Australia's new cap on emissions is a trading scheme in all but name

The Australian government has released its final draft for a cap on greenhouse gas emissions. The “safeguard mechanism” will form part of the government’s central climate policy, and will fine large businesses for exceeding emissions baselines.

Businesses that produce over 100,000 tonnes of greenhouse gases each year will have their emissions capped. The scheme makes some allowances for power generators and landfill (which produces greenhouse gases as rubbish breaks down), as well as those that expand production while improving their emissions efficiency.

The annual cap for the future will be based on the annual greenhouse gases emitted between 2010 and 2014. A final decision on the scheme will be made in late 2015 before starting in July 2016.

In effect, Australia’s climate policy armoury will include aspects of a “baseline and credit” emissions trading scheme.

Lower cost to business

An emissions trading scheme is a way of making businesses pay for the greenhouse gas emissions released from their business operations.

In a “baseline and credit” scheme each company must keep its emissions below a government-mandated level, for example, below the average of its previous five years’ emissions.

Let’s assume that the company’s “baseline emissions” had been set at 28,000 tonnes for a year. Also assume that the business emitted 30,000 tonnes of greenhouse in a year.

The company then has to pay for emissions that exceed the baseline, in this case 2,000 tonnes. They can pay for it by buying carbon credits locally or on the international market. Assuming a carbon price of A$10, the company’s cash outflow will be a modest A$20,000.

In contrast, under Labor’s “cap and trade” scheme, the government would release a number of permits into the market, based on national emissions reduction targets, such as Australia’s current 2020 5% less than 2000 levels by 2020. There is no limit imposed on individual companies’ emissions as long as they buy (pay for) enough permits, each permit giving them a right (but not an obligation) to emit 1 tonne of greenhouse gas. Assuming a permit price of A$10, then the same business will be paying A$300,000 under a “cap and trade”.

Thus the cost impost on businesses, and on the economy, is much less under the coalition’s safeguard mechanism compared to a cap and trade scheme.

Baseline and credit or cap and trade?

The two types of emissions trading schemes were debated in depth in the early 2000s, before the European Union favoured the cap-and-trade design in 2005 and it became the blueprint for Labor’s emissions trading scheme, introduced (albeit with a fixed initial price) in 2012. California and the Canadian province of Quebec have also adopted cap-and-trade schemes.

The case against the “baseline and credit” schemes back in 2005 included the fact that governments had insufficient information to set credible “baseline emissions” at individual business levels and that it involved more intrusive regulation than cap and trade schemes.

However, Australia has now detailed annual, company-level greenhouse gas emissions data for the large to medium-sized businesses, thanks to the National Greenhouse and Energy Reporting scheme introduced from 2008. Setting “baseline emissions” for each business need not be onerous, particularly if they are linked to individual companies past greenhouse gas emissions and their future plans.

The “baseline and credit” principle has already been used in the NSW Greenhouse Gas Abatement program in the last decade delivering low permit prices. That now-defunct scheme has been reviewed and presumably the lessons learnt would have informed the details the safeguard mechanism.

The actual performance of the European Union’s “cap and trade” scheme over the last 10 years shows its key weakness, namely governments’ inability to release the right number of carbon permits into the market, say for five future years at a time, based on various forecasts.

Random shocks such as the global financial crisis in 2008 impacted EU’s economic growth and greenhouse gas emissions. Demand for permits plummeted and the supply glut resulted in the permit price nose-diving from above 20 to around 5 Euros. So, the EU is now postponing the release of new permits to stabilise the supply demand balance.

Complementing other climate policies

The safeguard mechanism is complementary to the voluntary Emissions Reduction Fund (ERF), where the government pays businesses to reduce greenhouse gas emissions for specific projects.

The government will select only the low-cost emissions reduction projects using a tendering process. Those who get funding will reduce their emissions, but what about those who choose not to apply or do not get the funds? Will they continue to emit as before or more?

The safeguard mechanism is designed to ensure that there are mandatory obligations on greenhouse reductions from large businesses to not exceed their baseline emissions. Without a safeguard in the ERF design, emissions reductions by participants in the ERF could be nullified by emissions increases in other areas and businesses not participating in the ERF.

The safeguard mechanism - a baseline and credit emissions trading scheme - involves a fair degree of regulatory intrusion into the operations of liable businesses by mandating their individual baseline emissions.

While such high-handed regulation may be unwelcome, businesses would appreciate the lower cost of compliance to a baseline and credit scheme and the flexibilities built into the baseline setting process.

On the other hand, a “cap and trade” scheme is more market-based while imposing a higher cost of compliance on liable business.

This article is based on a post published on the Monash University website.

Gujji Muthuswamy received funding from Deakin University in 2014 for assisting in their ARC-funded research project into the carbon risk management practices adopted by businesses in a changing regulatory environment.