Will the market save us?

A lot has been written since the 1997 Kyoto conference – and even more since Kevin Rudd agreed to ratify the protocol in 2007, committing Australia to a reduction target. The media has, however, done very little to explain how the reduction of greenhouse gas emissions by at least 5 per cent below 1990 levels by 2012 via ‘flexible mechanisms’ would work.

Basically, the various participants in the debate – from most Green activists to the majority of Liberals – are arguing over two options to reduce CO2 emissions: ‘the stick’ and ‘the carrot’.

The first option – the stick – is about enforcing social change via law. This is a more traditionally Leftist approach: the logic being that, if high CO2 emissions are problematic, then the state should promulgate decrees to phase them out. The approach is not new: it is, for better or for worse, how countries have traditionally approached large development projects. A carbon tax on the 500 most polluting industries amounts to a mild version of the state-led approach which the Labor government, with the support of the Greens, will follow until July 2015. It employs the ‘stick’ principle, in that the state will use its power to redistribute capital so as to develop more renewable energies.

In recent times, western democracies have increasingly preferred ‘the carrot’ of financial incentives. This neoliberal approach, reliant on the invisible hand of the market, has been adopted by the Kyoto Protocol. In Australia, the ‘carrot’ is a carbon trading scheme that will kick in after July 2015 to become the most important aspect of the carbon package, with the declared objective of reducing greenhouse gas emissions by 80 per cent by 2050.

Counterintuitively, the Liberal Party, on paper committed to the free market, advocates ‘direct action’ mandated by the state (that is, the stick) while a Labor government proposes a hybrid, beginning with the traditional Left approach of a tax before transitioning to a neoliberal trading mechanism.

Act I: The tax (2011–15)

The announcement of a carbon tax spurred considerable media hype, from the staged anger from the opposition, to the populist protest encapsulated by the ‘Convoy of No Confidence’ that converged on Canberra in August to demand the government stand down.

All the major accounting firms, however, have crunched the numbers and concluded the tax will neither send anyone broke nor derail the Australian economy. Only 500 polluting companies will be directly taxed, and no household will have to send money to the Tax Office as such. Average householders will pay some $9.90 per week as businesses pass on the impact of the carbon tax via the price of electricity, airline tickets and so on, with low and middle income earners compensated by the government. Higher income earners can put things in perspective by noting that nine dollars per week is less than the oil price hike of 2008 or less than a 25 basis point increase (that is, 0.25 per cent) on an average mortgage rate. To put it even more dramatically, those nine dollars are a rounding error compared to the amounts wiped out from superannuation in recent financial market falls.

As for the 500 polluting businesses, their balance sheets will be hit but they will be able to absorb the extra cost. Commentators will be left to ponder the remarks from BHP Billiton CEO Marius Kloppers, who labelled the tax a ‘dead weight cost’ on the industry, after posting the biggest ever corporate profit in Australia (almost $22 billion). The average carbon tax cost on a tonne of Australian coal will be $1.90 after government assistance, whereas a tonne of coking coal costs between $200 and $300. In other words, for many businesses, too, the tax looks like rounding error amidst the fluctuations of commodity prices.

Even taking a historical view, the carbon tax is in line with previous fiscal regimes absorbed by the economy: Howard’s goods and services tax, Keating’s superannuation (in effect a 15 per cent up-front tax on salaries), Hawke’s fringe benefits tax or Fraser’s reforms of excises and tariffs.

Essentially, proponents of the tax overstate its benefit, and opponents its costs. The debate should not be on whether the tax will sink the Australian economy but whether it will be so innocuous as to have no material effect on our lifestyle and thus not mitigate climate change. Critics have a point when they argue that the three-year tax phase will have only a very limited impact on emissions. Its goal is really to get things started by raising funding for a few green initiatives and initiating an entry cost that industries will pay every time they release a tonne of CO2 in the atmosphere. The real deal is that this initial cost must rise to force industries to phase out their most carbon intensive processes. Enter the trading scheme.

Act II: The actual trading scheme (from 2015)

This second phase is a change of tack. Instead of imposing a price on each tonne of CO2, the trading scheme relies on a carbon market driving the price of CO2 up and thus forcing a reduction in emissions.

