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Focus: Garnaut releases Final Report on carbon price scheme

3 June 2011

In brief: The Federal Government's key climate change adviser, Professor Ross Garnaut, has released the Final Report of his updated advice on the design of a new carbon price scheme. It provides new and more detailed recommendations on governance and compensation arrangements for the scheme, but also raises difficult questions about how the scheme will switch from a rising fixed carbon price to a full cap-and-trade scheme. Partner Grant Anderson and Lawyer Fergus Green report.

How does it affect you?

  • The Final Report of the Garnaut Climate Change Review provides new details on the governance and compensation arrangements that Professor Garnaut recommends should be reflected in the Federal Government's proposed carbon pricing scheme.
  • The proposed governance arrangements would particularly affect the means by which the proposed scheme transitions from its initial rising fixed price phase to a floating price (cap-and-trade). Professor Garnaut thinks this transition should occur by 2015, but the basis for deciding to proceed with that transition, and the allocation of the power to make that decision and to set the necessary targets, are likely to be contentious issues.
  • If adopted, the more limited compensation arrangements Professor Garnaut proposes for emissions-intensive trade-exposed industries will result in those industries receiving considerably less assistance than under the Rudd Labor Government's proposed Carbon Pollution Reduction Scheme. Professor Garnaut has reiterated his view that there is no basis for providing compensation to coal-fired electricity generators for the reduction in asset values that will occur with the imposition of a carbon price.

Background

In November 2010, Professor Ross Garnaut was commissioned by the Minister for Climate Change and Energy Efficiency, Mr Greg Combet, to update his 2008 climate change review. This update has taken the form of a series of eight Update Papers released during February and March 2011, culminating in a Final Report that was presented to the Federal Government and publicly released on 31 May 2011. In an earlier Focus article, we summarised the principal findings and recommendations of the eight Update Papers. The Final Report reflects the principal findings and recommendations contained in these Update Papers, and so this Focus will summarise the additional details and recommendations contained in the Final Report.

At the time Professor Garnaut's Update was commissioned, the Government also announced the establishment of the Multi-Party Climate Change Committee (the MPCCC), the purpose of which is to explore options for the introduction of an Australian carbon price. The MPCCC, which has met regularly since October 2010, is chaired by the Prime Minister and comprises three Government members, two Australian Greens members and two independent Members of Parliament, Tony Windsor and Rob Oakeshott. Professor Garnaut is one of the four independent expert advisers to the Committee, and it was envisaged that his Update Papers and Final Report would be an important input into the Committee's deliberations.

On 24 February 2011 — in between the release of the third and fourth Garnaut Update Papers — the Government announced the 'broad architecture' for a new carbon pricing scheme in Australia that would require all major greenhouse gas-emitting sectors of the economy (except agriculture) to acquire and surrender carbon permits (and therefore pay a carbon price) for their emissions from as early as 1 July 2012. Under this proposal, the scheme will operate in two phases: a rising fixed price phase (effectively an indexed carbon tax) during which an unlimited quantity of carbon permits will be available for purchase from the Government at an indexed fixed price, and a floating price phase (an emissions trading scheme) during which the price for carbon permits is determined by the market, consequent upon the imposition of annual emissions caps that limit the number of carbon permits issued by the Government. It is intended that the fixed price phase would end, and the floating price phase would begin, three to five years after the commencement of the scheme, but the switch could be deferred if a review of international developments revealed a lack of movement towards a global regime of emissions targets and insufficient opportunities for international trade in carbon permits.

Since the release of this broad architecture, the MPCCC has been negotiating further key policy elements of the scheme. It is the Government's desire to reach political agreement on the scheme during July and to introduce implementing legislation into Parliament in the second half of 2011. The recommendations of Professor Garnaut's Final Report will be an important consideration in the MPCCC negotiations.

Governance arrangements and the switch from a fixed to a floating price scheme

The Final Report includes a supplementary note on governance arrangements for the new scheme that brings together discussions of the institutions and other scheme elements recommended in various Update Papers. Professor Garnaut sees the governance arrangements as particularly important because independent, strong, effective and well-resourced governance arrangements are necessary to avoid policy capture by vested interests.

