Effective Emission Reduction Mechanisms

Thursday, March 12th, 2015
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Do we have an effective emission reduction scheme in Australia?

The Australian government argues that they are committed to climate change action, and yes, they have the best possible emission reduction policy, the Emission Reduction Fund (ERF) is the mechanism, as part of its Direct Action policy.

In February 2015, the Federal Government announced the first round of auctions for the ERF will be held on the 15th of April 2015.

Given the newness of it, and the lack of substantive media coverage of it, one can ask: What is the ERF? How does it work, and how does it differ from what happened in Australia before?

Moreover, is it the only emission reduction scheme currently in place and is it the best? Is it an energy efficiency scheme in disguise? What will the reductions in emissions from the ERF be?

Finally, and perhaps most importantly, is it in line with international schemes, either current, or planned, and is it likely to be the predominant policy for the length of period over which climate related action is required to be carried out?

In broad terms, the Direct Action Policy and its ERF a method by which the federal government buys emission reductions from companies or organisations that emit significant amounts of CO2 or CO2 equivalent emissions (methane for example).

The scheme is voluntary in contrast with almost all other schemes implemented or proposed in Australia or around the world. In fact, any organisation can register for participation in the scheme if it either has a large enough emission level, or can aggregate activities from a number of smaller facilities to meet this level. A range of emissions reduction activities is eligible for participation including:

  • upgrading commercial buildings for higher energy efficiencies
  • improving energy efficiency of industrial facilities and houses
  • reducing electricity generator emissions
  • capturing landfill gas
  • reducing waste coal mine gas
  • reforesting and revegetating marginal lands
  • improving Australia’s agricultural soils.

From a high level perspective, when an organisation registers  for the ERF, it is assessed for compliance. Compliance means that the organisation, as well as having met the requirements of eligible activities, has provided sufficient assurance to the government minimising the risk of non-delivery of emissions. Furthermore, payment by the Government will be made only after emissions reductions are delivered and verified.

Once an organisation has been deemed eligible, it can participate in the reverse Auction process, to be held regularly. In this process, it offers the government a specified amount of CO2 equivalent emission reductions in tonnes CO2 per year at a certain cost and a delivery schedule based lowest cost bids will be accepted but subject to a maximum undisclosed benchmark price in dollars per tonne of CO2.

The government will attempt to accept 80 per cent of offers below that benchmark. However, this is subject to the budget available and some of those may therefore miss out. The total budget for the ERF is $2.55 Billion over three years starting from 1 July 2015. The price the government will pay will not be known until the first auction in April 2015, but at an assumed price of $15 per tonne, this implies a reduction of about 170 million tonnes of CO2 over the three-year period. However there have been, as yet, no publicly available government estimates of expected emissions reductions.

Any projection of emissions reductions must recognise the fact that the ERF scheme is  voluntary, and assume that there are sufficient  emissions reduction activities at around $10 to $15 per tonne levels..

Moreover, there is no requirement that organisations that don’t sign up for the scheme keep their emissions stable, and therefore any ERF gains could be offset by losses in the broader market. I do put this at a low probability, however, as emissions increases imply a dramatic change from the downward trajectory of energy consumed by the manufacturing sector due to its apparent decline.

The only trend that could counteract this decline in energy consumption and emissions is the deployment of more Liquefied Natural Gas (LNG) plants. This is also something that I would consider unlikely in the near term (two to five years) given the massive investments already made that need to show a return before their operators commit to any significant expansions, at a time where the recent unexpected crash in the price of crude oil is leading to a similar effect in the price of LNG. This decline is occurring due to most LNG purchase contracts are linked to the price of oil as it has been traditionally seen as substitutable to natural gas.

Next then, we can ask ourselves, how does this differ from the previous Australian climate change policy, namely the Carbon Tax, which is better described as an Emission Trading Scheme (ETS) with a three-year fixed price period.

Under the ETS, businesses would have paid money to the government for the right to emit greenhouse gases and the increased input costs would be expected to force businesses to reduce their emissions.

In contrast, under ERF, the government pays money to the businesses to reduce their emissions from their business-as-usual levels. The cost of emissions reduction is borne by the taxpayer (society).

Apart from those differences noted above, there are other key differences between the ERF and the others. For instance, the ETS is mandatory while the ERF is voluntary, so there is less firmness in the degree of emission reduction.

