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Chapter 10 Economic implications of Australia’s emissions reduction goals

Australia can achieve stronger targets than the minimum 5 per cent at a relatively small cost.

Australia faces a substantial but achievable emissions reduction task to 2020. Emissions are projected to grow to 17 per cent above 2000 levels in the absence of a carbon price or new policy. This is less than the previous projection of 22 per cent above 2000 levels, making Australia’s emissions reduction target range somewhat easier to achieve.

The Authority’s analysis shows that Australia can achieve a 15 or 25 per cent reduction target while national income and the economy continue to grow. Under the current legislation, and with the minimum 5 per cent target, Gross National Income (GNI) per person is projected to grow by an average of 0.80 per cent annually over the period to 2020. GNI per person is projected to grow by an average of 0.78 per cent with a 15 per cent target, and by 0.76 per cent with a 25 per cent target. In dollar terms, GNI per person is projected to grow from about $62 350 in 2012 to about $66 450 in 2020 with a 5 per cent target; $66 350 with a 15 per cent target; or $66 250 with a 25 per cent target (all in real terms). This means GNI per person would reach the same level as the 5 per cent target ($66 450) less than three months later if Australia adopted a 15 per cent target; or five months later if Australia adopted a 25 per cent target.

The slightly slower growth associated with stronger targets represents the cost of Australia making its fair contribution to global efforts to limit global average warming to 2 degrees or less, relative to pre-industrial levels.

Economic costs, and the distribution of those costs across industries and households, will vary under different policy settings. The Government intends to replace the current legislation with the Direct Action Plan to reduce Australia’s emissions. The details of this Plan are still being developed; the Authority has not speculated on its design. Nevertheless, the costs presented in this Chapter provide a useful comparative benchmark.

This analysis suggests using international emissions reductions to complement domestic reductions can help reduce the cost of meeting Australia’s targets.

The preceding chapters considered the scale of global emissions reductions required to limit global warming to below 2 degrees, the action other countries are taking and how Australia’s emissions reduction goals compare with other countries’ goals. They also identified Australia’s long term emissions budget and its implications for Australia’s short term goals.

Chapter 10 adds to the analysis by examining the economic implications of achieving different 2020 targets. It:

  • assesses the scale of Australia’s emissions reduction task to 2020;
  • considers how the economy would change if Australia moved beyond 5 per cent to a stronger target, and estimates the associated costs;
  • examines how these costs are affected by the mix of domestic and international emissions reductions used to meet the target; and
  • considers the longer term economic implications of 2020 targets.

10.1 Examining the economic implications of different 2020 targets

Australia’s emissions reduction goals set the overall scale of its contribution to global action on climate change, and set the pace of Australia’s transformation towards a low-emission economy.

Extensive analysis (such as Commonwealth of Australia 2011; Garnaut 2008), and Australia’s own experience over the past two decades, shows it is possible to reduce emissions, grow the economy and improve wellbeing at the same time. As Chapter 7 shows, Australia’s economic growth is gradually decoupling from emissions. Since 1990, the size of the Australian economy has approximately doubled, while emissions have remained relatively stable. This means the emissions intensity of the economy (emissions per dollar of Gross Domestic Product (GDP)) has halved.

Chapter 10 focuses on the cost of achieving different 2020 targets. The Authority has considered Australia’s emission trends in the absence of a carbon price to understand the scale of the emissions reduction task and the broad economic implications of achieving different targets. The 5 per cent target is unconditional, so Australia’s real choice is whether to stay with this minimum pledge or to adopt a stronger 2020 target. The 5 per cent target therefore provides an appropriate baseline for assessing the potential incremental cost of pursuing stronger targets.

10.1.1 Using models to estimate Australia’s emissions and economic outlook

The Authority has used economic modelling to help assess the economic implications of different targets. The modelling explores Australia’s emission trends, emissions reduction opportunities and economic outlook in the context of the global action required to reduce the risks of climate change. The modelling was conducted by the Commonwealth Treasury and the Department of Innovation, Industry, Climate Change, Science, Research and Tertiary Education (DIICCSRTE), in consultation with the Authority (referred to as The Treasury and DIICCSRTE modelling).

Economic models are useful for exploring the impacts of climate change mitigation policies, as they ensure internally consistent long term projections of economic activity and the resulting greenhouse gas emissions. While these models have their limitations, they integrate, in a comprehensive manner, economic and other data with economic theory about how the world responds to changing circumstances.

