Emerging Issue Of The Emissions Trading Schemes Accounting Essay

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Abstract: This report covers an overview of the origins of the carbon trading market and the mechanics involved in trading carbon emission units. The report seeks to analyse the carbon trading market in Europe and Australia. The carbon trading market is reviewed with an overall concern for the role government regulation plays in the market, as well as the impact of introducing an emission trading scheme on businesses in general. A summary of the current initiatives to climate change management in Europe and Australia is presented in this paper, including a review of the different types of schemes proposed under carbon trading and also the concept of carbon tax. The emissions trading scheme in Australia is turning into a hot topic, and the purpose of this paper is to analyse different trading schemes, and provide an economic analysis of the trading scheme and its implementation issues.

Keywords: Australian emissions trading scheme; Europe emissions trading scheme; carbon tax; carbon trading; least cost strategy; carbon emissions; sustainability; emissions trading scheme; Sustainable Society; Economics.

Reference to this paper should be made as follows: Sridhar, K. (xxxx)

'The emerging issue of the emissions trading schemes in Europe and Australia', Int. J. Sustainable Society, Vol. x, No. x, pp.xx-xx.

Biographical notes: Kaushik Sridhar is a Doctoral Scholar (PhD) at the Macquarie Graduate School of Management. His thesis is in the area of sustainability, and my primary focus is on the Triple Bottom Line approach, and its weakness/limitations. Prior to the PhD, he did his MBA at MGSM in 2008, and graduated in the top 10% of his class. He did his Bachelor of Science in Business and Art (double major), in South Carolina, and graduated dux of his class. Since commencing the PhD in June 2009, he has published three papers in international journals and one working paper at the Macquarie Graduate School of Management.

1 Introduction

There are many carbon trading schemes that have evolved across the world, but they all have the same purpose. The Rudd Government signed the Kyoto Protocol a few months ago, making Australia the 174th country to ratify the international agreement. This initiative set the country on course to cap its greenhouse gas (GHG) emissions to 108% of 1990 levels by 2012 and to achieve potentially even more ambitious targets afterwards Although the policies for achieving these targets have not been finalised, steps are under way for the creation of a national emissions registry to be in place before the trading scheme commences in 2010. Unlike countries that were early adopters of carbon trading, Australia has the opportunity to conduct trades at a global level from the very beginning.

Emissions trading can be seen as an administrative tool that has been adopted in an effort to monitor and control pollution by regulating the amount of pollutants that are emitted into the atmosphere with the goal being to reduce the volume of pollutants that arereleased into the earth's atmosphere (Bailey, 2007). On the initiative of leading nations around the world primarily in Europe a strong requirement for action on reducing emissions was formed via the Kyoto Protocol. The concept of using tradeable rights in an effort to control pollution was first suggested by John Dales in 1968. In light of Dales' suggestion for tradeable rights, the first emissions trading program was implemented in the USA known as the Clean Air Act of 1977 (Dales, 1968). An emissions trading scheme is one market-based mechanism that allows a country or firm to reduce its greenhouse gas emissions (GHGE). In order for domestic goals within countries to be reached, it is important that an emissions trading system that seeks to decrease gases such as carbon dioxide (CO2) be constructed as an international system. This sense of having an international system has been created with the creation of the Kyoto Protocol.

1.1 Kyoto protocol

The Kyoto protocol can be seen as an international agreement connected to the United Nations Framework Convention on Climate Change. The protocol sets binding targets for 37 industrialised countries who agree to reduce their GHGE. The amount of GHGs to be reduced is aimed at 5% of 1990 levels over the period 2008-2012. With GHGE in the atmosphere as a result of more than a century of industrial activity, the Kyoto Protocol places pressure on developed nations to abide by the targets and committing them to the targets. The Kyoto Protocol became effective after more than seven years since it was first adopted in Kyoto, Japan on 11 December 1997, coming into play on

