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.

This ‘international linkage’ effect reduces emissions costs for high-price countries and increases their effective emissions ‘caps’. They lose emissions permit revenue, however. This is a zero-sum game. Low-price countries incur increased emissions costs and reduced effective emissions ‘caps’.  They receive increased emissions permit revenue, however. 

If all emissions ‘caps’ are binding, this permit trade means tougher restrictions on developing country growth than they planned, matched by above-target growth capacity in developed countries.

Permit trade shifts production capacity complying with emissions ‘caps’ from poorer to richer countries.  

Could their permit revenue finance enough lower-emissions technology transfer to offset this additional restriction on poorer countries’ production growth?

This is an empirical question. Higher permit prices might help, but they will also constrain the number of permits developing countries can sell. Lower prices don’t help but sales volumes might be higher.

More importantly, developing countries are likely to have much higher short term priorities for spending net permit revenue – as indeed has been the case in Australia.  Household support and industry assistance are examples.

This suggests any developing country compliance with emissions ‘caps’ under this hypothetical world ETS will further limit their growth.

I doubt developing countries, heavily pressured to maximize their own growth, will buy this ETS deal.

Other schemes are supposed to help poorer countries. The Clean Development Mechanism (CDM) and Reducing Emissions from Deforestation and Degradation (REDD) provide finance to poorer countries reducing their emissions, and ‘credits’ (extra emissions permits) to those financing them. These schemes already have been corrupted and rorted.

ETS incentives will collide over time. 

Businesses want to buy emissions permits or ‘credits’ under ETS, CDM and REDD at least cost. 

But governments are supposed to make emissions permits and credits costlier to meet emissions reduction targets. Will they, when push comes to shove? Speculation on permit prices is inevitable. 

Will any global ETS crack as emissions ‘caps’ tighten? A climate policy equivalent of monetary policy ‘quantitative easing’ is possible. We’ve seen over-issuance of emissions permits before.

If governments can debauch the paper currencies they issue by printing more of them and letting inflation increase, why not (again) for emissions permits? The consequences are much less visible immediately.

Under any ‘patchwork’ world ETS, ‘kicking the emissions reduction can down the road’, as with the E.U. approach to debt today, seems quite possible. Each ETS participant may seek to offload its adjustment task to others, even though, collectively, that is impossible.

I don’t think any world ETS will work. Developing countries and North America probably won’t join. Any ETS will be a market for paper shuffling, speculation, price volatility and little global emissions abatement.

Focusing on national emissions production, plus international trade in permits, as embodied in the Government’s policy model, is a recipe for continued global failure, continuing the sorry mess starting about two decades ago, from Rio through Kyoto, Bali, Copenhagen, Cancun, (probably) Durban, and beyond. 

If we want to act, best we focus on reducing our own national emissions consumption, hoping others, eventually, do likewise. 

This focus includes emissions imports and excludes emissions exports, and works like the GST.  This ensures no adverse effects on our competitiveness, and avoids the disincentives and potential rorting inherent in international trade in emissions permits when emissions prices will start at very different levels.