Dec 15th 2009
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Loading ...Emissions trading: How does it work?
An emissions trading system is a complex solution to a wicked problem. But there are no easy answers. UTS Business lecturer Deborah Cotton explains how an emissions trading system works; its pros, cons and complexities.
The aim of carbon trading is to encourage the reduction of greenhouse gas emissions by rewarding the production of power, for example, through green sources and penalising power produced by the higher emitting sources. A Federal emissions trading scheme would put a limit or cap on the amount of greenhouse gas pollution allowed in Australia.
Setting the level of allowed emissions is where the Kyoto Protocol and current discussions in Copenhagen come in to play as it will have clearly described levels of emission reductions that should be made by the countries that ratify the Treaty. This limit is then divided into permits (certificates) to emit one tonne of CO2 equivalent emissions. So for each tonne of emissions made a business must have a permit (certificate) equivalent.
These certificates may be bought and sold in the market under an emissions trading scheme. While most of the Australian states have set up separate emissions trading schemes under their own state legislations it has always been clear that a Federal Scheme would provide a much more effective cover of emissions in Australia. One of the major benefits of carbon trading over a carbon tax is that it determines the exact volume of emissions allowed rather than trying to determine an appropriate price (tax) that would achieve those aims. This way the price of emissions are determined in the market place and are based on the costs of emission reduction rather than an estimate.
One of the most controversial and important aspects of marketable permit design is the initial allocation. This may be done through what is known as ‘Grandfathering’ where certificates are allocated to emitting companies according their previous levels of emissions. This has been considered a major factor in the fall in the prices in the European Emissions Trading Scheme in 2006 and a similar fall in the price of NSW Greenhouse Gas Emission Certificates in 2007 when the market realised the high number of surplus certificates available.
It is suggested that the companies overestimated their historical emissions levels in order to ensure the additional costs of reducing emissions were limited. An alternative is to auction the certificates and then companies will only purchase the number they believe they need. This does not preclude the idea of some compensation as the funds raised by the Government in selling the certificates may be used to assist the sectors/companies most affected. The issue of compensation to businesses affected by an emissions trading scheme is likely to be determined in the political arena.
The coverage of the different sectors of the economy is yet to be fully determined for the proposed Federal Scheme, which was rejected in Parliament in early December, but which the Government says it will bring back to Parliament in February 2010. The term “coverage” describes whether an industry or business is included in the scheme and required to purchase permits. At this stage it is understood that the stationary energy, transport, industrial processes and waste and forestry sectors of the economy would be included.
According to the NSW Department of Primary Industries the energy sector is the highest emitter contributing approximately 50% of emissions and the agricultural sector is the second highest with approximately 16%. It may also be suggested that the agricultural sector will be one of those most adversely affected by the extreme weather events predicted as effects of climate change. While research suggests the costs of reducing emissions in the agricultural sector are high it is worth considering whether these are greater than the long-term costs they will incur. Therefore it seems extremely important that the scheme to be introduced incorporates all large emitting sectors in its emission reduction requirements for it to be successful in its’ main task.
While there is no doubt about the importance of acting quickly to try and deal with the problems of climate change, it is important to note that a scheme not properly designed will not contribute significantly to the increase of low emission technology. Until the national scheme and its’ specifics are finalised this uncertainty, and therefore risk, encourages companies to delay investment into this new technology. Therefore while encouraging the current Australian Federal Government to act quickly, the introduction of an emissions trading scheme prior to all issues being completely considered and understood would be detrimental to the problem.
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