The Treasury and DIICCSRTE modelling uses a suite of global, national and sectoral models, including computable general equilibrium (CGE) models and detailed sector models for the electricity, transport and agriculture sectors. The detailed models provide granular analysis of the industrial sectors responsible for the majority of Australia’s emissions, while the CGE models capture the longer term, economy-wide reallocation of resources over time. This approach is the most useful and appropriate framework currently available to assess the market costs of climate change mitigation in Australia. It builds on previous work to define Australia’s goals and inform the design of Australia’s policies (Garnaut 2008; Commonwealth of Australia 2011).

Further information on the modelling approach and assumptions is provided in The Treasury and DIICCSRTE modelling report (2013) at Climate change authority.

In submissions responding to the Issues Paper, several stakeholders requested the potential costs of climate change itself be quantified and considered. For example, the Australian Conservation Foundation recommended that the Authority ‘[m]odel the social and economic costs of inaction on key ecosystem services in this and all subsequent reviews’ (Issues Paper submission, p. 2).

The analysis presented in this Chapter is limited to the costs of reducing emissions; however, the Authority understands the importance of considering these in parallel with the benefits of action. Chapter 2 discusses the potential impacts of climate change at different levels of warming, including estimates of the potential social and economic costs. By moving to a stronger target, Australia can contribute to stronger global action to mitigate these negative economic, environment and social impacts, and help limit global warming to no more than 2 degrees. In making its recommendations for Australia’s emissions reduction goals, the Authority has considered the benefits of stronger targets as well as the economic costs.

10.1.2 What scenarios have been modelled?

The Treasury and DIICCSRTE modelling examines a range of future scenarios to gauge Australia’s potential economic and emissions outlook. The modelling makes assumptions about the future, including regarding the global economy, technology development, commodity prices and policy settings. These assumptions affect the identified emissions reduction opportunities in Australia and the estimated cost of achieving national emissions reduction goals. The assumptions draw on international and Australian analysis, expert advice and public consultation conducted in April 2013, and are set out in detail in the modelling report.

Assumptions regarding policy settings are especially challenging, as Australia’s climate policy is currently being revised. The Government has indicated it intends to repeal the carbon pricing mechanism and implement its Direct Action Plan to reduce Australia’s emissions, however, the details of this Plan are still being developed and the Authority has not speculated on its design.

The modelling has therefore assessed the economic impacts of achieving different targets under the current legislative settings. It remains informative, even if the policy settings change. The Authority has used high, medium and low carbon price scenarios; a scenario without the carbon price; and a number of sensitivity scenarios to explore the impacts on the economy and emissions (Box 10.1).

There are three reasons that the results of the modelling are informative, even if the policy settings change.

  • First, the results estimate the scale of the emissions reduction task to 2020 for the minimum 5 per cent target and the stronger targets being considered. The ‘no price’ scenario provides the basis for this estimate – it projects Australia’s emissions with existing policies such as the Renewable Energy Target and energy efficiency standards, but excluding the carbon price.
  • Second, the results estimate the incremental cost of moving to stronger emissions reduction targets. The modelling shows that stronger targets are achievable while maintaining economic growth. Though the modelling reflects a different policy framework to that planned by the Government, the costs provide a useful comparative benchmark.
  • Third, the results indicate emissions reduction opportunities that might be available in the Australian economy at different incentive (price) levels, and the associated economy-wide costs. The modelling shows Australia has substantial emissions reduction opportunities across all sectors. While the results show the opportunities likely to be mobilised by the carbon price, many of these opportunities could be mobilised by other policies and incentives.

A key caveat on translating the modelling results to different policy settings is that the distributional effects for industry and households are highly sensitive to policy design. New analysis would be required to assess the distributional effects of the Direct Action Plan, once the detailed policy design is known. Again, the modelling presented here provides a useful benchmark against which to assess those effects.

The Authority will carefully monitor new policy developments, and their implications for the cost of achieving Australia’s emissions reduction goals. Similarly, the Authority will review new emissions data and projections as they become available. It will reflect relevant developments in its Final Report.

Projections of Australia’s emissions and economy from the modelling are used throughout this Draft Report. The next Section focuses on Australia’s emissions outlook in the absence of a carbon price or new mitigation policy.

Box 10.1: Carbon price scenarios in the modelling

The Treasury and DIICCSRTE modelling examines four core scenarios – one without a carbon price and three different price levels. Table 3.1 of the modelling report provides details of the scenario assumptions.

The three price scenarios are largely based on the current legislation. Companies covered by the carbon pricing mechanism (‘liable entities’) have to pay for their emissions by surrendering emission units for each tonne of their emissions. The annual emissions cap determines the supply of Australian Carbon Units (ACUs); liable entities can also use Kyoto Protocol units (such as Certified Emissions Reductions (CERs)) to meet up to 12.5 per cent of their liability, and other eligible international units (such as European Union allowances, or EUAs) to meet up to 50 per cent of their liability. Emissions-intensive, trade-exposed industries receive some free emissions units; and sectors such as agriculture and forestry can generate carbon offsets for emissions reductions through the Carbon Farming Initiative.

