Tuesday, August 11, 2009

The oppostion's rival carbon plan: greener, cheaper, smarter?

Malcolm Turnbull yesterday released an alternative carbon plan: "greener, cheaper, smarter". Sounds great. And finally some opposition policy on climate change. Well, not quite. The plan is a report by economic consultants 'Frontier Economics' commissioned by the oppostion and independent Senator Nic Xenophon. And it seems that it's largely a rehash of previous submissions that Frontier made both to the Garnaut review and government's green paper, on behalf of electricity generators.

So in terms of opposition policy announcements, this one's a whimper rather than a bang. They could have pretty much randomly selected any submission made to the Garnaut review or green paper and said "Here's a great idea, why doesn't the government negotiate with us and listen to alternative views like this? Not that it's Coalition policy. We haven't decided what we think of this yet".

But it promises really big things: twice the emissions reduction of the government's proposed carbon pollution reduction scheme at less than two-thirds the cost. Wow, the CPRS must have left some whopping great low-hanging fruit unpicked for those numbers to stack up.

Anyway, I spent last night reading it - badly, badly written as it is. There's 3 hours of my life I won't get back. At least some of the graphs were nice.

When people that really understand the economic modelling of emissions trading costs (not me) get to the bottom of this report I expect it to be thoroughly discredited or else I will learn some useful economic lessons - because I could not for the life of me see how the savings can be achieved. Because this scheme is not radically different to the CPRS; it's a minor tweak.

Very briefly, the idea is for special treatment of the electricity sector - because that's the sector affected most intensely by emissions trading. So instead of requiring electricity generators to have credits for all their emissions, they'd only require them for emissions above a 'best practice' baseline. That baseline would be progressively tightened, so rather than an immediate big electricity price rise, you get a gradual rise. As a result you get less revenue from auctioning permits but you also spend less compensating households and businesses for higher electricity prices. You also reduce the incentive for consumers to save electricity, but the report reckons this won't make much difference because consumers can only respond slowly to electricity price rises anyway: people won't go out and buy LED downlights and turn applicances off standby overnight.

All this is fine as far as it goes, but where do the massively higher emissions reductions at a massively lower cost come from? And the report's 86 pages are pretty hazy on this.

It's not because these tweaks makes it cheaper for firms and households to reduce emissions - rather, according to the report, it's "mostly due to a reduction in the economic distortions arising from the Government's revenue churning" when the CPRS means higher electricity prices, compensated for by other measures (eg, lower income tax). If you reduce the impact on electricity prices, much of that compensation isn't needed.

Well colour me sceptical. Nowhere could I see in the report an explanation of how collecting revenue from permits and using that revenue to reduce other taxes and increase welfare payments costs 1.5 times as much as keeping electricity prices low and collecting the revenue from existing sources instead. Why exactly is taxing electricity so wildly inefficient but taxing incomes just fine?

And how does shielding electricity from the full effects of the scheme allow us to double our target? Well, again, the report hints at this without really explaining it. What the report says is that international carbon trading means that the carbon price in Australia is the same regardless of our domestic target. We're a small country - we don't affect the international carbon price. Fair enough.

So, just to pick a round number out of the air, assume we emit a billion tonnes of carbon a year and the government wants to reduce that by 5% (down to 950 million tonnes). Assume also that the international carbon price is $20 a tonne and we can trade internationally.

So the government issues a 950 million permits. Let's say the government gives half of them away to industry and auctions or sells the other half at the international carbon price of $20. Each firm will reduce emissions where that will cost them less than $20 a tonne and will buy permits at $20 for emissions that it would cost them more than $20 a tonne to reduce. The government gets nothing for the half it gives away and gets $9.5 billion from the half it sells / auctions (475 million @ $20). Industry pays $9.5 billion plus the costs of reducing emissions that are cheaper than $20 a tonne to reduce.

Now, suggests Frontier, assume we double the target for reducing emissions from 5% to 10%. So instead of issuing 950 million permits, the government issues only 900 million. But the international carbon price stays the same, since Australia's decisions don't affect it. Now, each firm will still reduce emissions where that will cost them less than $20 a tonne and will buy permits at $20 for emissions that it would cost them more than $20 a tonne to reduce. So the cost to each firm is still the same. But now since the Australian government has issues fewer permits, it gets less revenue and indsutry buys them instead, at the same price, from overseas. The government now gives half away and sells the other half for $9 billion. Industry pays $9 billion to the government, $500 million for overseas permits and still pays the same to reduce emissions.

In effect, Australia's decision to lower its target is just the decision of a small supplier on a world market to supply less of a commodity - the world price doesn't change, the supplier just makes less money and other suppliers make more.

All this is fine, but the result is that the government gets $500 million less in revenue and that money instead goes overseas. That's $500 million less that the government has to cushion the financial impact of the CPRS on households and businesses. Frontier's report accepts that but says it doesn't matter: "This effectively represents a transfer from the Government to international markets, though in practice the magnitude of this transfer will be relatively small (see discussion later)". Unfortunately, there's no discussion later that I could find and I don't see why this should be small at all. In fact the transfer represents the total of any shift in the target multiplied by the carbon price. In other words, the government pays 100% of the cost of meeting any additional target by buying foreign permits.

Frontier does not explain the following, and to me it just doesn't seem explainable: Why does a reduction in emissions of 5%, spread over a range of industries, sectors, government and households, and with each of these groups making adjustments to the way they do things that reduce the costs they face, impose a huge burden on the economy - while reductions of a further 5% paid for completely by government buying permit, impose costs of a "relatively small" magnitude. It just doesn't make sense.

Now maybe I've missed something here but I've read the report and I'm still very unsure of how Frontier's proposed tweaks to the CPRS save money or allow for increased targets.

For the opposition to present this as an alternative to the CPRS strikes me as another big non-contribution by the opposition toe the climate debate.

Elsewhere: Joshua Gans (and more from Joshua), Peter Wood, Harry Clarke, Robert Merkel, Ben Eltham.

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