Wednesday 06 Oct 2021 | 20:55 | SYDNEY
Wednesday 06 Oct 2021 | 20:55 | SYDNEY

CPRS: Review cancelled, opportunity lost


Warwick McKibbin

23 February 2009 13:46

It was good news when Treasurer Wayne Swan announced that the House Economics Committee was to enquire whether the core of Australia’s response to climate change – the Carbon pollution Reduction Scheme (CPRS) — is the best way to tackle climate change.

This now cancelled review could have reconsidered the range of alternative approaches available and would have enabled the genuine concerns of all sides of politics, from the Greens to the conservatives and within the Labor Party, to be addressed. It would also have been an opportunity for the Government to produce a consensus policy framework.

The precise nature of the 'cap and trade' approach as currently proposed in the CPRS was never going to be easy to adjust to the political realities it was trying to address. The fundamental problem with the CPRS, as with the policy recommendations of the Garnaut Review, is that it starts with the idea that a rigid target and a timetable should be the basis of the policy design and that the problem of uncertain costs can either be ignored or tackled in an ad hoc way through exemptions and handouts.

However, the balance between reducing emissions as quickly as possible while smoothing costs over time should be integral to the policy design. The core of the policy design should be a clear, credible, deep cut in emissions where possible, with a clear mechanism for smoothing costs over time, based transparently on the evolution of international agreements and adjusted as information on costs and benefits are revealed. 

It is not too late to modify the CPRS to shift to a much simpler and more sensible approach that would address the genuine concerns of all sides of politics (though it would have been better to do this in an open enquiry with expert input rather than behind closed doors in political negotiations with the Senate). Here's how it can be done. 

First, a sensible modification would be to propose substantial cuts, with 10% proposed today and 60% by 2050. This would not be a pledge to absolutely reach the target by a particular date no matter what it costs, but a pledge to reach the target under the condition that a clear cost threshold over time not be exceeded. Perhaps deep cuts could be achieved at low cost, so why rule out this option (as the CPRS does)? On the other hand, it may be very expensive for Australia to reduce emissions significantly, so why lock in a target no matter what it costs, especially while the rest of the world is uncommitted to a clear policy?

A permit market based on this clear long-term commitment avoids the ambiguities of the CPRS, which involves gateways and the release of additional long-term permits in future years.

Second, establish a Central Bank of Carbon that would be charged with capping the annual price of carbon for a period (perhaps 5 years at a time) just like the Reserve Bank fixes the interest rate for one month. This price cap is achieved through the issue of expiring annual permits available each year to supplement the emissions allowed from long-term permits.

This is particularly useful if the reductions in emissions implied in any year prove to be too expensive relative to a cost commitment, which will evolve along with international policy responses. The additional annual permits act as a 'safety valve' in the short run and allow smoothing of costs over time.

The combination of long-term and short-term permits at a fixed price actually converts the emissions trading system into a carbon tax in the short run. The revenue from the carbon tax is divided between those who sold the long-term permits they were allocated, and the Central Bank of Carbon, which receives payments from emitters for the annual permits. The advantage of this approach is that there is then no need to import permits from overseas or to deal with banking and borrowing by private agents, because the Central Bank of Carbon does this for the market.

These changes to the CPRS also resolve the complexities of the various linkage issues and the problem of unhelpful speculation in the permit market. It also enables deep emission cuts to occur if they are cheap. If additional reduction programs are introduced they can drive down annual emissions rather than driving down the emissions price. The inflexibility and inability to reduce emissions beyond the announced target is one fundamental flaw in the CPRS cap and trade approach.

The modified approach outlined above is known as a Hybrid approach. Despite political rhetoric to the contrary, the Hybrid is just as compatible with the European ETS as the US scheme is likely to be (note that all US legislation at the national level has had a safety valve in the short-term pricing). The bottom line is that the US approach is likely to be closer to a Hybrid than the European ETS and will not be designed just to be compatible with the European system but will be in the US national interest.

The Australian Government still has a chance to lead the world with innovate climate policy. This need not be too different from the CPRS once the key changes proposed above are introduced. All of the excellent work done by the Department of Climate Change and the Treasury is still relevant and does not need to be jettisoned. It is just that some key design problems of the CPRS need to be ironed out. 

In the end, it is critical that the emissions trading system implemented in Australia be simple, transparent and supported by all sides of politics for it to be an effective climate policy.