The most important variable affecting emission levels is the price of ACUs (the carbon price). Given the links to international markets, the ACU price is assumed to follow the EUA price. The price outlook is uncertain and market forecasts vary. The scenarios therefore span a plausible range of prices, taking account of current carbon market conditions, market forecasts for international units and long term environmental goals.

The four scenarios presented in the modelling report and used in this Chapter are:

  • No price scenario – assumes there is no carbon price and no Carbon Farming Initiative. This scenario includes emissions reductions from pre-existing measures such as energy efficiency measures and the Renewable Energy Target (RET).
  • Low scenario – additionally assumes the carbon price and Carbon Farming Initiative are in place. The carbon price is fixed for two years, then moves to a flexible price. The flexible price begins at $5.49/tonne of carbon dioxide equivalent (t CO2-e) in 2015, and grows at 4 per cent per year in real terms to reach $6.31 in 2020. The price then follows a linear transition to $54.48 in 2030.1
  • Medium scenario – assumes the fixed price for two years, then a flexible price beginning at $5.49/t CO2-e in 2015, and following a linear transition to $30.14 in 2020. From 2021 onward, the price follows the international price from the medium global action scenario, which grows at 4 per cent per year in real terms in US dollars.
  • High scenario – assumes the fixed price for two years, then a flexible price beginning at $5.49/t CO2-e in 2015, and following a linear transition to $73.44 in 2020. From 2021 onward, the price follows the international price from the ambitious global action scenario, which grows at 4 per cent per year in real terms in US dollars.

Figure 10.1: Australian Carbon Unit prices for different scenarios, 2013–2030

This figure is a line chart presenting the three carbon price series from 2013 to 2030 in 2012 Australian dollars per tonne of carbon dioxide equivalent for the high, medium and low scenarios. The price for all three scenarios in 2013 and 2014 is $22.50 and $23 respectively. For all scenarios it then drops to $5.49 in 2015. In the high scenario, the price then grows linearly to $73.44 in 2020, and then grows to $134.92 in 2030. In the medium scenario, the price grows linearly from 2015 to $30.14 in 2020, and then grows to $54.44 in 2030. In the low scenario, the price grows at 4 per cent per year from $5.49 in 2015 to reach $6.31 in 2020. It then grows linearly to $54.44 in 2030.

Source: The Treasury and DIICCSRTE 2013.

Kyoto units such as CERs currently trade at prices well below the prices used in these scenarios, and the modelling assumes there is a price difference between CERs and ACUs for the period to 2020. As a result, liable entities face an effective carbon price below the ACU prices in Figure 10.1; this effective price is a weighted average of the ACU and CER price each year, with weights reflecting the CER sub-limit.

The Authority notes that some assumptions in the modelled scenarios differ from the current legislation; for example, the legislation provides for a three-year fixed price. Sensitivity analysis indicated the differences have only a small impact on emissions and costs. The Authority therefore uses the modelled scenarios for its analysis of the economic impacts in this Chapter.

10.2 Australia’s emissions reduction task to 2020

To assess the costs of achieving emissions reduction goals, we need to understand the scale of the task. To this end, the Authority has assessed the emissions outlook for Australia, taking into account existing policies such as the Renewable Energy Target (at its current legislated level) and energy efficiency programs, but excluding the carbon price and Carbon Farming Initiative. This is the ‘no price scenario’. Figure 10.2 shows the national emissions reduction task – that is, the level of additional emissions reductions that Australia’s new climate change policies will need to achieve to meet different 2020 targets.

In the no price scenario, Australia’s emissions are projected to grow to 17 per cent above 2000 levels by 2020. Australia’s international commitments relate to the period 2013 to 2020, so Australia needs to reduce its emissions every year to 2020. The cumulative emissions reduction task is 593 million tonnes of carbon dioxide equivalent (Mt CO2-e) to achieve an emissions budget consistent with a 5 per cent target (131 Mt in 2020 alone); 898 Mt for a 15 per cent target; and 1 203 Mt for a 25 per cent target (Figure 10.2).

Figure 10.2: Australia’s emissions reduction task to 2020

This figure shows Australia’s emissions without a carbon price from 2000 to 2020, and the 5, 15 and 25 per cent indicative national trajectories from 2013 to 2020. The emissions line shows that Australia’s emissions are projected to grow to 17 per cent above 2000 levels in 2020 without a carbon price. The difference between the emissions line and the trajectories indicates Australia’s emissions reduction task to 2020. A column chart next to the figure indicates that the cumulative abatement task over the period 2013 to 2020 is 593 megatonnes of carbon dioxide equivalent for the 5 per cent target, 898 megatonnes of carbon dioxide equivalent for the 15 per cent target, and 1203 megatonnes of carbon dioxide equivalent for the 25 per cent target.