Unlike the tax, it is a very complex construct, and there are many points at which the process could fail.

Like financial derivatives markets, carbon markets trade products that are difficult to define. The headache comes from building a ‘climate commodity’ – that is, something to be traded – from the requirement to decrease carbon pollution. The architects of the carbon system therefore came up with the concept of ‘cap and trade’, which creates a commercial system for industries to buy and sell permits whose value is equivalent to the price of a tonne of CO2 released into the atmosphere.

The first component of the mechanism – the ‘cap’ – is the part that addresses pollution by making the commodity more or less scarce. Authorities must determine how much emissions need to be cut year after year to have a positive effect on climate. The difficulty comes from the complexity of climate modelling. While we do know that pollution damages the climate, we lack data as to what socially optimal level of emissions will reverse the damage. This means that the chosen level of the cap is subject to endless debates and lobbying. Obviously, if the cap is too high, it won’t have any effect – as was the case with the European Union Emissions Trading System (ETS) from 2005 to 2007. The 2007 cap was 8.3 per cent higher than the 2005 verified emissions level and CO2 emissions actually went up. (Ironically, they decreased during the global financial crisis because of the slowdown of industrial activities, not because of the ETS.)

The second component of the scheme is the trade in carbon allowances. Targeted CO2 reductions are translated into quantifiable commodities, ‘allowances’, which are auctioned by governments, just like shares when state-owned companies are privatised. Then the trade kicks in. Companies that find physically reducing emissions expensive can buy allowances to keep emitting, whereas companies that can easily switch off CO2 can sell their surplus to those who have not cleaned up their act.

But the risk is that the ‘efficiency’ fostered by trading might not be effective in achieving the scheme’s purported goals. This is because of the artificial distance between the market and the emissions to be cut, with ‘climate commodities’ abstracted both from the type of technology causing the pollution and the place in which pollution is produced. In other words, a reduction of a certain number of CO2 molecules in Europe when a gas factory is made cleaner is judged as climatically equivalent to the same number of molecules saved in Victoria by replacing a dirty brown coal plant with a solar farm, regardless of the fundamentally different roles these play in the transition away from fossil fuel (which is, after all, what the scheme is meant to achieve).

This distance between the ‘market commodity’ and the ‘underlying asset’ (that is, the physical reality) was identified by the finance industry as a cause of the credit crisis of 2008, as the exotic products and derivatives bore no relation to the mortgages they were covering. That’s the risk with ‘climate commodities’: if not properly regulated, they become disconnected from the social necessity of transitioning away from fossil fuels.

Even putting such conceptual considerations aside, industry participants acknowledge that the carbon price initially set at $23 per tonne of CO2 by the carbon tax might not reach the $150 to $200 modelled by Treasury as necessary to drive pollution down. If the price doesn’t climb, polluters will keep buying cheap allowances instead of investing in more expensive renewable energies. The odds of such a scenario grow if we enter another economic recession, which would drive all commodity prices down.

Another factor contributing to low carbon prices is the supply of ‘offset credits’ that, in the name of cost-effectiveness, enable industries to delay reducing their emissions. Unlike allowances, offsets are not created by the government cap but are earned by projects able to demonstrate ‘additionality’, the proof they create genuine CO2 savings that would not occur otherwise. Projects must demonstrate that they are ‘additional’ in order for the Kyoto Protocol’s Clean Development Mechanism (CDM) Authority to issue credits. Offsets are generated outside the capped economy, mostly in developing countries, by projects designed to reduce, avoid or sequester greenhouse gases. They can then be sold to emitters within the capped economy to help them comply with their GHG limits. Offsets are typically tree plantations (which are supposed to absorb CO2), solar and wind farms or hydroelectric dams (which are supposed to replace fossil energy).

The difficulty with the offsetting mechanism is threefold.

Firstly, regulators face an incredibly complicated task assessing the carbon that would be saved via such projects in the developing world before they sell offsets to industries within the capped economy. Even with advances in satellite imaging, it is, for instance, difficult to verify how many tonnes of GHGs are sequestered by preventing deforestation or degradation of land.

