Caps Review Part 6: ETS design flaws and pitfalls

By James Wight
Posted on 15 March 2013
Filed under Carbon Reduction, Politics

This is the sixth part in a series about the Caps and Targets Review being conducted by the Australian Government’s independent Climate Change Authority (CCA) this year. Part 1 summarized the global climate crisis, Part 2 explained the importance of the review and how CCA should approach it, Part 3 outlined the role Australia should play in climate action, Part 4 debunked the economic justifications for inaction, and Part 5 makes my central recommendations on emissions caps. This part makes recommendations on the design of the carbon price mechanism.

The collapse of overseas carbon markets is a clear warning of the pitfalls of emissions trading schemes.[1] Given the Australian government has chosen to proceed with a carbon price that will become an ETS, it is essential that the Australian ETS does not fail like the EU ETS, NZ ETS, or Kyoto offset mechanisms.

Treasury projections show present Australian climate policies will not drive a phaseout of fossil-fuelled electricity generation in Australia, nor even an absolute reduction in domestic emissions, for many decades. Domestic emissions would actually rise until the 2030s then fall back to today’s level by 2050, and fossil fuels would still provide 60% of Australia’s electricity in 2035.[2] These outcomes are completely unacceptable.

International emissions trading

Australia’s present plans and agreements for international linking and offsets raise huge concerns:

  • It is difficult to determine whether international offsets represent real emissions cuts (eg. currently the most common type of Certified Emissions Reduction (CER) comes from Asian companies who produce gratuitous pollution so they can be paid to stop[3]). This criticism is based not on an irrational distrust of foreigners, but on a realistic skepticism about the difficulties of carbon accounting in developing countries with no absolute emissions caps, less regulation, and in some cases a less accountable government. (Linking to a scheme with an absolute emissions cap like the EU ETS is comparatively credible but still has the other problems outlined below.)
  • International linking and offsets hinder domestic decarbonization at a time when all countries need to decarbonize as quickly as possible.
  • International linking allows distinct emissions trading schemes to contaminate each other with their flaws (eg. the EU ETS has already achieved its 2020 emissions target eight years ahead of schedule[4], thus no longer provides any incentive to cut emissions, and so far Poland has vetoed all attempts to fix the scheme[5]). Difficulties may also arise from linking schemes with different accounting rules.
  • Australia’s carbon price would be largely determined by policy decisions made in other countries. Australia would likely be flooded by cheap international permits, causing the Australian carbon price to crash like its international counterparts. This is especially a concern considering the present rock-bottom carbon prices in the EU ETS and other international carbon markets. According to CCA modeling cited by the Australian Financial Review, the Australian carbon price could fall to $10/tonne in 2015.[6]
  • International offsets are unfair because they shift the burden of cutting emissions from Australia to other countries which are often poorer and less carbon-intensive. Although it is important for Australia to finance climate action in other countries, it should be supplementary to domestic action, not as an offset for domestic emissions.
  • The Australian public and other countries expect Australia to cut its own emissions.

The 50% “limit” on international offsets is meaningless because it allows companies to pollute up to twice the level of the Australian emissions cap.[7] Even the more recently added 12.5% limit on CERs (a step in the right direction) still allows companies to emit in excess of the cap by a very significant amount. It is unclear whether there will be any limit on importation of European permits.

South Korea and California will allow zero international permits in their emissions trading schemes.[8] Australia should do the same. The Australian government should not proceed with its intention to link to the EU ETS, Kyoto offset mechanisms, or any other international emissions trading scheme or offset mechanism.

Domestic emissions trading

There are also reasons for concern about the effectiveness of domestic emissions trading (particularly the intention to allow unlimited offsets from the domestic Carbon Farming Initiative).

Not all tonnes of CO2e are equivalent. A given amount of CO2e abated today in one way (eg. closing a coal mine) and the same amount of CO2e abated today in another way (eg. preserving a forest), although they may look the same on paper in the short term, may not be equally important in the long term. This is because different types and sources of greenhouse gases result from different economic processes and play different roles in the climate system. Although all emissions are important, it is of particular importance and urgency to phase out fossil fuel CO2 emissions because they are the largest and longest-lived cause of anthropogenic global warming (as opposed to land carbon or other greenhouse gases). If the world fails to phase out fossil fuels in a reasonable timeframe, all other efforts to mitigate climate change will matter little.