Notes: Emissions reduction task is in Mt CO2-e. Dashed lines indicate Australia’s Kyoto Protocol commitments: 108 per cent of 1990 emissions for 2008–2012; and 99.5 per cent of 1990 emissions for 2013–2020. The emissions reduction task has been adjusted (increased) to account for voluntary action (see Appendix E for estimates); it has not been adjusted for carryover from the first Kyoto commitment period (see Section 8.7.3 for estimates).
Source: Climate Change Authority, The Treasury and DIICCSRTE 2013.

The national emissions reduction task to 2020 is substantial, but smaller than previous estimates. This reflects updates to historical emissions data, a lower outlook for electricity demand and lower rates of underlying growth in some emissions-intensive industries. It also reflects changes to the emissions accounting rules under the second commitment period of the Kyoto Protocol; these allow Australia to count a broader coverage of land sector activities toward its target (discussed in Section 8.7).

The smaller emissions reduction task makes it easier for Australia to pursue any particular target. For example, national emissions projections in 2012 suggested that Australia would need to cut its emissions by 754 Mt over the period 2013 to 2020, including by 155 Mt in 2020, to achieve the unconditional 5 per cent target (DCCEE 2012). If Australia reduced emissions by 754 Mt over the period to 2020, the latest projections suggest it would achieve an 11 per cent target instead. Adding Australia’s carryover from the first commitment period of the Kyoto Protocol would increase this to a 14 per cent target (as discussed in Section 8.7.3)

Draft conclusion

C.10 Australia’s emissions reduction task for 2013 to 2020 is projected to be 593 Mt for the minimum 5 per cent target. This is substantial but achievable, and smaller than the 754 Mt task previously projected. If Australia reduced emissions by 754 Mt over the period to 2020, it would now achieve an 11 per cent target.

The next Section considers the incremental costs of adopting a target stronger than the minimum 5 per cent.

10.3 Costs of moving beyond 5 per cent to a stronger target

This Section considers the incremental costs of moving from the minimum 5 per cent target to the stronger target options of 15 per cent or 25 per cent. It outlines the methodology for estimating these costs, distinguishing the economic impacts of the target from the impacts of the carbon price. It then presents the analysis, showing that Australia can achieve stronger targets at a relatively small cost.

The Authority recognises that the costs, and distribution of those costs, will depend on the policy implemented to achieve the targets. The Authority has assessed costs based on the current legislative settings; this provides a useful comparative benchmark.

The Authority’s analysis assumes that a mix of domestic and international emissions reductions are used to achieve the target. Emissions are reduced within Australia if the marginal cost of achieving the reduction is less than or equal to the international carbon price. Section 10.4 examines the costs of achieving a greater share of the emissions reductions domestically.

10.3.1 The impact of the target is distinct from the impact of the carbon price

To assess the costs of moving beyond the minimum 5 per cent target under the current legislation, it is important to distinguish between the economic impact of the carbon price and the impact of stronger targets.

The level of the carbon price sets the incentive to reduce emissions and determines most of the economic costs

Under current legislation, liable entities pay a price for their emissions. This increases the cost of emitting activities, so it encourages firms to reduce their emissions. The carbon price leads to changes in the economy, away from higher emissions-intensive activities towards lower emissions-intensive activities. The higher the carbon price, the more emissions reductions occur in the economy, and the higher the overall costs.

The level of the carbon price is what matters most to business and households. All else being equal, the carbon price determines the level of incentive to reduce emissions, the compliance cost for liable entities, and the costs passed through to consumers of emission intensive goods and services. Higher carbon prices create a larger incentive for firms to find ways to reduce their emissions, and for consumers to shift their consumption towards less emissions-intensive goods and services. As a result, higher carbon prices have a relatively larger impact on the economy.

In summary, the level of the carbon price determines the amount of emissions reductions that occurs in the economy.

Moving to a stronger target does not change the carbon price

Under the current legislation, the carbon price is not expected to be materially affected by the target. This seems counter-intuitive at first, but is a result of the links between the Australian carbon market and international markets.

The carbon price is a function of supply (the number of emissions units available to liable entities) and demand (emissions from liable entities). Changing the target would have a substantial effect on supply in a domestic-only market, but has a much smaller effect in a market linked to international markets.