Secondly, measuring the emissions offset in the developed economy is also riddled with uncertainty. In 2007, the UN’s Intergovernmental Panel on Climate Change found significant margins of error across industries, reaching 60 per cent in the oil, gas and coal industries – and even 100 per cent in some agricultural processes. That year, the Guardian reported on an analysis conducted by Tufts University in Maine, and found that assessments of emissions for flights between Boston and Frankfurt varied between 1.43 tons and 4.14 tons. Those variations are explained by disagreement on what should be measured, and exacerbated by differences in cargo load and weather conditions. Dan Welch, a Manchester journalist who investigated offsetters for Ethical Consumer magazine, summarised his findings: ‘Offsets are an imaginary commodity created by deducting what you hope happens from what you guess would have happened.’

Thirdly, offsets are highly exposed to abuse and fraud. Tree-planting projects in Guatemala, Ecuador and Uganda have, for instance, been accused of disrupting water supplies and evicting thousands of villagers to make way for plantations designed to offset European and US industries. In 2009, Mother Jones reported that General Motors, Chevron and American Electric Power spent $18 million in 2000–02 to purchase 50 000 acres of Brazilian rainforest with the goal of using or trading the credits. An enquiry revealed that this created a lucrative business for local ‘Green Police’ who banned hunting, fishing and the removal of vegetation, effectively outlawing the lifestyle of the Indigenous community.

Even more disingenuously, in China, companies have been caught purposely creating emissions just to destroy them and make money from the credits. Dams have abused the scheme by claiming offsets even though they were built without any extra efforts made to offset climate change, in a process comparable to someone pretending to buy a $5 million mansion (the dirty coal power plant) before purchasing a $500 000 unit instead (the dam) and then asking their banker to credit the difference as a $4.5 million offset to their account – even though, in reality, they were always going to get that unit.

This is just the surface of an incredibly complex system.

It is worth reiterating that the carbon package is not the only option. Labor could, for instance, have decided to mandate decisive measures such as the immediate phasing out of certain automobiles, massive investments in public transport, the immediate decommissioning of the most polluting industries and so on.

Instead, by implementing a tax for only three years, Labor may politically alienate a significant part of the electorate, without giving the process enough time to deliver tangible benefits. Then, by switching to a neoliberal policy that might totally miss the goal of reducing CO2 emissions, Labor runs immense risks. A whole industry of carbon operators is likely to benefit from the transactions on this new market, irrespective of the climatic outcome, while the rest of society will simply lose if CO2 emissions don’t drop.

A good illustration of the risks came from Paul Keating’s intervention on ABC Lateline during the week in which the carbon package was announced. He compared the carbon package to the superannuation reforms of the 1990s, arguing that only markets can deliver the changes required to reduce emissions.

Yet a closer examination of the superannuation analogy actually confounds Keating’s own logic. The real comparison is between the price on carbon (those twenty-three dollars per tonne of CO2) and the superannuation contribution (today at 9 per cent) employers must pay to build the employee’s retirement kitty. The level of that contribution is still fixed by law – it was never an option to allow the market to decide how this percentage might fluctuate. Even Keating, a champion of neoliberal policies in the Labor Party, knew that. The superannuation scheme relies on the strict mandate by law of the ‘cap’ component, with the market only intervening on the wealth put aside by each employee after the contribution to their super.

To continue with Keating’s analogy, the superannuation reforms have bolstered the prosperity of the finance industry in Australia but they do not provide a guarantee that individuals’ life savings won’t vanish during a financial crisis. We will be in a similar position if we discover in a few years time that, while the price of carbon has fluctuated, emissions have not materially decreased and climate change is still accelerating.

A market mechanism might not be doomed to fail but it does not guarantee any change in our carbon-intensive life style. The market is only one part of the equation to deliver an effective climate policy: it is just a tool. This is why the Labor government should quickly devise the second part of the equation – the social vision of what a decarbonised Australia looks like – and start mandating the changes necessary to reach this new ‘light on the hill’.

Overland is a not-for-profit magazine with a proud history of supporting writers, and publishing ideas and voices often excluded from other places.

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Xavier Rizos researches relationships between economics, governance, regulation, politics and culture.

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