Policymakers must understand the basic facts of the carbon cycle. On human timescales carbon easily moves between the atmosphere, ocean, and land. It is only over geological timescales that these “surface reservoirs” exchange carbon with deeper, larger reservoirs. The most important thing humans are doing is mining and burning fossil carbon that has been buried for millions of years, thus emitting carbon at a pace many orders of magnitude greater than the rate of the processes which remove carbon from surface reservoirs. While storing more carbon in the land is a necessary part of climate action, it is far from sufficient and not nearly as urgent as eliminating fossil fuel emissions. Even if forest cover was returned to preindustrial levels, the carbon cycle would still be overwhelmed by fossil fuel emissions. A proportion of the fossil carbon will stay aboveground for millennia, and the land is a climate feedback so cannot store carbon permanently. Finally, from a practical perspective, land carbon is harder to measure.

Short-lived climate pollutants like methane, soot, ozone, and hydrofluorocarbons are more powerful at trapping heat than CO2 but do not linger in the atmosphere for as long. While it is very important to cut emissions of short-lived climate pollutants to prevent rapid near-term warming, this also should not be considered a substitute for phasing out fossil fuel CO2 emissions to limit long-term warming.

Other factors affecting the relative significance of different types of abatement which may not be accounted for by the carbon market (or by cost-benefit analysis) include: whether it locks in or prevents lock-in of fossil fuel infrastructure, whether it changes relative technology prices, whether the emissions reductions are permanent, and whether the emissions reductions will continue beyond the start year; in broad terms, its long-term contribution to systemic decarbonization of the economy.

The Productivity Commission, which is often referred to on whether climate policies are cost-effective, is not a credible source. It has published an inaccurate estimate of the cost of emissions cuts from solar PV[9], which it continues to cite[10] despite it having quietly debunked by the Productivity Commission itself.[11] Neither analysis accounted for technology price reductions.

An ETS is supposed to ensure emissions cuts occur where it is cheapest, but I am concerned the carbon market is unlikely to deem the most important places to cut emissions as the cheapest. If it does not, it will instead prevent the most urgently needed transition, away from fossil fuels (in which case it would merely limit the cost for the fossil fuel industry). This is especially a concern considering the free permits handed out to large polluters, which in at least some cases are making them more profitable.[12] [13] [14]

An alternative approach might be to compartmentalize the ETS by sector and/or greenhouse gas to ensure action on all fronts. Instead of a single catch-all commodity called “carbon” that equates many different things, there could be several commodities (eg. “fossil carbon”, “land carbon”, “chlorofluorocarbon”, etc), each with its own separate emissions caps and market. Companies would be allowed to exchange apples for apples, but not apples for oranges. Greatest priority (strongest cap, highest floor price) would be given to cutting the commodity with the most important role in climate change: fossil carbon. This compartmentalized emissions trading would allow each type of emissions to be reduced at the lowest credible cost.

Miscellaneous issues

Australia has delayed application of the latest science on the relative heat-trapping potential of greenhouse gases until 2017-18.[xv] It should be applied immediately so that present policy is based on the best available information.

Present measurement and accounting of fugitive emissions of methane from unconventional gas extraction is inadequate. Full measurement and accounting of these emissions should be mandated. There is evidence to suggest gas-fired electricity generation may actually be worse than coal-fired generation on a 20-year timescale when fugitive emissions are taken into account.[xvi]

The floor price should be reinstated (preferably at a higher level than the original $15/tonne) to help prevent the carbon price from crashing. The ceiling price should be removed because it limits the penalty for pollution.

Current rules allow liable companies to bank present carbon permits to use in the future, and borrow future permits to use in the present. This is unwise as it creates uncertainty in Australia’s emissions trajectory, and could result in a surplus of permits.

Emissions are counted on a facility-by-facility basis rather than company-by-company. I am concerned companies could avoid paying the carbon price by setting up a large number of small facilities each with small emissions.

It is often argued climate policy requires a choice between market mechanisms and regulatory ones, but that is a false dichotomy. A mix of markets and regulations are needed; indeed the carbon price already has both market-based and regulatory aspects. I am advocating a greater regulatory aspect to ensure the market aspect delivers an effective outcome. It would be unwise to leave too many greenhouse gas decisions to markets, because a market failure is driving the problem in the first place. On that basis, a climate policy is more likely to be effective the more limited its market aspects and the more restrictive its regulatory aspects. If markets are badly designed by governments then they will make the wrong investment decisions.

