Reflections on pricing carbon in Australia and South Africa

A trip to Australia to look at their carbon pricing mechanism (CPM) and related institutions and initiatives prompted some reflections on what might be possible in South Africa.[1]  The CPM is the centre-piece of climate policy led by the Australian Department of Climate Change and Energy Efficiency (DCCEE).

Overall impressions

Before digging into the details, my overall impression: There is an impressive set of institutions and people in Australia, ready to implement the CPM, meet the renewable energy target (20% of electricity by 2020),  a range of demand-side measures and a carbon farming initiative.  All of these fall under the , and central to the Clean Energy Future plan. A wide range of people in the DCCEE, other departments (including Energy), regulators, authorities, commissions, businesses (both associations and individual companies) academics and NGOs are actively engaged.  Several times I found myself wishing we in SA could have, just for example, the enthusiastic and skilled staff of a Clean Energy Regulator, or the legislated reviews (including their timing) of a Climate Change Authority (which I understand to be primarily a review body, but one with some teeth).  The levels of awareness of climate change are also something to envy.  Managing the continuous tension between the Commonwealth federal government, and powerful state governments, is something we can perhaps do without – though we’ve had our own issues between national and local governments.

There is strong bi-partisan (across Labour and the opposition Coalition) for Australia’s international commitment to reduce GHG emissions by 5%-15% below 2000 levels by 2020, and for its renewable energy target. It’s more fuzzy when one talks of moving to 25% (the bottom of the IPCC’s AR4 range). What is clear is that Australia intends to achieve much of this by buying international units. One could say that Australia will take domestic action by pricing carbon, renewables, efficiency and reducing land-based emissions; but roughly twice as much internationally.

And yet, and yet, there are always two sides to the coin. The high climate awareness of the Australian electorate means the CPM is a good thing, in my view, in making climate an important policy issue, but the flip-side is that it is also  deeply political issue – and when it becomes party-political, that’s not good for climate action. I’ll explain what I mean in more detail below – but first some background on the two countries.

Background – similar and different

Part of my interest in going to Australia is that our energy economies are quite similar. Both have high shares of coal in energy in general and electricity supply in particular; energy-intensive industries use much of the electricity in both countries, with smelters and mining being common sector, indeed sometimes the same companies. This results in similar intensity of emissions – both across the entire economy and for electricity specifically.  Absolute annual greenhouse gas (GHG) emissions are at fairly similar levels – but then the differences start. Australia’s per capita emissions are significantly higher (given the smaller population) – not something a South African energy and climate researchers gets to say very often – ours being high by world and developing country standards. Australia’s economy is only somewhat larger, but its the average Australian earns an income (GDPppp / capita) that is  about 3.5 times higher than the average South African. Of course there is no such thing as the average SA’n, with our high inequality and large portion of the population in serious poverty. While energy is similar, Australia has found so much coal seam gas (what we’d call coal bed methane) that large investments are being export liquefied natural gas (LNG) to Asia; whereas SA is only just starting to consider the potential of LNG imports.  We make 30% of our liquid fuel from coal, which is the major source of process emissions, while Australia does no coal-to-liquids.

The carbon pricing mechanism (CPM)

A brief overview that the DCCEE staff presented divides the CPM into four phases: 1) a reporting and regulatory framework – NGERS National Greenhouse and Energy Reporting System, 2) a fixed price period ($23, $24.15; $25.40 in three years); 3) a flexible period with price ceiling and partial link to EU (but no price floor); and finally 4) a fully operational ETS and full linking to the EU. The mechanism covers 60% of Australian emissions (with some sectors covered for new emissions, but not legacy emissions). Facilities are liable if they emit 25 kt CO2-eq or more per year – or natural gas supplier.  There is a jobs and competitiveness programme (JCP) giving support to EITEs – primary metals; non-metallic minerals, pulp and paper, petroleum and coal, chemicals.  Also important is the Clean Energy Future package – this is a great overview to read for the CPM and associated measures –  the strapline suggests that “carbon price + renewable energy + energy efficiency + land use = clean energy future”.