16 February 2005.

2 Types of emissions trading

There are three key types of emissions trading in which countries around the world have attempted to control and reduce emissions. The European Union Trading Scheme (EU ETS) has chosen to adopt the cap and trade system, with the Australian Government likely to adopt the same system given the apparent goals and targets those emissions trading schemes set out to address (Delbeke, 2006). As mentioned earlier, the provisions for international emissions for trading GHGs was introduced with the establishment of the Kyoto Protocol. Emission trading has increased dramatically over the last five years with the emerging market of emissions trading being pioneered by European countries under the EU ETS (Ellerman et al., 2007). To accurately state and define various emission trading schemes, the key and underlying question that is yet to be understood by the vast majority of the population is defining what exactly emission trading is. Emission trading is a relatively simple scheme. To best explain the scheme two companies will be used as an example. Consider the Australian companies BHP and RIO. Both BHP and Rio operate in industries that are sensitive to emissions, and themselves emit large amounts of various pollutants. It could be argued that the volumes of their emissions and other firms in similar industries may result in a degree of damage being carried out with regards to air quality and that it poses a health risk. This would likely be addressed by a regulator enforcing some type of reduction of emissions by a defined amount such as a 15% reduction. This imposed reduction would indicate that both RIO and BHP are to reduce its emissions by 15%, however, due to each of their production cycles and other costs it may prove to be more expensive for BHP to reduce its emissions than it is for Rio. By Rio being able to reduce its costs of emissions, it results in a favourable position for Rio given its flexibility in reducing costs. With the regulator deciding on a maximum amount of a pollutant that can be emitted in a particular area with a specified time frame, the regulator allocates a portion of the allowable GHG quota into a number of rights that are then allocated to firms such as BHP and Rio and other participants in industries that emit the same pollutant. This pollutant could be carbon dioxide for example.

Rio is able to decrease the amount of pollutants (carbon dioxide) at a cost that is cheap, and has the potential to make more reductions if required. BHP's cost to reduce its carbon dioxide is significantly higher than Rio, and so would look at attempting strategies or activities that would reduce the cost burden of reducing its carbon dioxide reduction. From this it can be seen that if Rio can reduce its carbon dioxide emissions at a relatively low cost compared to BHP, then Rio may potentially absorb the carbon dioxide reductions that BHP is responsible for. This would only be carried out by Rio if it was to be compensated by BHP at a price which is higher than Rio's actual cost of reducing its emissions, yet lower than the cost that BHP would incur if it was to reduce their emissions themselves.

This brief overview of what emissions trading ties into the fundamental reason why emissions trading exists, and what are the necessary elements that are essential to a trading program being effective in its underlying strategy to meet its desired goals (Weale et al., 2000). A well established trading system can be seen as an environmental regulation tool which permits various firms/industries to reach an emissions target set out by a regulator at a lower cost. Some key elements of a trading program are (Grubb et al., 1999):

A cap must be imposed on emissions, and this must be lower than the 'business as usual' emissions of the firms/industries in the program.

Firms/industries must face divergent clean up costs in order for savings from trading to take place. The size of the market of firms participating in the program must be relatively large to justify a competitive market.

Reliable and effective monitoring of actual emissions is essential for every participant, as well as reductions for each participant.

An effective enforcement system is required to ensure participant holds enough emission entitlements to cover its actual emissions.

When emissions have local impacts, a provision must be made to protect the local air quality by preventing shifts in the location of emission sources from having adverse environmental consequences.

2.1 Cap and trade system

With Australia more than likely to have a cap and trade emissions trading program, it is important to state the key attributes and benefits of such a program being adopted. Given that the Australian Government, is likely to impose a 'cap' that limits the total amount of pollution allowed by a certain GHG such as carbon dioxide. The Federal government could potentially allocate or auction credits such as carbon credits which represent the total amount of carbon dioxide that is allowed to be emitted into the atmosphere. These credits that are received or bought by firms become assets of the firm from a reporting perspective and can be traded as private property between firms. The fundamental element of carbon trading is the goal of reducing carbon emissions. This is carried out in the first stage of granting credits that total less than historical carbon emission levels, however, the ongoing reduction of credits allocated or auctioned by the government will decrease (Fairbrass and Jordan, 2004). As the cost of carbon credits increase over time, firms will ultimately elect to reduce their carbon emissions. The main benefit of a cap and trade program is that it allows firms to decide at what point and price they either leave the industry as it has become too expensive to purchase carbon credits or to reduce their carbon emissions by engaging in practices and technologies that reduce the emission levels. Technologies and practices may include switching to hybrid vehicles, rail transport for goods, wind power, solar power and nuclear power. In cases where firms can reduce their emissions by more than the required amount, they may then profit from this reduction by selling the credits that they no longer need to firms that cannot or will not reduce their emissions.

