Clean Energy Future

3.1 Pricing pollution: the basics

Putting a price on carbon pollution is the first element of the Government’s plan for Australia’s clean energy future. The other three elements are renewable energy, energy efficiency and action on the land.

A carbon price is the most environmentally effective and economically efficient way to reduce pollution.

The carbon pricing mechanism will apply directly to around 500 of the biggest polluters in Australia. The 50 largest polluters will be responsible for around 75 per cent of the pollution covered by the carbon pricing mechanism.

Every cent raised from a price on carbon will be used to provide ta xcuts and increased benefits to households, support jobs in the most affected industries, and build a new clean energy future.

3.1.1 The spillover problem

A carbon price may seem like a complex concept. Yet at its heart lies a simple and powerful insight. Some activities impose significant costs on society. If those activities are free or costless for the people or businesses who carry them out, then the whole of society will be worse off. These negative impacts are known as ‘spillover effects’. Governments can tackle negative spillover effects by regulation and pricing. Economists have demonstrated that putting a nextra price on activities with negative spillover effects can improve overall social welfare and is the most efficient and cheapest way to deal with the spillove rproblem.

Carbon pollution is this kind of problem. Releasing carbon dioxide and other greenhouse gases into the atmosphere risks dangerous climate change.Climate change will impose significant human, environmental and economic costson all societies. Yet, at the moment, releasing carbon pollution into the atmosphere is free in Australia.

When there is no charge for the social and economic costs of putting carbon pollution into the atmosphere, there is no reward for a business that finds a lower-pollution way of doing things. Nor is there any disincentive for a business which increases its levels of carbon pollution. A carbon price changes this by putting a price tag on pollution. This price tag will encourage businesses across the whole economy to reduce their pollution. A carbon price also creates a competitive advantage for businesses, investors, researchers and innovators who find cleaner ways of doing business. In this way, it creates powerful incentives and uses the market to deliver benefits for the whole of society.

Rather than relying on government decisions to regulate some activities or subsidise others, a carbon price leaves it to millions of businesses and consumers to find the most cost-effective ways of reducing carbon pollution. Analysis of more than 1000 different policies to reduce emissions by the Productivity Commission shows that market-based approaches like this are the most cost-effective way of reducing carbon pollution.

3.1.2 How a carbon price will reduce pollution

The carbon pricing mechanism will only apply to around 500 of the biggest polluters in the country. They will pay for each tonne of pollution they release into the atmosphere. If a business can lower its pollution then it will lower the carbon costs that it pays. This will create economic incentives for businesses to reduce their pollution, and to do so in the cheapest possible ways. It will also make lower-polluting technologies, especially clean energy, more competitive by boosting investment in, and take-up of, these technologies. In this way, introducing a price on carbon will trigger the transformation of the economy towards a clean energy future.

The types of changes a carbon price can deliver are:

• promoting more gas-fired or renewable electricity generation
• converting coal-fired boilers to gas-fired boilers in manufacturing plants, commercial buildings and hospitals
• making energy-efficient buildings more attractive to tenants
• providing an incentive for households and businesses to use energy more wisely
• prompting innovation in technology to reduce pollution from existing processes
• encouraging chemical plants to install scrubbers toreduce nitrous oxide emissions
• encouraging the installation of more efficient motors in industry
• encouraging the capture and use or flaring of emissions from mining and gas extraction.

3.1.3 Households and jobs will be supported

Every cent raised from a price on carbon will be used to provide taxcuts and increased benefits to households, support jobs in the most affected industries, and build a new clean energy future.

The carbon price will increase costs for those businesses that are covered by the mechanism. They will be able to lower this cost if they can reduce their pollution, or pass on the cost to their customers. The Government recognises that some big polluters will have trouble passing the cost on to their customers because the prices of goods and services they sell are set on international markets. An ongoing Jobs and Competitiveness Program worth $9.2billion over the period to 2014-15 will assist these businesses.

Other businesses will be able to pass on some or all of their carbon costs to customers. Treasury modelling has found that the cost of living impact for ordinary householders will be an increase of 0.7 per cent, as measured bythe consumer price index in 2012-13. To help families and individuals, the Government will provide income tax cuts, higher Family Tax Benefits, and increases in pensions,allowances and other Government benefits. This package of household assistance will mean that around two out of three households will receive assistance that offsets their average cost of living impact. Many households will be better off.

3.1.4 Our economy will be transformed

The carbon price is the first element of the Government’s plan for a clean energy future: it will trigger a broad transformation of the economy. Our economy has successfully handled comparable structural changes over its history. In fact, transformative changes – new products and technologies, and the integration of our economy into the global economy set in train by the reforms of the 1980s and 1990s – have underpinned rising prosperity and sustainable growth in Australia.

