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Australia’s carbon price

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In Brief

Australia is going to put in place carbon pricing at a level on par with the European Union with a design that could make it a solid foundation for long term policy.

It took five years of political struggle to get to this point, and several leaders of government and opposition lost their jobs in the process.

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That the most emissions intensive of the developed countries, awash with cheap coal, finally takes this step will send a signal around the globe.

The details of the scheme were released yesterday. It was negotiated between the minority Labor government, the Greens party and two independent parliamentarians, and while some of the political compromises weakened the scheme, others strengthened it.

The scheme will start in mid-2012 with a government-determined price of AUD$23 (USD$25, €17) per tonne of carbon dioxide. It applies to all energy use except private cars and some other categories of transport. The price will rise to $25.40 in 2014–15, then in mid-2015 the scheme converts to emissions trading with a price determined in the market.

The Australian carbon price could, for a while, be the world’s highest. Today’s European emissions trading price equates to $17, down from $23 a month ago on fears of recession and uncertainty about the effects of EU regulation on energy efficiency. The EU price is likely to rise again and the Australian dollar is likely to come down, so by 2015 the international price could again be higher than the Australian price. But markets are not always so predictable.

To help deal with the price uncertainty, there will be a guardrail for the price for at least the first three years. A price floor set at $15 rising at 4 per cent per year plus inflation, and a price ceiling that is $20 above the market price in 2015–16, rising at 5 per cent plus inflation. The price floor helps manage risk for low-carbon investment, and will result in more domestic low-carbon investment. Getting this provision in is a win for the Greens. The price ceiling is very unlikely to be triggered — which is just as well as it would inhibit market operation and international linking.

Linkage to international markets will be crucial for Australia. Achieving any kind of reduction at home in the short term will not be easy in the face of strong underlying emissions growth that partly stems from the rapid expansion of the resources sector. New modeling by the Australian Treasury indicates that almost two thirds of Australia’s overall effort to get a 5 per cent reduction in national net emissions by 2020 relative to 2000 may come from abatement purchased overseas. Although Australia’s scheme is small relative to the European trading scheme, the demand is sizeable in absolute terms.

Where international abatement will be sourced remains to be seen. Existing mechanisms like the Clean Development Mechanism will be eligible, but Australia will probably be looking toward broader and more reliable sources of supply. These could either come on the back of possible new global market mechanisms under the UN climate negotiations, or they might be arranged in bilateral or regional arrangements. In any event, the scheme that is about to be passed sets Australia on the path to becoming a major investor in greenhouse gas reduction programmes in developing countries in the region.

Three aspects of the carbon pricing policy design stand out as lessons other countries may follow on the road to putting a price on carbon.

The first is about the persistence of gifts to industry. When the precursor scheme was floated under Prime Minister Rudd in 2009, government invited industry to stake their claims. Despite advice to the contrary by the Garnaut Review and many other economists, many industries were granted large allocations of free permits — equivalent to government cash subsidies. In some cases these are necessary to preserve a level playing field in international markets, and in many cases they are inevitable for political reasons. But that money then is lacking for other purposes, and the problem is persistence of those subsidies. Australia’s new scheme offers the chance to change the scheme to lower, principles-based allocations of free permits, but whether and when this happens is unclear.

The second is about tax reform. The scheme will give over half the revenue back to households. This is done mostly through a threefold increase in the tax-free threshold for income tax coupled with changes to marginal tax rates, resulting in tax savings for low income earners. That will reduce the macroeconomic cost of the scheme as it improves incentives to participate in the labour force. At the same time, it will create a strong political advantage. Government estimates that one million people will no longer even have to file tax returns.

The third is about independent institutions. An independent Climate Change Authority will advise government on the amount of permits issued under the emissions trading phase of the scheme and other specific aspects of the running and evolution of the scheme. This is similar to the role of the UK Committee on Climate Change. Government will make the decisions, but going against the Authority’s advice could be awkward. Born out of a political impasse between the government and the Greens, this feature could make a big difference in making the scheme stand the test of time in the face of short-term political considerations that tend to preoccupy democratic governments.

Frank Jotzo is Director of the Centre for Climate Economics and Policy at the Australian National University’s Crawford School. He was an advisor to the Garnaut Review.

One response to “Australia’s carbon price”

  1. Frank, you say that “achieving any kind of reduction at home in the short term will not be easy in the face of strong underlying emissions growth that partly stems from the rapid expansion of the resources sector”. But the real problem is the rust belt of Victoria and NSW which collectively accounts for 50% of emissions and not much is happening in them. The new investment in the resource producing states is likely to be undertaken with the best low emissions technology. This should be enhancing our overall emissions performance per unit of output but the rust belt regions will remain a problem because they account for such a big share of emissions.

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