Key Point
- The devil will be in the detail with many key and challenging issues such as targets and trajectories for emissions reductions not becoming clear until later this year.
The Garnaut Climate Change Review Draft Report, released on 4 July 2008, cautions the Australian Government against any delay in taking mitigation action to address what Professor Garnaut refers to as the "diabolical policy problem of climate change".
The Draft Report is the first of three steps in releasing the Review's perspective on Australia's climate change policy options and includes the early findings of the joint economic modelling with the Treasury. A Submissions Report summarising almost 4000 submissions received by the Review will be published in July. The second step will be a draft Supplementary Report due to be released at the end of August which will examine the results of the joint modelling on the cost of climate change and the benefits of effective mitigation to Australia. The Final Report (due for release at the end of September) will set out the Review's assessment of Australia's best options for mitigating and adapting to climate change and include chapters on the industry sectors that will be most impacted by Australia's transition to a low carbon economy, namely: energy; agriculture and forestry; and transport.
In most major respects the Draft Report is little changed from the position contemplated by the Interim Report of February 2008 and its Discussion Paper on an Australian Emissions Trading Scheme (AETS). The Review's analysis of key issues such as targets, trajectories for emissions reductions and implications for carbon pricing will be left to the draft Supplementary Report. However, at some 537 pages and 20 Chapters, the Draft Report does flesh out the Review's perspective on the scientific and wider socioeconomic issues of climate change, the factors impeding international climate change negotiations (plus potential solutions) and Australia's domestic mitigation strategy.
Three main themes
Three recurring themes run through the Draft Report. The first theme is that the uncertainty surrounding climate change does not make the case for delay. Available science and early economic modelling supports a precautionary approach. According to the Review, delay is not postponing the decision but a deliberate choice to avoid attractive lower-cost options to reduce climate change risks.
The second theme is that Australia is well placed to deal with the climate change challenge. In the first quarter of 2008, the value of output per person in Australia exceeded that of the United States (the first time since World War 1) which the Review attributes to Australia's resource and skills sector reaping the benefits of the Asian economic boom and its flexible market-orientated economy (that has developed following the protectionist reforms in the 1980s). The Review states that investment in climate change mitigation and adaptation needs to be viewed in this context. Consequently, the Review still favours an AETS with broad sectoral coverage over a carbon tax or hybrid route.
The third theme is that domestic mitigation policy must be deeply integrated into global discussions and agreements. The Review states that only global agreement has any prospect of attaining deep greenhouse gas emission cuts and that the cost of Australia's mitigation efforts will be much lower within the framework of an international agreement. The Review warns that the integrity of the Australian market is likely to be corroded if strong mitigation steps are taken in the absence of an international agreement. However, according to the Review, it is in Australia's best interests to push for strong global measures as it has more to lose than any other developed country in environmental and economic terms.
What does the future hold for Australia?
The Review considers the potential impacts of climate change for various regions of Australia derived from "median probability" distribution results from climate change modelling undertaken by CSIRO and IPCC (supplemented by leading Australian experts on various topics).
If global development continues along a no-mitigation path, the Review states that for the next two decades or so, the impacts of climate change are likely to manifest themselves in stressed urban water supply and shifts in agricultural production. By 2050, in a no-mitigation scenario, output from irrigated agriculture in the Murray-Darling Basin will have declined by 50% and the Great Barrier Reef will have been effectively destroyed leading to knock-on ramifications for the tourism industry. By the close of the century, the Review presents a grim picture for the no-mitigation scenario (see Table 1) compared to potential impacts if global mitigation measures achieved greenhouse gas concentration targets of 450 parts per million or 550 parts per million carbon dioxide equivalent (CO2-e) respectively.
