Preparing for trading

Australia faces a tough decision on how to manage its climate change obligations. An analysis of the cost of various CO2 abatement methods suggests that the introduction of a trading scheme would not necessarily cause adverse impacts to the power industry.

Tim Burrows, Australia

Australia’s power industry stands on the brink of a step change to its operating conditions. As talk of the introduction of an emissions trading system for carbon dioxide increases, the industry is seeking to come to terms with the available options. As with all discontinuities however, companies that are best prepared for the change will find themselves in a leading position.

Australia’s dilemma

With a population of only 20 million, Australia is a minor player in the global carbon dioxide emissions game. Its current emissions of 0.31 Gt CO2e per annum equate to a little over two per cent of global CO2 emissions. However, it is the country’s vast stores of certain fossil fuels and its net fossil fuel exports that make it vulnerable to the implementation of a price signal to reduce carbon emissions.

Australia’s electricity prices are among the lowest in the world, primarily due to its abundant and accessible coal resources. In 2005, Australia exported over 200 million tonnes of coal – it is the world’s largest exporter of coal – and almost eight million tonnes of natural gas. It is partly because of these two facts that the Australian government has refused to ratify the Kyoto Protocol. On one hand, domestic electricity prices would be almost guaranteed to rise. On the other hand, if the carbon embedded in its exports was to be accounted for within the country’s borders, export costs would rise significantly and major changes would be forced on fossil fuel exporters. Both of these outcomes could put at risk the longest period of economic expansion since the 1980s, now in its 15th consecutive year.

Australia’s response

Instead of ratifying Kyoto and joining the emissions trading system now operating in Europe, the Australian government has taken on a centralist approach, subsidizing research into those technologies that it considers most likely to reduce emissions. The most recent example of this is the Asia-Pacific Partnership on Clean Development and Climate, or AP6, during which the Prime Minister announced an injection of $A100 million ($73 million) towards the development of specific clean power technologies. This adds to the $A1.8 billion that it has already either awarded or earmarked for research and development of a range of technologies for clean power and renewable energy. While this funding has undoubtedly stimulated research into certain clean power technologies in the country, detractors argue that this policy of ‘picking the winner’ is inferior to market based mechanisms, which they believe would automatically find the best solution.

Australia is one of the highest per capita emitters of carbon dioxide in the world
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The closest that the government has come to a traded solution to the problem is its Mandatory Renewable Energy Target scheme. The power industry ranks high on the list of CO2 sources (See Table 1). Launched in April 2001, the scheme requires every major electricity retailer in the country to purchase two per cent of its electricity supply from a defined list of eligible renewable sources by 2010, the target being to source at least 9500 GWh of renewable energy per annum. However, the scheme is due to expire in 2020, and no indication has been given from the government that it will continue beyond this date.

To price or not to price

All of this has led to increasing calls for a true market-based system to internalize the cost of carbon emissions in Australia. While the introduction of a carbon tax is theoretically an option, given the political risks associated with any kind of new tax, a more likely outcome would be for a cap and trade system similar to the type introduced across Europe in January 2005.

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The incumbent Liberal coalition government has conceded that an emissions trading system will likely be introduced in the longer term, albeit not until new “breakthrough technologies” are first developed. Given its current strong position in both the House of Representatives and the Senate, the likelihood of any kind of change to this situation in the short term is probably low. However, ultimately the implementation of any kind of trading system is a political process, the timing of which is hard to predict with any accuracy at the best of times. What then might help to generate a plausible timeline for an emissions trading system in Australia?

There are a number of key environmental triggers that that might indicate a change to the status quo, and that should be monitored by CEOs and those involved in setting strategic direction for power generators:

  1. Federal elections: The Australian Labor Party has a formal policy to implement carbon trading if it wins government at the next federal election, which must be held no later than January 2008.
  2. State-based national trading: The Australian state and territory governments agreed in April 2005 to implement a state-based national carbon trading scheme, although an implementation date has not been set. Given previous experience, it is unlikely that implementation would occur prior to 2010.
  3. Policy change: The incumbent Coalition/Liberal government is under increasing domestic and international pressure to implement carbon trading. A recent survey indicated that 70 per cent of Australians are “worried about global warming”, indicating a high level of electoral interest.

Economic impact

The impact of the introduction of any emissions trading system on the wider Australian economy is the subject of a spirited debate. Economic rationalists point to studies showing that GDP has historically been shown to be inversely proportional to the cost of energy. Others believe that the market is adaptable, with an ability to adjust to changes in the price of inputs. They point to global experience with CFCs and the Montreal Protocol, the oil price shocks of the 1970s and SO2 emissions trading, showing that businesses undertake unexpected actions when confronted with a problem, and that these actions are generally not catered for or predicted by economic models. Some even argue that the economy will become even stronger under emissions trading, with increased activity from investment in research and development and emissions trading driving economic growth.

While the impact on the overall economy may be debatable, there is little doubt that the introduction of an emissions trading scheme in Australia would add yet another layer of complexity to the operations of the power industry. But will it necessarily result in profit reductions?

Figure 2. Investment in energy efficiency is currently the most effective option
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The European experience under its ETS suggests that there is actually some hope for the power industry in Australia if carbon trading is introduced, albeit at the expense of electricity users generally – and energy intensive manufacturers in particular. Certainly, from a financial perspective, active lobbying of government by the power industry in Europe has resulted in reasonable caps, with many power generators actually declaring increased profits.

Preparation is key

The key to riding this wave, of course, is preparation and information. Managers need to invest in scenario planning to determine the most appropriate response. And while carbon credit futures can be purchased, alliances formed and businesses divested, in its simplest form, the question that must be asked is, “What is the cheapest way to avoid the emission of a tonne of CO2 to atmosphere?”

If carbon trading were introduced in Australia, there is a clear course of action that should be followed, based on the simple cost of carbon abatement. The lowest cost of capture is increased via investment in energy efficiency measures. Indeed, investments into energy efficiency can be justified even in the absence of a price signal. If carbon trading were to be introduced, the case would only become more compelling. The next cheapest capture method would be to invest in permanent biosequestration, or forestry, with analysis forecasting costs around $A10 to $A15 per tonne of carbon captured.

Coal fired power generation dominates in Australia
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If carbon credits in Australia are priced at roughly the same level as the current European price, both of the above options will provide significant savings compared to the alternatives to those with the foresight to implement them. The remaining options will likely be non-viable in the near term. However, this situation will change over time, at an unpredictable rate. Technological improvements in energy efficiency, renewable energy and carbon capture and storage will reduce the cost of capture. At the same time, as land suitable for forestry is consumed by those seeking cheap credits, the supply of available land will gradually diminish, leading to an increase in the cost of capture via forestry. If technologies that are currently in the demonstration phase, such as pre-combustion decarbonization, oxyfuel combustion, membrane separation and post combustion scrubbing, or a combination of these technologies, can be implemented at less than 50 per cent of their current cost, these will become viable and cost effective.

While the current government is standing by its policy of solving global warming through investment in technology, there is a strong likelihood that a carbon trading scheme will be implemented in Australia at some stage. Those players that are prepared will be able to take advantage of the situation, through learning from the experience of others and ensuring that they understand all of the available options.

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