Australia is almost certain to get a Greenhouse Gas Emissions Trading scheme in the next five years. Trading is now embraced by both parties at a Federal level, and by all the States, as a key policy to address greenhouse gas emissions. But the story doesn’t end there – there are crucial design and implementation decisions that will affect the efficiency and effectiveness of an emissions trading scheme, and it is vital for the Australian economy that we get this right.

Addressing greenhouse gas emissions will be a massive and costly effort, and we need to make sure this happens, but at the lowest possible cost. Populist solutions and silver bullets abound, but there are no simple solutions and we need to start taking action on a broad front to minimise the cost.

Emissions trading will have major and lasting impacts on the broader Australian economy, but is likely to be felt most in the energy sector. We need informed and rational discussion and policy development to get it right.

Uncertainty (and sometimes deliberate misinformation) regarding the science, and the cost of action versus the cost of climate change, are cited as reasons we shouldn’t be acting on climate change. We consider both the science and economic case for action to be compelling.

The level of reliability and consensus of climate science is worthy of an article on its own. While there is uncertainty in the science, the work and conclusions of the Intergovernmental Panel on Climate Change is broadly supported by the overwhelming majority of experts. Their consensus is that greenhouse gas emissions are very likely to cause dangerous future global warming and climate change, supported by an unprecedented degree of scrutiny and peer review.

There was recognition at Rio in 1992 and Kyoto in 1997 that the risks and costs of climate change warranted concerted action. Substantially cutting greenhouse gas emissions will impose significant costs on the Australian and global economies, but these costs are relative to a “business as usual” case – no greenhouse effect and no climate change – that simply doesn’t exist. The cost of climate change and adaptation must be considered, and is worse than the cost of action. This was the finding of the detailed analysis by the “establishment” economist Nicholas Stern in 2006, and should be confirmed by any credible and independent analysis in the Australian context.

Emissions trading works by creating a tradeable “right” to emit, and allowing participants to buy and sell those rights. Emitters surrender permits to cover all their emissions, or pay a penalty if they don’t hold enough permits. The cost of these emission rights will increase until they are sufficient to justify sufficient investment in abatement to meet the required cap on emissions. Trading allows low cost abatement to be “sold” to those with higher cost abatement options – achieving the desired level of emissions at least cost.

International emissions trading is allowed under the Kyoto Protocol, which allows developed countries (with emissions targets) to purchase emission rights from other developed countries that have not expended their assigned amount of emissions, or from developing countries (without emissions targets) where specific projects reduce emissions.

Domestic emissions trading schemes operate within a country, and it is an Australian domestic emissions trading scheme that is being discussed now at both Commonwealth and State levels. In a domestic trading scheme participants are companies within that country, while international trading under Kyoto is currently between governments. A domestic scheme may one day be linked to Kyoto or other emerging international markets, but there is no framework or timetable in place for this to happen currently. Beware of people claiming they’re selling “credits” overseas!

A domestic emissions trading scheme for Australia must firstly choose between two fundamental approaches:

• Credit schemes where the tradeable unit is a tonne of CO2 abated or saved, with credits created by parties that have taken specific action to reduce emissions. Example are the NSW Greenhouse Gas Abatement Scheme and the Commonwealth Mandatory (2%) Renewable Energy Scheme.
• Permit schemes where the tradeable unit is a permit to emit a tonne of CO2. Examples are the EU Emissions trading scheme, and the future Australian schemes proposed by both the Commonwealth and States.
• Up to now Australia has had some limited credit style schemes. These are good at driving limited early action, and quarantining the costs of emissions trading to a few abatement projects, leaving the bulk of emitters that don’t want to participate alone. If a permit style scheme is introduced a cost of carbon will be imposed on all emitters. This is the most efficient option for the economy, but may face opposition from some incumbents that have largely escaped carbon costs until now.

A key problem with credit schemes is that abatement cannot be directly measured, but is always compared to a hypothetical “business as usual” case that by definition didn’t happen. In practice, there are “baselines” that are often arbitrary and complex eligibility rules that seek to minimise “hot air” (credits created when nothing has really happened) without excluding worthy projects.

Administration and verification costs are high, as increasingly complex rules are developed to improve the robustness of credits.

Permit schemes are generally simpler, relying on measurement of actual emissions. If you have reduced your emissions you simply won’t need to buy as many permits, and the money you save will pay for your efforts –you just don’t have to prove it to anyone to create a credit. Both the Commonwealth and states taskforces have recommended a permit style scheme for Australia because of its reduced administration costs and greater effectiveness.

The stationary energy sector accounts for half of Australia’s greenhouse gas emissions. Electricity generation alone contributes a third of total emissions and is the fastest growing source of emissions.

Emissions trading will have significant impacts on the energy sector, affecting the economics of existing technologies, and making electricity generation from coal using current technology increasingly unviable.

Research into “clean coal” and geosequestration are underway, but in what timeframe these technologies may become cost effective is uncertain. This is why we believe emissions trading should start sooner rather than later, so that a broad range of actions can begin and we’re not relying on a single technology breakthrough that may never arrive.

Other “silver bullets” such as renewable energy also have their limitations, though it is generally unpopular to say so. Wind power is increasingly cost effective, but we can’t guarantee the wind will be blowing when demand for electricity is high, and to substantially cut emissions would need tens of thousands of turbines. Solar power only works when the sun is shining, and even though the sun is free the panels are costly at present, with overall abatement costs that are an order of magnitude higher than other options – a cost our economy can’t afford on a large scale. Geothermal and hot dry rock technologies are potentially low cost solutions, but the extent to which these technologies can make a material impact on a global scale is uncertain.

Energy efficiency offers significant savings at low cost, but getting people to change behaviour and adopt new technologies is difficult. Emissions trading is an inefficient way of driving energy efficiency – the projects are too small and too numerous to cost effectively capture through “credits”, and there are double counting issues on top of the measurement issues discussed earlier.  What is needed is a combination of regulation, incentives and education to improve energy efficiency, remembering that under emissions trading the cost of power station emissions will flow through to end users, and hence the savings from energy efficiency will include “credit” for the avoided emissions.

Which brings us to nuclear! Nuclear power has risk and ongoing waste management issues that can’t be ignored. It is also the only zero greenhouse technology that is currently proven in the large scale required to achieve the level of emissions reductions needed to avoid dangerous climate change. Nuclear may or may not be the answer, but we at least need a rational debate that considers not just the problems and risks of nuclear, but the potential costs and downside if we take it off the table as an option.

The greenhouse issue will not go away just because we don’t like it or ignoring it seems easier in the short term. Taking action will impose significant costs to business and households alike, but in the long term will be cheaper than adapting to climate change. Reducing emissions will require structural change in the economy, and a turnover in infrastructure with long lives – for this reason we need to start incremental change now, rather than wait and hope for a technology breakthrough.

Emissions trading is not a simple fix-all. The reality is it will be very politically uncomfortable, noting that costs borne by generators will inevitably flow through to small energy consumers – the mums and dads. The challenge will be to design and implement a scheme that is economically effective, rather than politically expedient. A sensible emissions trading scheme is a vital and necessary part of a least cost solution. If implemented poorly, it will be an impediment to change that will be even more costly to fix. It is incumbent on all of us to hold our governments accountable to act responsibly and avoid expediency and populism.

© Sinclair Knight Merz
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