There are causes for concern around the collapse in the European carbon price. BS summarises them well enough:
Shadow treasurer Joe Hockey said if Australia adopted Europe’s carbon price today, it would have serious ramifications for government revenue.
“If the European price today is to be applied to the budget, then there will be a budget hole of at least $7 billion in just one year,” he said.
The European Union voted against a controversial plan to reform Europe’s emissions trading scheme (ETS) by temporarily removing 900 million permits from its market.
The move sent European carbon prices crashing to below €3 ($3.84) per tonne, before they recovered some lost ground to trade at just under $4.
In last year’s budget, Treasury projected the carbon price at $29 per tonne in 2015/16.
Climate change minister Greg Combet said fresh modelling would be carried out in coming weeks.
The Opposition is aiming to paint this as a calamity in the making for the budget with Greg Hunt describing it as potential “chaos”. Current forward estimates for the four years from July 2012 include almost $25 billion in carbon tax revenue based on a fixed price of $23 per tonne for the first three years then the floating price in the fourth. From the 2012/32 Budget:
Hockey’s $7 billion figure is basically the third or fourth year of projections if the scheme is scrapped so he is actually discussing the implications of his own policy of abolishing the price. That’s not to say that falls in the European price won’t be be a blow to the budget but the chaos is coming from calls to abolish the scheme on the run, not the fall in the price itself. As Tony Wood, carbon markets guy at the Grattan Institute, argues today at the AFR:
The collapse in the European price of emissions permits has led to wide spread claims that markets don’t work and that the Australian government was wrong to link our emissions trading scheme with the European ETS. Neither conclusion is right, but that doesn’t mean we should just carry on. Carbon markets can work, but only if they are credible and politicians are committed to them for the long term.
…Certainly the planned intervention would have been a failure – and so it should have been. It was almost exactly the wrong sort of intervention in a market and would have only increased investor uncertainty.
Since its establishment in 2005, the European ETS has evolved to work well as a market. The collapse in price, claimed by some to represent a market failure, was rather an efficient market response to a collapse in demand for permits. Demand has fallen because of flaws in the implementation of the ETS – an excess of allocated permits in earlier periods – but, more importantly, because reduced economic activity in Europe has reduced emissions.
As emissions have fallen, so has the price of permits, which is exactly as it should do in a free market. If and when economic activity increases, the ETS will respond just as efficiently in the other direction: prices will rise. Claims of market failure can usually be traced either to those with a commercial interest in technologies which need a higher carbon price, or to those who would like to see the back of climate change policies in any form.
As Wood points out, so long as governments remain committed to carbon mitigation, the long term price of EU carbon permits will rise by itself. He concludes that it would be best to link to the EU scheme sooner rather than later to prevent a collapse in the local price in 2015. If Europe remains in its long term funk, emissions keep falling, and the Australian price with them, then good. If it’s going to halve the moment it floats, the certainty argument for a fixed Australian price is undermined. But let’s give some time, eh? Besides, the whole point of pricing carbon is that the overall carbon amount is reduced most efficiently, not just those of one nation.
Some of you will argue that not everyone is yet pricing carbon so the aggregate reductions argument is academic but, as Wood argues, the “patchwork” of carbon pricing schemes that unites over time is still the way to ultimately produce a binding outcome for all. With China also looking to price carbon in the near future it’s better persist in this course in my view.
Which brings us back to the question of what an earlier linkage of the Australian price to the European price would mean to the budget and does it matter anyway if that path were chosen? Reducing the Australian carbon price to $10 now would knock $3 billion plus per annum out of forward estimates. A sizable amount, but these are the kind of budget decisions that are made every day in a $370 billion budget in response to changing economic circumstances. And so long as governments remain committed to carbon pricing, the price will still rise from here.
However, with our two political parties stuck in the narrative of government surpluses, a sensible assessment of these adaptations will be as elusive as ever.