|
Sector |
No Mitigation |
Mitigation |
||
|
550 ppm CO2-e |
450 ppm CO2-e |
|||
|
Irrigated agriculture in Murray-Darling Basin |
92% decline in irrigated agriculture production in the Basin, affecting dairy fruit, vegetables and grains |
20% decline in irrigated agriculture in the Basin |
6% decline in irrigated agriculture in the Basin |
|
|
Natural resource-based tourism |
Catastrophic destruction of the Great Barrier Reef. Reef no longer dominated by corals |
Disappearance of Reef as we know it with high impact to reef-based tourism. 3D structure of corals largely gone and system dominated by fleshy seaweed and soft corals |
Mass bleaching of the coral reef twice as common as today |
|
|
Snow-based tourism in Australia is likely to have disappeared. Alpine flora and fauna highly vulnerable because of retreat of snowline |
Moderate increase in artificial snowmaking |
|||
|
Water supply infrastructure |
Up to 35% increase in the cost of supplying urban water due largely to extensive supplementation of urban water systems with alternative water sources |
Up to 5% increase in the cost of supplying urban water. Low-level supplementation with alternative water sources |
Up to 4% increase in the cost of supplying urban water. Low-level supplementation with alternative water sources |
|
|
Buildings in coastal settlements |
Significant risk to coastal buildings from storm events and sea-level rise, leading to localised coastal and flash flooding and extreme wind damage |
Significantly less storm energy in the climate system and in turn reduced risk to coastal buildings from storm damage |
Substantially less storm energy in the climate system and in turn greatly reduced risk to coastal buildings from storm damage |
|
|
Temperature-related deaths |
Over 4000 additional heat-related deaths in Queensland each year. A "bad end story" (ie.10% chance rather than median) would lead to more than 9500 additional heat-related deaths |
Fewer than 80 additional heat-related deaths in Queensland each year |
Fewer deaths in Queensland than at present because of a slight warming leading to decline in cold-related deaths |
|
|
Dengue virus |
5.5 million Australians exposed to Dengue virus |
720,000 Australians exposed to Dengue virus |
||
|
Geopolitical stability in the Asia-Pacific region |
Sea-level rise beginning to cause major dislocation in coastal megacities of south-east Asia and China and displacement of people in islands adjacent to Australia |
Substantially lower sea-level rise anticipated and in turn greatly reduced risk to low-lying populations |
||
Note: this table does not take the effects of centrally co-ordinated adaptation into account. The median of the probability distribution is used for the scenarios considered.
The Review also states that Australia is projected to be the developed economy whose terms of trade will be most adversely impacted by climate change. According to the Review, key Australian export markets in China, India, Indonesia are projected to have significantly lower economic activity as a result of climate change resulting in a decline in demand for Australia's mineral, energy and agricultural products. Further, Australia's immediate neighbours will have limited capacity to adapt to climate change and Australia may need to intervene to avoid political and humanitarian crises.
The Draft Report presents the early results of the joint economic modelling in respect of the growth and structural change of the Australian economy over the 21st century based on a reference case (where no climate change exists) and a scenario where unmitigated climate change continues (see Chapter 9). In the absence of climate change, the model indicates that the Australian population will more than double to 47 million, per capita output will almost quadruple, and economic output will expand by over 700% by 2100. In a no-mitigation scenario (based on median climate modelling predictions), Australia's GDP will decline from the reference case by around 4.8%, household consumption will decrease by 5.4% and real wages by 7.8% by 2100. These figures do not take "insurance value" (ie. how much would we be prepared to pay to avoid a small possibility of a highly damaging or catastrophic outcome?) and "non market impacts" (ie. the value of environmental amenity and future generational equity) into account. Such factors will be integrated into the economic analysis in the Supplementary Report.
The Review envisages that the two primary drivers for energy reform over the next decades will be:
- global fuel dynamics (in the form of the major uplift in the price of petroleum, coal (ie. this has increased by 118% over the past year) and natural gas prices); and
- the AETS which will provide the long-term price expectations needed to frame major investment in new energy infrastructure.