Treasury modelling shows that, under a carbon price, the economy continues to grow (Figure 3.1).

Figure 3.1: Gross National Income with and without the carbon price

Source: Treasury modelling, 2011 (core policy scenario).

3.2 Pricing pollution: the details

3.2.1 A two-stage approach

The Government will introduce a carbon pricing mechanism from 1 July2012. From that date, businesses that are covered will pay a price for each tonne of carbon pollution they put into the atmosphere each year.

There will be two stages. For the first three years, the price for each tonne of pollution will be fixed, like a carbon tax. Then, from 1 July 2015,the carbon pricing mechanism will transition to a ‘cap and trade’ emissions trading scheme. In this second ‘flexible price’ stage, the carbon price will beset by the market.

3.2.2 Prices will be fixed for three years

An initial stage with fixed carbon prices will provide stability and predictability. This will give businesses time to get used to the new system,to understand their obligations and to start planning ways of reducing their pollution.Businesses will reduce their pollution when it is cheaper to do so than to paythe fixed price. Thus the market will create incentives to cut carbon pollution.

The price will start at $23 per tonne on 1 July 2012. In each of the next two years, it will rise by 2.5 per cent in real terms, assuming inflation of 2.5 per cent a year, which is the mid-point of the Reserve Bank of Australia’s target range for inflation. The carbon price will be $24.15 per tonne in 2013-14 and $25.40 per tonne in 2014-15.

3.2.3 Then prices will be flexible

The carbon pricing mechanism will move automatically to a flexible,market-driven approach on 1 July 2015. From this date, the carbon price will no longer be fixed, but will be set by the market.

During the flexible price period, an overall limit (or cap) will be placed on Australia’s annual greenhouse gas emissions from all sources of pollution covered by the carbon price. There will be no limits on individual sectors, firms or facilities.

The Government will set the cap by issuing a fixed number of carbon permits each year. Each permit will represent one tonne of pollution. This will be one of the main ways Australia ensures it meets the pollution targets outlined in Chapter 2. Some of the carbon permits issued each year will be sold by the Government at auction. Others will be allocated to businesses without charge to support jobs and competitiveness, and help strongly affected industries make the transition a clean energy future. Chapters5, 6 and 7 provide more details on how the Government will assist industries to make the transition.

Businesses will be free to buy and sell the carbon permits they have acquired from the Government. This will create a market for carbon permits that is designed to ensure the reductions in pollution under the carbon price are achieved at the lowest cost to the economy:firms will buy permits if they cannot reduce their pollution for less than thecost of the permits.

3.2.4 Setting pollution caps

In the flexible price period, the Government will set annual caps on pollution. Before the start of this flexible price period, the Government will set out the caps for the first five years from 1 July 2015. Once the flexible price system is under way, the caps will be extended each year. This ensures that businesses always have five years of certainty about the pollution caps they face.

Further details on transition arrangements and pollution caps are provided in Appendix A, Table 2.

3.2.5 A new Climate Change Authority

The Government will create an independent statutory body, the Climate Change Authority, to provide independent advice to the Government on the performance of the carbon price and other initiatives.

One of the Authority’s roles will be to make recommendations to the Government on the year-by-year steps, and on the longer-term path, that Australia should take towards the 2050 target. The Government will make the final decisions. The Authority will report regularly on progress,giving the public an independent assessment of whether we are on track to meet our targets.

The Authority will conduct regular, public reviews and its reports will be made public. The Government will respond to its recommendations within a limited timeframe.

The Authority will complete its first review – which will provide recommendations on the carbon pricing mechanism’s first five years of pollution caps – by February 2014.

Further details on the Climate Change Authority are provided in Appendix A, Table 11.

3.2.6 Safety valves

For the first three years of the flexible price period, safety valves will be built into the system to avoid price spikes or plunges. This will reduce the risk for businesses as they gain experience in having a market setthe carbon price.

The first safety valve is a price ceiling. This will be set $20 higher than the expected international carbon price at the start of the flexible price period (1 July 2015). The second safety valve is a price floor. This will mean that the carbon price cannot fall any lower than $15 a tonne in 2015-16.The floor is designed to reduce the risk of sharp downward movements in the price, which could undermine long-term investment in clean technologies.Both the price ceiling and the price floor will increase gradually each year.

These safety valves will apply for the first three years of the flexible price period. A review by the Climate Change Authority of the role of the price ceiling and price floor will occur in 2017.

3.2.7 Coverage of the carbon price

Carbon pollution from the following sources will be covered by a carbon price: stationary energy, waste, rail, domestic aviation and shipping, industrial processes and fugitive emissions. The Government also intends to expand the coverage of the carbon price to include heavy on-road vehicles from 1 July2014. This measure was not agreed by the Multi-Party Climate Change Committee (see Appendix D).

