Taxing times as Australia looks to secure its energy transition

Welcome to Carbon Risk — helping investors navigate 'The Currency of Decarbonisation'! 🏭.

If you want to know more about how carbon markets combat climate change, what this burgeoning market means for investors, and the latest trends affecting decarbonisation then please consider upgrading your subscription.

“Bog standard is beneath you.”

- Simon Stiell, executive secretary of the UNFCCC

In late July, Professor Ross Garnaut, known as the father of emissions trading in Australia, was addressing the audience at the Australian Clean Energy Summit. In a speech entitled ‘The Energy Productivity Agenda’ he warned that without significant market reform, the nation is on the verge of an "energy and climate policy crisis.”

As the United States retreats from both domestic and international climate and environmental policy, other large economies are struggling to strike a balance between continuing to tread a path towards decarbonisation, while ensuring that their economies remain competitive.

The Labor Party defied the incumbency curse to win re-election in May’s general election. The new government now looks to tread a course through, what appears at face value at least, to be the same opposing priorities. It’s a pivotal moment for Australia, and a clear opportunity for the nation to signal the economic benefits of strong climate policy (see Safeguarding Australia's climate policies: The trifecta of carbon market sensitive elections is almost over).

The Australian government have yet to set their Nationally Determined Contribution (NDC) as part of its commitment under the Paris Agreement. The nations current pledge is a 43% cut by 2030 versus 2005 levels, but its being urged to go much further by 2035. The Climate Change Authority (CCA), Australia’s independent body advising on climate policy, has indicated that 65% to 75% would be an appropriate target. Simon Stiell, executive secretary of the UNFCCC, has argued that "colossal" economic rewards could be reaped by Australia if it aims high.

Even with a more ambitious 2035 NDC, Australia looks set to miss some of its 2030 targets such as 82% of the grid to be powered by renewable sources. A combination of state-level rollbacks, grid connection delays, and inadequate investment are responsible according to Wood Mackenzie; the consultancy is projecting that renewables could meet a 58% share of power generation by the end of the decade.

However, electricity bills for households and small businesses are set to rise by 30-40% by 2030 if the renewables rollout continues to stall, according to analysis by the Clean Energy Council. Ramping up the deployment of solar, wind, and battery capacity could be the best way for the country to meet its climate targets, while also keeping energy bills in check.1

With the government signalling a desire to expand support for renewable generation investment via its Capacity Investment Scheme (CIS), attention has now turned towards the impact on the budget deficit, and the potential crowding out of private sector investment in renewables. Professor Garnaut believes that Australia’s energy and climate policy is "on a path to comprehensive failure" unless the government urgently reintroduce an economy-wide carbon price:

"[The] introduction of carbon pricing is the most economically efficient tax reform available to Australia at a time when we need budget repair. It delivers all of the economic advantages claimed for increases in [Goods and Services Tax] GST by its advocates, with the additional advantage of increasing the efficiency of markets. The carbon price unleashes the innovation, dynamism and capital resources of competitive markets to build the transition. It efficiently reduces emissions through most of the economy and not only in electricity generation."

The country has been here before. Back in 2012 Australia was the first major economy outside of Europe to introduce a carbon tax. The tax was initially set at A$23 per tonne CO2 with a plan to transition to a cap-and-trade scheme three years later. However, public opinion began to shift as households, under pressure from rising living costs and economic uncertainty, began to perceive the carbon tax as a burden, rather than a necessary policy tool to decarbonise Australia’s economy.

The Abbot government capitalised on public discontent and petitioned to ‘Axe the tax’ during the 2013 election campaign. The decision to repeal the carbon tax in 2014 marked a significant turning point in Australia’s approach to climate change and environmental policy. During the two year period in which the tax was active, Australia’s emissions declined by 2%; over the subsequent four years after it was repealed, emissions kept on rising.