Politics

The announcement of an election in September 2013 means that the CPM is a highly political issue, with the Coalition – of conservative opposition parties[2] – says it will repeal the carbon tax.  The spokesperson for the opposition Coalition, Greg Hunt, he expressed great determination to repeal the ‘carbon tax’ – and he says under any conditions. Apparently it is not so simple, needing majority in both houses – and at odds, at least for me, with a clear commitments to using economic instruments. Somehow the $10 billion Clean Energy Finance Corporation is ‘inefficient’, but Hunt propose an Emissions Reduction  Fund of his own, which for some reason will be efficient. When asked support for which renewables is inefficient, it seems to be solar PV, but then that’s part of his plan for “Direct Action as well. It seems inexplicable why a CPM is unacceptable, but it’s okay that “businesses that reduce emissions below their baseline … sell their CO2 abatement to the government”. I walked away with the impression of a highly intelligent person making an argument for purely political reasons  – to oppose a specific instrument of the Gillard government, because of previous campaigns promises and a perception that the carbon tax hurts the electorate. Rather than affirming certainty about the need to price carbon, the debate about the instrument has become a political football. Business in Australia seems to be taking this as a sign not to move too fast, though this may also be a comfortable position despite the oft-espoused wish for ‘loud, long and legal’ pricing signals.

And where are we with SA’s C tax?

For SA, we have our own uncertainties, at an earlier stage. Pravin Gordhan in the 2012 budget speech and associated review said that “a carbon tax at R120 per ton of CO2e above the suggested thresholds is proposed to take effect during 2013/14, with annual increases of 10% until 2019/20”. Seemingly a clear move to carbon, this was qualified by exemptions energy-intensive and trade-exposed (EITE) sectors.

Impact on EITEs and poor

The design of compensation for Australian EITE sectors has been more thoroughly considered, with thresholds relating to output (rather than absolute emissions), free permits differentiated in two categories, defined by thresholds in kt CO2-eq / $m revenue (or value added).  The CPM allocates free permits to businesses in EITE, based on an industry-average emissions and electricity intensity baseline, giving 94.5% assistance to those above a higher threshold (by emissions / revenue or value added), or 66% if at a lower threshold. Assistance declines at 1.3% per year, so that the ‘grandfathering’ even in these sectors is phased out over time.

Economy-wide modeling analyses by Treasuries in both countries highlight the importance of how revenue is used – particularly for contributions to mitigation by EITEs (e.g. through energy efficiency) and for poor households. The key political uncertainty for us is whether Minister Gordhan will indeed announce on 27 February 2013 the implementation of his (refined) proposal from last year. If Australia indeed were to step back from its carbon price, it would be difficult to argue SA should increase its initial rate. The tax rate is still, in my view, too low to really transform the SA energy economy, particularly with exemptions granted before it has even started. Yet the most important step is to start pricing carbon – and to ensure it does so with positive benefits for the poor.

Impacts on the poor

The possibility of increased energy prices and impacts on poor households is a particularly challenging issue for SA’s proposals for a carbon tax.  In Australia, there seemed to be no evidence that the carbon price had been terrible for low-income households. Having now seen a fixed price period, it has neither ‘killed industry’ nor been a major cause for higher energy prices. Rising electricity prices are a problem, but they are  due to huge investment in networks (what Ross Garnaut calls ‘gold-plated poles’). Minister Combet, with a strong trade union background, in a brief meeting explained that a million households no longer paid income tax – a massive benefit to poorer households.

Modeling by our own Treasury has shown that the impacts of carbon tax of  R100 – R200 / t CO2-eq on GDP is modest. With recycling of revenue, the small negative impact can be further reduced (if put to reduce  VAT, company and / or personal imcome tax, or increase direct transfers). If put to government savings and investments, it even can have a net positive benefit – reducing existing inefficiencies. Australia’s Treasury similarly used both sectoral and economy-wide models (global and national on the latter) – and also found modest impacts on GDP – though the story is much more complex in the Strong Growth Low Pollution study. The Garnaut Review in 2008 had already found impacts between -1.1% and -1.6% of GDP.

Renewable energy target

The Australian CPM is a complex instrument, but not the only instrument. The renewable energy target is 20% of electricity by 2020. While there is debate, given falling electricity demand, whether the absolute value of 45,000 GWh originally set should be retained, or adjusted to revised projections, there is bi-partisan political support for this. And a range of institutions is implementing, across government and the private sector – with an important role for consumers. A startling acceleration in solar systems in households has taken place. In SA, we are focused primarily on solar water heating (SWH), in Australia, solar PV has also taken off. Some 4-5,000 homes per week have installations, I was told by the Clean Energy Regulator. South African friends whom I visited have installed a system – not cheap, but with a substantial subsidy, and are earning back by selling electricity back, in total maybe A$2,000 per year, so it will pay back in four or five years. Overall, somewhere between 1.5 and 2 million homes have gone solar – according to one article, 18% of all households in Sept 2012 had SWH or PV, and counting solar PV only, 10%.  Chloe Munro, the dynamic CEO of the CER, pointed out this article – which also argues that solar is popular not only among the upper class “technology enthusiasts”, but even more so in “struggle street” – relatively poor Australian households (though this means something different to poor in SA).

