Carbon wars go global

Gillard on King Island

IN the latest proof of Labor's "whatever it takes" strategy, the government has accentuated its climate change policy differences with Tony Abbott, while offering industry potential cost savings to make carbon pricing in Australia more acceptable.

Labor's aim is to change the politics surrounding its unpopular carbon pricing scheme.

It seeks to project three messages -- that carbon pricing is here to stay, in Australia and in the world; that the Opposition Leader's aspiration to dismantle the scheme is doomed; and that business has an incentive to think about how to make carbon pricing work, not how to abolish it.

This week's announcement is filled with uncertainties about the budget, the future price and the scheme's ability to redirect investment into cleaner energy. It has a sustained political intent -- to derail Abbott's anti-carbon pricing crusade and throw new factors into the mix. Labor is not fool enough to think carbon pricing will become a positive, but its game plan is to undermine Abbott's single most potent electoral strength.

Yet the deeper messages lie elsewhere. For Labor there is no escaping the numerous difficulties inherent in an emissions trading scheme against a weak global carbon market, a lingering financial crisis and a domestic obsession with maximum compensation. Turning this into an effective ETS becomes a more daunting proposition.

Interviewed by Inquirer, the architect of the changes, Climate Change Minister Greg Combet, says: "This is what business wants -- a fully flexible market price.

"In effect, this is John Howard's planned scheme. We are now part of the international action. We are not on our own, not operating solo. We are linked to Europe and a carbon price that covers 530 million people."

Normally a government making such a retreat would feel embarrassed. Not the Gillard government. Retreat on its negatives and projection of its positives is its core business.

The essence of the change is that after the three-year fixed-price period ends Australia's ETS will be tied to the EU scheme from July 1, 2015. That means Europe will drive and largely determine our carbon price and the two prices will be the same.

In short, Labor has committed Australia to European climate change strategies, prices and values. To make this work, Combet has ditched the proposed $15-a-tonne Australia floor price, in effect a guaranteed minimum, that was to apply from mid-2015 to keep prices up in the contingency of a weak global market. Labor never liked the floor price concept. It was pushed by the Greens and loathed by industry.

Combet has won in-principle support for the policy change from the Greens and the independents, Tony Windsor and Rob Oakeshott, so it should be passed.

Industry reaction is predictable: "Thanks, but what about the elephant in the room?" The elephant is the three-year fixed price at $23 a tonne adjusted for inflation annually. Business Council of Australia head Jennifer Westacott said the policy change "fails to address the fact that Australian businesses will still face the world's highest carbon price until 2015".

She welcomed the admission by Labor and the Greens that the floor price was defective but said business still faced a "huge cost" relative to competitors because until 2015 the carbon price was artificially high and did not reflect global conditions. Abbott will hammer this mercilessly. There was never any prospect Labor would alter the fixed price. This means keeping the "Rudd opening" -- a reference to Kevin Rudd's pledge, if he becomes PM, to move as fast as practicable to a floating price, thereby addressing business alarm. Even as PM, Rudd would be unable to get any such change through the current parliament, and could only take this proposed policy to the next election.

Combet's new link to the EU has long been envisaged; witness Labor's 2011 policy that said: "Linking to other credible schemes including the EU emissions trading scheme and the NZ emissions trading scheme is in Australia's national interest."

Quoting Abbott to the effect that "there is no sign, no sign whatsoever that the rest of the world is going to do things like introduce carbon taxes or emissions trading schemes", Combet said the new agreement "exposes the audacity of that lie".

This is a huge vote of confidence by Labor in Europe given the current eurozone crisis. Can Australia assume that Europe will get it right? The risk is this decision was driven by weakness. Labor feels compelled to link as fast as possible with Europe to prove that its own ETS has a head of steam and is building momentum against Abbott's demolition threat.

The alternative for Australia is to hedge its bets, wait to see how the Europe story evolves and, in the words of Warwick McKibbin, avoid further intensifying our exposure to Europe via the price of carbon.