In the final part, I will argue for and suggest some complementary measures.



[1] ‘U.N. offsets crash to 15 cents ahead of EU ban vote’, Point Carbon, 12 December 2012, viewed 21 February 2013, http://www.pointcarbon.com/news/1.2098417

[2] Commonwealth of Australia, Strong Growth, Low Pollution: Modelling a carbon price, 2011, viewed 12 November 2012, http://archive.treasury.gov.au/carbonpricemodelling/content/report/downloads/Modelling_Report_Consolidated_update.pdf, Charts 5.2, 5.19.

[3] E Rosenthal & AW Lehren, ‘Profits on carbon credits drive output of a harmful gas’, New York Times, 9 August 2012, viewed 21 February 2013, http://www.nytimes.com/2012/08/09/world/asia/incentive-to-slow-climate-change-drives-output-of-harmful-gases.html

[4] F Harvey, ‘Doha climate talks: EU weakened over new emissions targets’, Guardian, 23 November 2012, viewed 21 February 2013, http://www.guardian.co.uk/environment/2012/nov/23/doha-climate-talks-eu-weakened-emissions

[5] G Parkinson, ‘The triumph of Tony Abbott’s carbon alter-ego’, Renew Economy, 29 August 2012, viewed 21 February 2013, http://reneweconomy.com.au/2012/the-triumph-of-tony-abbotts-carbon-alter-ego-92270

[6] G Winestock & M Priest, ‘EU carbon price a hard act to follow’, Australian Financial Review, 18 February 2013, viewed 21 February 2013, http://www.afr.com/p/national/eu_carbon_price_hard_act_to_follow_Lt5XbJv3iE9iyKRMit5tUI

[7] T Edis, ‘How Labor can improve the carbon pricing scheme’, Climate Spectator, 13 August 2012, viewed 21 February 2013, http://www.climatespectator.com.au/commentary/how-labor-can-improve-carbon-pricing-scheme

[8] A Morton, ‘Australia lags on carbon tax rules’, Age, 26 July 2012, viewed 21 November 2013, http://www.theage.com.au/opinion/political-news/australia-lags-on-carbon-tax-rules-20120725-22qz9.html

[9] Productivity Commission, Carbon Emission Policies in Key Economies, Research Report, 2011, viewed 14 September 2012, http://www.pc.gov.au/__data/assets/pdf_file/0003/109830/carbon-prices.pdf

[10] G Parkinson, ‘Why you are paying $10/hr to run your neighbour’s air-con’, Renew Economy, 18 October 2012, viewed 21 February 2013, http://reneweconomy.com.au/2012/why-you-are-paying-10hr-to-run-your-neighbours-air-con-21376

[11] Productivity Commission, Carbon Emission Policies in Key Economies: Responses to Feedback on Certain Estimates for Australia, Supplement to Research Report, 2011, viewed 14 September 2012, http://www.pc.gov.au/__data/assets/pdf_file/0016/114244/carbon-prices-supplement.pdf

[12] S Cullen, ‘Coal-fired stations “$1b better off under carbon tax”’, ABC News, 6 September 2012, viewed 21 November 2012, http://www.abc.net.au/news/2012-09-06/coal-fired-stations-1b-better-off-under-carbon-tax/4246100

[13] S Lauder & S Lane, ‘Consumers “paying twice” as carbon emitters compensated’, ABC News, 20 February 2013, viewed 21 February 2013, http://www.abc.net.au/news/2013-02-20/consumers-paying-twice-as-carbon-emitters-compensated/4529268

[14] T Edis, ‘How polluters can cream the carbon scheme’, Climate Spectator, 5 September 2012, viewed 21 February 2013, http://www.climatespectator.com.au/commentary/how-polluters-can-cream-carbon-scheme

[xv] G Combet, Australia ready to join Kyoto second commitment period, Australian Government Department of Climate Change and Energy Efficiency, 9 November 2012, viewed 21 February 2013, http://www.climatechange.gov.au/~/media/Files/minister/combet/2012/media/November/Combet-MediaRelease-302-12.pdf

[xvi] RW Howarth, Santoro, R & Ingraffea, A, ‘Methane and the greenhouse-gas footprint of natural gas from shale formations’, Climate Change, 2011, viewed 14 September 2012, http://www.eeb.cornell.edu/howarth/Howarth et al  2011.pdf

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