Responsible economic policy, political compromise, or a victory for big business?

The proposed introduction of an Emissions Trading System in Australia is generating a significant amount of attention. And quite rightly too, as it is the biggest reform of the Australian economy in decades, and will have a significant impact on our government’s ability to negotiate a new global framework on climate change.

Broadly, I think that the proposed system is satisfactory as a national cap-and-trade carbon reduction system. Most of the elements you would expect to see in an ETS are present. It is a genuine attempt at reducing Australia’s carbon emissions on a planned (though yet to be specified) trajectory at least cost to the economy. There were, however, three significant compromises, which I’ll describe below.

Petrol

Perhaps the least significant compromise was the pledge to effectively exempt petrol from the ETS in the short term by providing a cent-for-cent reduction in the petrol excise. As I have said before, this will make little difference as there is already a significant price signal from the current record prices for consumers to reduce their petrol consumption, and this situation is unlikely to change in the short or medium term.

Emissions Intensive Trade Exposed industries

The second compromise was to provide support for Emissions Intensive Trade Exposed industries, by issuing free permits. Around 20% of the carbon permits will be given to companies involved in trade-exposed activities for free, rather than being auctioned. At first glance this seems like a triumph for the big business lobby and a heavy loss for environmentalists. But I’m not so sure. The green paper justifies that:

“trade-exposed industries may not be able to pass on the costs as they face prices set in international markets, and compete against firms that do not at this stage have comparable carbon constraints.”

The assistance will remain in place at least until 2020, unless:

“broadly comparable carbon constraints are introduced in key competitor economies, in which case assistance be withdrawn.”

The concern here is about carbon leakage. If the costs we impose on companies that must compete in international markets are too high, they will simply move their operations off shore, to countries that do not impose carbon constraints. That is the reality of our globalised economy. For example if our aluminum producers move their production facilities to China as a result of our ETS, our national carbon emissions will reduce but the global emissions will stay the same or possibly increase. That’s not a win for the environment.

Assistance for coal-fired power stations

The third compromise is the one that has worried left-leaning commentators and environmentalists the most. The Green Paper is foreshadowing assistance for “strongly-affected” industries, in particular for coal-fired power generators. This is a one-off injection of an as yet unspecified amount of cash. The justification is that investors in power stations, who have significant sunk capital costs, were not aware of this government policy when they made their investment. Therefore, to “ameliorate the risk of adversely affecting the investment environment”, the government will compensate those who stand to lose the most.

I won’t go as far as to call this gutless, but it is a difficult argument to make, given that coal generators must have seen the writing on the wall long ago.

Moreover, we must accept that there will be winners and losers from the introduction of an ETS. Moving to a low-carbon society involves radical innovation in many respects – in the way we use energy, in the technologies we use to produce energy, in our behaviours and attitudes. Radical innovation has another important aspect, described by Joseph Shrumpter as creative destruction. This is the process by which incumbents, trapped in the paradigm of the old, are pushed aside by new entrants. It is a painful, but necessary process, and to deny it is to deny the need for change.

One important point to make, though, is that compensating the “strongly affected” industries does not influence the overall effectiveness of the scheme, which will still be driven by the total carbon that is permitted to be released per year. The big polluters (at least the ones that aren’t trade exposed) will still have to purchase their permits in the auctions, same as everyone else, and the are still incentivised to reduce their emissions over time.

Questions

However, given that we are not about to scrap our coal-fired power stations and replace them with wind farms overnight, a la Al Gore’s challenge for America, the more important question for me is the effect this will have on the implementation of carbon capture and storage (CCS) technology. Currently, while the government is keen to wave a big carrot in the form of the $500 million Clean Coal Fund, it is reluctant to wield the regulatory stick. They are continuing with their softly, softly approach with this decision to compensate our heaviest polluters prior to the introduction of the ETS. Overall, this sends a mixed message – “we want you to do the right thing, but we’ll protect you if you don’t”.

Another interesting question is whether the compromises I have described here were made in the interests of pursuing “responsible economic policies”, as claimed by the Green Paper, or in the interests of getting the legislation through the senate. We might never know the answer to that. For me, these are much more likely explanations than claiming that the government is in the thrall of the big bad lobbyists who are directing things from behind the scenes.

While I’m asking questions, here’s another thorny one. The ETS covers emissions from fossil fuels burnt within our borders. What about the carbon emissions produced from the coal and gas that we export? Are we responsible for them? And while we’re at it, what about the carbon released from the manufacture of the products that we import? I’ll try to address these in future posts.

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