Australia now has bi-partisan commitment to introduce a greenhouse emissions cap and trade scheme, and that’s got to be worth a toast or two. Yet neither of the major political parties have told us what cap they have in mind - at least for any time period that is meaningful ( i.e. 2020 and 2030).

Considering that the whole reason for introducing emissions trading is to cut greenhouse emissions, the lack of any real detail on the emissions cap for the scheme within the next 20 years is extremely significant and quite deflating - a bit like going to the pub and finding no beer.

In an ideal economist’s world, setting a cap for greenhouse emissions would be a matter of precisely quantifying the monetary cost imposed on society by each extra tonne of CO2 and undertaking all greenhouse abatement opportunities that came at a cost less than or equal to this social cost. But the impacts of climate change are not particularly amenable to precise financial accounting.

Highly subjective valuation judgements are required (for example, what price a human life? and should it matter what their income earning capacity is?). The impacts are subject to uncertainty and contingent events, such as how societies react to change (do affected people move seamlessly and peacefully across geographic regions, or do they end up in conflict?). Work undertaken as part of the Stern Review identified a huge range in estimates of the social cost of greenhouse emissions. Their analysis suggested a number of $US85 per tonne of CO2 (year 2000 prices) for the central business-as-usual case. This suggests a very stringent cap for Australia as the switching price required for a large amount of renewable energy projects to compete against coal is less than half this social cost.

But in terms of political realities, governments in Australia have traditionally baulked at even mild increases in electricity prices. Also there is not yet an equal commitment from other countries to impose a price on carbon of such an amount. Introducing such a price relatively quickly is likely to create significant adjustment difficulties for a number of households and drive premature shut-downs of major power and industrial plants. This would ultimately undermine the political support for an emissions trading scheme and harm prospects for maintaining strong action on greenhouse emissions in the longer term. Consequently $US85 (about $A100), per tonne of CO2 would not be politically palatable, at least for the next decade with our current electricity emissions intensity of one tonne of CO2 per megawatt hour (MWh) and our poor energy efficiency.

Perhaps it is better to begin with the bare minimum Australia must do before we start defining what we must ultimately do. This needs to start with a focus on a time period that is meaningful, where today’s politicians and governments can be held accountable, where their actions are likely to make a discernable difference. Aspirational targets are well and good but accountable and actionable targets are better.

Criteria 1: Avoid major investment mistakes that make it more economically painful to reduce emissions

The bare minimum one would think is to at least avoid getting ourselves into an even more difficult situation than we already find ourselves in. One of the worst things we could do would be to commit large sums of money into new plant and equipment that we’ll have to scrap five or 10 years down the track creating significant economic dislocation and stranded assets. This won’t serve our environmental goals but it also won’t serve our economic goals. New coal-fired power stations clearly fall into this category. They involve large investments of about $1 billion each, and have investment lives of more than 20 years. They are simply no longer viable. Any emissions trading scheme needs to give a price signal that will prevent such unwise investments while also providing sufficient return for alternatives such as combined cycle natural gas plant.

Criteria 2 – Economic cost acceptable to the Australian community

Any target we implement needs to involve a manageable economic cost that is acceptable to the majority of Australian voters. Understandably if the scheme imposes a severe and sudden economic loss similar to a recession then voter support for emissions reductions, no matter its long-term value, is likely to evaporate.

Criteria 3 – Stop emissions growing worse

One would also think that considering the science suggests there is a significant risk of catastrophic events if emissions are maintained at current levels, and the need to accommodate increased energy consumption from the poor of this world, we should at the very least stop emissions from growing any further than the target we agreed to under the Kyoto protocol. While some might argue about whether we cut emissions by 40 per cent or by 60 per cent or even by 90 per cent by 2050, one would hope that if we’re serious about addressing global warming we should at least stop emissions growing beyond 2012 when an emissions trading scheme should be well and truly in place.

Criteria 4 – Acceptable to our international peers

Any target we set must be acceptable to our international peers. European leaders have locked in a unilateral target of 20 per cent cuts from 1990 levels by 2020, and this could be increased to 30 per cent depending on what countries outside the European Union agree to. This will be backed by a legally enforced emissions trading scheme that is already in existence.