Furthermore, once an ETS is fully implemented with a floating price, the target becomes a total annual emission reduction level getting us closer to a fixed emission reduction target. This target cannot be guaranteed under any scheme proposed to date but an ETS comes as close as we have. The only way to guarantee a system-wide reduction would be through a command-and-control type system such as in China or other fully government owned systems, but that still requires the government to strongly intervene through tough regulations. This is something that seems unlikely in any developed country while even China is trialling emission trading schemes.

However, there is in fact another climate scheme that is still running and has pretty strong targets: the Renewable Energy Target (RET). Furthermore, there are still state based energy efficiency schemes in NSW, Victoria, the ACT and South Australia.

It is worth noting that the RET is a kind of Frankenstein’s monster of a scheme as initially it was developed by the Howard government in 2003 to act as a small scale technology development scheme and then modified by the Rudd Labor government to be an all singing all dancing renewable industry development and emission reduction scheme. Many criticisms can be, and have been, levelled at it for this reason but it cannot be argued that it has led to a significant deployment of large scale wind farms and other projects.

The RET and the energy efficiency schemes all have CO2 emission reduction impacts, although they don’t directly target CO2 through pricing, but rather either low emission renewable energy in the case of the RET and total energy consumption from the electricity sector in the case of the energy efficiency schemes. These can both be translated into CO2 reduction terms by using the emission intensity of the Australian electricity sector, which is close to one kilogram of CO2 per kilowatt/hour as a rough approximation. The targets for these however are fairly week and will not contribute a large amount to Australia’s total reduction target.

The RET has higher firmness than the ERF as well due to a fixed GWh target and trajectory. It is also mandatory.

Finally, the various state based energy efficiency schemes are all mandatory and provide a firmer degree of emission reduction. Given the relative lack of public objection to this scheme by the Coalition government either now or when it was in opposition, one might be forgiven for thinking that the RET is much cheaper than the other schemes, but this is not so. The certificates have traded between $30 per MWh and  $50 per MWh, and could go as high as $92 per MWh as the deadline of 2020 approaches if sufficient projects are not deployed.

At Australia’s current electricity system’s emission intensity of one tonne of CO2 per MWh (one kilogram per kWh) this means a price of $30 to $92 per tonne CO2 for any emissions purchase. For a fair comparison with an ETS based price, as in both cases, the price gets pass to the consumer, there is a technical reason why for the 20 per cent by 2020 target one should divide those prices by five, yielding a range of roughly $6  to $18 per tonne, not much less than many of the other schemes.

Finally there are the honourable mentions: the also run/ran schemes in the emission reduction policy free for all, the solar feed-in-tariff (net and gross) schemes, which pay for solar energy exported into the grid. These are neither firm, nor mandatory in the technical sense. Although if a household does put a system in, the retailer is obliged to pay them a certain rate.

Now what does the future hold for all these schemes? The economic purists among us would say there should be only one scheme and that would be a sufficiently strong emission trading scheme. However, they agree that longer term the targets required to achieve the temperature targets the science tells us we must, they will have to have quite a high price of as much as $80 to $120 per tonne (assuming current estimates of the cost of new technologies such as carbon capture and storage – CCS or Concentrating Solar Thermal). This price will, however, be passed on to all consumers. In my view, such a high price period however will only last a relatively short time, as innovation and technological learning quickly drives costs down.

The preference for emission trading schemes is strong amongst the vast majority of economists and policy makers around the world with the European Union, California, the north-eastern states of the US, and several provinces of China already running these in various forms. For this reason, it would be a safe bet that ultimately the ERF, as well as energy efficiency schemes and some feed-in-tariffs will ultimately disappear and be replaced by an internationally linked ETS.

The future coverage of linking is not clear as it is possible to link with the EU scheme but not with say the California scheme, or vice versa. The potential opportunities for political machinations here abound. Although when this will happen is not clear, my bet is that it will be sooner rather than later and possibly before 2020 given the current Coalition’s political fortunes and Malcolm Turnbull’s known preference for an ETS, contrary recent statements on the matter not withstanding.

So in summary, in the ERF we have Australia’s main emission reduction policy whose effectiveness is not yet clear, mainly due to the fact that it is voluntary. We have other policies that have been effective to date but which cannot do the heavy lifting that an ETS would do. Finally the most likely future outlook is for a return to an ETS that would be at least partially internationally linked.

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