July 05, 2012 - 9:28am
This piece originally appeared in the Australian Financial Review on 5 July 2012.
By Frank Jotzo, Director, Centre for Climate Economics and Policy, Australian National University, Crawford School of Public Policy, Erwin Jackson, Deputy CEO, The Climate Institute, Tony Wood, Program Director Energy, Grattan Institute and Cameron Hepburn is Senior Research Fellow, Grantham Institute, London School of Economics and Political Science
While the political noise around Australia’s carbon laws continues, we risk losing sight of the fact that a minimum carbon price floor guards against the policy becoming a toothless tiger in 2015.
The government, the Greens and Independents agreed to keep the domestic carbon price at or above fifteen dollars between 2015 and 2018 to provide some degree of confidence for industry to make low-carbon investments.
In the short-term this avoids the domestic effort being determined by the projected very low price of international offset credits.
Some in business have questioned the need for the price floor, in part, based on an argument that price floors are inappropriate interferences in markets. This is misleading. An emissions trading scheme is a policy tool created by government to achieve the objective of reducing emissions.
It is important to get the rules right to ensure the market works to meet its national interest objective of to start the transition to a lower carbon economy.
International credits from projects to reduce emissions in developing countries now trade at less than $5 per tonne because of oversupply and limits on demand from European buyers. We should not fool ourselves that those prices reflect efficient climate policy or the extent of global action. Nor do they reflect the true long-term value of reducing emissions.
Letting Australia’s carbon price fall to single digits would compromise incentives to make low-carbon investments, compound investment uncertainty in the energy sector and increase the long-term cost of reducing emissions.
There’s a strong economic case for keeping Australia’s domestic price above the fire-sale prices for international credits.
First, it reduces the costs of investments in curbing emissions.
The price of international offset credits has fluctuated between $4 and over $20 over the last three years. With a floor, predictability is increased as investors can bank on a guaranteed minimum carbon price. This matters for the economy.
Recent analysis by economists at AGL suggests that additional capital costs driven by investors hedging against carbon policy risk will unnecessarily cost $5 billion between 2015 and 2020 in the electricity sector alone.
Second, a price floor helps with long-run economic efficiency. Moving to a low-carbon economy is a marathon, not a sprint. Success requires setting policy that provides incentives for Australian firms to get going now.
With the possibility of a very low price, investments in low-carbon technologies will be delayed and sequestration projects in forestry and agriculture would be less viable.
A longer delay in making low-carbon investments will increase the economic costs of meeting longer term emission targets. If the price is too low, Australian investors will commit to long-term assets that are too emissions-intensive. To achieve emission reductions later on, much more will have to be spent.
Third, no major economy has directly coupled its domestic carbon price to the price in international carbon credit markets. The European Union places strict limits on the import of credits. Such quantity limits are the alternative to a price floor. For Australia, it would require a drastic reduction in the limit on international credits allowed into the scheme.
Australia’s floor price of $15 is not high by international standards. The UK’s price floor is around $25 a tonne in 2013 and is legislated to rise to $115 a tonne in 2030.
California’s price floor will be $11-12 a tonne in 2015 and will rise by 5 per cent per year.
Once global emissions markets have matured, there is no case for price constraints. At this current stage however, without a price floor or quantitative limits, Australia’s price would simply reflect the current excess of supply over demand in the international market.
Once global emissions markets are more developed, and linking between markets is likely, the advantages of full international integration may outweigh the arguments for floors and ceilings. In the meantime it is important to make sure that the Australian carbon price will be effective.