AUSTRALIA S EMISSIONS TRADING SCHEME

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1 NATIONAL GEOGRAPHIC STOCK/ RALPH LEE HOPKINS / WWF AUSTRALIA S EMISSIONS TRADING SCHEME IMPLICATIONS OF AN EARLY MOVE TO A FLEXIBLE PRICE Introduction Australia s emissions trading scheme (ETS), which came into effect in July 2012, is currently scheduled to transition from a fixed price (determined by the Government) to a flexible price (determined by the market) in mid The Government has announced its intention to shift to a flexible price one year earlier. This policy brief assesses the implications of an earlier move to a flexible price, with a particular focus on the environmental effectiveness of the scheme. WWF has for more than a decade advocated for the Australian Government to have as its core response to reducing carbon pollution a scheme that puts a price and a limit on carbon pollution. We believe an emissions trading scheme provides the most economically efficient and environmentally effective way to reduce emissions. We also believe additional complementary measure will be needed in the short-to-medium term to encourage energy efficiency and drive the domestic transition to renewable energy. How Australia s ETS works? Australia s ETS is a cap and trade scheme which involves the Federal Government setting an annual cap (limit) on emissions that can be released by major polluting business (liable companies). By setting a cap the Government can determine exactly how much carbon pollution can be released into the atmosphere, and hence ensure that Australia s emissions targets will be met. Once the cap is set, the Government will issue a set number of permits which add up to the total emissions that can be released under the cap. Most of these permits will be issued via a series of auctions, which means the market will set the price paid for the permits. A smaller share of the permits will be issued for free to businesses defined as being emissions intensive and trade exposed, as well as small number of coal-fired electricity generators who are being provided with assistance in the early years of the ETS. When a liable business does not have enough permits it either has to (a) reduce its emissions, (b) buy a credit from the Carbon farming Initiative, or (c) purchase a permit elsewhere (either from another Australian business or from an eligible overseas market). page 1

2 For the first few years of Australia s ETS, the price has been set by the Government (a fixed price), and is currently $24.50 a tonne. Under current arrangements (i.e. not taking into account the planned changes), from 1 July 2015 the price will be set by businesses and the market (a flexible or floating price). In November 2012, the Government announced that Australia s ETS would link to the European Union ETS from 1 July 2015 when Australia s price is set to become flexible. This means Australian business can, if needed, buy up to 50 per cent of their permits per annum from overseas, largely from the European Union and a small portion (12.5 per cent) from the UN s Clean Development Mechanism. 1 The Australian ETS is designed to drive incremental cuts in emissions each year. This means the cap (pollution limit) will start at a level slightly below current emission levels and decline over time. In the short-term it is expected that the supply of Australian permits will be sufficient to meet the majority of demand from liable companies. Indeed, we estimate that international permits will only account for around 12 per cent of the total permits needed by Australian businesses in 2014, well short of the 50 per cent limit. 2 However, exactly how many international permits will be purchased in any given year will depend on the strength of the Australian cap and the permit price. Under some scenarios 3 it is possible that the 50 per cent restriction will be met in the final years of this decade. Given the EU ETS is a significantly larger market than Australia s, the price of Australian permits is expected to match the EU price in the short to medium term. The consequence of purchasing international permits is that abatement (emissions reductions) will occur overseas rather than in Australia. For example, if an Australian business purchases a European permit this means there will be one less permit available to European companies, which means more abatement will need to occur in Europe to make up for the shortfall. Over time as international action accelerates and the caps in Europe, Australia and elsewhere are tightened, there will be fewer permits available. As explained below, this means the carbon price paid by Australian businesses is expected to rise over time. This provides a strong incentive for businesses to start implementing long-term strategies for cutting emissions, in the knowledge that permits are going to become more expensive in the future. Achievements to date In its first year of operation the ETS has contributed to measurable benefits, including: a 7.4 per cent reduction in carbon pollution from electricity production; a 30 per cent increase in renewable energy generation; and a 12 per cent reduction in electricity generation from brown coal. 4 Crucially, these outcomes have been achieved while employment and the economy have remained strong, with around 150,000 jobs created in the past twelve months and the economy growing at around 2.5 per cent (industrial production is up 5.1 per cent and retail trade up 3.1 per cent). The Clean Energy Finance Corporation has begun investing $5 billion in renewable energy, with 3 projects already announced. Another 642 business have received funding to assist with energy efficiency or investments in clean technology. 1TheEUemissionstradingschemeissimilartoAustralia sinthatitincludesfirmcapontheregion semissions.thecdmisanoffsetmechanism, wherebycompaniesindevelopedcountriescaninvestinpollutionsavingactivitiesindevelopingcountries. 2Assumesthedefaultcapwillapply(-38Mtbelow levels),whichmeanscapofapproximately350MtCO2-efor2014.Thismeans350 millionaustralianpermitswillbeissuedtoaustralianbusinesses.giventhatemissionsfromliableentitiesareexpectedtoreacharound396mtin 2014,thismeanstherewillbeshortfallofapproximately46Mtin2014.Inotherwords,around46Mtofoverseaspermitstobeimportedforuse in2014.thatisapprox.12percentofcoveredemissions,wellshortofthe50percentlimitation. 3Forexample,scenariowhereAustraliaadoptsstringentcapandtheinternationalpriceremainsrelativelylow. 4DepartmentofIndustry,Innovation,ClimateChang,Science,ResearchandTertiaryEducation(2013),HowAustralia scarbonpriceisworking Oneyearonhttp:// page 2