  • If Australia’s carbon market was not linked to international markets, its target would determine the supply of emissions units – and, as a result, determine the level of emissions reductions required within Australia. Moving to a stronger target would reduce the supply of emissions units and increase the carbon price. The higher carbon price would drive greater emissions reduction efforts by liable entities, so that Australia’s domestic emissions would fall to the target level. This extra effort would impose a relatively larger impact on the domestic economy.
  • With international linking, Australia’s target determines the supply of Australian carbon units. Moving to a stronger target would reduce the supply of Australian units, but have relatively little effect on global supply, as Australia is only a small share of the total market (Appendix C7 provides further detail). Moving to a stronger target is therefore not expected to have a material impact on the carbon price. If the carbon price does not change, incentives to reduce domestic emissions do not change; nor do the compliance costs faced by liable entities and the carbon costs passed through to consumers. Instead, liable entities would buy fewer Australian units and more international units (as long as they stayed within the overall 50 per cent limit on international units). Moving to a stronger target would drive additional emissions reductions – contributing to global climate action – but these would largely occur overseas rather than within Australia. Economic activity within Australia would be largely unchanged.

In summary, under the current legislation, the level of the carbon price (which is determined by international markets) is the primary determinant of economic costs, not the level of Australia’s own target. Moving to a stronger target would not be expected to materially change domestic emissions and economic activity, and GDP would be largely unaffected.

A stronger target does have an impact on the economy

Under the current legislation, moving to a stronger target is expected to have three broad economic effects on Gross National Income (GNI):

  • a direct income transfer from Australia to buy additional emissions units from overseas;
  • a smaller indirect cost from the changes in the terms of trade due to this income transfer (the ‘terms of trade effect’); and
  • a smaller indirect cost associated with replacing the government revenue forgone due to selling fewer Australian carbon units (the ‘revenue effect’).

GNI is a broader measure of economic welfare than the more commonly used GDP. While GDP measures the total output of the Australian economy, GNI measures output, international income transfers and the impacts on the terms of trade. GNI therefore provides a more complete measure of Australians’ current and future consumption possibilities – that is, what Australia can afford to buy.

The size of the direct income transfer would be equal to the number of additional international emissions reductions purchased from overseas to meet the stronger target, multiplied by the international carbon price. This income transfer would be small compared to the transfers associated with routine international income flows associated with commodity trade, foreign investment and other factors.

The direct income transfer would have a small additional impact because it would affect the balance of payments. Exports would have to be higher to generate the additional foreign currency, entailing lower export prices which would tend to reduce the terms of trade.

Moving to a stronger target also reduces government revenue by reducing the number of domestic units available for the Government to sell. To maintain the same level of government services, the forgone revenue would need to be replaced; this would typically involve an additional welfare cost reflecting the marginal excess burden of raising replacement government revenue.

The combined impact of these three effects on GNI is estimated to be 1.55 times the direct cost of the additional international units (The Treasury and DIICCSRTE 2013). For example, if changing the target requires an additional $100 of international emissions reductions, GNI is reduced by $155, comprising:

  • $100 more emissions units bought from overseas – a direct income transfer;
  • $30 through the terms of trade effect; and
  • $25 due to the revenue effect.

The same costs would arise if the Government purchased international units directly, rather than liable entities purchasing international units under the carbon pricing mechanism. The only difference would be that instead of replacing auction revenue, the revenue effect would arise from raising funds to purchase the additional international units.

The impacts of the income transfer and terms of trade effect would be broadly distributed across the economy. The modelling results suggest the lower terms of trade would support growth in export-oriented and import-competing industries, such as agriculture, mining and manufacturing. On the other hand, more domestically focused industries, such as construction and services, would grow more slowly. The impact from the lower terms of trade associated with moving from the minimum 5 per cent target to a 15 or 25 per cent target is relatively small; changes in projected sector output levels in 2020 are less than 0.4 of a percentage point (The Treasury and DIICCSRTE 2013, p. 86). The distributional impact of the revenue effect would depend on how the additional revenue is raised.

The next Section estimates the cost to the economy of moving beyond the minimum 5 per cent target to a stronger target.

10.3.2 The cost of achieving a 15 or 25 per cent target

Australia needs to reduce emissions by an estimated total of 593 Mt over the period 2013 to 2020 to achieve the minimum 5 per cent target, as discussed in Section 10.2. Moving from 5 to 15 per cent requires an additional 305 Mt of emissions reductions (for a total of 898 Mt over the period). Moving from 15 to 25 per cent requires a further 305 Mt of emissions reductions (for a total of 1 203 Mt over the period).

Figure 10.3 shows Australia’s domestic emissions under the medium scenario, where the carbon price starts at a fixed price of $23 in 2013, and reaches $30 in real terms by 2020 (Box 10.1). Australia’s emissions grow to 6 per cent above 2000 levels by 2020; significantly less than the 17 per cent growth in the no price scenario. The remaining emissions reductions – reflected by the gap between domestic emissions and the indicative national trajectory – would be achieved by purchasing emissions reductions from overseas.