In his Update Papers, Professor Garnaut recommended that the following institutions be established to govern the new scheme:

  • an Independent Committee to advise the Government on national emissions targets, scheme caps, the switch to a floating price, linkage with other schemes and expansions in the scheme's coverage (eg to agriculture);
  • an independent agency to advise (on an ongoing basis) on the level of compensation for emissions-intensive trade-exposed (EITE) industries, that would operate similarly to, or be a new part of, the Productivity Commission;
  • an independent Carbon Bank to administer the scheme (eg to monitor and enforce compliance, issue permits that are provided by way of transitional assistance, manage the permit registry and trading platform, and conduct permit auctions during, and in advance of,1 the floating price phase);
  • an Energy Security Council to implement measures to counter energy market instability (including in the contracts market) and to provide limited guarantees for high emissions intensity electricity generators; and
  • a Low Emissions Innovation Council to allocate funding for the research, development and commercialisation of low emissions technology.

Of particular note in the Final Report is Professor Garnaut's elaboration of his proposal for the first of these bodies, the Independent Committee.

Professor Garnaut recommends that the committee be established as an independent advisory panel with two primary functions:

  • to conduct regular reviews and assessments of the scheme's operation, of Australia's progress toward its emissions reduction targets, and of progress on international climate change action; and
  • to advise the Government on the timing of the switch to the floating price phase, national emissions targets, scheme caps and scheme coverage. While Professor Garnaut envisages the Government would retain the final authority to determine these matters, he recommends that it be required to accept or reject the Independent Committee's recommendations within 60 days and, if it chooses to reject a recommendation, be required to present to Parliament the reasons for this rejection and any alternative decision.

The processes by which Australia's medium-term (2020) emissions reduction target is to be set, and by which the decision to switch from the fixed to the floating price phase is to be made, will have a major bearing on the evolution, stringency and stability of the scheme. These issues have accordingly emerged as crucial points in the MPCCC negotiations.

While the 2020 target is directly relevant to the scheme's administration during the floating price phase (since it will dictate the annual scheme caps), the early establishment of a target will, even during the fixed price phase, raise the level of certainty about the scheme's longer-term orientation in a way that will promote investment in covered sectors, particularly in long-lived energy generation assets. An initial question the MPCCC must face is, therefore, whether the authorising legislation will include a 2020 target, or require the target to be provided later in regulations. On this point, Professor Garnaut recommends that the authorising legislation initially set Australia's 2020 emissions reductions target at a 5 per cent reduction below 2000 emissions levels, this being the target that currently has bipartisan support.2 However, for political reasons, neither the Government nor the Greens wants to settle on a 2020 target at this stage.

A further question concerns the timing and process by which the level of the 2020 emissions reduction target can be changed (or subsequently set, if one is not set initially). Professor Garnaut recommends that 'the Government' retain the power to alter the target, on the advice of the Independent Committee following the Committee's review of the scheme (the first review is proposed for 2014). But his report is ambiguous as to the branch of 'the Government' in which this power should reside: the Parliament or the Executive. Presumably, given his recommendation that the target initially be set in legislation, he thinks that the Parliament should have this power (since amending the original, legislated target would require further legislation).3

According to media reports this position is shared by the Greens, who will most likely hold the balance of power in the Senate until at least 1 July 2017, giving them some political leverage over the setting of the 2020 target (assuming that the Government and the Opposition cannot agree). By contrast, the Government is reportedly pushing for the target to be set out in regulations before the scheme switches to a floating price phase, ensuring that the Executive has the final say over any target (assuming that the Opposition and the Greens do not combine to disallow the regulations).

A related issue is the process for switching from the fixed to the floating price phase. Professor Garnaut recommends that this switch occur after three years (ie in mid-2015), 'unless it is judged by the Independent Committee, and agreed by the Government, that there are insufficient opportunities for international trade in entitlements to support a liquid and stable market for emissions permits'. In this case, the 'default' position, as provided in the initial scheme legislation, will be all-important. If the legislation provides for a default switch in 2015 (or 2016 or 2017, for that matter), then a decision to prolong the fixed price phase (eg if this is advised by the Independent Committee because of unsuitable international circumstances) will require a legislative amendment and therefore need the support of the Government of the day and the Greens in the Senate; if, on the other hand, the switch can only be triggered by executive action (eg through a ministerial determination), the Government of the day will have the final say over whether and when the switch occurs. The political dynamic will also be important because the switch to the floating price phase will need to be accompanied by the establishment of annual emissions caps, and these caps will need to be set by reference to medium-term emissions reduction targets (as to which, see above). The annual caps will play a significant role in setting the market price for carbon permits in the floating price phase, and so will influence the nature of the transition from the fixed price phase to the floating price phase (the trajectory of the fixed price during the fixed price phase is equally important in this respect).

