The Australian opposition and Senator Nick Xenophon have commissioned a report from consultants Frontier Economics on the proposed Carbon Pollution Reduction Scheme (CPRS), and possible modifications. Opposition Leader Malcolm Turnbull has described it as a greener, cheaper, smarter ETS; Minister for Climate Change Penny Wong has stated “It is not a hybrid, it is a mongrel. It is not a credible alternative, it is a smokescreen.”
The main feature of this “intensity based” proposal is that the electricity generation sector is treated in a similar way to “Emissions Intensive Trade Exposed” industries are treated under the CPRS, firms are allocated a large amount of free permits based on their production, so if the amount of the good being produced is reduced, they receive less free permits. Under Frontier Economics’ proposal, electricity generators will receive a large amount of free permits provided that they continue to produce the same amount of electricity.
So if I was to own a brown coal fired power station, I would have less incentive to close it down or generate less electricity, but I would still have an incentive to find ways to make it burn brown coal with less emissions. This will reduce the amount of opportunities to reduce emissions, and increase the cost of reducing emissions. This would increase the carbon price, but Frontier Economics’ modelling assumes that Australia would be part of a well linked global carbon market, and so assumes that the carbon price is completely exogenous. This is why Australia imports more permits from overseas. In practice this would likely mean that we buy more CDM credits, whose additionality properties are questionable.
There is no problem with credible international permits. As far as the earth is concerned, it does not matter where emissions reductions occur. The problem with the Frontier Economics proposal is with why there will be more purchases of international permits. More international permits will be purchased because it will be harder and more expensive to reduce emissions in Australia.
Another problem with shielding the electricity generation sector is that if all countries did this, there will be far less opportunities for emissions reductions, the global carbon price will be much higher, and emissions reductions will be more expensive. Also, by shielding the electricity generation sector, the impact on electricity prices is reduced, dramatically reducing the incentive to reduce electricity usage. The approach in the CPRS to provide payments to households that would offset the effect on prices of the CPRS is much more sensible.
The modelling not only assumes that the carbon price is exogenous, it also assumes that it has no volatility (it increases in real terms by about 4% per year), and there is no uncertainty about what it is. The report therefore has nothing to say about whether an ETS, carbon tax, or hybrid approach (with price ceilings, price floors, or both) is preferable. However, a complex CGE model of the Australian economy is not neccessary to answer this question. The results of Roberts and Spence (1976) and subsequent studies strongly suggests that a hybrid approach with ceilings and floors is the best way of managing this uncertainty.
One more problem with the Frontier Economics report is that it describes its approach to the electricity generation sector as being similar to that proposed in the Waxman-Markey bill that is presently before the US Senate. This is nonsense. Waxman-Markey allocates a large amount of free permits to electricity retailers, who must pass on these benefits to customers, but not in the form of cheaper electricity — payment to customers would not depend on how much electricity they use. The approach of Waxman-Markey is closer to the CPRS, both do not reduce the incentive to decrease electricity usage. The Frontier Economics approach completely distorts this incentive.
Elsewhere: Comments by Ben Eltham at New Matilda, Bernard Keane at Crikey, Robert Merkel at Larvatus Prodeo, Joshua Gans at Core Economics, Andrew Bartlett.
Update: Harry Clarke states “Turnbull’s attempt to give them more to ease electricity prices is not good economics. Make consumers bear the higher prices and give them generalised tax relief. Capture the sought after substitution effects you want but offset the impoverishing income effects.”
Update: Stephen Howes and Frank Jotzo in the Sydney Morning Herald state “Frontier’s modelling fails to establish its claim that it would deliver cheaper mitigation. In fact, it suggests the opposite.”
August 10, 2009 at 9:39 pm
A decision to invest in clean electricity is based on the price and expected sales of clean electricty, not the price of dirty electricty. Putting a price on carbon is just a very clumsy way of pushing up the price of clean electricity. It is clumsy because it depends on jumping the average price of electricity high enough to justify investment in clean electricity. The average will only have to ramp up slowly if only clean electricty producers get the higher price and the price of dirty electricity stays unchanged. We are letting our visceral desire to punish polluters stop us from thinking clearly.
August 10, 2009 at 9:56 pm
John, what matters when people decide to invest in clean electricity is the relative price compared to other forms of electricty. But emission reductions are not just about clean electricity, which is why it is best for any activity that increases emissions to face a carbon price.
If the impact of a carbon price is not reflected in the price of electricity, then there will be no incentive to reduce excessive electricity usage. I would have no incentive to buy a TV that uses a low amount of electricity compared to a big plasma TV that uses a huge amount of electricity. I may decide that it is cheaper to continue to use electric heaters rather than insulate my house.
This is not about punishing polluters, it is about transforming to a low emissions economy.
August 15, 2009 at 3:27 pm
Peter, the relative price of clean and dirty electricty is not what matters is they are separate markets. (Separate markets was the mechanism that John Howard used to encourage invstment in clean electricity without the need for dramatic increases in the price of electricity.) What counts is expected price and market for clean power. Changing the price of dirty electricity is just a clumsy way of changing the price that producers of clean power will get.
Pushing up the average price of electricity may provide an incentive to save power but the effect may be quite small. For example, tutning off the radiator on a cold night may save me 17 cent/hr but it is hardly big enough to change what I do. Don’t have the figures but I suspect that the same is true for the TV options. Cost of power will be trivial compaed with differences in the cost of the TV.
November 2, 2009 at 8:30 am
I fear the people in possession of the awesome power that is being derived from the colossal scale and soon to become patently unsustainable growth of the global political economy are greed-mongering manipulators of democratic principles and practices who do not care about anything more than profits and accumulating material things. Their incorrigible idolatry of business-as-usual, wealth concentration, conspicuous consumption and unconscionable hoarding has reached so huge a scale and unsustainble a growth rate that the very future of the children is being put at risk. Perhaps necessary change toward the survival of offspring and sustainability, rather than the ruin of Earth as a fit place for human habitation, is in the offing.