CARBON TRADING SCHEME IS NOT HOT AIR
12 July 2008
Ross Gittins
A well-structured emissions credits program will have economic benefits.
A LOT of people have only the vaguest idea of how an emissions trading scheme would work, which is hardly surprising because it involves several unfamiliar mechanisms.
Even the name is misleading because, though the trading of permits to emit a certain quantity of carbon dioxide or other greenhouse gases is desirable, it's not a central element of the scheme.
A "cap and trade" scheme is a bit better, but calling it a carbon pricing scheme would be more descriptive.
The key to understanding how the scheme would work is to remember that it was designed by an economic rationalist, which means it's based on the belief that changes in the price of a product relative to the prices of other products have a big effect on the way people behave towards that product.
The way the scheme would work is that the Government sets a limit (or cap) on the total amount of carbon dioxide it will allow to be emitted during a particular year, and gradually lowers the limit each year.
This means it's effectively restricting the supply of those goods or services that are emissions-intensive, particularly petrol and electricity produced by coal- or gas-fired power stations.
What happens when people want to consume more of those emissions-intensive products, but the Government is deliberately reducing the supply of those products?
It forces up the prices of those products relative to the prices of all other products.
The point of forcing up the retail prices of petrol and electricity is to encourage consumers to be more economical in their use of them. Motorists are encouraged to use more public transport, switch to more fuel-efficient cars, join a car pool, or ride or walk to the shops.
Householders are encouraged to reduce their use of electricity by not leaving equipment on standby, switching to more energy-efficient models, adjusting thermostats on heating and systems, or installing insulation.
All this happens because the Government restricts the supply of emissions-intensive products, making them more expensive. At the same time as it sets the limit on emissions, it issues permits to the relevant companies to emit carbon dioxide up to the limit.
If it gives those permits away, the oil refineries and power stations simply pocket the increase in the prices they're able to charge. But if it sells those permits at an auction, the sum it raises should be equal to the increase in prices paid by users of petrol and electricity.
This means the introduction of an emissions trading scheme should yield the Government a huge new source of revenue - perhaps as much as $20 billion a year - when the scheme has been working for a while.
The Government will be able to use this revenue to compensate people for the higher cost of living by means of cuts in income tax and increases in benefits. It will also use some of the revenue to subsidise research and development of new emissions-reducing technology, and to ensure trade-exposed emissions-intensive industries aren't exposed to unfair competition with companies in countries that don't have similar emissions schemes to ours.
The second mechanism the scheme sets in train is that by raising the prices of fossil fuels it makes the use of renewable energy sources - and nuclear power - more economic.
So this encourages the expansion of renewable energy industries, as well as making it more financially attractive for households to install solar water heaters or solar panels.
The third mechanism is that the need of the producers of emissions-intensive products to buy expensive emissions permits encourages them to search for new ways to reduce emissions. The more they can do that, the fewer permits they need.
The fourth mechanism involved in an emissions trading scheme is the one that involves trading. Allowing companies that don't need all their emissions permits to sell them to others minimises the cost to the economy of achieving the Government's limit on emissions. It does this by shifting the burden of emissions reduction to those companies that can do so at the least cost.
You see from all this that, apart from using higher prices to encourage consumers to reduce their use of emissions-intensive products, the scheme aims to create a financial incentive for companies to search for new technological solutions to the problem.
And the whole point of using price changes rather than regulations and restrictions is to achieve the desired reduction in emissions at minimum cost to our material standard of living.
©2008 Copyright John Fairfax Holdings Limited. www.theage.com.au
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