No gain and lots of pain with the ETS

Supporters of carbon pricing argue it is the cheapest way to reduce global greenhouse gas (GHG) emissions. However, their assumptions are unlikely to be achieved in practice, as it is unlikely such a program can be implemented and sustained for the considerable time required for it to work. With the Emissions Trading Scheme (ETS) representing a key difference between the Rudd Government and Opposition, this article examines the underlying logic and argues that it can never succeed and should be repealed without delay.

Australia’s carbon-pricing scheme assumes a global carbon-pricing system with our ETS a part of it. This assumption is probably wrong. For a number of reasons it is unlikely a global carbon-pricing system will be implemented, let alone sustained for long enough – decades, even centuries — to reduce global greenhouse gas emissions to what is commonly described as ‘a sustainable level’.

Without a global accord on carbon-pricing, national or regional carbon-pricing schemes would be prohibitively expensive if they are to achieve the projected benefits and, therefore, they are unsustainable. The high cost means that a scheme like the one Australia has legislated is not viable and would deliver little or no benefit. Further, even regional carbon-pricing schemes like the European ETS will not last.

Carbon pricing cannot succeed unless it is global

Analyses by Professor William Nordhaus, a long-time advocate of carbon pricing and a recognised authority on estimating the costs or benefits of climate change, greenhouse-gas mitigation policies and "optimal" carbon-pricing, demonstrates that any such scheme must be global or it will not succeed. Nordhaus (2008), p198, says:

“Complete participation is important because the cost function for abatement appears to be highly convex. We preliminarily estimate that a participation rate of 50 percent instead of 100 percent will impose a cost penalty on abatement of 250 percent.”

So, if only 50% of GHG emissions are included in a global carbon-pricing scheme, the cost penalty for the participants would be 250%. The 50% participation could be achieved by, for example, 100% of countries participating in the scheme, but with only 50% of those countries’ emissions, or 50% of countries participating and 100% of their emissions figuring in such a scheme (i.e. taxed or traded).

The explanation for the convex abatement-cost penalty curve is as follows: with a high level of participation the least-cost abatement options are used first. However, if there is less participation, some low cost options are not available, so higher cost options have to be used to achieve the same emission reductions. The chart below illustrates the ratio by which the abatement cost would increase with less than full participation. For example, at 50% participation, the cost penalty would be higher than with full participation by a factor of 3.5 (i.e. 250%), as in my chart (below) referencing  ‘A Question of Balance’ Chapter VI, pp116-122

In reality, the cost penalty for participants would be worse than this because, with less than full participation, there would be "leakage" of emissions from participants to non-participants. The abatement costs are likely to be higher than Nordhaus has estimated because the compliance cost of carbon monitoring, reporting, policing and disputation has not been included. The compliance cost would escalate as smaller emissions sources are included.

Given all of the above, we should consider what level of participation could realistically be achieved and what the compliance cost would be.  Furthermore, given the cost penalty for participants, is there a high probability of a global agreement to price carbon being implemented and maintained for as long as necessary to achieve the stated goals?

Nordhaus explains that the assumptions used for the cost-benefit analyses, used to justify global carbon pricing, are academic and entirely unrealistic for the real world.  He says (page 68):

“We should provide a word of caution about the optimal case. It is not presented in the belief that an environmental czar will suddenly appear to promulgate infallible canons of policy that will be religiously followed by all. Rather, the optimal policy is a benchmark to determine how efficient or inefficient alternative approaches may be. This is the best possible policy path for emissions reductions, given the economic, technological, and geophysical constraints that we have estimated.”

In other words, the assumptions that underpin the economic analyses used to justify carbon pricing are academic; they are appropriate for an theoretical modelling exercises, but they are unrealistic, impracticable and highly unlikely to be achieved in the real world. Some of the key assumptions are: 

• There will be negligible leakage (of emissions between countries, between industries and between emissions sources)
  
• All GHG emission sources are included (all countries and all GHG emissions in each country)
  
• There will be negligible compliance cost and negligible fraud
  
• There will be an optimal carbon price and the whole world implements it in unison
  
• The whole world acts in unison to increase the optimal carbon price periodically and will continue to maintain the carbon price at the optimal level for all of this century (and thereafter).If these assumptions are not met, the estimated benefits of carbon pricing would not be achieved.

Carbon pricing cannot succeed unless it is global

Professor Richard Tol, a long-time advocate for carbon pricing and recognised authority on estimating the damages of global warming, discusses the probability of achieving a global agreement: He said in November, 2012:

“The 18th UN Conference on climate change negotiations has just started in Doha. This column suggests that the probability of success is a mere 2.3%. Recently, over $100 million per year was spent on fruitless negotiations. Having flogged, ever harder for 18 years, the dead horse of legally binding emission targets, the UN should close that chapter and try something new.”

Tol’s article (and chart above) explain why a meaningful global agreement is highly unlikely to be achieved. For example he says:

“Game theory suggests that attempts to negotiate an international environmental agreement, aiming to provide a global public good such as greenhouse gas emission reduction, are bound to fail (Barrett 1991, Carraro and Siniscalco 1992, Carraro and Siniscalco 1993).”

Tol’s article reveals that it was known and predicted as long ago as 1991 that binding international agreements were a forlorn hope, with targets and timetables for emission reductions, penalties for breaches of commitments and, indeed, carbon-pricing schemes like Australia’s, incapable of drawing sufficient support to be workable.

Australia’s ETS would be high cost for little to no benefit

Treasury projections of the net cost-benefit of the Australian ETS and Nordhaus’ projections of benefit (i.e. climate damages avoided), reveal Australia’s ETS would cost roughly $10 for every $1 of projected benefit to 2050, which cannot will not be achieved unless there is a global carbon price.  

Therefore, if Australia continues with its ETS, it will incur the costs but receive negligible-to-no benefits.

In summary, carbon pricing cannot succeed unless it is global because the cost for the participants would be prohibitive unless the participation rate is very high. Participants know this, just as they realise it would be irrational to commit unless there is assurance of global agreement to a global carbon-pricing scheme with high participation rate.

Since participants know the situation, it is unlikely there will be a global agreement. Any country or region that attempts to run ahead and set an example – as the EU and Australia have done – will be economically  disadvantaged. Therefore, it is more than reasonable to conclude both the EU and Australian ETS schemes will be abandoned.

Uncertainty about the problem is a given, but uncertainty about the chosen solution is inexcusable.  We should be confident that our solutions are going to be effective, and the more expensive the solution the more confident we should be.

Big responses require high levels of confidence that they will work. Carbon-pricing schemes fail this test.

Peter Lang is a retired geologist and engineer with 40 years experience on a wide range of energy projects throughout the world, including managing energy R&D and providing policy advice for government and opposition. His experience includes: hydro, geothermal, nuclear, coal, oil, and gas plants and a wide range of energy end use management projects