The Carbon Briefing: Australia’s punt on the EU ETS – how does it work?

  • 05 Sep 2012, 10:00
  • Ros Donald

Last week Australia and the European Commission  announced they would begin linking emissions trading schemes (ETS) in two years' time.

An emissions trading scheme sets a cap on carbon emissions, requiring polluters to hold a permit for each tonne of carbon dioxide they emit. The level of the cap dictates how many permits are available.

Under  the European ETS, each EU member state sets a national cap for carbon emissions, which is then converted into allowances for polluters. At the end of every year, polluting industries must say how much carbon dioxide they have emitted. If they've used more than their allocation, they have to buy permits from those that have spare, and the market sets the price of those permits.

David Parnell, director of the Centre for Environmental Economics at the University of Western Australia,  explains that under the EU ETS:

"[I]t's not actually the price that causes the overall cuts in emissions. The cap determines the level of emissions, and the required cuts in emissions cause the price. That is, permits have a value because they allow you to avoid making cuts in emissions."

The current Australian system works in a different way, with the government setting the price of carbon dioxide allowances. This may be why the scheme is commonly referred to in Australia as a carbon tax, even though it isn't really a tax, but a capped emissions trading scheme. The government decided that a fixed carbon price would reduce uncertainty in the scheme's early years, but Australia plans to move to a full blown emissions trading market over the next few years.

What's going to happen?

Last week, Australia and the European Commission announced there would be a full two-way link between their emissions trading systems by July 2018. Businesses will be able to use carbon units from either the Australian or the European emissions trading systems interchangeably.

Until then, Australian businesses will be able to use EU allowances to meet up to 50 per cent of their needs from 2015. But European businesses won't be able to use Australian carbon credits until 2018.

How is the Australian scheme going to change?

The Australian government has announced it's going to make some  changes to its scheme so the systems interact successfully.

Originally, it had planned to enforce a minimum price for emissions permits of around AU$15 dollars (around £7). But it's now dropped the price floor - the European Commission says removing it will make it easier to link the schemes, ensuring there's a single price for EU and Australian units.

Second, the Australian government is going to limit the amount of  international emissions units Australian emitters will be able to trade. These units are created under the Kyoto Protocol of the United Nations Framework Convention on Climate Change, and allow international trading in greenhouse gas emissions, as well as things like changes in land use.

Australian emitters will only be able to use Kyoto units to cover 12.5 per cent of their 50 per cent international allowance. This is to ensure that these credits, which are incredibly cheap, don't  drag the price of EU and Australian credits down.

And third, the Australian scheme will adopt the expected European 2015-6 carbon allowance price, essentially making credits interchangeable.

Why bother?

Why link carbon markets in the first place?  The European Commission argues that creating international carbon markets helps countries cut their carbon dioxide emissions more cheaply by increasing market liquidity.

In a liquid carbon market, permits can be easily and quickly sold without losing their value. The commission says a more liquid market will provide a more stable price signal, and also give businesses more opportunities to trade their excess units. The more buyers and sellers and the more diverse the market, the theory goes, the better it works.

The commission says the link with Australia is the  first step in creating broader links with developing carbon markets in the Asia Pacific region. Australian energy minister Greg Combet recently told reporters  that his government is pursuing carbon market links with California, New Zealand and South Korea, and China could be another important potential partner - its 12th five-year plan, announced in 2011, includes provisions to  pilot cap-and trade schemes in some provinces.

Linking to a larger international carbon market may also make it more likely that Australia's carbon policy will survive, as repeal would also mean "severing the connection to the world's largest carbon market",  says Frank Jotzo, the man who helped design Australia's carbon floor price.

What are the downsides?

Commenters have pointed out several ways the link could have downsides for Australia.

The announcement comes at a time when, because of a surplus in permits, EU allowance prices are at a record low. The current cost of an EU allowance is around €7 (£5.40), €4 (€3) lower than Australia's proposed carbon price floor.

Sandbag, a campaign group that deals with the ETS, notes that if the issue isn't dealt with, it could have consequences for linked schemes:

"Failure to act will mean European policymakers could be responsible for dragging down not just the EU system, but also the Australian scheme."

And even if the price goes up, Australian permits will be exposed to price fluctuations in the international market. This will increase uncertainty, and meaning the Australian government won't have much say over the price,  critics say.

Newspaper the Australian, meanwhile, has pointed out that country's coal industry -  one of the country's biggest export sectors - could lose out, because methane is regulated under the Australian regime, but not under the EU ETS. Australian coal mines will have to pay for emitting methane, a potent greenhouse gas, but those in Europe won't. The Australian also claims that while many European businesses receive free carbon permits, the Australian government hasn't yet determined which sectors will get the same benefit.

While it might be an exaggeration to claim, as  the Australian does, that "those crafty European bureaucrats have locked a gullible Gillard government into a carbon headlock", it's certainly true that the EU ETS has some fairly major flaws it hasn't dealt with yet. Australia's decision to link up could help the EU carbon market survive - or mean that Australia's carbon trading system is at the mercy of the same flaws that have plagued the EU ETS.

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