Calculating the carbon price after 2015
By Gujji Muthuswamy
The Government may hope carbon pricing will die down as an election issue after 1 July 2012 as people come to realise that the sky is not falling due to the carbon tax. In fact, the debate will continue but most likely centre around two important areas: the ‘devil’ associated with the ‘details’ of the scheme implementation and the various views on the likely price of carbon beyond 2015 when the emissions trading scheme (ETS) kicks in and prices are set by the market.
The implementation issues post-July 2012 will be mainly teething troubles, so to speak, but will be enough to give ammunition for negative campaigning to the opponents of carbon pricing. High on the list is the complex issue of how the carbon tax affects retail electricity and gas prices.
Most people do not distinguish between the two major components of customers’ electricity costs, namely market-driven electricity generation prices and the regulator-determined charges for transmitting and distributing the electricity from the power stations to the customers’ boundaries. The impact of the carbon tax on the two is even less understood and the various competitive offers by electricity retailers could increase this sense of bewilderment about the nature of the carbon tax. The money handed out by the Government will long be forgotten by the time the utility bills start hitting the mailboxes. Some form of communication from the Prime Minister explaining the carbon price and electricity pricing in simple language is needed as a band-aid.
The lack of progress on the replacement of the Kyoto Protocol, which expires at the end of 2012, will be an additional sore point, despite the likely emergence of standalone ETSs in places like Korea and parts of China. It remains to be seen whether the regulatory systems for the measurement and reporting of greenhouse gas (GHG) emissions in other countries will be as robust as what we have in Australia. If they are not, the legitimate question “Are the foreign permits as good as ours?” could also be misused to stir up latent xenophobia and dissatisfaction with carbon pricing as a whole.
The more substantial controversy will surround the question of what the price of carbon will be after 30 June 2015 when the carbon tax ends. The $23/tonne tax will have crept up to $25.36 in 2014/15. Will it take a nose dive in 2015/16 as some people suggest, or will it remain in the high 20s as Treasury models predict? What about the prices in the period to 2025? The reality is that one person’s guess is as good as anyone else’s and predicting the price in a yet-to-be established market is a risky venture.
Those predicting a low carbon price in the post-2015 period point to the currently prevailing low prices for European permits and Certified Emissions Reduction units (CERs) issued by the UNFCCC under the Kyoto Protocol. CERs are generated by various low-GHG emissions projects in developing countries and will be available to Australian businesses as an alternative to Australian permits from 2015/16 up to 50% of their requirements. While CERs are currently tracking at less than $10, will these low prices continue into 2015/16? Moreover, the fate of the Clean Development Mechanism (CDM) itself, which generates CERs, is linked to the uncertain future of the Kyoto Protocol.
Over the five year period to 2010 since CDM’s inception, about half of all CERs issued came from Chinese projects. If, in the future, China were to use its CERs in its own developing ETSs, the supply of CERs in the international markets would dry up and there may not be sufficient CERs available to meet the Australian or global demand. Furthermore, philosophically, the issue will be argued never-endingly either as rich countries exporting their pollution to poorer countries (“bad”) or as exporting new low-emissions technologies (“good”). Other emotive questions will also arise: “Are we exporting Australian ‘green’ jobs by allowing the use of international permits?” for instance.
Nevertheless, those subscribing to low carbon price forecasts beyond 2015 would say our starting price of $23/tonne in 2012 is too high. In their scenario, the revenue from carbon permits would drop dramatically after 2015 but the outlays in the form of tax cuts and other non-carbon price-related assistance would remain, thus exerting pressure on balancing the national budget.
The key issue is that investors need the carbon price forecasts to decide where to put their money – for example, in coal or gas or renewable power generation. A low carbon price forecast would mean continuing investment in coal power stations while a high carbon price will favour more investment in renewables.
A whole range of factors set by the Government and the marketplace will determine the market price. One can describe these factors, but quantification of how they might interact is not easy.
The list of regulated factors is quite long: yet-to-be-decided medium-term GHG reduction targets, the floor and ceiling prices, type and frequency of auctions, limits on the use of international certificates and local farming offsets, penalty charges for non-compliance and so on.
As for the demand for permits by the more than 400 liable parties, it will be determined by the scope for these companies to reduce their emissions by using energy efficiently. Put simply, will it be cheaper to reduce emissions or to buy permits?
Other factors governing the market price include how the free permits are used by the recipients, potential for exercising market power by the big players, ability of companies to move production facilities offshore, impact of a renewable energy target scheme on the need for permits, general improvements in the emissions intensity of the economy and the introduction of ‘carbon forests’ capable of generating large numbers of carbon credit units under the Carbon Farming Initiative (CFI). The CFI program holds great potential for carbon abatement at low cost but it is still in its very early stages of development.
With so many variables, there can be no certainty about carbon price forecasts for the 2015-2025 period. It will be difficult to develop financial derivatives to manage the price risk until deep and liquid primary and secondary markets for carbon develop in Australia, perhaps in the 2015-2020 period. Investment uncertainty in the energy and export sectors may prevail til then, and so will the debate - up to and beyond the next election.
Mr Gujji Muthuswamy is an Adjunct Lecturer in the Faculty of Business and Economics, Monash University and lectures on carbon pricing. He has been working in the Victorian electricity industry for more than 30 years.