The key economic impacts analysis has been reserved for the Supplementary and Final Reports. Nevertheless Garnaut stresses that the future for coal-based electricity generation, both domestic and exported, will depend on the commercial viability of carbon capture storage and strongly encourages Australia to lead a major international effort towards testing and deployment of this technology.
Moving towards a global solution
The Draft Report expands on the core principles identified in the Interim Report that are necessary for effective international action, such as the need for:
- all high-income countries and China to adopt binding emissions commitments;
- middle-income developing countries to adopt one-sided, below-business-as-usual emissions targets; and
- low-income developing countries to be subject to minimal commitments but invited to take on one-sided targets to allow them to benefit from clean development mechanism-type activities.
The Review also reiterates the views it expressed in the Interim Report for budget allocation on a population or "per capita emissions" (also referred to as "contraction and convergence") basis. The simplicity of such an approach is attractive but will require global agreement on:
- a start date for actual emissions levels - the Review suggests that this could be the end of the first Kyoto period (2012) and, for Kyoto ratifiers, an average of emissions for 2008 to 2012 in order to reward good performers;
- the convergence date - this is the main equity lever ie. a later date favours emitters that are above the global per capita average at the start point; an earlier date gives more emissions rights to low per capita emitters. The Review suggests 2050 as a candidate date; and
- headroom in emissions allocations - this will be particularly important for China and India with rapidly growing economies and thus emissions. The Review suggests that headroom could take the form of challenging emissions targets (ie. permit allocations could be allowed to increase by half the rate of GDP growth) and renewable energy targets.
The Draft Report states that mitigation efforts will not fully succeed without international public funding to develop and transfer new technology as quickly and widely as possible. In order to encourage adequate global funding and equitable burden sharing, the Review recommends that high-income countries support an International Low Emissions Technology Commitment. This would require those countries to commit a small proportion of their GDP above a certain threshold of per capita income. Flexibility would be maintained in the use of funds (ie. money could be spent domestically or abroad or through national or collaborative ventures). The Review will consider the size of the Commitment in the Final Report but suggests that Australia's share could be in the order of $3bn. The Review also recommends an International Adaptation Assistance Commitment to provide adaptation assistance to developing countries that join the global mitigation effort with Australia's assistance being focused on the South Pacific, Papua New Guinea, Timor-Leste and Indonesia.
The Review is strongly in favour of early sectoral agreements to place the main trade-exposed, emissions-intensive industries (including shipping and aviation) on a broadly level playing field.
Enforcement and effective participation are likely to be the key hurdles in any international mechanism to combat climate change. The Draft Report suggests that financial incentives such as mitigation and adaptation financing may encourage developing countries while developed countries will be pressured by their domestic constituencies and international alliances. From an enforcement perspective, WTO trade sanctions could potentially have a role in the future.
Domestic mitigation centrepiece
An AETS remains the centrepiece of Garnaut's proposed domestic mitigation strategy. The Draft Report fleshes out some of the key design features for an AETS which are summarised in Table 2:
|
Garnaut Review proposals for an AETS Draft Report, July 2008 |
|
|
Coverage |
The AETS should initially cover emissions from all sectors of the Australian economy, other than forestry, waste and agriculture. Petrol (liquid fuels) and transport to be covered. Waste and forestry should be included on the earliest possible timetable. Full inclusion of agriculture and forestry will require measurement and monitoring systems for greenhouse gases to be developed. A sector should be included unless the costs of measurement and verification are prohibitive. |
|
Structure |
The AETS should be a cap and trade scheme, under which the aggregate emissions from the covered sectors are capped. Permits for emissions will be issued by the Government up to the quantity of the cap. Liable parties will be required to surrender permits to the Government equivalent to the quantity of emissions attributable to their operation. |
|
Regulator |
An Independent Carbon Bank |
|
Commencement |
As soon as possible. A decision to delay would be a decision against the need for the scheme. |
|
Liability points |
In most sectors, the point of liability will be directly imposed on the operator of the emitting facility. In the liquid fuels and gases sectors, liability in respect of the combustion of the fuel or gas will be imposed at an upstream point. |