2.2 Baseline and credit

The main difference between a cap and trade program and a baseline and credit is that unlike cap and trade the baseline and credit program participants are required to earn their credits before the trading of them commences. Initially a baseline for emissions is defined for each firm by a regulator such as the federal government. In simple terms, a firm is allocated a level of emissions that it is allowed to emit during a specified period. At the end of the period, calculations are carried out to determine a firms emissions output. If a firm has emitted less than the amount that it was assigned then the firm will receive credits for the difference between the 'baseline' and the actual amount it emitted. For example, baseline issued to a firm such as BHP is 30 tonnes of carbon dioxide, with actual BHP actual emissions being 25 tonnes of CO2, this results in a credit of 5 tonnes being received by BHP whereby BHP is permitted to sell the credits, or keep them. If a firm has emitted more than its baseline, then it must purchase carbon credits equal to the amount that it breached its baseline by Eg. If Rio had a baseline of 30 tonnes, and it emitted 39 tonnes of carbon dioxide, then it would have to purchase 9 tonnes of carbon credits.

2.3 Hybrid schemes

Hybrid schemes create a link between price and quantity. 'The basic feature of these models is the establishment of an emissions trading scheme with an imposed upper limit on the price of permits' (McKibbin and Wilcoxen, 2002). This scheme initially issues tradable permits up to a cap, but has a commitment by government to issue unlimited amounts of extra permits at a specified ceiling price. Like the carbon tax, the hybrid approach with a ceiling price has the advantage of providing certainty about the maximum permit price while preserving some aspects of an emissions trading scheme to the extent that the market price can be expected to remain below the cap.

2.4 Offset

An offset program is used primarily to make an allowance for the extra emissions from a source that is new or the expansion of a new firm. This scheme allows those responsible for the new or expanding firm to purchase credits equal to emission reductions achieved by existing firms. It is mandatory to offset any emissions from a new or expanding firm, as if it is not offset it undermines the goals and objectives of any cap and trade program or baseline and credit program that sets to impose restrictions on the volume of a pollutant that a firm emits (Figure 1).

Figure 1 ETS example (AgCert International, 2006)

3 Example of emissions trading

3.1 Carbon tax

Carbon tax, a tax on emissions, is straightforward to apply and avoids the need for governments to take discretionary decisions about who ought to be allowed to emit. However, the intended aim of emissions reductions targets with a carbon tax cannot be guaranteed. Companies that are reaping heavy profits through high emissions are not motivated to reduce by paying a marginal tax amount.

3.1.1 Logic of least cost strategy

'Least cost strategy is the economic answer to top down regulation' (Jones, 2008). Let's take an example that analyses the effect of regulation to 2 least cost options, tax on emissions and a system of tradable credits. Companies A and B use different technologies to generate different products, although both have high emissions. In the first case, the Australian government decides to allow the companies to emit an amount that can be absorbed by the natural environment. This threshold is represented by the dotted line in Figure 2. Company A can reduce its emissions at a low cost, and does so immediately. Company B has increasing costs each time it reduces its GHGE. Hence, it will either go out of business or place pressure on the government to regulate the market.

Using a carbon tax method, each company will now have an incentive to reduce its emissions until further reductions starts to cost more than the tax. Hence, the marginal cost of reducing an extra unit of emission grows to become greater than the tax on the unit of emission. This is represented in Figure 3.

Figure 2 Capping emissions by regulation

Source: Jones (2008).

Figure 3 Economic decision making by firms

Source: Jones (2008).

3.1.2 Why government prefers the tradable credits scheme

A tradable credits scheme minimises costs and also creates additional revenue for some businesses. The tax scheme functions only for companies that cannot meet the required level of reduction of emissions.

In Figure 3, assume now that there is no tax. The firms can generate a credit for every unit of emission they reduce below the dotted line. Company A can sell these credits to other companies who are having trouble reducing their emissions. Company B still has an incentive to reduce its emissions, due do its reluctance in wanting to buy credits.

The choice between the two options showcases what the government wants to control and where it wants certainty. A tax provides certainty for an industry by stating the price of emissions, but omits the actual output of the GHGE to be determined by the market. The government would not have the right to set and enforce targets and would be pressurised to move towards the best scenario by constant adjustments to the tax system. With the tradable credits scheme, the government seizes control over the amount of emissions, while at the same time, allows the price of credits to fluctuate on waves of supply and demand.

