Alternative approaches to carbon reduction schemes

1. Alternative approaches to carbon reduction schemes Parliamentary Library vital issues seminar – 17 March 2009

2. Context Nature of policy problem • Fast, effective response required • Costs are upfront, but benefits arrive in the future • Differing allocation of costs and benefits • A global problem – countries do not gain from acting in isolation • of particular relevance to small open economies (competitiveness and leakage effects) • These questions cut first to the overall reduction target, rather than scheme design • Scheme design issues are important in whether reduction commitments can be achieved at lower cost • all schemes will fail if they do not meet required reduction target

3. Scheme types More or less, all schemes seek to do the same thing • To switch the economics of being a cleaner producer and consumer • It does so by changing the relative costs of cleaner production/consumption compared to higher emission behaviour • In switching the relative costs there is an effect on absolute prices (i.e. higher) • Higher under some schemes than others • It is these higher prices that cause many of the economic issues worrying policymakers • Response is to apply more moderate targets What are the alternatives? • Cap and trade – works by charging for all emissions. Purely ‘sticks’ to induce cleaner activity • Carbon Tax – also works by charging for all emissions. Purely sticks but with none of the benefits that come from trading emissions entitlements. Assumed to be more certain (which is most likely to be an illusion) • Intensity based approaches – works by rewarding cleaner production and consumption and charging for emissions above ‘clean benchmark’. Combination of carrots and sticks

4. Who is doing what? Cap and trade Tax Intensity approach Australia CPRS Switzer-land EU USA - RGGI Korea (planned) Japan J-VETS Canada NB – solid red indicated primary mechanism; dotted red indicates secondary mechanism

5. Who is doing what? (cont) Increased emphasis on intensity-based measures in countries that are more open to trade • Some trade to GDP ratios: • EU: 26.4%, • USA: 27.2%; • Australia: 44.7%; • Canada: 71.4% • Switzerland: 108% • Reflects concerns regarding carbon leakage and adjustment through loss of competitiveness. • NB – carbon leakage a cost to global economy, not just the implementing jurisdiction • Adjustment effects are largely assumed away in macro-modelling • Key is to adopt scheme that is suited to economy, which maximises chances of adoption of meaningful targets. It therefore may not be desirable, and it is certainly not necessary, to have one uniform scheme around the world

6. Intensity based approaches Consider one variant – output-based allocation (a.k.a. the “Canadian approach”) • Government sets a emissions intensity target – a ‘clean benchmark’ (e.g. for sector/ industry/ activity). • Benchmark can be set at any level – effectively the CPRS is set at zero • Benchmark can be set to achieve same emissions cap as CPRS • If you are above the benchmark you have to pay for your ‘excess’ emissions • If you are below the benchmark you are ‘rewarded’ for you cleanliness • How is cleaner activity rewarded? • they get to sell the value of their relatively cleaner activity – by way of a clean permit - to those that emit higher than the clean benchmark • this provides cleaner producers with additional revenue to compensate for the additional costs of cleaner activity

7. Illustrative example Can establish clean benchmark for electricity, steel, aluminium, pulp and paper, transport, agriculture… etc Emissions per unit of output Emissions Liability: permits bought Clean benchmark Surplus: permits sold Emissions High emitter Low emitter

8. Intensity based approaches This approach has several benefits, but the biggest are: the absolute price effect is much smaller – which limit the concerns with carbon leakage, and also opens opportunity to stiffen target Demand effects of lower prices addressed through demand side abatement approach (which you would need to adopt under any scheme) the Government isn’t involve in churning revenue, which would otherwise create its own inefficiencies high emitters are not let off the hook if others abate relatively minor change to CPRS, so doesn’t require Government going back to drawing board CPRS infact adopts a variant of the intensity approach to deal with emissions intensive activities …but arbitrary eligibility subsidises higher emitters –a perverse outcome Intensity approach is completely compatible with other international trading schemes

9. Example of price effects - electricity

10. Who to contact about this presentation Amar Breckenridge email: amar.breckenridge@frontier-economics.com.au Danny Price email: danny.price@frontier-economics.com

11. Disclaimer None of Frontier Economics Pty Ltd (including the directors and employees) make any representation or warranty as to the accuracy or completeness of this report. Nor shall they have any liability (whether arising from negligence or otherwise) for any representations (express or implied) or information contained in, or for any omissions from, the report or any written or oral communications transmitted in the course of the project. The Frontier Economics Network Frontier Economics Limited in Australia is a member of the Frontier Economics network, which consists of separate companies based in Australia (Melbourne, Sydney & Brisbane) and Europe (London, Cologne and Brussels). The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Pty Ltd.

12. THE FRONTIER ECONOMICS NETWORK MELBOURNE|SYDNEY | BRISBANE | LONDON|COLOGNE |BRUSSELS |MADRID   Frontier Economics Pty Ltd, 395 Collins Street, Melbourne 3000 Tel. +61 (0)3 9620 4488 Fax. +61 (0)3 9620 4499 www.frontier-economics.com