Thursday, 18 July 2013

D Uren - Walk away from European debacle

Walk away from European debacle
ECONOMISTS love emissions trading systems. The creation of a set of rights to emit and a market for them to be auctioned and exchanged ensures the most efficient distribution of effort to meet a fixed reduction target.
Their history goes back to the 1980s when under Ronald Reagan a trading system was developed to phase out the use of leaded petrol. It was more successful than anticipated, achieving the transition faster and at a lower cost.
In the early 1990s, amid concern that "acid rain" caused by factories emitting sulphur dioxide was damaging forests and lakes, the first Bush administration introduced an emissions trading system in the US.
As an essentially Republican answer to environmental problems, it was opposed by the green movement for conferring a "right to pollute" on big business, but it proved highly effective in controlling the acid rain problem.
Labor has always ridiculed the Coalition's opposition to an emissions trading system for carbon as a betrayal of its free-market principals.
Labor reminds voters that leading Coalition members Joe Hockey and Malcolm Turnbull have had to suppress their support for a market-based solution to global warming to endorse Tony Abbott's "direct action" policy based on regulation.
Yet the European emissions trading system, to which the government has now linked Australia's carbon emission reduction effort, has been a debacle.
The price of a permit to emit a tonne of carbon into the atmosphere has slumped from the equivalent of $40 ahead of the global financial crisis to as little as $3.50. No business is going to make serious investments in abatement to deliver such small savings.
When Treasury was drawing up the specifications for Australia's carbon pricing three years ago, it believed that a price of about $25 was required to encourage power generators to use gas rather than coal.
However, the government's last industry reference group report on carbon pricing estimates that with rising gas prices it would now require a carbon price of $60 a tonne to make gas competitive with the much more emissions-intensive black coal.
Treasury's expectation that the price will be no more than $6 by 2014 means it will be a nuisance tax, but will not lead to the least change in Australia's carbon emissions. On the contrary, it makes coal more attractive.
The European carbon price has collapsed because the trading system was flooded with permits.
As in Australia, political pressure and deft lobbying resulted in free permits being given to companies in sectors seen to be vulnerable.
The distribution of permits in the lead-up to the financial crisis assumed further economic growth. With the recession, huge surpluses of emissions permits accumulated. Companies that were in financial trouble, such as European steel mills, found that selling their unused permits into the market was a way of shoring up their bottom line.
The low price has resulted in perverse interactions with renewable energy schemes so that the trading system now provides an incentive to increase emissions, one estimate showing it has reduced abatement effort by 700 million tonnes of carbon dioxide.
The lowering of the carbon price in Australia similarly has the potential to reduce abatement through the local renewable energy scheme.
Electricity retailers who fail to purchase sufficient renewable energy have to pay a penalty. The fall in the carbon price increases the gap between the wholesale price and the cost of renewable energy, creating an incentive for retailers to pay the penalty rather than support the cost of new renewable energy projects.
There are many flaws in the European system, but two are pivotal: the difficulty in estimating the future course of emissions and the susceptibility of the system to political influence over the issue of free permits.
The economists' idyll has unravelled before both the economists' own shortcomings in dealing with uncertainty and the brutish world of politics.
The European Parliament has been attempting to reduce the overhang of permits, but still faces difficulty in getting the assent of governments worried about anything that will raise costs for struggling industries.
The Rudd government's decision to bring forward Australia's link to the European system similarly shows the vulnerability of carbon policy to short-term politics. There is no attempt to justify it as a move to improve Australia's carbon emissions effort - indeed, it has the opposite effect.
Rather, it has been presented as an effort to lower the cost of living for households and the burden on business, objectives that have nothing to do with carbon abatement and are purely political with the imminent federal election uppermost in mind.
One has to feel some sympathy for the electricity industry, which is facing an election in which each side is promising radically different approaches to pricing its energy inputs, as well as having separate plans to overhaul the regulatory framework for the electricity industry to force lower prices.
How carbon is priced makes a massive difference to electricity generators and the uncertainty is undermining investment and the value of generating assets.
The NSW government's recent sale of the nation's biggest power station, the 2900-megawatt Eraring coal-fired plant, to Origin Energy for a paltry net $50 million makes the point.
The ambition of the Kyoto Protocol, signed 16 years ago, was that a global trading system backed by binding emission reduction commitments would already be covering the 37 advanced countries. Emerging nations that reduced emissions, for example by reafforestation, could sell permits into the system, generating a new export industry.
Although experimentation with emissions trading systems continues, the Kyoto dream will never be realised. Global consensus has evaporated and Europe's experience provides a discouraging precedent.
As business groups have argued over the past few days, rather than hastening the link with Europe's scheme it is time for a rethink.

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