3.2 Economics of international emissions trading

The impact of a carbon trading scheme in Australia is likely to result in consumers paying a higher price for their goods. Economic theory states that if the costs associated with the good increases, ceteris paribus, its price to consumers will also increase, and those that cannot afford the good, will opt for the closest substitute. The overall impact depends on the elasticity of demand. In essence, the governments of the world have ultimately changed the fundamentals of business (Hanemann et al., 1996). This is due to the fact that prior to the introduction of the Kyoto protocol the right to pollute the air was in most cases was not seen as a business cost. Today, polluting the environment in many parts of the world is no longer a free good at which firms can emit GHGs. Firms in industries such as electricity and coal fired generators will have their costs increased. If firms are generating output at the point and rate which marginal costs is equal to marginal revenue, the price of goods will rise as long as there is some economic benefit for consumers to search for alternative goods where the price are at a more competitive levels. The main focus of the economic factors associated with emissions trading; in particular carbon trading is the impact of the marginal abatement cost (Greene, 1993). The marginal abatement cost (MAC) can be best described as the cost of eliminating an additional unit of pollution as it differs with each country. It could be stated that marginal abatement cost curves (MACCs) are a key tool used to identify the effects of emissions trading and the Kyoto Protocol. It has been found that a contributing factor that influences MACC's is energy prices. The questions of how one defines MACC's in a general equilibrium context where the total abatement level across the world influences energy prices which also impacts national MACC's is important. The findings of the research indicated that actual changes in energy prices as a result of differing abatement levels around the world do affect the national MACCs (Green et al., 2007). For example, in order for India to eliminate 2 tonnes of CO2 it may cost $3 for each tonne, however, this cost of reducing carbon dioxide may result in a higher MAC from a developed country such as Germany or Sweden. The varying MAC's of a large number of countries are the reason in which international emissions trading were developed.

3.3 Economics of price vs. quantity, and the safety valve

With carbon trading to be a part of daily business activities and the question of whether the underlying drivers of programme are strong enough to meet it required goals, a brief overview of the elements of programs is necessary (Fischhoff and Furby, 1988). Firstly, an emission cap and credit/permit trading system is a quantity-based instrument as it seeks to cap overall emissions with the price of the credits/permits fluctuating according to supply and demand. The risk associated with a cap and trade system is the uncertainty of carbon credits in the future which in turn brings considerable business risk to a firm. An emissions tax can be seen as a price instrument whereby the price of a carbon credit would be fixed, with the emission level permitted to fluctuate as demand and supply forces carry out (Lefevre, 2005). The impact of a tax results in a direct cost to businesses, and has been found to be less cost efficient than a quantity-based system. Given that a price system cannot guarantee the amount of pollutants being emitted, it poses a greater risk than a quantity system where it has been found by some scientists that levels of carbon dioxide may reach levels that are greater than anticipated allowing for a global warming effect to take place (Franck, 1990). The combination of an emissions tax (price based) and a trading scheme (quantity based) is a hybrid scheme that is best described as a safety valve. It has features similar to a cap, and tradeable credit, however, it has a price cap placed on the upside and a floor on the downside, which prevents volatility and speculators and market makers driving up prices. This allows for decreased risk of market manipulation, and allows for greater confidence within firms as they know that the credits they have cannot be devalued past a certain point, and firms who wish to purchase credits in the future know the maximum price at which they are to purchase credits, and can therefore allocate required funds for future purchases. These three methods have all been adopted to combat and control GHG emissions. In particular the largest carbon trading market in the world, the European Union Emission Trading Scheme (EU ETS) has adopted the quantity system as it is more closely correlated to the aims and objectives of the Kyoto Protocol than a direct tax (price) system. The UK's Climate Change Levy is by definition a price system as it is a direct carbon tax. China uses the CO2 market price for funding of its Clean Development Mechanism projects, however, it has a safety valve where it imposes a minimum price per tonne of CO2.

4 Analysis of carbon trading in Europe: the European climate change program EU ETS

In January 2005, the European Union Greenhouse Gas Emission Trading Scheme (EU ETS) Commenced as the largest multi country, multi sector GHG emission trading scheme in the world. The EU ETS is a result of the European Union pushing ahead of the rest of the world in trying to cap carbon dioxide emissions within its own expanding borders as more countries become members of the European Union. Since 2005, when the scheme was introduced 15 countries were in the European Union, now that number has grown to 27, and is to grow more with the inclusion of non-European Union countries Norway, Iceland and Liechtenstein to join the scheme (EU ETS) also (Ellerman and Buchner, 2007). By the EU implementing market driven mechanisms that give a price on carbon emissions, it allowed private investors, government bodies and industries to allocate funds and factor the cost as part of the costs of operating. By placing an economic value, and price on carbon emissions some evidence suggests that the implementation of carbon trading has resulted in a reduction of carbon dioxide emissions in the first trading period or phase 1 (January 2005-December 2007) (European Commission, 2008).