Figure 10.3: Domestic emissions and imports of emissions reductions for different targets, medium scenario, 2013–2020

This figure shows the domestic emissions projections for the medium scenario from 2013 to 2020, and the indicative national trajectories for the 5, 15 and 25 per cent targets. It shows that domestic emissions in the medium scenario grow to 6 per cent above 2000 levels. The gap between the domestic emissions and the trajectories reflects the level of projected imported emissions reductions needed to meet each target. A column chart next to the figure shows the projected level of imported emissions reductions over the period for each target. 300 Mt of imported emissions reductions are projected for the 5 per cent target, 604 Mt of imported emissions reductions are projected for the 15 per cent target, and 909 Mt of imported emissions reductions are projected for the 25 per cent target.

Source: Climate Change Authority, The Treasury and DIICCSRTE 2013

This suggests that, under the current legislation, Australia could meet the whole of the additional emissions reduction task associated with moving from 5 per cent to stronger targets through additional imports2. The costs presented in this Section are estimated on that basis.

Purchasing the emissions reductions required to move from the minimum 5 to 15 or 25 per cent targets would lead to a slowing of GNI growth (Figure 10.4), due to the transfer of funds overseas, the associated terms of trade effect and the impact on Government revenue.

The economic impact can be described using different metrics.

  • Growth in GNI per person – With a 5 per cent target, GNI per person is projected to grow by an average of 0.80 per cent annually over the period to 2020. Moving to a 15 per cent target slows GNI per person growth to an average of 0.78 per cent; and moving to a target of 25 per cent slows GNI per person growth to 0.76 per cent.
  • Level of GNI per person – In dollar terms, GNI per person is projected to grow from about $62 350 in 2012 to about $66 450 in 2020 with a 5 per cent target; $66 350 in 2020 with a 15 per cent target; or about $66 250 in 2020 with a 25 per cent target (Figure 10.4).
  • Time to attain the same level of GNI per person – Average Australian income is projected to continue to rise even with a 25 per cent target, but at a slightly slower rate. The level of GNI per person in 2020 with a 5 per cent target ($66 450) would be attained less than three months later with a 15 per cent target; and five months later with a 25 per cent target.
  • Reduction in GNI level (economy-wide) – GNI is projected to continue to grow even with a 25 per cent target, but at a slightly slower rate. With slower growth, GNI in 2020 would be $2.7 billion (0.16 per cent) lower with a 15 per cent target than it would have been with a 5 per cent target. With a 25 per cent target, GNI in 2020 would be $5.5 billion (0.31 per cent) lower than with a 5 per cent target.

Figure 10.4: Gross National Income per person for different targets, medium scenario, 2013–2020

This figure presents the time series for Gross National Income (GNI) per person for the medium scenario for the period 2013 to 2020. In 2013 GNI per person is around $62 100 in all scenarios. GNI grows to $66 450 with a 5 per cent target, to $66 350 with a 15 per cent target, and to $66 250 with a 25 per cent target.

Source: The Treasury and DIICCSRTE 2013

These impacts on GNI are small relative to other forces driving GNI. For example, the boom in Australia’s mining sector and terms of trade is estimated to have added 1.2 percentage points to average annual growth in GNI per person since 2000 (Dolman and Gruen 2012). In contrast, moving to stronger emissions reduction targets is estimated to reduce average annual growth in GNI per person to 2020 by 0.02 percentage points for a 15 per cent target, and by 0.04 percentage points for a 25 per cent target.

Draft conclusion

C.11 Stronger targets can be achieved with relatively small impacts on national income and economic growth. Under the current legislation, moving to a stronger target would slow annual growth in GNI per person to 2020 from 0.80 per cent (5 per cent) to 0.78 (15 per cent) or 0.76 (25 per cent).

As noted at the start of this Section, the costs of achieving targets depend on the policy implemented to achieve them. Nevertheless, if Australia achieved stronger targets by purchasing international emissions reductions, this analysis provides a robust estimate of the economic impact. The costs would be broadly the same if the Government purchased the emissions reductions directly rather than liable entities purchasing them under the carbon pricing mechanism. In both cases, the income transfer, terms of trade and revenue effects would be the same. The next Section explains how costs could be more or less depending on the price of international emissions reductions purchased.

The price of international emissions reductions matters in determining the cost of stronger targets

In addition to the medium scenario used in the cost estimates presented in Section 10.3.2, the modelling also explored a high-price scenario. This high price applies to both domestic and international emissions reductions. In this scenario, more domestic emissions reductions occur, and fewer international emissions reductions are purchased to meet any given target.