Canada has set a target of 20 per cent reduction from current 2006 emission levels by 2020 covering electricity, industrial and mining processes and backed it with an emissions trading scheme based on intensity limits.

In the US, while President Bush has been the biggest obstacle to meaningful progress globally, he won’t be around for much longer. Instead of looking at him it’s probably more useful to look at two other benchmarks – the state-based emissions trading schemes and what is being proposed in the US Congress. The State Based Emissions Trading Schemes emerging are not to be sneezed at. According to Dr Hugh Saddler and Adjunct Professor Frank Muller the 15 states that are developing emissions trading schemes (under either the North-Eastern or the Western Regional schemes) constitute 38 per cent of the US economy (i.e. share of total GDP). Their combined emissions are 22 per cent of the US total, greater than those of Japan or Germany. As a separate country, they would rank as the sixth largest emitter after the US, China, EU, Russia and India. Under the North-Eastern regional scheme emissions will stabilise from the power sector at 2006 levels and then will be reduced to 10 per cent below 2006 levels by 2019. In terms of the Western States, each have their own seperate targets by 2020.

Within the US Congress there are nine proposed bills for cap and trade schemes that would apply nationally. These are outlined in the table below.

So how does the joint State Governments’ proposal in Australia (the only target we actually have in the public domain) stack up against these bare minimum criteria?

In terms of a tolerable economic cost for voters it passes with flying colours. Its economic impact is about the same as the last Reserve Bank interest rate increase of 0.25 per cent - but is spread out over the space of 20 years! GDP nearly doubles over the period of the scheme and there’s virtually no distinguishable difference as a result of implementing emissions trading.

Also, based on the modelling prepared by McLennan Magasanik (MMA), the proposed scheme should be sufficient to prevent major investment mistakes.

But it is a dismal failure when compared against criteria 3 and 4. Missing from the governments’ Discussion Paper, but available in the supporting economic modelling report by Allen Consulting Group, is a graph (page 29) which illustrates that overall Australian greenhouse emissions (not just electricity) continue to rise significantly over the whole period of the emissions trading scheme.

If we consider just electricity emissions, the picture is certainly better but it is still not anything close to matching what Europe, the US and Canada are intending to do. Emissions continue to grow until 2015 and then decline very slowly taking until 2025 or 2030 to get back to 2000 levels. Most of the US Congress proposals envisage reducing electricity emissions to 1990 levels by 2020 and in a number of circumstances they extend this target to cover a number of other major sectors. They also aim to immediately halt emissions from growing.

In light of the moderate costs, surely we can do better than an emissions trading scheme that will still see Australia’s overall emissions grow substantially between 2010 and 2030?

Modelling work undertaken by MMA for the Climate Institute, profiled in this issue, details a greenhouse emissions abatement strategy for the electricity sector that reduces greenhouse emissions from the electricity sector to a little under 2000 levels by 2020. Through emissions trading complemented with energy efficiency measures as well as a deployment mechanism for renewables, the strategy achieves a better greenhouse outcome than the states’ proposed scheme and still at moderate cost. Wholesale electricity prices are higher than under the States’ scheme but this is offset by lowered electricity consumption as a result of improved energy efficiency.

For households the increased expenditure on electricity is only $3 to $4 per week. In terms of overall resource costs, the report provides figures for the whole period of the envisaged strategy from 2008 to 2050. This involves further reductions in emissions after 2020 to 80 per cent below 1990 levels by 2050. The resource cost within the electricity sector for these deep cuts is $14.3 billion on a net present value basis. While this sounds like a big number, this one-off cost to the economy is not out of keeping with other investments the Australian Government undertakes on important issues. For example in this year’s Federal Budget the government set aside $5 billion in a higher education endowment fund. Delaying the tax cuts announced in this year’s Budget by just two years could have delivered the full amount of the required investment.

Stabilising electricity emissions at 2000 levels by 2020, as outlined in the Climate Institute paper, should be the bare minimum an Australian emissions trading scheme aims for.