The scheme's evolution will also be influenced by the precise formulation of the criteria on which any such Independent Committee must base its advice to Government as to the timing of the switch. The MPCCC in its February 'broad architecture' document suggested that that decision would be based on, among other things, international developments, including progress on a binding international agreement and associated targets, real and shadow carbon prices in other major economies, and opportunities for linking to other emissions trading schemes. As mentioned above, Professor Garnaut recommends that opportunities for international linking should be the primary criterion on which to base the decision about when to switch phases. The requirement for there to be liquid and deep international trade in carbon permits is necessary to enable participants in the Australian carbon price scheme to access cheaper emissions reductions overseas for the purpose of acquitting their scheme liabilities at minimum cost.

In this regard, Professor Garnaut's recommendation of a switch to emissions trading after only three years (implying that he believes sufficient linking opportunities will exist by then) sits oddly with his assessment of the evolution of international mitigation action on climate change. Before the Copenhagen meeting in 2009, it was widely assumed that international mitigation action would result from a 'top-down' model under which an international treaty imposed binding national emissions reduction targets that would 'add-up' to a global emissions reduction goal. An international regime of this nature would provide a firm basis for international trade in entitlements and associated scheme linkages. However, since Copenhagen, international mitigation action has become characterised by a 'bottom-up' model (as exemplified by the Copenhagen Accord, the Cancun Decisions, and the recent explicit repudiations of the Kyoto Protocol by Japan, Canada, Russia and the United States) under which countries make voluntary, non-binding emissions reduction pledges. As Professor Garnaut recognises, one of the issues with the bottom-up model is that the associated voluntary emissions reduction commitments 'provide a less firm foundation for international trade in entitlements'. While it is possible that regional emissions trading schemes could be developed and linked within such a framework, this would seem unlikely to occur for some time, let alone by Professor Garnaut's preferred switch date of 2015. In these circumstances, it seems likely that the fixed price phase will need to be extended well into the future.

Compensation arrangements

In his Final Report, Professor Garnaut sets out a recommended distribution of the revenue raised from the sale of carbon permits under the scheme over its first 10 years of operation. As a precursor to this, he identifies one of the disadvantages of 'direct action' schemes of the kind proposed by the Opposition as being that they do not raise any revenue which can be used to ease and facilitate the transition to a low-carbon economy.4

Professor Garnaut projects that an initial carbon price of $26/tCO2-e (he recommends that the initial carbon price should be set somewhere between $20 to $30/tCO2-e, rising by 4 per cent per annum in real terms) would generate some $11.5 billion in revenue in 2012-13. However, he notes that the annual revenue derived from the carbon price scheme will fall during the floating price phase if the scheme accepts internationally traded emissions reduction units (making lower-cost emissions reductions accessible to Australian scheme participants) and the caps are reduced to achieve a more stringent emissions reduction target (reducing the number of carbon permits issued by the Government).

Taking one of the MPCCC's agreed principles that the scheme should be revenue neutral, so that 100 per cent of scheme revenue is to be distributed, the Final Report sets out a proposed allocation of that revenue. Professor Garnaut recommends that the majority of scheme revenue be allocated to households – initially 55 per cent, rising to up to 65 per cent by 2021-22 – and that this should predominantly be distributed to lower-income households through reforms to personal income tax rates, most notably by raising the tax-free threshold from $6,000 to $25,000 (as recommended in the Henry Tax Review). Some of the household distributions would also be in the form of transfer payments, albeit a significantly less amount than under the Rudd Government's proposed Carbon Pollution Reduction Scheme (the CPRS), and a small portion would be allocated for energy efficiency upgrades to low-income households.

