Focus: Garnaut update papers
31 March 2011
In brief: The Federal Government's expert climate change adviser, Professor Ross Garnaut, has now released the last of his papers updating his 2008 climate change review. Partner Grant Anderson reports on the principal findings and recommendations of the update papers, which will be influential in the development of the Government's carbon pricing mechanism.
- Australia's emissions profile
- Why should Australia act?
- What is the appropriate carbon price mechanism for Australia?
- Transitional assistance
- Electricity sector
- Land use
How does it affect you?
- The Garnaut Climate Change Review update papers contain a number of recommendations that affect the application of the Federal Government's proposed carbon pricing mechanism to emissions-intensive trade-exposed industries, the electricity sector (including coal-fired electricity generators) and the land use sector.
- The update papers also contain recommendations about some of the detail required to establish the carbon pricing mechanism, including the initial fixed carbon price and carbon price trajectory.
- Industry participants who are likely to be affected by the carbon pricing mechanism should be aware of these proposals so that they can make submissions to the Government as it develops its carbon pricing mechanism.
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, and will culminate in a final report to be presented to the Federal Government by 31 May 2011. It is expected that these update papers and the final report will be an important input into the deliberations of the Multi-Party Climate Change Committee. This committee has been established for the purpose of exploring options for the introduction of an Australian carbon price, and is chaired by the Prime Minister. It comprises three Government members, two Australian Greens members and two independent members of Parliament. Professor Garnaut is one of the four independent expert advisers to the committee. The principal findings and recommendations of the update papers are described below.
Under a business-as-usual scenario (ie in the absence of effective climate change mitigation action), global greenhouse gas emissions will double between 2005 and 2030 (growing at 2.8 per cent per annum), with developing countries accounting for about 70 per cent of 2030 emissions (China: 41 per cent; India: 11 per cent; others: 19 per cent), and developed countries' emissions remaining at 2005 levels. Going against the trend for most other developed countries, Australia's emissions are expected to increase to 24 per cent above 2000 levels by 2020, with fugitive emissions from coal mining and oil and gas extraction, as well as direct fuel combustion emissions from LNG projects, accounting for almost half of that growth.1
The overwhelming weight of authoritative scientific opinion is that anthropogenic (human-induced) emissions of greenhouse gases are the primary cause of the statistically significant warming trend that has been observed since the industrial revolution. Given the potentially serious consequences if global average temperatures increase by 2°C or more above pre-industrial levels, it is in Australia's national interest that global greenhouse gas concentrations are limited to 450 parts per million.2
Although Australia's contribution to global emissions is relatively small (around 1 per cent), as the highest per capita developed country emitter (around 27 tCO2-epa per person), the failure of Australia to commit to a significant reduction in its emissions would 'go a long way towards ensuring there would be no effective global action'.3 Yet Australia is one of the countries that has the most to gain from the development of an effective international climate change agreement:
- the resultant trade in international emissions entitlements will give Australia access to the lower cost mitigation opportunities overseas that are necessary to enable it to cost-effectively meet international expectations that it will make an emission abatement contribution that is proportionate to its emissions responsibility (in per capita terms);
- because it is already subject to climate extremes and is proximate to developing countries that are particularly vulnerable to the adverse effects of climate change, unmitigated climate change will have a serious impact on Australia's economy, environment and society; and
- Australia stands to benefit economically from a future low-carbon global economy – while Australia is currently heavily dependent on fossil fuels, it has significant renewable energy resources (uranium oxide, solar, wind and waves/tides) as well as extensive natural and coal-bed gas reserves.4
In the absence of an effective international agreement to restrict global greenhouse gas concentrations to an acceptable level, which would include provision for international trade in emissions entitlements, Professor Garnaut considers it to be appropriate to commence with a fixed price scheme (ie an emissions trading scheme in which liable entities are able to purchase an unlimited number of permits from the Federal Government at a fixed price per permit). The advantages of such a fixed price scheme are that it:
- provides some certainty in circumstances where the first few years of the scheme are otherwise likely to be characterised by considerable price volatility while the scheme is bedded down;
- allows liable entities to become familiar with compliance under the scheme;
- allows the building and testing of industry capacity and administrative infrastructure; and
- provides a pathway for moving from a price constraint to a quantity constraint under a market-based cap and trade scheme.
