long term strategy to address global warming would become similar to that of the opposition – essentially non-existent.  

If the political need is to be seen to be doing something, then a change to an ETS, with a floor around $25, might achieve something.  It might dissociate Rudd’s “new policy” from Gillard’s so called dishonestly introduced carbon tax yet maintain the price at a level at which it is plausible, if far from assured, that investors would believe the government to be serious and thereby consider cleaner rather than more carbon intensive investments.

Matthew Wright is the executive director of climate and energy think-tank Zero Emissions. Trevor Jack is an actuary with JAC Actuarial Consulting

Go to Original Article at The Age Opinion  FOR COMMENT: Matthew Wright 0421 616 733 - matthew@zeroemissions.org.au