Will Australia's emissions policy encourage global action?

Last Tuesday Australia’s carbon tax/emissions trading scheme (ETS) became law. A carbon tax of $A23/tonne in 2012 – already high by international standards – will increase 2.5 per cent annum in real terms for three years. This will undermine competitiveness and emissions reductions.

After 2015, Australia plans to trade in an international ETS market, but with regulations (price ceilings, a minimum Australian price starting at $A15, and limits on permit purchases overseas). Emissions ‘caps’ remain uncertain. 

Will the world follow, as optimists assert? History suggests almost zero chance. Recognising this, some now spruik an alternative: ‘creeping’ adoption of national emissions targets, sometimes including an ETS, sometimes not.

Suppose emissions reduction targets are adopted by most countries, and, for many, include an ETS allowing international permit trading.

Australia’s policy envisages businesses purchasing many permits from overseas (subject to a limit) where they are cheaper, supporting lower-cost global emissions cuts. Will practice match theory?

Suppose we divide this ETS world into developed and developing countries. Realistically, any deal requires developed countries to accept much tougher emissions targets than developing countries.

As a result, average emissions prices initially will be much higher in developed countries than in developing countries. 

International permit trading then reduces these price differences, (subject to regulatory constraints) as permit demand shifts to low-price markets, and permit supply to high-price markets.

This is how Australian, N.Z. and E.U. ETS models are intended to work.

This convergence of emissions prices will require net purchases of permits by developed economies, matched by net sales from developing economies.

As a result, effective emissions targets are relaxed in rich countries (net buyers of permits internationally), and become correspondingly tougher in poorer countries selling some of their permits.

International permit trading alters their effective national allocation. This is exactly how the Government expects Australia will do much of its emissions reduction – by shifting it to other countries.