I am back home in Australia this week and by chance arrived on the day that the government announced its formal intention to implement a carbon price across the economy. This wasn’t exactly a surprise, given the issue is under review and a number of consultation processes between government and civil society, including business, are underway. At this early stage the outline is sketchy, but the scope is broadly as follows:

  • Starts on July 1st 2012
  • Will likely be allowance based – i.e. buy fixed price allowances from the Government for emissions compliance. This structure is important in that it then establishes the infrastructure for a later transition to cap-and-trade.
  • Transitions to a cap-and-trade in 3-5 years, but with an option to defer.
  • Will be a fixed price during this period, but rising on an annual basis. 
  • Wide coverage of the economy – but precise coverage wasn’t announced.
  • No international linkage during the fixed price period – i.e. this rules out the use of the CDM or similar instruments.
  • There is no indication of the price, although the Green party (which the government needs for passage in the Senate) wants to see it high enough to start to trigger change in the power sector where coal is the principal means of generation.

The announcement was widely covered, such is the very high profile of climate change and related legislation in Australia. Over the past 10 years the country has seen the worst drought, the worst flooding and highest temperatures in its short recorded history (about 120-150 years of records depending on the region). Many of these phenomena, including the recent severe floods, are part of natural cycles that Australia has always seen, but the severity is showing signs of change. The news media in all its forms from print and television to blogs featured the story as headline news and the Federal Opposition promptly accused the government of “the ultimate betrayal” given promises not to implement a carbon tax in the recent elections. The issue will likely be debated vigorously and that started in the weekend editions of various media outlets as the government began to defend its change of position.

While there will doubtless be many political battle lines drawn on this issue, the real discussion will likely be with Australian industry. Australia is a resource rich economy and much of which is drilled for, mined and grown is exported into the global commodity market where price is established based on global supply, demand and cost structure. As was the case when a full emissions trading system was under discussion in Australia, resource exporters remain nervous about the impact of the carbon price on their competitiveness, given that they cannot be sure of cost recovery through the international markets. In addition, as the scale of production for domestic use of certain products is relatively small when compared with the global picture, there is also nervousness that additional costs will tip the balance towards imports, thus undermining local capacity. Both of these issues were at the heart of the call for some portion of free allowance allocation in the CPRS (Carbon Pollution Reduction Scheme) discussion and they will certainly appear again as a call for price rebates under the proposed approach.

Key to this discussion will be determining the basis on which rebates might be given and then how the rebate could be structured so as to at least maintain the carbon price signal. The mechanism for determining trade exposure requires careful inspection of the prevailing market conditions – in the EU this was carried out by the Commission prior to their release of a list of trade exposed sectors which would then receive some portion of their allowances for free in Phase III of the ETS. In Australia, a similar analysis was performed for the CPRS so that work may well be valid.

In terms of the structure of the rebate itself, as long as it is based on historical emissions or a benchmark, the incentive at the margin to abate remains regardless of how big the rebate is. This is also how the free allowance allocation works in a cap and trade system (benchmarks are applied in the EU-ETS) and it can essentially be replicated under a carbon tax.

In a coal based economy such as Australia, a carbon price is potentially a powerful mechanism to drive the change to a lower carbon economy. It can trigger responses such as the implementation of CCS, the increased use of domestic natural gas for power generation or the development of newer technologies such as concentrated solar. Such choices cannot be easily made by dictate, rather they require the long term market signal that a carbon price gives for the most cost effective solution to develop.