Indeed, the Federal Government's proposed carbon pricing mechanism provides for just such an interim fixed price scheme. For this purpose, Professor Garnaut recommends an initial permit price of A$20 to A$30 per tCO2-e, rising by 4 per cent per annum in real terms.5 However, this recommendation will be just one input into the Government's consideration of the appropriate starting carbon price and carbon price trajectory, with another important input being the Productivity Commission's report (due by the end of May 2011) on the effective carbon prices faced by the electricity generation and transport sectors in Australia, the United Kingdom, the United States of America, Germany, New Zealand, China, India, Japan and South Korea.6 In this regard it is noted that a previous study has suggested that the implied carbon price faced by Australia's electricity sector is relatively low, at US$1.70, compared with the United Kingdom (US$29.30), China (US$14.20) and the United States of America (US$5.10).7
It is only once international trade in emissions entitlements has developed, thereby providing Australia with access to lower cost overseas emissions reductions, that Professor Garnaut proposes there should be a transition from a fixed price scheme to a floating price scheme (for this purpose, he suggests a target date in the middle of 2015).8 Again, this is reasonably consistent with the Federal Government's proposed carbon pricing mechanism. In preparation for this transition, and so as to encourage the development of a forward price curve and forward physical market, Professor Garnaut suggests that an amount of undated permits, equivalent to 5 to 10 per cent of each year's volume of carbon permits, should be auctioned for use after the expiry of the fixed price phase, with such auctions to be held from the beginning of the fixed price phase.9 Forward trading would be expected to reduce the volatility of the carbon price when the scheme transitions from the fixed price phase to the floating price phase. However, Professor Garnaut opposes the imposition of any permit price floor or ceiling that might otherwise 'collar' carbon price fluctuations during or after the transition.10
A recommendation that is likely to cause some political angst is that, consistently with the 2008 Garnaut Climate Change Review, Professor Garnaut reiterates his support for the scheme to be administered by an independent institution (akin to the Reserve Bank of Australia or the UK Independent Committee on Climate Change), which would also advise the Government on Australia's emission reduction targets and annual carbon budgets.11
One of the most publicised aspects of the Garnaut update papers has been their support for using much of the revenue raised from permit sales12 to remove distorting taxes on households (as well as firms) and to offset the regressive income effects of a carbon price on income distribution – this has entwined the carbon pricing debate with the broader debate about reform of Australia's tax system. Professor Garnaut recommends such tax reform as the best means of delivering compensation to lower and middle income households. He proposes that the remaining revenue should be used to provide transitional assistance to emissions-intensive trade-exposed industries and to regions that are vulnerable to large-scale unemployment as a result of the implementation of a carbon price (eg coal-based regions), as well as to support innovation in low-emissions technologies.13 In so far as the increase in petrol prices consequent on the introduction of a carbon price is concerned, Professor Garnaut proposes that there should be a one-off compensatory reduction in petrol excise that is funded through reforming the fringe benefits tax arrangements relating to private vehicle use.14 Whether petrol should be included in the carbon pricing mechanism (the position taken by Professor Garnaut) or excluded from it is a highly politically charged issue.
Emissions-intensive trade-exposed industries
While criticising the Federal Government's previously proposed transitional assistance arrangements for emissions-intensive trade-exposed industries as 'arbitrary and approximate',15 Professor Garnaut acknowledges that these arrangements (which provided for an initial level of assistance of 60 per cent for moderately emissions intensive industries and 90 per cent for highly emissions intensive industries) have gained broad acceptance and so should apply for the first three years of the carbon pricing mechanism (subject to the removal of the global recession buffer). However, he has recommended that these assistance arrangements should then be revised, so that assistance is based on the gap between the world product prices for the relevant industries that are expected with a global carbon price and those that are expected with only an Australian carbon price (this assistance would also be subject to materiality threshold). In Professor Garnaut's view, this approach has the advantage of automatically reducing assistance as the rest of the world imposes carbon constraints, thereby delivering a strong price signal to such industries while still protecting Australia from 'carbon leakage'.16 On the other hand, it is likely that the administration of a scheme of this kind will be quite complex and it remains to be seen whether this recommendation is discarded for reasons of practicality.
Coal-fired electricity generation
In contrast to his position on transitional assistance for emissions-intensive trade-exposed industries, Professor Garnaut has maintained his opposition to assistance for coal-fired electricity generators, whose profits and asset values will be adversely impacted by a carbon price:
Any fall in asset value stemming from the internalisation of the carbon externality (through pricing carbon) creates no greater case for compensation than other government reforms to reduce other externalities, such as the introduction of measures to discourage smoking or control the use of asbestos, lead in petrol or tighter safety or general environmental requirements.17
In Professor Garnaut's view, the national electricity market is sufficiently flexible to address any risk to physical energy security as a result of the possible closure of high-emission power generators. To the extent there is unmet demand, wholesale electricity prices will rise sufficiently to forestall the withdrawal of that capacity (even if that means that previously base-load generators will then be operating on an intermittent basis). Professor Garnaut's greater concern is with the potential for instability in the contract (financial) market. For this purpose he supports the establishment of an Energy Security Council that will have the authority to intervene, as a last resort, to stabilise this market by providing generators with a short-term (seven-year) guarantee for, say, 75 per cent of their debt as at 1 January 2011. Such a guarantee would be able to be requested during a period of two years, starting before the introduction of the carbon pricing mechanism, so as to ensure that it is clearly directed at reducing the risk of generator insolvency associated with any loss of lender confidence due to the imposition of a carbon price. The guarantee would come at a price that would increase over time (25 basis points per annum) to encourage a subsequent transition to private sector finance.18
There will be much detail that needs to be worked out for this scheme to be implemented, including the relationship between the guaranteeing government and the guaranteed generator's other creditors (whose financing arrangements may well extend beyond the relevant generation plant). However, Professor Garnaut considers such an arrangement to be preferable to the government simply paying emissions-intensive generators to shut down, as this would lead to higher electricity prices following the withdrawal of their capacity from the market.
