Carbon package built on a gamble

THE key to grasping Julia Gillard's climate change package is to realise that pricing carbon is not enough - this package both prices carbon across much of the economy and simultaneously offers incentives to generate a $100 billion renewable sector by 2050.

The policy is explicit about this. It says a carbon price is a "powerful incentive" to reshape the energy mix, but because the transformation is so large there is a "strong case" for direct government intervention.

Put another way, Labor thinks the carbon price is not high enough and seeks to resort to complementary measures.

The policy is a hybrid. It is a market reform and a government-engineered creation of a new industry. The market-based economic reform starts with a $23 a tonne carbon price next year and rises over decades.

The government industry policy comprises existing and new interventions; both off the budget and leveraging the government balance sheet to make private investment in renewables more viable.

The long-range restructuring is ambitious and Treasury modelling identifies the transition from 2011 to 2050. Within the energy mix conventional coal falls from 70 per cent to 10 per cent over 40 years. Carbon capture and storage for coal is assumed to provide about 15 per cent of the 2050 mix. While the role of gas is enhanced the real shift is from coal to renewables, which are estimated to provide 40 per cent of the 2050 mix.

Senior ministers publicly affirm they do not expect any new conventional coal power stations will be built in Australia and they plan before 2020 to pay for the closure of significant brown coal power generation.

On the renewable side, the new Clean Energy Finance Corporation will fund renewables to $10 billion over five years, offering cheap loans and commercial loans, loan guarantees and equity with a cost to the budget for cheap money of nearly $1bn across the forward estimates.

Yes, it is a green bank. The aim is to use the government's balance sheet to persuade private investors and super funds into renewables.

This comes in addition to the existing renewable energy target, a government intervention designed to ensure that 20 per cent of Australia's electricity supply will come from renewable sources by 2020.

A new statutory body, Australian Renewable Energy Agency, is created to upgrade funding of renewables, offer early stage grants, support renewables technology and supposedly reform the current multiple schemes to assist renewables.

This is a policy, overall, that offers something of everything. It is compromise piled upon compromise. It is designed by a committee with three elements that had to be satisfied: Labor, Greens and rural independents. Witness the political fix on fuel - cars and light vehicles are exempted forever, but heavy on-road transport will be

liable to the carbon tax from 2014, after the next election.

In conceptual terms, the policy is a market reform and a centrally directed plan. The problem with the market reform is the sheer degree of compensation given to households for electoral reasons and to industry for competitive and job reasons. The upshot is that the package, once assumed to be revenue neutral, costs $4.3bn across the forward estimates. Labor, however, should be applauded for building its tax reform window into the compensation arrangements.

The problem with the renewable industry strategy arises in the Productivity Commission finding that renewable energy is high cost and inequitable abatement. It wanted such schemes wound back with carbon pricing. But Labor ducks any such explicit reform pledge and the risk, despite the new renewable industry machinery, is that this high-cost abatement will be prolonged.

The policy, above all, reflects two fundamental beliefs. First, that the science is right. For Labor and the Greens this is a no-brainer. They are contemptuous of doubts about the science. Gillard began her Sunday media conference with a declaration about "the avalanche of science" and warnings that icons such as the Great Barrier Reef "are at risk".

Labor's policy is alarmist. Carbon pricing is essential because global temperatures "could rise" up to 6.4C by 2100.

It says warming of more than 2C "will overwhelm the capacity of many of our natural ecosystems to adapt". The only conclusion from this policy is that global warming has now become one of Labor's deepest beliefs.

The second belief embedded in this policy is that the rest of the world is taking assertive action against global warming.

This theme underpins the entire policy and Treasury modelling. You may have thought Copenhagen was a setback for global action but this policy assumes the precise opposite. Australia is now taxing carbon on the basis that Copenhagen was a success. This follows pledges made at Copenhagen and affirmed later at Cancun.

What happened is that more than 100 nations at Cancun agreed to limit carbon pollution so the average global temperature rise can be held below 2C above pre-industrial levels. The US and China supported this lofty ambition. It means global action to stabilise greenhouse gases at 450 parts per million by 2100 or at a less ambitious 550 ppm.

On the 550 ppm, Treasury assumes a world carbon price of $29 a tonne in 2016 and this is the price it assumes for Australia at the transition to a flexible price under emissions trading. Labor's policy merrily asserts that "governments around the world" are acting on such commitments and, as a result, Australia's price is its "fair share" in global terms.

These claims are heroic. They may be right. Yet such Cancun pledges are voluntary and non-binding. As Ross Garnaut said, it is because they are non-binding that they are more ambitious.

The truth is that real progress in each nation will be determined by domestic politics. That's right, domestic politics. Think about it. The extent to which these ambitious pledges are realised remains highly uncertain and Labor's assumption may be optimistic folly.

In order to invest its policy with credibility Labor has gambled these Cancun pledges are fair dinkum. The truth, however, is that Gillard's scheme would be inconceivable coming from a US administration any time in the near future. Will these countries deliver? Who knows? But Australia will deliver once this scheme is legislated and we disadvantage ourselves unless other nations take equivalent action.

However, if they don't, the world's carbon prices could be lower with the paradox that Australian companies could source abatement overseas and ease their overall mitigation costs.

It is true carbon pricing is not the biggest structural change facing our economy. But this is the change the Labor-Green alliance demanded as the price for its existence. The package is driven by politics.

Gillard's problem is that it probably embodies too many compromises with too many interests to fly with the Australian public.