This is a contest between Labor and the Coalition over the global utility of the ETS model. Julia Gillard and Combet have to prove that emissions trading is the future despite the absence of any global deal, while Abbott insists it is yesterday's solution.

The risks for Labor are significant. Abbott's response, in effect, is to brand this a "lose-lose" result. If the EU price stays low, then Australia has a huge tax hole in its budgets from 2015-16; but if the EU price recovers, then our industry is uncompetitive in much of the world.

The story is that both the carbon tax and mining tax, locked into downward trends on global markets, may deliver far less revenue than predicted.

That would be a budget blow to Labor but also mock Abbott's efforts to cast such taxes as economy-wide wreckers.

Meanwhile, Labor neatly plays both sides of the fence. On the one hand, it argues the European price will recover to verify Treasury's estimate of a $29-a-tonne Australian price at 2015, but on the other hand it extends to industry the prospect of relief by having a lower price, courtesy of abolition of the post-2015 floor price.

The truth is that senior ministers such as Combet and Wayne Swan must be professional optimists about Europe's carbon pricing. They have no choice given our budget estimates, yet this is not necessarily a good place to find oneself. "The Treasury modelling is something we stand by," Combet said. This will become a major point of contention.

Ministers argue the European price will recover from current abject lows of about $10 a tonne. Combet signals the message he got from the EU is its determination to lift the price via adjustment of permit allocation.

Yet the European price has fluctuated wildly in recent times and some projections have the price at only $12 a tonne by 2015.

Greens leader Christine Milne said it could rise as high as $50 a tonne. Shortfalls from the $29-a-tonne Treasury estimate will show up as lost revenue and the Business Council has warned previously that this could become an annual loss of more than $3 billion a year. Combet pledges that household assistance will remain unchanged, raising fears the net impact of carbon pricing will be a significant cost to revenue.

One possible scenario is bizarre -- that after a three-year fixed period our carbon price suddenly falls in a hole. This would border on farce. Market apprehension of the price falling in 2015 can ruin any prospect of investment certainty into cleaner energy along with compounding Labor's fiscal legacy, where two themes are apparent: weaker revenues and higher spending.

Combet made clear that Labor would seek to strengthen and stabilise the carbon price by reducing industry's ability to meet its obligations by sourcing abatement from the UN Clean Development Mechanism where prices are currently as low as $3.50.

Companies are allowed to buy 50 per cent of their liability in international markets but access to the very cheap CDM credits will now be limited to 12.5 per cent of emission obligations. The rest must be bought from the more expensive EU market.

Combet said: "To put it in a bit of context, the EU market is worth about $125bn and the CDM is worth a bit over $2bn."

Labor argues, however, the transition from the fixed price to the ETS will assist major polluters because if they maximise their use of cheap permits they will be better off.

The bigger picture, however, reveals the multiple variables that can go wrong in this ETS design. Labor's policy suffers from the abandonment of any UN-sponsored binding deal, the shattering impact of the 2008-09 global financial crisis on climate change policy, the difficulty for Treasury in devising reliable estimates of the future carbon price and the "locked in" household assistance.

The assistance to industry, on the other hand, is not fixed. That is tied to the carbon price. If the price falls, so does the assistance.

Combet's new deal does not meet either of the chief demands from industry -- it wants a low price now plus an earlier move to a floating price. For Combet, the insider politics of this deal have been intense. He put the proposal to his European counterpart, Connie Hedegaard, in South Africa at the end of last year. Follow-up talks were conducted this year in Brussels and Germany.

There was broad support from the Greens and independents for the principle of tying Australia's ETS to Europe. The trade-off to deliver the Greens was to substitute the restriction on Kyoto CDM units for abolition of the floor price.

Labor's climate change edifice is now tied to the EU.

It is a further elaboration of the market and administrative arrangements that Abbott is determined to tear down. His pledge to repeal every aspect of Labor's structure looms as one of the defining policy and ideological contests of recent decades.