ENVIRONMENT: by John DaleyNews Weekly
How KyotoÂ’s greenhouse gas cuts will hit the hip-pocket
, April 8, 2000
Most Australians remain oblivious to how the Kyoto Protocols on reducing greenhouse gas emissions will affect them.
John Daley explains the practical consequences.
This is an extract from a review appearing in the current issue of The National Observer, the publication of the Council for the National Interest. (See details on page 13)
The economic implications of the Kyoto Protocol for Australia are not adequately appreciated. Australia's commitment to emit no more than 108 per cent of its 1990 level of CO2 equivalent emissions might appear generous. However, the picture is very different if one looks in a little more detail at the evolving structure of Australia's economy.
The Kyoto Protocol contains commitments for developed countries to reduce net greenhouse gas emissions by an average of 5.2 per cent below their 1990 levels in the period 2008-12.
The Kyoto targets, measured against 1990 baselines, are differentiated between countries. The European Union is required to reduce its emissions to 92 per cent, and the United States to 93 per cent; Australia is allowed to increase by 8 per cent and Iceland by 10 per cent.
However, the impact of emission reduction varies widely between countries. Russia, with a 100 per cent target, has already cut emissions thanks to the closure of inefficient Soviet era factories, and is expected to be the biggest seller of "assigned amounts" in any emissions trading regime.
Despite a common view to the contrary, the emission target for Australia is demonstrably tougher than that for most countries. This is because of the increasing preponderance of emissions intensive industries in the Australian economy - a consequence of our comparative advantage in energy and resources - and because of our relatively fast rate of population growth.
Once population growth is allowed for, there is no account whatsoever in Australia's target allocation for the fact that energy intensive industries (like aluminium, steel, zinc, magnesium, fertilisers, LNG, shale oil, etc) would otherwise produce a much higher proportion of Australia's emissions in 2010 than they did in 1990. All the more painful, their products will mostly be for use in other countries - lowering their emissions - and they will be used to replace higher carbon fuels or heavier components in vehicles, thereby helping to reduce global emissions. Under Kyoto, no credit for these greenhouse benefits accrues to Australia.
There are two inevitable economic implications of Kyoto.
First, abatement action in developed countries will increase the costs of business in those countries. The greatest burden of emission reduction will fall on those countries whose emissions were projected, in ordinary circumstances, to rise the fastest. These countries are New Zealand, Australia, Canada and the United States.
Secondly, national and sectoral output and trade in and between countries will be affected. Emissions intensive industries (and new investment) will migrate to developing countries, which have no commitments under Kyoto - the phenomenon known as "carbon leakage".
And the phenomenon is not imaginary. Investment by internationally competing industries is always footloose. The oil shocks of the seventies - real market changes - illustrated that. Thus there is the striking example of aluminium production which simply moved, lock, stock and barrel, from Japan to Australia in the course of three parliaments.
Australia, with its resource endowment and the human and physical capital accumulated to exploit it, has a comparative advantage in energy intensive industry based on fossil fuels.
The structure of our economy is markedly different from other OECD countries. Australian manufacturing (which in OECD data encompasses the refining of metals and the liquefaction of natural gas) has been increasingly energy intensive. If Australia is to continue to grow at rates allowed by our comparative advantage in the world, we will become even more energy intensive in the next twenty years. Regrettably this means more emissions, not less.
Another key factor which adds to the pain is that Australia's main competitors are countries which do not have any commitments under Kyoto (developing countries). We are disadvantaged more than our OECD counterparts because they compete primarily with each other.
There are four classes of policy instruments that may be used in any national regime to reduce greenhouse gas emissions:
* public information, persuasion, and "voluntary" agreements,
* government regulations,
* carbon/ energy taxes (and their negative, subsidies), and
* emissions trading.
Market economists recognise efficiency advantages of "market" instruments like taxes and permits as they give clear price incentives. Emissions trading differs from a tax in the sense that allocation can be separated from price. Permit trading is a better instrument than taxes because it encourages the "supply side" in ways subsidies may not, and is likely to lead to a better discovery of low cost options. It also provides opportunity to "get governments out of it".
In principle, and subject to a raft of caveats about timing and risks, emissions trading seems to be a good option if action is required to curtail emissions substantially. The regulatory and tax alternatives are more damaging in adding costs and eroding competitiveness.
Commercial interest suggests that permits should be available authorising emissions far into the future. This would imply a once only allocation. In the event that the permits on issue were to exceed some future target to be agreed by Australia, the Government could either buy back permits or unilaterally devalue them.
Compliance with Kyoto means inevitably that the electricity market will be smaller - especially given threats to the viability of major customers, notably in metals smelting.
The imposition of an emissions tax, or an obligation to purchase permits - which is equivalent if the price is the same as the tax rate - would add to the costs of power station operators. Some of those costs would be recouped in the marketplace but, in competitive markets, not all costs can be passed on. Average electricity prices would rise and dampen demand, compounding the problem of cost recoupment for coal-fired generators. These effects are intended consequences.Wake-up call?
The prevailing view in Australian Government circles seems to be that everything was "fixed" at Kyoto; that the task now is simply one of implementing the announced National Greenhouse Strategy. What is becoming clear is that this perception is dangerously complacent.
How can governments be so sanguine? The most charitable explanation is that they believe the costs are relatively low. A senior official in Canberra suggested recently that the mandatory two per cent additional renewables measure was relatively low cost.
The Government's own issues paper on that measure says it will save between 4 and 5.5 million tonnes of CO2 in 2010 (with 0.5 million tonnes of that "saving" arising from its own depressing effect on the economy!) at an annual cost of between $100 million and $250 million. So the "saving" will cost somewhere between $20 and $60 per tonne of CO2. Given the power stations' example, it is simply naive to think of this as low cost.
What is not well appreciated is the risk ordinary Australians are exposed to. And the wake up call prompted by the power stations example above is for Australian residents and investors - including the superannuation funds - who have a great deal at stake in those stations.
The alarm is, of course, ringing already for the project financiers. So it should be too for the citizens of Queensland, New South Wales, South Australia and Western Australia who, through their State governments, have $30 or $40 billion invested in power stations. This amounts to perhaps $6000-9000 per family. And that amount is clearly exposed.
The reality is that Australia cannot comply with Kyoto without serious damage to our competitiveness and a substantial erosion of asset and business values.