emissions trading made easy

Emissions trading made easy
Ross Gittins
February 10, 2007

WITH the release of the federal taskforce's issues paper this week, we moved a small step closer to a national trading scheme for greenhouse gas emissions. But do you know much about how such a scheme would work?

Try yourself on this: how does issuing power stations with permits to emit carbon dioxide into the atmosphere help stop global warming?

Gas and coal-fired power stations are expected to generate almost 70 per cent of the increase in carbon dioxide and other greenhouse gas emissions between 1990 and 2010.

So any emissions trading scheme is likely to concentrate on them; we'd need some other measure to influence transport, which will account for a further 16 per cent of the increase.

Obviously, if nothing is done, our power stations will go on producing more electricity every year and emitting more gas in the process. Equally obviously, we can't just close them down.

An emissions scheme starts by setting a limit on the amount of gas the power industry is permitted to emit during a year — for example, no more than last year. You'd distribute permits to operators that added up to that limit (or cap).

But the taskforce's issues paper reminds us that merely stabilising the level of emissions isn't enough. We need to reduce them significantly. So when you set the initial cap on power stations' emissions, you'd also announce a firm program to reduce the cap — the industry's maximum permitted annual emissions — over time.

Do you see how such a scheme would force up the cost of electricity and, hence, the prices of the things electricity was used to produce?

For a start, if you were doing it properly, you wouldn't just give away the emission permits to existing power stations according to their share of last year's total emissions, you'd auction them off to the highest bidders.

But even if you did give away the permits initially, they'd soon acquire a value — known to economists as a "scarcity value" — because the demand for them would exceed supply.

The more you reduced the cap, the more demand would exceed supply and the more valuable the ownership of an emission permit would become.

And because the demand for electricity would also exceed supply, the power stations would be able to raise the price they charged for electricity accordingly. But isn't it a bad thing for the Government to be taking steps that force up the price of electricity? Yes, which is why you'd do it only if you had a good enough reason — such as helping save the planet from global warming.

To reduce emissions from electricity generation, you could pass a law allowing people to use their air conditioners only every second day.

But economists believe it's almost always better to ration scarce resources by raising the price rather than by imposing quantitative restrictions.

Rationing by price rather than quantity ensures the scarce resource is used by the people who value it most highly, thereby avoiding inefficiency. This is the way to minimise the economic disruption caused by emission abatement.

To some extent, the higher price will simply encourage people to be less wasteful in their use of electricity. And to this extent it's excellent news. Eliminating waste involves no cost in terms of lost economic activity.

But the virtues of emission trading don't end there. Those power stations that find a better way to limit their gas emissions from burning coal can make a buck on the side by selling their spare permits to those stations that find it more expensive to limit their emissions.

That way, the emission target is met with least loss of electricity generation. What's more, you've created a strong monetary incentive in the search for new and better ways of reducing emissions without reducing production.

So that, you see, is the rationale for tradeable emission permits. They're a device for minimising the cost to the economy of achieving your environmental objectives by harnessing market forces to the cause.

And whatever people tell you, the cost of a national emissions trading scheme isn't likely to be particularly high.

age.com.au