3 How would an early move to a flexible price happen? An early move to a flexible price would first require a series of amendments to the Clean Energy Act, which outlines the timing for the transition from a fixed to a floating price. Amendments would need to be passed by both houses of parliament. Assuming these amendments are passed, the Government would then need to set annual carbon pollution caps for the first five years of the flexible price period (e.g ). The independent Climate Change Authority (CCA) is currently undertaking a review of Australia s targets and in January 2014 will make recommendations of what Australia s 2020 target should be and what caps should be set under Australia s ETS. While the CCA takes into account Government policy in making its recommendations, ultimately it is up to the Minister to set the caps. While the Minister for Climate Change is responsible for setting the caps through regulations, the Clean Energy Act includes provisions for either house of parliament to disallow these regulations. This, in effect, gives both the House of Representatives and the Senate a veto over the annual pollution caps. If the regulations are disallowed and agreement cannot be reached on new regulations, a default cap for the first year of flexible price period will come into effect. 5 Once an annual pollution cap is in place the Government will issue the equivalent number of permits into the market. How would this affect the price paid by businesses? As noted above given the Australian carbon market is small compared to the EU carbon market, the price of carbon under flexible pricing arrangements would primarily be determined by the level of demand in the EU. Demand in the EU is currently weak due to the region s economic circumstances. This means there is an oversupply of EU carbon permits, which has caused the EU carbon price to fall to near record low levels. While EU carbon permits were trading above 30 in 2008, today they are trading at around 4.30 (AU$5.90). 6 For businesses this means rather than paying the current fixed price of $24.50 a tonne, they will be paying significantly less. It is uncertain for how long the EU carbon price will remain low and how it will track in the coming years. This will be determined by a range of factors including: The pace and extent of economic recovery in the EU; The effect of short-term efforts by the EU to increase the carbon price (e.g. by delaying the auction of new permits, which the EU parliament has agreed to do); and Decisions on the EU s pre- and post-2020 climate policies, including strengthening emission reduction targets by moving to the 30 per cent of their per cent range for 2020 cuts (stronger targets will increase demand for permits and push the price up). In the short-term, the EU carbon price is expected to remain relatively low. Current futures trading has EU carbon permits selling for around AU$6.20 in 2014, which is around half the price projected by Treasury for (when the flexible price period is currently planned to begin). 7 Looking further ahead, there is general agreement that the EU carbon price will recover in the second half of this decade, especially if the EU takes on stronger targets. Treasury projects a 2020 carbon price of AU$38, while recent analysis by Vivid Economics for WWF assumes that prices will reach $15 in Thedefaultcapis38milliontonnesbelowthelevelofemissionsrecordedbetweenJuly2012and30June EuropeanEnvironmentAgency(2012),GreenhousegasemissiontrendsandprojectionsinEurope2012TrackingprogresstowardsKyotoand2020 targetshttp:// CarbonColumn, 12July2013edition. 7DeutscheBankMarketsResearch(2013), TheCarbonColumn 12July2013edition. 8CommonwealthofAustralia(2013),FederalBudgetwww.budget.gov.auVividEconomics(2013),ThecostsandbenefitsofgreaterAustralian emissionsreductionambitionreportpreparedforwwfaustralia, page 3

