Practical realities of carbon trading

New Zealand should move cautiously and in line with key trading partners … It should not proceed with ill-considered actions that could involve large costs for firms and households, seriously damage the New Zealand economy, and have no discernible impact on global warming.

These and other analyses raise a question as to whether the conclusion reached by the IPCC in its February presentation of The Physical Science Basis (PDF 1.25MB) does actually provide a satisfactory basis for major policy action to reduce emissions. For example, its conclusion that it is 90 per cent certain that most of the recent warming is due to increased human activity is the weakest acceptable level of confidence in a hypothesis test.

Caution about policy action is enhanced to the extent there is a wide range of possible temperature outcomes and/or of costs of mitigation or business as usual policies. For example, Stern claims a mitigation cost of only 1 per cent of GDP a year for reducing emissions by 60-90 per cent in industrial countries by 2050. That estimate is derived, however, as an average of “most” of the estimates stated to be “clustered in the range of -2 per cent of GDP to 5 per cent of GDP”. But it is also stated that estimates outside this cluster range from -4 per cent to +15 per cent of GDP.

Perhaps times have changed but when I was in Treasury an average derived from such a wide range of possibilities would have provided only limited confidence for recommending major policy action. There are similar reservations about Stern’s claim that business as usual would cost 5-20 per cent of GDP a year.

Individual governments will be additionally cautious if there is doubt about support by major emitting countries for policy reducing measures. At present there is no sign of developing countries joining the emission-reducers league in any substantive way. On a business-as-usual basis (BAU), emissions of CO2 by China and India alone are projected to increase from 18 per cent of the world total in 2003 to about 30 per cent by 2030 and, surprisingly in view of his advocacy of urgent global action, Stern himself appears readily to accept that those two countries are unlikely to adopt a national cap on emissions before 2020.

With emissions of CO2 by all non-OECD countries projected to increase from 48 per cent of the world total in 2003 to 60 per cent in 2030, individual governments have every reason to proceed cautiously unless a global agreement emerges.

CO2 produced in developing countries can, of course, still be part of a carbon trading market if businesses in developed countries invest either directly or indirectly in developing countries in ways that make them eligible for obtaining carbon credits. However, the scope for genuine trade-offs of such a nature seems relatively limited unless developing countries set emission limits themselves.

Media reports of increased carbon-trading with developing countries such as China and India suggest that a significant proportion of the credits currently being obtained may involve emission reductions that are either limited or that relate to more energy efficient investment that represents current state of the art technology.

Even so, the availability of such trading for Australian businesses - and of potential trading with businesses in countries that operate trading systems - does raise the question of whether Australia itself actually needs an officially organised trading market. The setting of official emission limits for certain Australian businesses would quickly lead financial institutions to develop the market without official involvement. Indeed, the adoption by some businesses of carbon neutral policies in Australia is already involving purchases of carbon credits overseas.

Doubts over the possible extent of policy action by the United States are also relevant to policy determinations by individual developed countries such as Australia. Although recent changes in the United States political and judicial situations foreshadow more politically serious attempts to reduce emissions in that country, it must remain doubtful that the US will move in the foreseeable future to an actual carbon-withdrawal position.

A major component of any emission reduction program for the US (and for countries such as Australia and Canada) would likely involve the replacement of coal burning electricity power stations with nuclear power that could double electricity costs and would presumably need to be spread over a considerable period of time.

Taking account of such possible adjustment processes, if the US about halved the current BAU projected rate of growth (1.1 per cent pa) of CO2 emissions over the period to 2030, it would then still be the second biggest emitter (after China) and emissions by non-OECD countries plus the US would have increased by 87 per cent since 2003.