Had the carbon tax stayed in place, Australia’s emissions would be 25 Mt CO2 lower in 2020, and 72 Mt CO2 lower for the period 2015 to 2020, according to research published by The Australia Institute. The authors of the report conclude that the country would have also experienced cheaper and less volatile wholesale electricity prices as the carbon tax would have acted as a strong signal for investment.2

Speaking shortly after Professor Garnaut’s remarks, Australia’s climate change minister, Chris Bowen, poured cold water on the idea, rejecting calls for the reintroduction of a carbon tax. Despite the ministers dismissive remarks, there is an emerging groundswell of opinion in favour of an economy-wide carbon price.

A way forward could be reached in a matter of weeks. The federal government's Economic Reform Roundtable (ERR) takes place on 19-21 August and brings together government, business leaders and other representatives to build a consensus on how to make Australia’s economy more productive and resilient.

Several business groups and other bodies have submitted proposals to the Productivity Commission, the independent research body charged with compiling the agenda for the ERR, with many lobbying for the reintroduction of an economy-wide carbon price. For example, Rio Tinto, one of the worlds largest mining companies, has voiced its support for a ‘market-based’ carbon price, rather than a carbon tax (see Scope 3 forces mining companies into rethink):

“A market-based price on carbon is the most effective way to incentivise the private sector to make low-carbon investments and drive down emissions. Carbon pricing is the most effective incentive for business to reduce emissions, but may not be sufficient for hard-to-abate parts of our carbon footprint.”

But in a nod to the increasing difficulty it and other companies active in ‘hard-to-abate’ sectors face, Rio Tino is calling for an expansion in the recently reformed Safeguard Mechanism and its system of Australian Carbon Credit Units (ACCUs) (see Everything you need to know about Australian Carbon Credit Units (ACCUs)).

“It is imperative that the ACCU Scheme is conducive to the development of a liquid market of high-quality ACCUs at the scale that will be required by Australia’s harder to abate sectors.”

The Productivity Commission itself has warned that inconsistent and overlapping emissions reduction schemes, combined with a broken planning approvals system are increasing the cost of Australia’s energy transition. Their recent report mirrors the Institute for Fiscal Studies (IFS) recent criticism of Britain’s incoherent system of taxes and subsidies (see A chaotic patchwork of inconsistent incentives). The Productivity Commission outlines four recommendations to the government related to its use of carbon pricing:3

1. Task an independent agency with developing national target-consistent carbon values (TCCVs), i.e., estimates of the implied carbon prices needed to meet Australia’s emissions targets.
2. Design and evolve policy settings to be broadly aligned with TCCVs, including as policy benchmarks across government and in regular reporting on the cost-effectiveness of emissions-reduction policies.
3. Develop a framework for extending emissions-reduction incentives to new sectors with the costs aligning with the TCCVs.
4. Ensure that ACCUs are high integrity and seek to integrate ACCUs into every national emissions-reduction policy in the long term so hard-to-abate emitters face consistent incentives.

The carbon tax is very unlikely to return. As other countries have found to their cost, its just too politically toxic. But that doesn’t mean there isn’t an alternative approach. Expanding the Safeguard Mechanism to cover a broader share of the economy, combined with a more ambitious cap trajectory, will generate revenue to channel into renewables, while relieving pressure on government finances. Meanwhile, tying the implicit carbon prices embedded in government policies together, while linking to market based carbon price discovery, will ensure consistent and coherent carbon pricing across the Australian economy.

Its Brazil’s turn to host this years COP with the 30th edition of the United Nations climate conference due to be held in November in the Amazonian city of Belém. Australia is hoping to host next years climate talks in order to demonstrate the scale of its renewable energy transition, the opportunity for clean material exports (metals, fertilisers, and fuels), and the precarious future faced by many of the Pacific island nations it seeks to co-host the conference with.

If the Australian government is to square the circle, and make its COP31 dreams a reality, it’s clear that carbon pricing must play a more central role in its climate and economic policy strategy.

Europe must learn from Canada's 'price on pollution' debacle

Welcome to Carbon Risk — helping investors navigate 'The Currency of Decarbonisation'! 🏭

Carbon RiskPeter Sainsbury