Carbon pricing after Paris

How far and fast are carbon prices spreading? To Australian observers the question may seem absurd.  Here the question may be more “exactly how dead is carbon pricing?”.

But in the many discussions at the recent Paris climate conference between businesses, experts, and officials, carbon pricing was one of the hottest subjects. Why?

Carbon pricing, for reference, is an approach to reducing greenhouse gas emissions that is an alternative to traditional regulations or subsidies.  Instead of specifying who must do what or guessing who deserves cash, this approach puts a price on emissions and lets the market work out where cuts and lower-emissions options are worthwhile in response. It has been deeply controversial in Australia, particularly over the potential impact of higher prices on jobs and competitiveness.

The Paris Agreement itself doesn’t have much to say on carbon pricing. It gives countries wide latitude to use market and non-market policies to meet their emissions reduction commitments, and provides for some very important rules to allow and regulate international emissions trading. For more detail, see our blog post on the Agreement – or the full text of the Agreement itself.

Ultimately how each country meets their self-assigned targets is up to them. And many – though far from all – are using some form of carbon price as a major tool. There is a lot of variety, and some of these schemes don’t look much like the models pursued by the Rudd-Gillard-Rudd Governments.

There are also some common features that are of great importance to industry, however. So who’s doing what?

Several major economies have or are building Emissions Trading Schemes (ETS), where major emitters of greenhouse gases must hold a permit for each tonne emitted – and the number of permits sold or issued by the system declines over time.

These schemes are sometimes called ‘cap and trade’ because emissions are capped and holders of permits can trade them to reduce costs and increase flexibility. Many have caps that have turned out to be looser than anticipated, leading to weak demand and low prices:

  • The European Union has had an ETS in several tumultuous phases since 2005 and is reforming it to avoid a repeat of the huge backlog of permits that sapped prices after the Global Financial Crisis crunched Europe’s expected growth.
  • China has operated numerous regional ETS pilots over the last several years and is preparing to bring in a national scheme from 2017. They put great stress on learning from Europe’s experience.
  • In North America, California and Quebec have linked their schemes and expect to be joined by Ontario and Manitoba. The nine-state RGGI scheme covers the Northeastern United States and is exploring linkage to the California-led alliance. At the national level, the United States is pursuing a controversial regulatory approach through the EPA, though states can opt to comply through an ETS instead.
  • South Korea’s ETS started in 2015, though in the face of litigation and industry concern at tight caps it is being retooled.
  • New Zealand has had an ETS operating since 2010.
  • Kazakhstan has had an ETS since 2013, though it recently suspended it for two years to allow legislative flaws to be corrected.

Some countries apply carbon taxes, where emissions attract a set price that may rise over time. These are sometimes applied alongside an ETS, covering additional sectors:

  • Several European countries have carbon taxes, often high ones, on emissions outside the EU ETS. They include Denmark, Finland, Ireland, the Netherlands, Norway, Slovenia, Sweden, Switzerland, and the United Kingdom.
  • British Columbia applies a high broad-based carbon tax, though the level is frozen until at least 2018.
  • Japan has a small carbon tax on fossil fuels.
  • Mexico introduced a modest carbon tax in 2014 covering all fuels more emissions-intensive than natural gas.
  • Chile has legislated for a carbon tax to commence in 2017.
  • South Africa is developing a carbon tax to commence in 2017.

And some countries pursue other harder-to-categorise approaches that introduce a form of carbon price. For instance, India applies a mandatory energy efficiency trading scheme, Perform Achieve Trade, to energy-intensive heavy industry, as well as a small but growing coal tax.

Perhaps surprisingly, Australia may fit into this category too. Australia’s Direct Action policies include a reverse auction system for public purchases of abatement, and a Safeguard Mechanism that penalises emitters who exceed baselines unless they acquire offsets from the private market. Both have the effect of establishing a form of carbon price, though with a shape and incidence very different to that under the former Australian carbon tax. This ‘baseline and credit’ approach may develop further.

While many countries are not looking to markets or prices to achieve their climate commitments, we are likely to see further announcements from some of the participants in the World Bank’s Partnership for Market Readiness:  Brazil, Chile, China, Colombia, Costa Rica, India, Indonesia, Jordan, Mexico, Morocco, Peru, South Africa, Thailand, Tunisia, Turkey, Ukraine and Vietnam.

Three points are worth taking away from this proliferation of schemes:

  • First, many countries are using price mechanisms – whether markets, taxes or more exotic designs – as a key tool to reduce emissions at least cost.
  • Second, design matters. A lot. Nearly every scheme has had problems that need careful attention, often from poorly set caps or inflexible rules. Detailed design issues are going to be much more important than abstract theories.
  • Thirdly, competitiveness matters. Every carbon pricing scheme to date has been designed with industry competitiveness in mind. They all include either substantial free permit allocation to trade-exposed industry, or high baselines or tax-free thresholds, or set the overall price at a modest level for everyone. These are policies intended to lower emissions without weakening trade-exposed businesses.

Each of these lessons should be front of mind when the next Australian Government considers how to evolve its climate policies to achieve our substantial emissions commitments.

Do you see a future for carbon pricing in Australia? Design matters a lot – so what is your preferred model? Please add your comments below and start an important conversation!

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Tennant is Principal National Adviser – Public Policy at Ai Group. He has worked heavily on climate and energy issues, advising Ai Group’s Leaders’ Group on Energy and Climate Policy and developing reports on natural gas supply, energy prices and energy efficiency. He also works on a range of issues related to manufacturing and innovation. Previously he was an adviser in the Department of Prime Minister and Cabinet, working on fiscal policy, stimulus and infrastructure.

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