|
Allocation |
100% auctioning. No free allocation of permits. Auctioning could be periodic (weekly, monthly or quarterly). The report does not recommend a period, but notes that liquidity is likely to be provided by secondary and derivative markets developing quickly. It is recommended by the report that permits be made available to the market as soon as possible after the full details of the scheme are announced, to support a forward market and price discovery. |
|
Compensation |
The money raised by the Government (the Draft Report does not contemplate what this would be, but at current EU carbon prices would be in the range of A$10 billion per annum) should be fully redistributed by the Government, with about:
No compensation is to be paid to those existing emitters that will be adversely affected by the requirement to purchase emissions permits, notwithstanding that the plant may already be permitted to operate under existing state-based environmental licences. |
|
Cap |
The availability of emissions permits should be confined to the proposed domestic emissions target. The trajectory until 2012 would be based on Australia's Kyoto cap (after deducting emissions associated with uncovered sectors), but beyond that period there may be different trajectories (or an overall budget cap for emissions). The conditions for movement between trajectories should be established in advance, and the movement between trajectories occur on five years notice after the trigger condition is met. There should be five years of firm caps, and then indicative caps stretching out to 2050. The trajectories, or caps, are anticipated to tighten over time. |
|
Hoarding and lending |
"Hoarding" (also known as "banking" or "saving", where permits are bought in one year and used in another year) and "lending" (also known as "borrowing", where permits are used in years ahead of their intended trajectory year), should be permitted. |
|
Initial phase |
The Draft Report's preference is for an unconstrained carbon price. However permits available up to Australia's Kyoto target at fixed prices in the first two years (2010-2012) would be a second best option. It is not clear what would occur if the emissions permits required in this period exceeded the Kyoto target – would the secondary market price rise above the fixed issue price, to some higher "cash penalty" price? |
|
Liability point |
The directly emitting facility is the starting point, but another point in the supply chain might be selected for any sector where it is an easier point to measure and assess the liability. For petroleum, the same point that is used for liability for Commonwealth fuel excise is likely to be used (upstream). However, some netting or credit arrangement would need to be introduced to cover fuel sales which do not result in emissions (eg. fuel used in plastics manufacture). |
|
Opt in |
The Draft Report countenances the possibility of large consumers of electric power being able to opt in and manage the exposure of their (scope 2) stationary energy emissions, rather than the directly emitting generator. The Draft Report notes that generators would need to have the ability to track and net out that, and that the existence of a power purchase agreements may support this option. The Draft Report overlooks the fact that the vast majority of electric power in Australia is traded on grid through a compulsory spot market, for which there are not power purchase agreements between generator and customer. Opt in for electric power emissions is unlikely to be feasible anywhere except WA and NT. |
|
Offsets |
Offsets should be available in non-covered sectors, and fungible with emission permits. However, recognition of forestry and land-use related offsets may present problems for linkages with the EU scheme. The Draft Report recognises the "inherent flaws in the design of offsets" such as the CERs from CDM projects. The Draft Report recommends provision be made for acceptance of international offsets, but with restrictions on the source and quantity of such offsets being accepted into the AETS (as a maximum fixed proportion of Australian permits). |
|
Price ceilings |
The Draft Report concludes that the disadvantages of price ceilings on permit prices outweigh their benefits. With the possible exception of an initial 2010-2012 transitional period, prices should not be fixed or capped. Lending (by the Government from future periods) and banking (by participants from earlier periods) should assist in dealing with liquidity issues. |
One interesting omission of the Draft Report is its failure to countenance the position of sellers under contracts entered prior to the announcement of the introduction of the scheme.
Unless this is dealt with, many facilities with large scope 2 emissions attributable to their energy purchases may escape the liability and cost of the scheme, by having entered long term energy purchase agreements prior to the announcement of the scheme, which agreements do not contain a provision for review to market price or pass-through of the costs of the ETS (because the ETS had not been announced).