In our own electricity plan, solar PV was dramatically increased late in the process, due to information about falling costs, with 8.4 GW by 2030. This is all grid-connected, as I understand, and the Australian experience might prompt a rethink of how much can be done in households – and which ones.

Carbon farming

It’s not all energy, but Australia also has a carbon farming initiative (CFI).  Some activities (e.g. afforestation) will generate off-sets that can be used under the Kyoto Protocol, another set of activities (e.g. carbon sequestration) incentivies by a Non-Kyoto Carbon Fund. The latter at least has bi-partisan report – though whether it can deliver 60% of a reductions of even 5% below 2000 by 2020, as the Coalition suggests, seems implausible to this energy researcher.

Decentralised generation and avoidable network costs

At the Institute for Sustainable Futures, Chris Dunstan makes even more far-reaching argument. He – and the team around him – argue for energy efficiency and decentralized energy. Careful analysis of the ‘avoidable network costs’ suggests that ability to delay further investment can fund other things – such as hybrid solar-biomass systems.

Linking

From the local back to the global. The agreement to link the CPM with the EU’s emissions trading scheme (ETS) was done bi-laterally, rather than multi-laterally. Certainly one can say that movement on market-based mechanisms in the UNFCCC negotiations has been slows. Clearly Australia has a big incentive of a lower carbon price – and since the EU insisted that the price floor of the CPM design be dropped, the prices are likely to be significantly lower than in the current fixed price period (A$23, rising to 25); and much lower than if only done domestically (A$60). There is a limit of 50% on use of international units, and 12.5% Kyoto units; since EUA’s are the ETS units, this effectively seems to mean Australia would buy 37.5% of its units from the EU, and only a third of that (12.5%) from the CDM – or JI, if there are credits. That’s before talking about other market-based instrument, under the Convention – or even outside of it.  My view remains that to have the benefits of trade, you need to set a cap – and a credible cap at that, which is not exactly what we have under the Convention yet for non-KP developed countries.

Gas prices and exports

Meeting with Ross Garnaut, apart from discussing carbon pricing, gave me another insight. Prof Garnaut predicts that the carbon price will be overwhelmed by rising gas price, quadrupling form earlier levels. Also fascinating is the different effect of finding cheap gas in the US and Australia. Australia has coal seam gas and allows free exports – and investment in export facilities has already increased the gas price. In US, increased availability of shale gas, with restriction on exports, has led to collapse of gas price. Others, like Tony Wood from the Grattan Institute, also indicated that gas prices – and those of the liquid component, are a factor to watch.

Energy institutions

Climate aside, Australia has an interesting set of institutions focused on energy and electricity. The Australian Energy Regulator (AER) sets distribution tariffs; the Australian Energy Market Commission (AEMC) makes detailed rules; and the Australian Electricity Market Operator does dispatch  (except in Western Australia, which seems like another country – and whose gird is not connected to the eastern one).

I only had time to visit one energy company, but an impressive one it was.  AGL is the 2nd largest retailed in electricity and gas. It deals in renewables, coal, gas, renewables, not networks. They confirmed what I’d heard from the Business Council, that reporting under the CPM is work, but do-able for larger business (although a materiality limit that excludes having to report a ‘barbie’ or braai, would be welcome). And I’ve never come across a company with a research report series, which gets converted in journal articles. Some deep thinking from Tim Nelson and others in this company – and they’ve earned a reputation for sound advice when they do make policy recommendations.

Electricity demand in Australia is falling – to the extent that no new baseload is needed, and it expectations seem to be that this might persist for some time. Yet while the energy component of electricity prices have declined, network costs (due to investment in maintenance, some say over-investment) has seen overall prices increase. So you might think there’s no need for demand-side management? Far from it. The AEMC has published a fascinating Power of Choice review. Just two ideas from a rich document – that there might be competition in installing smart meters (although it’s unclear whether with displays) and that customers could access wholesale prices without retailers. The latter may involve new agents in ‘demand side participation’, and /or  mechanism in the National Electricity Market (NEM). The AEMC suggests that customers should have a choice to make demand resources (DR) to the wholesale market in a similar way to peak generators.  As an AEMC explanatory note puts it, “the DR [demand resource] consumer is required to continue to pay the retailer this same counterfactual volume at its retail contract price”. A report by NERA Economic Consulting gives some further detail on a mechanism would give consumers an option to respond to wholesale market prices when those are higher than the value of electricity use, but still have a retail tariff product to manage price volatility.  If consumers curtail demand when prices are high, they could then pay baseline demand (rather than actual). Clearly methodologies for energy demand baselines are a crucial area to be determined.

