Where Australia's Climate Policy Should be Heading

Warwick J McKibbinAustralian National University

& The Lowy Institute for International Policy, Sydney

& The Brookings Institution, Washington DC

Presentation prepared for Canberra Business Council Lunch August 7,2008

Overview

• Climate Science and Policy• Lessons from Kyoto • Why Prices Matter• Post Kyoto Policy • What Australia Should Do

What do we know?

• Climate is a complex system that is always changing

• Average global temperatures have risen 0.6 degrees in the past century

• Natural variability and human induced change coexist

• We are pumping enormous amounts of greenhouse gases into the atmosphere

• Increasing evidence that there is a warming problem

• Policy uncertainty is causing economic losses

Figure 2: Global Temperature Record, Vostok Ice Core Data

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Climate Science

• “Science” does not tell us exactly what the global concentration target should be - but it guides us

• Even if we knew the concentration target, “Science” does not tell us which of the many global paths for emissions should be followed for a given concentration target

• Even if we knew the global path for emissions “Science” has nothing to say about what target an individual country should follow

Climate Change Policy

• Is all about managing risk and dealing with climate uncertainty

• It is not about picking an arbitrary target and hitting that each year no matter what

Climate Change Policy

• Should be about enabling the whole society to manage the risks associated with climate change

• Should be about creating long term institutions and clear policy frameworks that can steer the global economy towards a less carbon intensive future

• Should be about creating a system that all countries find in their own self interest to be involved

What is Needed

• A change in the behaviour of energy users

• Technologies to reduce carbon emissions

• Technologies to reduce energy demand and increase energy efficiency

The Role of Prices

Figure 3: GDP, Energy Use, CO2 EmissionsUSA

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Figure 4: GDP, Energy Use, CO2 EmissionsJapan

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The Role of a Price on carbon

• The relevant carbon price is the long term carbon price

• Long term credible carbon prices are crucial for encouraging– Demand side management– The emergence of alternative technologies– The adoption and diffusion of alternative

technologies

Lessons from Kyoto Experience

• A system of rigid targets and timetables is difficult to negotiate because it is a zero sum game

• It is problematic for countries to commit to a rigid target for emissions under uncertainty about costs

• Even the most dedicated countries may be unable to meet their targets due to unforeseen events out of their control

A Reality Check on the Global Debate

• Countries will develop their own systems

• There will never be a global market for permits because permits are like money – they are the promise of a government to hit an emission target

Permit Trading Systems

• Require a permit to emit carbon

• Government either – limits the supply of permits and a market

determines the price given the scarcity of supply

– or sets a price that permits can be bought from the government (a tax)

The McKibbin Wilcoxen Hybrid

• Aim – Impose a long term carbon goal for the world and

distribute across economies– Generate a long term price for carbon in each country

to guide energy related investment decisions– Keep short term costs low– Provide a way for corporation and households to

manage climate risk– Each country adopts nationally and cooperate globally

Components of the Policy

• Long-term permits– A bundle of annual permits with different

dates that the permits can be used– Quantity of permits over time is the long run

goal – Supply is fixed (and diminishing) and

allocated to households and industry– Traded in a market with a flexible price

Components of the Policy

• Annual permits– Must be acquitted against carbon emissions in

the year of issue– Expire in year of issue– Elastic supply from national government– Price fixed for five (or ten) years and then reset

given information available– Act as a “safety valve” to cap the cost each year

Long Term Emission Permit

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Carbon price

• In any year companies will use a mix of an annual coupon from the long term permit and annual permits printed by the government for a fixed price to satisfy their emissions

• The price of annual permits will be fixed

Climate Policy is like monetary policy

• Need clear long term targets (not necessarily timetables) with an independent agency charged with reaching those targets at lowest cost to the economy

• Need clear long term prices to drive investment

• Need fixed short term prices to minimize costs

Coordination of National Markets

• Independent but coordinated via fixed carbon price (P)

Japan

US

EU

Australia

P

An Illustration

• Use the G-Cubed multi-country model

The G-Cubed Model

– Countries (10)

• United States• Japan• Australia• Europe• Rest of OECD• China• India• Eastern Europe and Former Soviet Union• Oil Exporting Developing Countries• Other non Oil Exporting Developing Countries

The G-Cubed Model

– Sectors (12)– Electric Utilities– Gas Utilities– Petroleum Refining– Coal Mining– Crude Oil and Gas Extraction– Other Mining– Agriculture, Fishing and Hunting– Forestry and Wood Products– Durable Manufacturing– Non Durable Manufacturing– Transportation– Services

– Capital Producing sector

An illustrative example

• Generate a baseline of the model from 2003

• Generate a target path for emissions reduction to reach a global target of peaking emissions by 2028 and to be 60% below 2002 emissions by 2100.

• Impose an arbitrary but approximately equal burden across countries

Australia CO2 Emissions from Energy

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Figure 2: Carbon Prices by Country

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Australia CO2 Emissions from Energy

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BAU Target Trading

Australia GDP Change

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Target Trading

What if the world gets it wrong

Example of high growth in China and India

Australia GDP Change

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Global cap and trade Hybrid

Conclusions

• Dealing with climate change uncertainty will be a major change to the Australian and global economy

• Still a great deal unresolved about where the world is heading

• It is critical to get the balance between long run environmental issues and short run economic costs right.

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