The much anticipated draft report of the Garnaut Climate Change Review (Review), released on 4 July 2008, concludes that Australia needs to pursue mitigation of greenhouse gas emissions through the introduction of a 'cap and trade' Emissions Trading Scheme (ETS) as a matter of urgency.
A model ETS was the subject of a specific Discussion Paper released by the Review earlier this year. Part of that discussion was considering the benefit of including a transition period for the ETS, during which time the price of carbon permits would be fixed. It appears that there is little change to the key design features of the ETS since the Discussion Paper.
A substantial part of the Report is devoted to the reasons for action and the costs of inaction, rather than on the details of the proposed design and operation of the ETS. In light of that focus, it is important to appreciate what the draft Report does not do. In particular, the draft Report does not provide concrete recommendations on specific targets and trajectories for emissions reduction, and hence allows clear predictions on carbon prices. These matters will be elaborated on in a supplementary draft Report which has not yet been released, after the completion of modelling with the Commonwealth Treasury. However, the Review provides its audience with a strong indication that the final Report will recommend an ETS that contains the key features set out below.
An overall national emissions limit would consist of not one but several paths or 'trajectories'. Each trajectory would be expressed as a series of annual emissions targets, the first trajectory (up until 2012) will be be based on Australia's Kyoto commitments. Each increasingly ambitious trajectory would require greater annual levels of reduction in emissions (and thus the impact of each would be increasingly severe). The emergence of firm global mitigation efforts should be the 'triggers' for movement under the Australian ETS to a more ambitious trajectory. Government should give 5 years' notice of movement to another trajectory.
The supplementary draft Report will address budgets, trajectories and point-in-time targets for the ETS in further detail.
The Review considers the Scheme's coverage (of both greenhouse gases and industry sectors) should be as broad as possible. It recommends the ETS should cover emission of the 6 greenhouse gases defined by the Kyoto Protocol and that the stationary energy, industrial processes, fugitive emissions and transport sectors should be included from the outset.
The Review believes the waste and forestry sectors should be included as soon as practicable, while the inclusion of agriculture should be subject to progress on measurement and administration.
Given the broad coverage of the scheme (and the well-accepted principle that offsets should not be created in covered sectors due to double counting), the Review envisages that domestic offsets will not play a large part in the ETS. While supporting the use of offsets from forestry, for the agriculture and waste sectors the Review suggests investigating other policies to encourage mitigation as an alternative to offsets.
In discussing 'additionality' tests for offsets, in particular regulatory additionality, the Review comments that 'such tests are arbitrary, and potentially a source of distortion, with the potential to undermine the credibility and scarcity principles of the scheme'.
The Review suggests a limit on the use of international offsets as a fixed proportion of Australian permits.
Point of obligation
Point of obligation refers to the point in the supply chain at which monitoring and reporting of emissions is conducted for the purposes of the ETS. For a number of sectors, including stationary energy, the Review prefers the source of emissions as the point of obligation.
However, the Review recognises that an 'upstream' or 'downstream' point of obligation may be preferable where transaction costs are lower, accuracy of emissions measurement higher, or coverage greater. One example is the transport sector where an upstream point of obligation might be the most efficient way in which to capture a large number of small emitters.
The Review also considers the possibility of allowing large energy users to opt in to the scheme (which would require the generator to net out that energy use).
The Review strongly favours issue of permits by way of auction at regular intervals (weekly, monthly, quarterly or any other basis that suited market participants) over free allocation. Auction is favoured because of its simplicity, credibility and the ease with which it might facilitate integration of the Australian ETS with international carbon trading markets as they emerge.
The Review found that allocating permits for free 'would be highly complex, generate high transaction costs, and require value-based judgments'. However, the Review concedes that free permits may be issued as part of assistance measures to trade-exposed, emissions-intensive industries, in lieu of cash payments (see further below).
Price controls and transitional arrangements
The Review considers that, as a transitional arrangement until the end of 2012, it may be desirable (although not necessarily preferable) to set a fixed price for permits on commencement of the ETS, so as to ease the pain of adjustment and provide certainty in the early stages of the ETS's operation, but otherwise no price controls should apply.
Penalty and make-good
The Review proposes that a financial penalty would apply for non-compliance, which would need to be set high enough to discourage non-compliance and avoid it becoming merely a price cap. Make-good provisions would apply in addition, to ensure the integrity of the scheme.
Banking and borrowing
The Review proposes to allow unlimited banking of permits, and borrowing of permits for a period of up to 5 years.
The Review notes risks in linking the Australian ETS with countries that have a flawed domestic emissions mitigation system, but considers that international permit markets could be linked on a case by case basis, after they were certified by an independent government regulatory authority as being of a suitable standard.
Treatment of trade exposed, emissions intensive industries
The Review recognises that if suitable arrangements are not made to provide assistance to trade exposed, emissions intensive industries (TEEIIs) then, in the extreme result, those industries might relocate to a country with lesser constraints on emissions. This would provide the worst of both worlds: a loss to Australia of economic activity and no reductions in the emissions made by those industries.
No straightforward solution to this dilemma exists. The Review suggests that 'pursuit of global and sectoral agreements to achieve comparable treatment of emissions in important competitors' should be pursued as a priority and, where such agreements have not been reached post 2012, assistance should be given to account for the disparity between the TEEIIs' obligations under an Australian ETS and that of countries where their competitors operate.
Such assistance could take the form of cash or free permits. Rigorous materiality thresholds are proposed, and it is suggested that only a limited number of industries might clearly satisfy the criteria.
Compensation to existing generators
By contrast, however, the Review does not support compensation for existing coal-fired generators or other existing high emitters. The Review states that 'providing assistance to address the failure of our global competitors to act on limiting their carbon emissions is not the same as compensating domestic firms for the government's decision to implement a domestic emissions trading scheme', and 'there is no basis for compensation arising from the loss of profits or reductions in asset values following the introduction of the domestic emissions trading scheme'.
Use of permit revenue
The Review strongly favours returning all revenue garnered by the ETS to households or businesses according to a range of competing priorities including:
- payments to trade-exposed, emissions-intensive firms
- support for investment in research, development and commercialisation of low-emissions technologies
- cash reserves to purchase international permits/offsets to reconcile domestic emissions with international commitments.
The Review is optimistic that a significant amount of revenue from the ETS will be used for research and development of commercially viable mitigation strategies for existing fossil fuel based energy generation facilities.
The Supplementary Draft Report is due for release in late August 2008, and the Final Report is due by 30 September 2008.
The Australian Government's Green Paper on scheme design is due in July 2008. Exposure draft legislation is due to be publicly released in December 2008, with the scheme to commence in 2010.
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