Over half of Australia’s emissions will be directly covered by the carbon pricing mechanism and around two-thirds will be covered by a carbon price applied through various means.

Farming and other land-based activities will not be covered. However,the Carbon Farming Initiative will give farmers and other land managers an opportunity to generate income from taking action to reduce their pollution(see Chapter 9).

The broad coverage of the carbon price will ensure that the economy asa whole starts moving towards a clean energy future and that the cheapest ways of reducing pollution will be implemented.

Treasury modelling shows that a broad-based carbon price will encourage pollution reductions across all sectors of the economy (Figure 3.2). If sectors are excluded, it means that Australia misses out on their contributions to the pollution reduction task. In turn, this means that other sectors would need to reduce their pollution even further (at higher cost), or that Australia would need to rely more heavily on buying pollution reduction from overseas through international carbon markets. In addition, the Carbon Farming Initiative is estimated to drive emissions reductions in agriculture and forestry.

Figure 3.2: Emissions reduction by sector with a carbon price

Source: Treasury modelling, 2011 (core policy scenario).

The coverage arrangements are summarised below and detailed in Appendix
A, Table 4.

Gases

The carbon pricing mechanism will cover four of the six greenhouse gases counted under the Kyoto Protocol – carbon dioxide, methane, nitrous oxide and per fluorocarbon emissions from the aluminium sector. The remaining greenhouse gases counted under the Kyoto Protocol (hydrofluorocarbons and sulphur hexafluoride) will face an equivalent carbon price, which will be applied through existing synthetic greenhouse gas legislation.

Large polluters

It is important to ensure that the carbon pricing mechanism is practical and minimises costs to business. For this reason, only firms that release over a certain amount of carbon pollution a year, or are large suppliers of natural gas, will pay the carbon price. Facilities that have direct greenhouse gas emissions of 25,000 tonnes of CO₂-e a year or more (excluding emissions from transport fuels and some synthetic greenhouse gases) will be covered. There will be a lower threshold for certain landfill facilities. Retailers of natural gas will be liable for carbon pollution from the use of the fuels they supply to customers.

Transport

Households and light commercial vehicles will not face a carbon price on the fuel they use for transport. In addition, the agriculture, forestry and fishing industries will not face a carbon price on their off-road fueluse.

A carbon price will apply to fuels used in domestic aviation, marine and rail transport.

Similarly, a carbon price will apply when transport fuels are used for other purposes, such as running diesel generators on a mine site.

No transport fuels will be covered directly under the carbon pricing mechanism. Where a carbon price applies, it will be achieved in a different way- through changes in fuel tax credits or changes in excise. The changes will be calculated to have the same effect as directly applying a carbon price. The changes to fuel tax credits or excise will be adjusted to ensure the carbon price on transport fuels is in step with the carbon price applying to the rest of the economy.

The Government intends to apply a carbon price to heavy on-road transport from 1 July 2014. This measure was not agreed by the Multi-Party Climate Change Committee.

3.3 Linking to action by households, action on the land and global action

3.3.1 Recognising action taken by households

Many individuals are concerned about climate change and want to make their own direct contribution towards protecting the environment. People taking voluntary action want to know that they are making a real contribution to Australia’s carbon pollution reduction activities. Voluntary action will be recognised under the carbon price in four ways. First, the Government will take voluntary action into account when setting pollution caps. Voluntary action will be treated as additional when accounting for Australia’s pollution reduction targets after 2012. Second, in the carbon pricing mechanism’s flexible price period, carbon permit holders may voluntarily cancel their permits.Third, a tax-deductible Pledge Fund will be established to help individuals buy and cancel carbon permits. Fourth, any purchases of accredited GreenPower from the start of the carbon pricing mechanism will be treated as voluntary action.

Further discussion of voluntary action can be found in Appendix A,Table 9.

3.3.2 Encouraging action on the land

Action on the land is one of the four elements of the Australian Government’s plan for a clean energy future. The Carbon Farming Initiative will reward farmers and land managers who take steps to reduce pollution. It will do this by creating credits for each tonne of carbon pollution that farmers and land managers reduce or store on the land. These credits can then be sold to businesses that want to offset their carbon pollution. Credits that are Kyoto-compliant can be used to meet liabilities under the carbon pricing mechanism. In the fixed price period, liable parties will be able to meet no more than 5 per cent of their obligations using Carbon Farming Initiative credits.

Safeguards will ensure the environmental integrity of the Carbon Farming Initiative. Linking the Carbon Farming Initiative with the carbon price will create incentives for actions which reduce emissions or maintain and enhance the landscape’s carbon storage capacity, and there will be important benefits for sustainability and biodiversity.

The eligibility of Carbon Farming Initiative credits under the carbon pricing mechanism is set out in Appendix A, Table 7.