The higher price of both domestic and international emissions reductions has a slightly larger impact on GNI than the costs outlined above. Under this scenario, average annual growth in GNI per person is projected to be 0.73 per cent over the period to 2020 if Australia pursues the minimum 5 per cent target (Authority analysis, see Appendix C7 for details).

  • Moving to a 15 per cent target still requires an additional 305 Mt of emissions reductions (cumulative, 2013–2020); GNI per person growth slows to 0.68 per cent. GNI is projected to be $6.7 billion lower in 2020 (relative to the 5 per cent target).
  • Moving to a 25 per cent target still requires an additional 609 Mt of emissions reductions (cumulative, 2013–2020); GNI per person growth slows to 0.63 per cent. GNI would be $13.3 billion lower in 2020 (relative to the 5 per cent target).

These impacts remain relatively small compared to other economic forces. The change to annual growth in GNI per person would be between 0.05 and 0.1 percentage points; about 10 times smaller than the change due to the mining boom.

The modelling also explored a low-price scenario. Again, this low price applies to both domestic emissions reductions and the price of international emissions reductions. The lower price has a smaller impact on GNI than outlined above. Under this scenario, average annual growth in GNI per person is projected to be 0.823 per cent over the period to 2020 if Australia pursues the minimum 5 per cent target (see Appendix C7 for details).

  • Moving to a 15 per cent target still requires an additional 305 Mt of emissions reductions (cumulative, 2013–2020); GNI per person growth slows to 0.819 per cent. GNI is projected to be $0.6 billion lower in 2020 (relative to the 5 per cent target).
  • Moving to a 25 per cent target still requires an additional 609 Mt of emissions reductions (cumulative, 2013–2020); GNI per person growth slows to 0.815 per cent, and GNI would be $1.1 billion lower in 2020 (relative to the 5 per cent target).

The type of international units purchased also affects the costs. The Authority’s analysis and the cost estimates presented above are based on the modelled price for European units. Emissions reductions generated under the Kyoto Protocol are available at significantly lower prices (currently, Kyoto units are selling at less than $1.00). If Kyoto units were purchased to achieve the stronger target, the impact on the economy would be lower again.

This Section has shown Australia can achieve stronger targets at relatively small cost. One of the key reasons why the costs are small is because the Authority assumes Australia achieves its targets using a mix of domestic and international emissions reductions. The next Section considers Australia’s emissions reduction opportunities, and how economic impacts would change if Australia pursued more reductions domestically.

10.4 Using a mix of domestic and international emissions reductions

The Government has committed to achieving Australia’s minimum 5 per cent target through domestic emissions reductions. The modelling sheds light on the emissions reduction opportunities that may be available in Australia, and the associated economic impacts. It shows Australia has substantial potential to reduce its emissions, but suggests the costs of meeting stronger targets is likely to be lower if Australia uses some international emissions reductions to complement its domestic efforts. As long as the imported reductions represent genuine emissions reductions, the environmental outcome would be the same (see Chapter 13).

10.4.1 Domestic emissions reductions under different scenarios

The Authority has assessed the outlook for Australia’s emissions and economy under three carbon price scenarios – high, medium and low – in addition to the no price scenario. The higher the carbon price, the more domestic emissions fall. While emissions in the no price scenario grow to 17 per cent above 2000 levels in 2020, in the low scenario they grow to 11 per cent above 2000 levels, in the medium scenario they grow to 6 per cent above 2000 levels, and in the high scenario they fall to 6 per cent below 2000 levels in 2020 (Figure 10.5). Reductions are projected to occur across all sectors, as discussed in Part D of this report.

These scenarios provide a broad indication of the emissions reductions opportunities that may be available over time at different prices. The results provide useful insights for the development of the Government’s Direct Action Plan. While the scope and level of incentives are yet to be determined, in general, higher prices at auctions would mobilise more domestic emissions reductions.

Figure 10.5: Domestic emissions and cumulative emission reductions for different scenarios, 5 per cent target, 2013–2020