Those facilities with large scope 2 emissions under non-reviewable contracts may also receive a windfall, by their products attracting a higher value (because of the embedded emission costs of competitors' products) whilst they do not themselves pay an increased energy cost under their non-reviewable energy supply contract.
This issue was dealt with on the introduction of the GST by having a special provision dealing with non-reviewable supply contracts entered prior to the announcement of the tax.
The issue could be similarly dealt with under the ETS by providing that, where a facility has reportable scope 2 emissions attributable to purchases under a non-reviewable energy supply agreement entered prior to the announcement of the scheme, the point of liability for the ETS is the scope 2 emitter rather than the scope 1 emitter. This would need to be mandatory rather than an opt-in arrangement, because there is no incentive for the scope 2 emitter to give up its windfall and opt in for a liability. This could apply to gas purchases and physical power purchase agreements entered prior to the scheme announcement date.
Importance of low emissions technology
Establishing a carbon emission price is only part of the mitigation solution. The Draft Report states that Australia is well positioned to develop and deploy a wide range of new mitigation technologies, particularly in the energy sector. The Review states that current Government expenditure on R&D is inadequate and a new institutional body (similar to the National Health and Medical Research Council) is needed to drive early research for low emissions technologies. As discussed above, the Draft Report recommends that additional funding could come from the revenue from auctioning emissions permits.
The Draft Report highlights two key criteria that should determine early funding decisions:
- Is this area of research of national interest to Australia? Due to Australia's high reliance on coal any proven technology that cost-effectively reduces emissions from coal burning will be highly desirable eg. carbon capture storage, algal biofuels.
- Is this an area of early research where Australia has a comparative advantage? For example, Australia has a clear comparative advantage in agricultural research in comparison to nuclear research.
Importantly, the Review emphasises the need to compensate "early movers" (ie. those that undertake the first demonstration and commercialisation of projects). It recommends a matched funding scheme to compensate early movers for a variety of cost spillovers such as technology demonstration costs, training costs and legal costs in working with Government to develop new regulatory frameworks.
Network infrastructure and information barrier challenges
There is a risk that network infrastructure market failures relating to electricity grids and carbon dioxide transport systems could increase the cost of adjustment to a low-emissions economy. The Draft Report focuses on infrastructure requirements for the transmission of electricity. The Review identifies the need for additional interconnector capacity, extension or augmentation of transmission networks and a national transmission planner to promote a strategic, co-ordinated and efficient national network.
The Draft Report also discusses potential roles for Government and potential market challenges in establishing a system of pipelines for the transport of carbon dioxide from the point of capture to the point of storage. Interestingly, the Draft Report notes the efficiency of the existing privately owned and unregulated gas pipeline infrastructure and indicates that a privately owned grid for carbon dioxide would be the preferred outcome if co-ordination failures and monopoly market failures can be overcome.
The draft Supplementary Report and Final Report will consider transport and urban planning infrastructure and services.
The Draft Report states there are potentially large and early gains to be made from energy efficiency, fuel switching and low-emission transport options. It identifies information and principal-agency barriers as potentially inhibiting energy saving opportunities in electrical appliance, building and vehicle sectors and recommends a combination of improvements in information dissemination and skills, regulation and restructuring of contracts to align principal-agency interests.
Food for thought
The Draft Report sets out a plethora of issues for the Government to consider in formulating its international and domestic policy position on climate change. It is likely that the Government has been giving extensive consideration to those issues already. The devil, however, will be in the detail with many key and challenging issues such as targets and trajectories for emissions reductions, with the implications these have for carbon pricing, not becoming clear until the draft Supplementary Report and Final Report are published later in the year. Nevertheless, it will be interesting to see how the Government responds to the Draft Report's recommendations on the proposed design of an emissions trading scheme when the Government releases its Green Paper on the Emissions Trading Scheme on 16 July.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