4.1 European emissions trading scheme (2005-2012 - phases 1 and 2)

Phase 1 effectively established a market for emissions trading, and resulted in a price being determined for carbon per cubic tonne (Vis, 2006). It also laid a foundation for which a scheme could be enhanced and modified to meet the challenges of reducing carbon emissions in the future, and more information becomes available. In essence, market mechanics and data on emissions trading allowed for participants especially policy makers within the EU to allow for greater progress and awareness in phase 2 of the EU ETS which commenced at the beginning of 2008. Within phase 1, the carbon dioxide emissions of the EU members covered 10,000 facilities and the emissions as set out by the EU were capped at 2.1 billion tonnes per year. Facilities within the EU were granted with European union allowances (EUA's) with each member state having discretion over determining the actual process of allocation of EUA's for their facilities within their own country (Damro and Mendez, 2003). The scheme required that at the end of each year the facilities that had been issued EUA's were to surrender the quantity of EUA's equal to the amount that the facility emits. The excess EUA's that a facility has at the end of the period are able to be sold, or they can be saved as a form of 'banking' or if facilities emit more that their allowance they can purchase them.

With the introduction of EUA's marketplaces, private trading of allowances took place and a spot market was created in 2005. Formalised exchange-based futures on carbon emissions commenced in the middle of 2005. At the beginning trading volumes in 2005 were a mere 262 tonnes (Mt) and have seen a rapid increase (Hægstad Flåm, 2008). As at 2006 trading volumes had increased to (809 Mt), and by 2007 had increased to 1,500 (Mt). With the increased volume of trading the total value of turnover has more grown almost five fold from €5.97 billion euros at the commencement of phase 1 to €24.1 billion at the end of phase 1.The transactions carried out in the EU ETS make it the most significant environmental market in the world given the participation of more than 27 European countries, and accounts for 80% of the world carbon market according to the World Bank.

4.2 Impacts of emissions trading in Europe

To ascertain whether the adoption of an emissions trading program will have an adverse effect on Australian companies once carbon trading is adopted in Australia in 2010, it is essential that the impacts of carbon trading are assessed in relation to EU member states who for the last three years have been ahead of the curve in terms of being the first to adopt a multi country trading program. The major concerns relating to the adoption of a carbon trading scheme in Europe was that the result of the extra costs to either reduce GHG's by installing more environmentally friendly equipment/materials would ultimately be passed on to consumers. This raised questions about whether or not EU member states would be able to offer competitive prices for goods and services, and compete against non-EU member firms. Another significant concern was the way in which the EU members were allowed to allocate allowances for their industrial sectors within their own countries, which had little micro directive to deter member states from propping up some industries with state aid which allowed for those industries to compete with other EU member states (Kruger and Pizer, 2004). In essence, the internal allocation of allowances could be seen to result in various strategies being deployed by various EU member states to increase competitiveness (Smale et al., 2006). Other concerns of emissions trading was that prices of household electricity would rise and that reductions in actual emissions may not be attained due to the complexity of the scheme, given that it is based on a large amount of theory being applied to a relatively dynamic market where it is challenging to determine if emissions trading is a science or a social phenomenon that has little impact on total GHG's being emitted. The academic literature on carbon trading indicates that firms are likely to see an increase in profits from being a part of an emissions trading scheme. Despite the fundamentals of economics indicating that an increase in price will result in lower volume/turnover for firms this appears not to apply in such a scheme. Given the fact that the EU ETS is a cap and trade system where the cap and trade scheme results in an increase in marginal costs, the effect of the EU member states being allocated allowances for free resulted in the market value of emitted CO2 being passed on to the consumer, with firms profiting on the over allocation of allowances. This large economic rent for member states and their firms allowed for some economic benefits being achieved.