Compliance, reviews and the Climate Change Authority

I’ve mentioned the inspiring teams at the Clean Energy Regulator already – by the way an institution that seem likely to survive the election, regardless of outcome. One other highlight from that discussion – how compliance can work at domestic level. The For non-compliance with the renewable energy target, there is a  130% penalty, payable within 5 days. Rather different to a 30% in the Kyoto compliance mechanism – over the next five years (or now eight).

The Climate Change Authority has a mandate to review the renewable energy target, emissions caps and targets (due in Feb 2014), the economic implications of the CPM, and Australia’s contribution to the global mitigation effort.  The Authority is a statutory body established by the 2011 Climate Change Authority Act , and its functions include reviews mandated under other laws – on Clean Energy, Carbon Credits, the National Greenhouse and Energy Reporting Act and Renewable Energy legislation. In addition to these strongly mandated reviews, the CCA can be requested by the Minister to review other matters, conduct research and more. It is required to observe principles of economic efficiency, environmental effectiveness, equity, public interest, impact on households, business, workers and communities, the global response, and consistency with foreign and trade policy (section 12 of the Act). With a Secretariat of 25, a diverse and independent Board, and Anthea Harris at the helm, this is another institution we might consider establishing. We might, of course, also look at models elsewhere, such as the Brazilian Panel on Climate Change. Back to the CCA, it will targets annually, so they are always set five years ahead; so that annual reviews produce a rolling 50year target. Hopefully enough certainty for business people and politicians.

The CCA will also look at the circumstances or conditions set for Australia to move to 15% or 25% below 2000 by 2020. Not least in this is the Aussie sense of what their “fair share” is, so there’s ample room for discussion with BASIC experts who looked at equitable access to sustainable development and dividing burdens or a global carbon budget. My sense from the negotiations has been that the conditions for 15% have been met, and that the DCCEE seems to know this – although there is no official study (which is also understandable).

Climate change is communicated by a Climate Commission established by government.  Some commissioners are scientists; another, Gerry Hueston, was President of BP for a long while, and is now engaging stakeholders on climate change.

One distinct impression was an impressive set of institutions. Another was that this may be a mixed blessing – though I qualify this immediately by my very lmited understanding, from all of one week’s experience. It did seem in some exchanges that institutions had very specific mandates (a good thing, as in focused) but also a narrow interpretation (not great for integration or fundamentally changing a system). Having multiple institutions creates many boundary issues, with my sense being that institutions are cautious not to imping on others’ turf. That’s a common enough pattern, and we can certainly tell stories of boundary issues among SA authorities (or within University departments, for that matter), but not one that enables bold action.

Universities and NGOs

That’s before all the work done in universities and by NGOs.  I gave talks at the Australian National University in Canberra – at CCEP – and another at the University of Melbourne.  The discussions were too rich and varied to summarise – so just a highlight. Andrew McIntosh taught me not to apply my distinctions between conservative (pro-market) and progressive (regulation), but between polluter pays (Green, Labour?) and beneficiary pays (Coalition).  Frank Jotzo at ANU’s Centre for Climate Economics and Policy convened great discussions, and mentioned the intriguing idea of a combined mitigation – finance obligation for developed countries (am waiting for the paper, Frank!).  The Melbourne Energy Institute’s seminar series cohosted a talk with the Grattan Institute, and was much better attended than any I’ve ever seen at home. My talk in Sydney was at Baker & McKenzie, a major law firm with a carbon market practice from which we can learn – and will, since they’ve established an office in Jo’burg. For me, several old contacts were renewed, and many new ones made – and at least some of those will hope will lead to future collaboration.

There is still much more that I learned on this trip, but this blog post is already too long.

 

[1] The trip was enabled by the Department of Climate Change and Energy Efficiency’s special climate visitor programme, my visit was from 3-10 February 2013.

[2] The current government is a minority, combining Labour, Greens and independents; the opposition Coalition combines the Liberal and Country Parties.