3.3.3 International linking for a global approach

Australia’s carbon price will be linked to carbon markets around the world from the start of the flexible price period. This will allow reductions in carbon pollution to be pursued globally at the lowest cost. Carbon pollution is not confined to national borders. It affects the whole planet. International linking of carbon markets will allow businesses that release carbon in one country to be matched up with businesses in other countries that are able to reduce their carbon pollution at lower costs. International linking encourages action to reduce carbon pollution around the world, and plays an important role in helping developing countries adopt clean technologies.

International linking will start when the carbon price moves to its flexible price period from 1 July 2015. Australian businesses will be able to buy international permits from credible international carbon markets or emissions trading schemes in other countries. They will be allowed to use these permits to meet some of their local obligations. When an Australian business buys an international permit, it means that a tonne of pollution cannot be released overseas. Farmers will be able to sell their Carbon Farming Initiative credits to international markets.

Safeguards will be in place to ensure international permits are credible and do not undermine the environmental integrity of Australia’s pollution reduction efforts. Until 2020, businesses will have to meet at least half of their annual obligations each year by buying Australian carbon permits or Carbon Farming Initiative credits. It will be more efficient and less costly to reduce Australia’s carbon pollution by a mixture of domestic reductions and international permit purchases compared with relying on domestic actional one. International linking allows Australian businesses to pursue credible,cheaper carbon pollution reduction opportunities wherever they are available.

The price of international permits will act as an additional safety valve on carbon prices in Australia. If reducing carbon pollution in Australia is more expensive than reducing carbon pollution in another country, Australian firms will be able to purchase an international permit. With international linking, the carbon price in Australia will be set by international supply and demand for permits.

Detailed linking arrangements are described in Appendix A,Table 8.

3.4 Governance: making and administering the rules

Sound governance will ensure that the carbon pricing mechanism is efficient and effective. The roles of making,administering and reviewing the rules have been carefully allocated to ensure that appropriate accountabilities are in place.

The Government and the Parliament will be responsible for major policy decisions that require the balancing of environmental, economic and social factors and have far-reaching implications.

The Clean Energy Regulator will administer key elements of the carbon pricing mechanism as well as the Carbon Farming Initiative (see Appendix A, Table 12).

The Climate Change Authority will review pollution caps, the futuretrajectory of Australia’s pollution levels and the performance of the carbonprice and will track Australia’s progress towards meeting its targets forreducing carbon pollution.

The Productivity Commission will review industry assistance under the Jobs and Competitiveness Program and the Coal Sector Jobs Package. It will also review the impact of the carbon price on industry and continue reporting onactions by other countries to reduce carbon pollution (see Appendix A, Table 13).

Figure 3.3: The carbon pricing mechanism’s governance structure

3.5 The way forward

A carbon price will encourage the largest polluters to reduce the greenhouse gases they put into the atmosphere. A carbon price will also give economic impetus to the efforts of scientists, researchers, investors and entrepreneurs to find new less-polluting ways of doing the things we take for granted: producing and consuming the energy, goods and services of a modern economy. It will harness the power of markets to kick-start thist ransformation to a clean energy future and to ensure the transformation unfolds in the lowest cost way.

Carbon pricing is an economic reform that will put a price tag on activities that have significant negative spillover effects on the rest of society. In this way, the costs of carbon pollution will be factored into our behaviour and our decisions in the future. The end result will be lower carbon pollution, reduced risks of dangerous climate change and better outcomes for society as a whole. The Government is committed to this reform and is committed to introducing it in a way that is manageable for individuals, families and households, and for businesses and their employees.

The Government will support households, support jobs and competitiveness, and invest in renewable energy, energy efficiency and action on the land. Support will be provided to:

• households, so they can manage price impacts due to the carbon price (see Chapter 4)
• businesses, through the Jobs and Competitiveness Program and other measures to help manufacturing and small businesses save energy and adjust to a carbon price (see Chapter 5)
• Australian innovation in renewable energy and low-pollution technologies (see Chapter 6)
• policies to underpin the energy sector’s move to a cleaner future and maintain secure energy supplies (see Chapter 7)
• initiatives to promote energy efficiency through the public, private and household
  sectors [see Chapter 8]
• opportunities for farmers and landholders to reduce or store carbon pollution, and to support biodiversity (see Chapter 9).

The plan involves a net cost to the Budget of $3.8 billion over the four years to 2014-15 ($4.3 billion including Government measures). The majority of this cost ($2.7 billion) is provided prior to the commencement of the carbon price to assist households and businesses adjust. The ongoing fiscal cost is relatively modest, and includes the additional cost of the tax reform elements of the household assistance package. The plan will be delivered in a manner that is consistent with the Government’s overall fiscal strategy. Detailed fiscal tables are provided at Appendix C.

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