In reality, the results of carbon trading are as academics had predicted as stated above. In phase 1 of the EU ETS where allowances were allocated with some countries such as Poland having a surplus it resulted in significant profits being attained by power generators across Europe. The allocations of allowances which incur zero economic cost to firms is treated as a cost by some firms such as power generating firms, and therefore pass the market value of the allowance to the end consumer which ultimately pushes up the price of electricity despite having no extra cost to these firms. Treating this free hand out as a cost has resulted in the European Commission agreeing to alter the way in which allowances are distributed. In a statement, the commission released it mentioned 'will also eliminate windfall profit' which are made by firms producing electricity. The UK's Office of Gas Electricity Markets (Ofgem) estimated that as a result of the country participating in the ETS that each consumer pays 31 pounds a year to finance the 'costs' which electricity firms incur to reduce their carbon emissions (Brouwer et al., 2008). The over allocation of free allowances in phase 1 of the EU ETS can be seen to have had the effect of inflicting increased upward pressure on the price of wholesale electricity. Within phase 1, the greatest increases in profit have been power producers such as Poland, where their ratio of CO2 emitted was greater than any other EU member, and where the CO2 costs ratio passed through to wholesale power prices was the highest. Poland's gains were further enhanced as it elected to allocate the greatest amount of free allowances to the power sector. Despite this appearing to be an effective strategy in increasing profits in the initial phase of the scheme, the fact that the price of carbon had fallen to a price which was €0.22 (average price over period February 2007-April 2008) did not allow for as much 'costs' being passed on to wholesale prices as otherwise would have been if carbon prices were at €15-€20 prior to their spectacular collapse as a result of the over allocation of permits. With regards to phase 2 of the EU ETS, there is an even greater probability that there will be abuse of the carbon trading mechanism across a number of countries. The transition from phase 1 to phase 2 of the scheme brought about the retirement of EUA's that were only valid until the end of 2007. Countries that had banked their allowances in anticipation of using them at a later stage, or deferring investments in technology to reduce carbon emissions, lead to an over allocation. As at October 2008, the December 2008 EUA is trading in a range between 23 and 25 Euros. Given the potential to make excessive profits from the EUA's their price has risen nearly one hundred fold, and will ultimately lead to a significant increase in the price of wholesale power, and will result in greater profits being achieved by power generating firms.

4.3 The Australian government's carbon pollution scheme

To carry out further analysis and understanding of how emissions trading via a scheme such as the EU ETS will impact Australia it is important to highlight the key factors associated with carbon pollution and the drivers behind building a scheme to reduce carbon emissions. The desired goal is to reduce Australia's GHG emissions by 60% of the year 2000 levels by 2050 (Carbon Trust, 2007). Given that carbon pollution is allegedly causing climate change Australia is under increased global and domestic pressure to act, and to make measures that are seen to actually reduce carbon emissions. The fear for Australia and other countries is one of the driving forces behind the evolvement of the mentality towards becoming proactive and implementing systems that will lead to a sustainable environment in the future. As stated in the Green Paper, 'the 12 hottest years in history have all been in the last 13 years'. Facts such as these along with statements alluding to Australia currently suffering economic and environmental costs as a result of not taking steps to alleviate the risks of a change in global warming have no doubt been an underlying source of Australia's fast pace approach to creating a carbon trading scheme (Cubria and Rivoe, 2006). In terms of offering solution to what Australia sees as a problem, it must be stated that in order to address any perceived or actual problems it must be done with the realisation that there is no single solution to defeating climate change. The Australian Government's climate change strategy is based on three pillars

1 reducing Australia's GHG emissions

2 adapting to climate change that we cannot avoid

3 helping to shape a global solution.

As predicted, the Australian Government will follow the lead of the EU ETS, and adopt a carbon pollution reduction scheme that is a cap and trade scheme as it will place a maximum limit on the amount of carbon dioxide an industry can emit.41. With Australia's biggest polluters being limited to a mere 1,000 companies they each represent emitting more than 25,000 tonnes of carbon pollution per year. With more than 7.6 million registered businesses in Australia they are likely to have significantly less obligations placed on them. With the EU ETS member states having received free credits via a national allocation plan that allows for free permits to those industries that are most exposed to emissions and sensitive to trade, it allows for a soft introduction of carbon trading than a system that would have involved auctioning off all permits. The Australian Government has the advantage of being able to review the EU ETS, and the problems it had, and can now apply a trading scheme that is seemingly more robust.