Because the development of low-emissions technologies will lower the cost of Australia's transformation from a high-carbon economy to a low-carbon economy, Professor Garnaut identifies government as having an important role to play in funding the research, development and commercialisation of such technologies where private expenditure is likely to be insufficient (particularly during the fixed price phase and for so long as there is uncertainty around the future of the carbon pricing mechanism). In particular, Professor Garnaut recommends additional funding for basic research in low-emissions technologies (including through matching grants and a premium on the proposed research and development tax incentive) and up-front matching grants for the demonstration and commercialisation of low-emissions technologies. Such funding would be administered by an independent Low-Emissions Innovation Council (modelled on the National Health and Medical Research Council) and would double over the next five years to around $2.5 billion per year (where it would remain constant for about five years, following which the need for such funding is expected to decline).19
Professor Garnaut also notes that, in part due to global financial crisis stimulus packages that have been focused on low-emissions technologies, the cost of many of these technologies has decreased, with the exception being carbon capture and storage.20 This should reduce the cost of Australia's mitigation effort.
Clearly aware that the imposition of a carbon price is much more politically sensitive in an environment where there have been recent substantial network-driven increases in retail electricity prices,21 Professor Garnaut devotes considerable space to identifying potential inefficiencies in the regulation of electricity transmission and distribution networks in the national electricity market. He singles out for special attention:22
- the lack of a seamless east coast transmission network, suggesting that responsibility for all national electricity market transmission planning should be removed from the existing transmission network service providers and centralised in the National Transmission Planner, that the costs of interstate transmission should be recovered nationally, and that national transmission reliability standards should replace the existing 'conservative' state-based standards;
- the 'excessive' regulated rates of return allowed to transmission and distribution network service providers (particularly government-owned network service providers who face lower borrowing costs and enjoy relatively more favourable tax arrangements), which have led to over-investment in transmission and distribution networks;
- the availability of merits-based review arrangements for electricity transmission and distribution price determinations that provide an incentive for network service providers to 'cherry pick' for review particular issues that arise from these determinations, rather than expose the regulated entities to the risk of the determination being entirely re-opened; and
- the failure to fully reward distributed generation (eg for avoiding network expenditure where the generator services peak demand).
It must be said that, unlike other parts of the Garnaut update papers, these observations do not seem to be backed up by any convincing or rigorous analysis, and they have certainly attracted robust criticism from the electricity industry.23 Professor Garnaut also strongly advocates the lifting of retail price caps where competition is effective, the roll-out of smart meters coupled with the introduction of time-of-use tariffs, and government funding for smart grid innovations.24 In addition, he identifies a need for government assistance (funding, energy audits and education) directed at low income households to encourage the adoption of energy efficient appliances and measures.25
Agriculture, forestry and land use contribute around 20 per cent of Australia's total greenhouse gas emissions. However, due to the administrative challenges in imposing liability for agricultural emissions (there are a large number of small entities responsible for these emissions), it is widely recognised that it is not feasible to cover these under an emissions trading scheme; at least, not immediately. While Professor Garnaut advocates that forestry should be covered from the outset of the carbon pricing mechanism, albeit on a voluntary basis, he sees the Carbon Farming Initiative as a valuable interim measure to incentivise emissions reductions and sequestration in the land use sector until those emissions are covered by the carbon pricing mechanism. Legislation to implement the Carbon Farming Initiative is currently before the Federal Parliament and will be the subject of a separate Focus article in due course. However, at this stage it is worth noting two matters.