4 How would this effect the environmental effectiveness of the scheme? Shifting to a floating price one year earlier than currently planned should not affect the environmental effectiveness of Australia s ETS. Indeed, it could deliver even greater environmental benefits (in the form of deeper cuts to carbon pollution) if the move to a flexible price involves the setting of an ambitious cap. As explained above, moving from a fixed price to a flexible price is very likely to see a significant fall in the carbon price paid by Australian businesses, as Australia s price will match the EU price. This means in the short-term, Australian businesses will have less of an incentive to reduce emissions in Australia. This is because it will most likely be cheaper for businesses to purchase international emissions permits in order to cover their remaining emissions liability (after they have purchased the Australian permits). But this does not impact on the environmental effectiveness of the scheme for two important reasons: (1) The same amount pollution will be saved, irrespective of the price. A change to a flexible price influences where the pollution will be saved not how much will be saved. The lower price means that more of the abatement (emissions reduction) will occur in Europe and less in Australia (see How Australia s ETS works for more explanation). (2) Climate change is a global problem requiring a reduction in global greenhouse gas emissions. As long as the abatement actually happens, from an environmental perspective it doesn t really matter where it occurs. This is illustrated in Figure 1. Figure 1: The carbon price faced by Australian firms effects where the pollution is saved, but does not change the total amount saved. The biggest risk for the environment right now is not the low carbon price in Europe, but the uncertainty about whether Australia will have an ETS at all in the coming years. Once businesses have some certainty that an ETS is here to stay, they can start factoring a long-term carbon price in to their investment decisions. How could the environmental outcome of the scheme be improved? The best way to strengthen the environmental outcomes from Australia s ETS is to increase Australia s 2020 target which will tighten the scheme s cap. Indeed, the environmental effectiveness of Australia s ETS is ultimately determined by the strength of the cap the Government puts in place. A weak cap means more pollution is allowed page 4

5 to be released into the atmosphere. Conversely, a strong cap means less pollution will be released into the atmosphere. Currently there is bipartisan support for an Australia s 2020 target to be set between 5 and 25 per cent depending on certain international conditions being met. 9 The Intergovernmental Panel on Climate Change (IPCC) recommends that developed countries cut their emissions by between 25 and 40 per cent from 1990 levels by One upside of the low carbon price is that it dramatically lowers the cost of Australia achieving its 2020 emissions targets. Indeed, recent modelling by Vivid Economics and Monash University found that the economic cost of achieving Australia s unconditional 5 per cent target is now 75 per cent lower than when this target received bipartisan endorsement back in This same modelling found that moving from a 5 per cent target to a 25 per cent target can be achieved at almost no additional impact on Gross Domestic Product (GDP) (0.01 per cent) and around a 0.06 per cent impact on Gross National Income (Figure 2). Figure 2: Economic costs of Australia moving to a stronger 2020 emissions target (Vivid Economics based on modelling results from CoPS MMRF). 11 % change relative to reference case % 15% 25% GDP GNI With the world currently on track to experience around 4C of global warming, WWF is calling on the Government to increase Australia s 2020 target to at least 25 per cent by As both sides of politics agree, this would represent Australia s fair share of the global effort required to keep global warming below 2C. As explained above, this could be done under an ETS with basically no cost to the economy and would be an important step to show Australia is serious about tackling climate change. Analysis by the Department of Industry, Innovation, Climate Change, Science, Research and Tertiary Education 12 suggests that, given the actions currently being taken by other nations, Australia should be prepared to raise its unconditional 5 per cent target and commit to at least a per cent emissions reduction target. Significantly, the Department s analysis also concluded that China s emissions target would contribute to satisfying the conditions required by Australia before Australia moves to a 25% target. 13 Other independent analysts including 9Thepercenttargetisminimumunconditionaltarget;thefullconditionssetbythegovernmentformovingtoeither15or25percenttarget canbeviewedhere: 10IPCC(200&),FourthAssessmentReportwww.ipcc.ch 11VividEconomics(2013),ThecostsandbenefitsofgreaterAustralianemissionsreductionambitionreportpreparedforWWFAustralia, 12FormerlytheDepartmentofClimateChangeandEnergyEfficiency 13TheClimateInstitute(2010), SummaryofFreedomofInformationRequestfromTheClimateInstitutetotheDepartmentofClimateChangeand EnergyEfficiency:DocumentsregardingtheinfluenceofforeignemissionreductiontargetsonAustralia semissionreductiontargets,mediabrief November2010, page 5

