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Putting a Price Cap on Australia’s Greenhouse Integrity

August 16, 2009

Satan is frolicking naked in the detail of the offset rules in Australia’s  Carbon Pollution Reduction Scheme Bill, and he needs to be stopped before the November Senate vote!

Under the currently proposed legislation before the Senate, Australian polluters would be allowed to substitute up to 100 per cent of their permits with international offset credits. The vast majority of international offset credits likely would come from so-called Certified Emissions Reductions (CERs) created via the Kyoto Protocol’s Clean Development Mechanism (CDM).

CERs are created by investments in carbon reducing technologies in developing countries, such as China and India. To the extent that these investments are deemed to reduce carbon emissions relative to an estimation of what they would have been otherwise, CERs are granted to the investor.

As the European Emissions Trading Scheme has demonstrated, buying CERs is often cheaper than either buying domestic permits, or investing in abatement (they are currently around AU$20 per tonne of carbon emissions, although prices fluctuate). Thus, industry will often prefer to emit more carbon than its domestic permits allow, and then make up the difference with international offset credits.

On aggregate, this has the effect of inflating the total domestic emissions cap, because additional permits – in the form of offset credits – are being imported into the scheme.

Even more importantly, because firms here will tend to buy whichever permit is cheaper, demand for Australian permits will fall whenever the Australian permit prices rises significantly above the price of CERs (the supply of which dwarfs Australian demand). Thus, the Government has effectively capped the Australian permit price at the CER price.

This is likely to delay much feasible domestic abatement, because it will no longer be cost effective for Australian polluters to reduce emissions when they can buy either cheaper Australian permits or cheap CERs offsets and continue to emit instead.

One might ask why this is a problem. If they are supposed to be offsets, aren’t international offsets environmentally equivalent to domestic abatement, just cheaper?

Because they are calculated by comparing emissions from an investment project to an estimation of what would have been emitted otherwise, there will always be an inherent uncertainty about the true reductions that each credit represents.

Even more important is the arithmetic which now confronts policy makers. Stabilising CO2 concentrations between 445 to 490 parts per million now requires developed countries to reduce their own emissions by between 25 to 40 per cent below 2000 levels, plus cuts of 15 to 30 percent from developing countries below their business as usual levels. Substituting domestic abatement with small reductions from developing countries’ current emissions trajectories is therefore inconsistent with taking the required action if, as the government does, you claim to accept the mainstream scientific consensus.

The Clean Development Mechanism has been useful in the first phase of Kyoto, mobilising investment in cleaner technologies in developing countries when they had no reduction targets of their own. It also allowed developed countries to pick so-called “low-hanging fruit” from the abatement tree. But the arithmetic with which the mainstream science now presents us is that, in its current form, the CDM is no longer the right policy tool. The rules of the current scheme proposal therefore send the wrong message to other countries about Australia’s preparedness to do its fair share under an ambitious global agreement.

In its White Paper, the Government argues that the Federal Treasury’s modelling finds that Australia would still meet most of its reduction target at home, with the majority of our targets achieved via domestic action. But this result appears to rely on the assumption that the price of CERs will consistently rise at 4 per cent a year from their current levels and it does not report having modelled how changes in its assumptions would affect the results. If anything, the Treasury’s result surely begs the question as to why Australian industry even needs unlimited offset credits? As our recent experience with economic forecasting has made clear enough, such modelling will only ever be an approximation – not something on which to hang crucial policy details!

The Australian Government would do well to take a closer look at a much cleverer approach to CDM which has been demonstrated by the Europeans. Fully aware that China (50 per cent of the CER market) and India (25 per cent) have come to enjoy the US$95 billion that CDM has brought into their countries, they have made it a bargaining chip in the current negotiations. 

The European Commission has said it will not allow European purchases of any more CER credits up to 2020 unless developing countries adopt suitable targets of their own at Copenhagen. Even then, the firms in its emissions trading scheme – totalling 40 per cent of European emissions – can only use a maximum of 30 per cent of CERs each to meet their obligations.

Perhaps it’s possible to deliver both principled environmental policy and be strategically astute at the same time?

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