One interesting note regarding climate change is that in Professor Garnaut's Review Draft Report of June 2008, it states that Australia is emitting GHGs that are hovering in a range that is in the upper bound regions of the scenarios modelled by the Inter Governmental Panel on Climate Change (IPCC). With this example it must be realised that attempting to predict the future of various scientific modelling may be seen as inaccurate and highly risky due to the uncertainty of providing any truly reliable information. In response to the Green Paper indicating that a Carbon Pollution Reduction Scheme is in the best interest of Australians, and that a delay in the introduction of such a system would lead to prolonging in investment, and further uncertainty for those who wish to invest in technologies and processes that can reduce GHG emissions. Given the fact that the Green Paper was released in June 2008, with somewhat conflicting indications on the robustness of the macroeconomic environment being 'challenging' then stating that the Australian economy is well placed to face the challenges of responding to climate change, then the events that have unfolded since June 2008 need to be realised (McLennan, 2006). The worldwide financial crisis has resulted in the Australian Securities Exchange benchmark index falling more than 50% from its highs in November 2007. The sheer severity of wealth being wiped from the balance sheet of businesses and individuals is one of the worst that Australia and the world have seen. As a result, the likelihood of Australian going into a recession with a rise in unemployment could be seen as events that would make the introduction of an emissions trading scheme very difficult for businesses to fund.

4.4 Legislation vs. emissions trading

The Green Paper states that relying on regulations as the sole source of reducing emissions would not be practical due to the fact that the information required in order to be able to identify the emissions that a firm needs to reduce would be better managed at the firm level, rather than at government level. This is due to the fact that businesses and households should be able to identify how they can reduce their emissions at the lowest economic cost. The concept of placing a monetary value on GHG emissions such as carbon dioxide can be seen as an encouraging and soft approach to reducing GHG emissions, however, the actual activity of trading emissions via permits, credits and offsets may make the objective of achieving an actual reduction of carbon pollution challenging due to the monetary incentive to manipulate reporting of emissions, paving way for fraudulent actions.

4.5 Significance of schemes on Australian economy

The Australian government has developed a method to measure the impact of a carbon pollution reduction scheme on the consumer price index. 'It has revealed that a hypothetical carbon price of $20 a tonne will have a 0.9% impact on the CPI' (Maiden, 2008). Maiden further states that on the current CPI of 4.2%, this could potentially push the inflation rate to 5.1%, well beyond the Reserve Bank's target range of 3% over the cycle, which determines interest rate decision making.

5 Problems

5.1 Pricing volatility

The carbon trading scheme relies on tradable permits, and volatility combined with calculating and issuing the right number of permits can make the scheme dangerous and useless. The price of tradable permits in the USA has varied by 40% in the mid-1990's (The Economist, 2007).

5.2 Free allocation of permits

Allocation of permits will have a negative effect on the distribution of income. Free permit allocation would be highly complex, generate high transaction costs and require value-based judgements regarding who is most deserving.

5.3 Consumer behaviour

The Kyoto Protocol proposes a differentiated response between developed and developing countries and there's a fairly divided view or at least a differentiated response within developed countries. To reduce the emissions, a globally united response is required, which does not seem to exist today, as seen in the Green Paper. Hence, the outcome will be a community backlash against what's going on, because if an Australia acts on the model, it loses competitiveness that leads to jobs being shifted offshore. In conclusion, the country would actually import the law of GHG emissions by increasing its imports. The employment goes down and the world's climate does not undergo a transformation.

In a competitive world, these policies send a price signal through the economy, and that price signal must pass all the way through to the final consumer. If the price for a permit is too low, it will not push up prices much and therefore will not change people's purchasing habits or encourage them to save energy. On the other hand, if the price for permits is very high, it might cause a major shock to the economy as prices of all sorts of goods shoot up.

6 Conclusion

Carbon taxes are transparent and simple, whereas cap and trade systems are complicated and conveniently opaque (The Economist, 2007). From a political perspective, the execution of the cap and trade scheme will be tricky, as polluters in rich industries could be paid off by governments to reduce their emissions. Companies in the mining industry in Australia are a potential example. One alternative has been proposed by economist Warren McKibben, who argues for permits to be issued to consumers and end-users rather than industry and energy suppliers (McKibben, 2002). A reason for adopting the scheme currently proposed by Garnaut is it looks likely to be similar to the model adopted internationally, meaning it will be easier to link the Australian system with overseas emissions trading schemes in future. Ultimately, the goal of reducing GHG emissions should be the primary focus for selecting the appropriate scheme.


The author wishes to thank the referees for their useful comments and suggestions on earlier versions of this paper, although they are not responsible for any errors and shortcomings that may remain.


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