6 Professor Ross Garnaut have also shown that Australia s unconditional 5 per cent target falls short of the efforts being taken by other countries. 14 Indeed Garnaut has recently recommended that Australia should at least be willing to match the US target of 17 per cent below 2005 levels. 15 What about Australia s transition to a low carbon economy? Since July 2012 when Australian businesses first started paying for their carbon pollution, there has been a 7.4 per cent reduction in emissions in the electricity sector and a 30 per cent increase in renewable energy generation. Energy sector analysts agree that these changes are the result of a range of factors, including the carbon price. Other factors include falling electricity demand; strong growth in the uptake of small-scale solar; and the deployment of large-scale renewable energy through the Renewable Energy Target. Even at a low price the ETS will provide a price signal for medium and long-term investments such as energy generation that are being made now. However, there is no doubt that a lower carbon price will lessen the role that the ETS will play in facilitating the transition to a low carbon energy system in Australia in the short-term, although this will change as the EU carbon price continues to rise. In the meantime, other policies can continue to drive the transition to a low carbon energy system. In particular, the role of the RET and the Clean Energy Finance Corporation (CEFC) will be particularly important. What about government revenue? The Government has already acknowledged that a lower than anticipated international carbon price means that they expect to see a drop in revenue from the sale of carbon permits when the scheme shifts to the flexible price in July An early move to a flexible price will mean this impact on revenue will occur earlier than expected. The exact impact on government revenue will depend on the EU carbon price at the time of the shift to a flexible price and the number of permits auctioned by the Government. However, it is important to keep this in perspective. Total revenue from the carbon price currently makes up around 2 per cent of total Commonwealth revenue and is only one small part of much bigger structural challenges facing the budget in the coming years. 16 One option available to the Government to help offset the impact on revenue is to wind back fossil fuel subsidies provided to industry. For example, it is estimated that approximately $5 billion a year could be saved by phasing out the fuel tax credit provided to energy intensive industries. 17 WWF-Australia s position WWF-Australia is a strong supporter of a price and cap on carbon pollution as a core mechanism to tackle climate change. We have been advocating for an Australian ETS for more than a decade. We supported the model negotiated by the ALP and the Coalition in 2009 (which subsequently failed to pass the Senate) and have also supported the model that is currently in place. If it is coupled with stronger targets and domestic measures, moving to a flexible carbon price one year early could actually strengthen the environmental effectiveness of Australia s ETS, which will have significant benefits for our economy, society and environment. 14Garnaut,(2011),AustraliaintheGlobalResponsetoClimateChange:Summaryhttp:// Jotzo,F.(2010), CopenhagentargetsandAustralia sclimatecommitment,politybriefcentreforclimateeconomicspolicy,anu, 15Garnaut,(2013),AddresstoGrattanInstitute,Melbourne, 16CommonwealthofAustralia(2012)FederalBudget http:// 17Webb(2012)Fossilfueltaxes.BackgroundnotebytheParliamentaryLibrary, page 6

7 We recommend the move to a flexible price one year earlier should be accompanied by the following commitments, aimed at strengthening the environmental outcome and ensuring the domestic transition to a low carbon economy continues: A 2020 emissions target to reduce emissions by at least 25 per cent below 1990 levels by At a minimum increase the unconditional/minimum range to 15 per cent now; Retain the Climate Change Authority and all of its functions; Retain the legislated 2050 emissions target and look to increase it from 80 per cent to be in line with Australia s commitment to limit warming to below 2C; Retain the CEFC, the Biodiversity Fund, and the Clean Technology Fund with at least their current levels of funding; Retain the 41,000 GWh Renewable Energy Target to 2020, then keep a safety RET to 2030 with a target of at least 50 per cent of Australia s electricity supply to come from renewable sources by 2030; Implement the National Energy Savings Initiative (a market-based tool for driving economy wide improvements in energy efficiency). Such a scheme would encourage energy retailers to help household and business consumers to save money by encouraging the take-up of energy efficient technologies; No additional allocations of free permits to industry; The ratification of the second commitment period ( ) of the Kyoto Protocol (an international treaty that sets binding obligations on industrialised countries to reduce emissions of greenhouse gases); and A fast-tracked review of the use of carbon permits from the UN s Clean Development Mechanism (CDM), with consideration to further constraining their use. (There is a high degree of uncertainty about the future of the CDM beyond This means there are doubts about the environmental integrity of these permits, which are currently trading at less than $1 per tonne). For more information Will McGoldrick, Policy Manager, Climate Change OR Kellie Caught, National Manager, Climate Change Ph: E: wmcgoldrick@wwf.org.au Ph: E: kcaught@wwf.org.au July 2013 page 7