Under this proposed allocation, a further 30 per cent of the scheme revenue will initially be distributed (presumably in the form of free carbon permits)5 as assistance to EITE industries in 2012. This figure is estimated on the basis that the EITE assistance levels for the first three years of the scheme will be consistent with those provided under the CPRS, albeit without the global financial crisis buffer. However, EITE assistance would fall to 25 per cent of carbon price scheme revenue after three years (when Professor Garnaut thinks the floating price phase should commence) and to 20 per cent by 2020. This follows from Professor Garnaut's recommendation that this 'overly generous' assistance regime should be replaced with one that is based on principles defined by the proposed new 'Productivity Commission'-type independent agency created to monitor and review the EITE assistance program. Under this 'principled' approach, assistance would be provided to the extent that product prices would be higher if Australia's competitors faced similar carbon constraints to the EITE industries.6 In this regard, Professor Garnaut suggests that the resources sector (including LNG and coal) might have a lesser claim to assistance (compared with, say, the manufacturing, tourism and agriculture sectors), on the basis that the current resources boom is driving up the costs of other sectors as they compete with the resources sector for capital and labour.

For the electricity generation sector, Professor Garnaut recommends the provision of around $1 billion for short-term loan guarantees to the extent these are needed to ensure market stability in the event of financial distress of a major emissions-intensive generator. In another politically contentious recommendation, however, he suggests that there is no reason to provide any other kind of assistance to coal-fired generators.7 This is very much at odds with the previous CPRS arrangements, and is unlikely to be accepted by the Government.

According to Professor Garnaut, clean technology innovation should receive an initial allocation of 10 per cent of the scheme revenue, rising to 20 per cent by 2021-22, mostly in the form of grant funding for research and development and matched funding (or other benefits) for the commercialisation and deployment of marketable clean energy technologies. This is intended to equate to $2 billion to $3 billion per year over the first 10 years of the scheme, although some of this funding will be met through existing budget allocations for clean energy innovation.

Finally, Professor Garnaut recommends allocating 5 per cent of scheme revenue to purchasing non-Kyoto compliant land sector and agricultural abatement credits generated under the Government's proposed Carbon Farming Initiative, rising to 15 per cent by 2021-22. This is intended to create demand for such credits and therefore underpin a price for them that will encourage investment in abatement of this kind.

Next steps

At the same time as the Garnaut Final Report was released, the Productivity Commission presented to the Government its report on its analysis of Emission Reduction Policies and Carbon Prices in Key Economies. This report is another key input into the MPCCC policy deliberations and is expected to be released publicly in the first half of June. While the Government wants to introduce legislation establishing the scheme into Parliament in September 2011, this would seem to be an extremely ambitious timeframe and will, in any event, depend very much on the progress of the MPCCC in resolving key policy elements concerning the carbon price scheme.

Footnotes
  1. In light of the Opposition's policy that it will repeal the carbon price legislation if it wins government, Professor Garnaut recommends that the holders of carbon permits auctioned in anticipation of the floating price phase should be entitled to compensation if the carbon price scheme is repealed before the occurrence of the vintage year of those permits.
  2. Professor Garnaut has suggested that the conditions have already been satisfied for Australia to adopt a 2020 emissions reduction target of between 10 and 16 per cent below 2000 levels.
  3. Professor Garnaut recommends that changes to Australia's emissions reduction targets and scheme caps should only be able to be made with five years' notice.
  4. His most trenchant criticism of such schemes, however, is that they entrench the 'old political culture' under which government funds are provided to those who are most effective in lobbying for them.
  5. It has yet to be revealed how the provision of EITE assistance in the form of free carbon permits will be of value to recipients who do not themselves require those permits to acquit scheme obligations but wish to liquidate them to obtain cash. During the fixed price phase, there would seem to be limited scope for trading such permits, as carbon permits will be available in an unlimited amount from the Government at the applicable fixed price.
  6. Professor Garnaut recommends that the Government would have 60 days to act on the recommendations of the independent agency and, if it adopts a different approach, that the Government would be required to provide reasons to Parliament.
  7. This is not to be confused with the provision of structural adjustment assistance to workers and communities in, say, coal-based emissions intensive power generation regions. Professor Garnaut recommends that $1 billion over the first four years of the scheme be set aside for this kind of assistance.

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