Hybrid scheme the best of both worlds for cutting carbon


John Daley and Tristan Edis

Published in The Age, page 17, Friday 24 September 2010

A mix of “cap and trade” and emissions taxes is needed to do the job, writes John Daley and Tristan Edis.

Imagine you could only sell your house by auction, but weren’t allowed a reserve price. Doubtless auctions would be more exciting, with buyers hoping for a bargain. But it is also likely that house prices would fall. Many people would fear to invest in housing in case they sold on a bad day. Energy investors face the same issues with carbon pollution prices, even if the price tags are bigger. Investors in less polluting energy – such as gas, wind and solar power – worry that the carbon price may turn out to be too low. If it is, they won’t make enough to justify investing.

That is why the debate about carbon pricing has turned to “carbon taxes”. Taxes provide more certainty of making a profit on energy investments. However, unlike the “cap and trade” policy proposed last year in the Labor government’s carbon pollution reduction scheme, carbon taxes provide less certainty of big enough cuts in emissions.

A hybrid scheme – a trading scheme with a floor price, a bit like a house auction – would be the best of both worlds. It would reduce uncertainty and, ultimately, the costs of cutting carbon pollution.

Carbon pricing is a key issue when building new power stations. Major private sector energy companies in Australia are not seriously considering building coal-fired power stations in eastern Australia, and banks aren’t likely to be keen to lend money for such projects, either. Instead, they are planning lower-carbon, baseload power stations using gas.

This is exactly the point of carbon pollution prices. We need these new power stations to keep up with rising energy demand and ultimately replace high-pollution power stations such as Hazelwood. But it only makes sense to invest if gas-fired generators cost less to operate than coal-fired generators (including paying for carbon pollution).

A “cap and trade” scheme caps the maximum amount of carbon dioxide that can be emitted each year. Polluters need to buy a permit for each tonne they emit. If there are fewer polluters than permits, then permit prices can crash.

This has already occurred with environmental permit trading schemes in Europe and the US, and with Australia’s three existing trading schemes. Unlike normal markets, the supply of permits is fixed by the government, and does not reduce with lower prices.

A simple levy on carbon pollution gives investors more confidence. It becomes cheaper to finance new power stations, and ultimately consumers pay lower electricity prices. Companies that emit carbon pollution directly, such as chemicals manufacturers, think the same way – with more certainty, they will be quicker to invest in their plant to reduce emissions.

The problem with a levy is that it does not guarantee how much carbon we emit. Trading schemes also cushion the economy during recessions: when the economy slows, emissions fall and carbon prices fall.

The best solution may be a “hybrid” scheme, where for each tonne of carbon dioxide emitted, polluters must both pay a levy and purchase a permit.