© Frontier Economics Pty Ltd, Melbourne.

Alternative approaches to carbon reduction schemes

Parliamentary Library vital issues seminar – 17 March 2009

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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

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Scheme typesMore 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

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  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

Who is doing what?

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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

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Intensity based approachesConsider 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

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Emissions

Illustrative example

High emitter Low emitter

Emissions per unit of output Liability:

permits boughtClean

benchmark

Emissions

Surplus: permits sold

Can establish clean benchmark for electricity, steel, aluminium, pulp and paper, transport, agriculture… etc

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Intensity based approachesThis 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

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Example of price effects - electricity

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2010 2015 2020 2025 2030 2035 2040 2045 2050

LRM

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DCC Reference Case Scenario 1: Green Paper ETS Scenario 2: Canadian Cap and Trade

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Who to contact about this presentation

Amar Breckenridge

email:

amar.breckenridge@frontier-economics.com.au

Danny Price

email: danny.price@frontier-economics.com

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