The first is that the Federal Government has obviously heeded Professor Garnaut's recommendation that 'financial additionality' should not be a prerequisite for a project to qualify under the Carbon Farming Initiative – that is, it will not be necessary to demonstrate that the project would not have been economically feasible in the absence of income generated by the carbon offsets.25
The second is Professor Garnaut's recommendation to link the Carbon Farming Initiative and any future carbon pricing mechanism by allowing:
- entities that are liable under the carbon pricing mechanism to purchase Kyoto-compliant offsets created under the Carbon Farming Initiative, with these offsets being able to be surrendered to meet their liability; and
- the carbon scheme regulator to purchase non Kyoto-compliant offsets created under the Carbon Farming Initiative, using a proportion of the revenue from the sale of carbon permits.27
However, Professor Garnaut also recognises that there needs to be a balance between these two elements. The unlimited ability to use Kyoto-compliant offsets to meet liabilities under the carbon pricing mechanism would reduce the number of permits required to be purchased from the Government and therefore reduce the revenue that the Government is able to raise from the sale of permits. This would put in jeopardy the 'budget neutral' funding of many of the initiatives that are proposed to be funded by permit revenue. Accordingly, Professor Garnaut proposes that:28
- liable entities under the carbon pricing mechanism only be permitted to use Kyoto-compliant offsets to meet 4 per cent of their liabilities in 2012, rising by 0.75 percentage points per year to 10 per cent in 2020; and
- the total permit revenue to be expended by the scheme regulator on purchasing non Kyoto-compliant offsets be limited to 2 per cent in 2012, rising by 0.25 percentage points per year to 4 per cent in 2020 – for so long as there is a fixed carbon price, the scheme regulator would only be able to purchase such offsets at the fixed carbon price (or, more specifically, at a small discount to it so as to account for the transaction costs associated with the sale of Kyoto-compliant offsets).
These limits would be removed upon full coverage of the land use sector under the carbon pricing mechanism.
If you would like further information in relation to the Garnaut Climate Change Review update papers or the Federal Government's proposed carbon pricing mechanism, or would like assistance in drafting submissions responding to them, please contact any of the people below.
- Third Update Paper, 'Global emissions trends', pp.23-24, 27.
- Fifth Update Paper, 'The science of climate change', pp.38-39.
- First Update Paper,' Weighing the costs and benefits of climate change action', p.24.
- Second Update Paper, 'Progress towards effective global action on climate change', pp.5, 8-9, 30.
- Sixth Update Paper, 'Carbon pricing and reducing Australia's emissions', pp.20-21.
- Such prices may be explicit (eg as is the case with carbon taxes and permit prices under an emissions trading scheme) or implicit (eg as is the case with the direct regulation of technologies, feed-in tariffs, renewable energy targets, subsidies for low-emissions technologies, taxes on fossil fuels, biofuel content standards for transport fuels, vehicle emission standards and energy efficiency measures). Note, however, that the Productivity Commission has warned that its study will not be able to estimate carbon-price equivalents but will only be able to identify whether the abatement being achieved under existing policies could be achieved at lower cost by alternative policies: see Productivity Commission, Emission Reduction Policies and Carbon Prices in Key Economies (March 2011), esp. p.25.
- Vivid Economics, 'The implicit price of carbon in the electricity sector of six major economies' (October 2010).
- Sixth Update Paper, pp.17, 21. This does not mean that global trade is a necessary precondition to this transition. A more likely precondition is the establishment of a regional trading partnership in the Asia Pacific region (eg with New Zealand and Indonesia): see Second Update Paper, p.31.
- Sixth Update Paper, p.22.
- Sixth Update Paper, p.24.
- Sixth Update Paper, p.22.
- Estimated to be as much as $11.8 billion per annum with a carbon price of $26 per tCO2-e: 'Millions win in carbon tax plan: Labor', The Sunday Age, 27 February 2011.
- Sixth Update Paper, p.26.
- Sixth Update Paper, p.28.
- Sixth Update Paper, p. 33.
- Sixth Update Paper, p.33.
- Sixth Update Paper, p.32.
- Eighth Update Paper, 'Transforming the electricity sector', pp.21-22, 23-24, 25-26, 27-28.
- Seventh Update Paper, 'Low emissions technology and the innovation challenge', pp.6, 13, 30-31, 41-43.
- Second Update Paper, pp.7, 26.
- The impact of a carbon price on household electricity bills is likely to account for only a small proportion of the increase in such bills due to non-carbon price related factors: 'Voters knew Labor stance on carbon price, says PM', The Saturday Age, 26 February 2011.
- Eighth Update Paper, pp.32, 34-35, 38, 41-45.
- 'Electricity industry dismisses Garnaut claims', The Australian Financial Review, 31 March 2011.
- Eighth Update Paper, pp.45-46.
- Eighth Update Paper, p.50.
- Fourth Update Paper, 'Transforming rural land use', p.15.
- Fourth Update Paper, p.15.
- Fourth Update Paper, pp.16-17; Sixth Update Paper, p.25.
- Chris SchulzConsultant,
Ph: +61 3 9613 8772
- Ben ZillmannPartner,
Ph: +61 7 3334 3538
- Bill McCrediePartner,
Ph: +61 7 3334 3049
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