While it's better than nothing, the Federal Government's Green paper on carbon trading recently released by Minister Penny Wong, rates about a five out of ten.
All the essential elements of an effective carbon market are there, but there is one word that has me worried: "however". Just about every time the report discusses best practice, or recommends the sorts of approaches identified by the Garnaut Review to reduce greenhouse emissions, it's followed up with the word however, and some excuse as to why they're not going to implement best practice.
The challenge I see is that all these "howevers" are potential market distortions which are going to get in the way of the "Carbon Pollution Reduction Scheme" actually delivering any emissions reduction, let alone delivering it at the lowest cost (which is ultimately the point of any trading scheme).
And while, on the one hand, I don't have any problem with compensating households for what will be a one off supply shock to the economy, and I can understand the argument for providing trade exposed industries with some transitional protection, the government is making a considerable mistake when it comes to the issuing a number of "free" emissions permits to so called "strongly affected industries".
The indication at this stage is that up to 30% of the permits in the scheme will be issued for free, while the rest will be auctioned. The final numbers of permits to be issued won't be revealed until the Government's Whitepaper comes out in December, however, the final numbers won't matter quite so much as the fundamental inequity of a scheme where some emitters will get a free ride, while other's have to pay full price for the right to emit greenhouse gases.
It is giving out free property rights to one sector, while other industry sectors are expected to pay for the very same property right. Not only is this eliciting cries of "why not us" and "you are giving them an unfair advantage", it is also distracting the market from the ultimate and key challenge of beginning to reduce the nation's overall carbon emissions.
There is also the potential for a domino effect if more industry sectors manage to use the fact that one of their competitors has been granted free permits to negotiate their own special treatment during the consultation phase leading up to the release of the White paper.
Another major ‘however" in the Green paper is the suggestion that the cost of carbon might be capped in some way. Once again the paper presents a logical and well thought out auction process that satisfies the three key ingredients of an effective market, transparency, equity and efficiency, and then the "however" of a cap on the amount that business will have to pay for permits in the early years of the scheme is introduced. I'm intrigued to see how the government will combine the auction process with a price cap. It's hard to see how they can apply a cap without totally destroying the integrity and efficiency of the market mechanism they are attempting to create.
It is almost as though someone put the cap idea in there at the last minute without really considering that the suggestion could effectively neuter the competitive nature of the auction process. What is even more ironic is the statement in the Green paper assuring readers that the cap will be set well above where the market would actually clear (the price point where supply meets demand). If that was truly to be the case the cap would be redundant. (Is a double however the same as a double negative?)
The risk is that a permit price cap introduces a potential market distortion - market distortions mean it will take longer for the market to establish the true price for carbon and therefore the longer it takes to create a fully functional liquid carbon market.
The reality is that the sooner we have a fully functional liquid carbon market, the sooner we can create hedging and risk management products and make them available to industry to reduce the impact of operating in a carbon constrained world. In attempting to soften the blow by introducing market distortions, the government will postpone the roll out of these risk management products, and ultimately the more time it will take and the more costly it will be for Australia to transition to a lower carbon economy.
One has to ask why the government went through the expensive exercise of including the design of an emissions trading scheme in the scope of Professor Garnaut's review process if it was going to place a "however" on the end of so many of his recommendations and stray so far from the principles he espoused.
Tim Hanlin is Managing Director and co-founder of Australian Climate Exchange Limited and as such has been intimately involved in all stages of the planning and development of the ACX. He is also Principal Consultant for all strategic and corporate advisory consulting assignments accepted by the ACX. In overseeing the development and operation of the first emissions trading exchange in Australia and its associated infrastructure Tim has developed a unique perspective of both the Australian and international carbon markets.