This figure shows domestic emissions for each of the carbon price scenarios and the 5 per cent national indicative trajectory from 2013 to 2020. In the no price scenario, emissions grow to 685 megatonnes of carbon dioxide equivalent in 2020, 17 per cent above 2000 levels. In the low price scenario, emissions grow to 651 megatonnes of carbon dioxide equivalent in 2020, 11 per cent above 2000 levels. In the medium scenario, emissions grow to 620 megatonnes of carbon dioxide equivalent in 2020, 6 per cent above 2000 levels. In the high price scenario, emissions decline to 552 megatonnes of carbon dioxide equivalent in 2020, 6 per cent below 2000 levels. Comparing the emissions scenarios to the indicative national trajectory, emissions are above the trajectory across the whole period for all scenarios except the high scenario. In the high scenario, emissions are above the trajectory in each year except for 2020. The gap between the emissions lines and the trajectory indicates imported emissions reductions. A column chart next to the figure shows the cumulative mix of domestic and imported emissions reductions for each scenario over the period 2013 to 2020. In the low scenario, domestic emissions are reduced by 201 megatonnes of carbon dioxide equivalent, and 392 megatonnes of carbon dioxide equivalent emissions reductions are imported. In the medium scenario, domestic emissions are reduced by 294 megatonnes of carbon dioxide equivalent, and 300 megatonnes of carbon dioxide equivalent emissions reductions are imported. In the high scenario, domestic emissions are reduced by 494 megatonnes of carbon dioxide equivalent, and 99 megatonnes of carbon dioxide equivalent emissions reductions are imported.

Source: Climate Change Authority; The Treasury and DIICCSRTE 2013.

None of the scenarios modelled achieves enough domestic emissions reductions to meet the 2013–2020 budget consistent with the minimum 5 per cent target (Figure 10.5). In the medium scenario, 294 million of the required 593 million tonnes of emissions reductions over the period to 2020 are achieved domestically3. The high scenario gets closest – a total of 494 million of the required 593 million tonnes of emissions reductions is achieved domestically4. While domestic emissions in the high scenario fall to 6 per cent below 2000 levels by 2020, emissions in the intervening years exceed the budget.

10.4.2 Economic impacts of reducing domestic emissions

As with emissions, each scenario generates a different economic outcome. This Section focuses on GDP rather than GNI, as the GDP results primarily reflect changes in domestic economic activity rather than the effects of international trade in emissions reductions.

All of the scenarios show the economy grows, even with strong action to reduce emissions in Australia and globally. The effects on GDP growth are relatively small (Figure 10.6), and scale with the carbon price. The high scenario involves the largest shift from high to low emission activities in the economy, and involves the greatest cost. Average annual growth in GDP to 2020 is 2.99 per cent in the high scenario compared with 3.06 in the medium scenario, and 3.08 per cent in the low scenario (The Treasury and DIICCSRTE 2013).

These costs provide a broad indication of the relative scale and change in potential macroeconomic impacts if a greater share of domestic emissions reductions is pursued. If emissions reductions were purchased by the Government using general revenue, the costs would be borne by taxpayers. The impacts on industries that generate emissions, and the consumers of those goods and services, would depend on the detailed policy design.

Figure 10.6: Gross Domestic Product for each scenario with a 5 per cent target, 2012–2020

This figure presents the time series for Gross Domestic Product (GDP) in each carbon price scenario with the 5 per cent target from 2012 to 2020, indexed to 2012. In the high scenario, GDP increases by 126.55 per cent over the period. In the medium scenario, GDP increases by 127.26 per cent over the period. In the low scenario, GDP increases by 127.47 per cent over the period. In the no price scenario, GDP increases by 127.65 per cent over the period.

Source: Climate Change Authority; The Treasury and DIICCSRTE 2013

10.4.3 Using international emissions reductions can reduce costs

While Australia could achieve the minimum 5 per cent target through domestic reductions alone, using international reductions to complement domestic reductions could lower the cost of achieving Australia’s emissions reduction goals, and make stronger targets more affordable.

For example, the results of the high scenario suggest that an effective carbon price rising to over $65/t CO2-e by 2020 would be required to achieve the minimum 5 per cent target through domestic reductions alone. In this scenario, GDP in 2020 is estimated to be 0.86 per cent lower than in the no price scenario5. In contrast, in the medium scenario Australia meets the minimum 5 per cent target using a mix of domestic and international emissions reductions; the effective carbon price is about $27/t in 2020, and GDP in 2020 is estimated to be 0.31 per cent lower than in the no price scenario.

Of course, it is difficult to project exactly how Australia’s emissions and economy will develop over time, and which emissions reduction opportunities will emerge. Projections often overestimate future emissions and economic analysis often overestimates the costs of reducing emissions. The Authority examined previous national emissions projections and found that Australia has overestimated emissions by roughly 10 per cent on average6. Analysis by the Grattan Institute found that environmental markets routinely reduce emissions at lower cost than expected (Daley and Edis 2010). One reason is that, with credible incentives in place, business and households find new and unanticipated ways to reduce emissions. Box 10.2 discusses how technology innovation can affect the projections.

If Australia has more low-cost emissions reduction opportunities than projected in the modelling, the share of domestic emissions reductions would increase, and the cost of achieving any given target would fall. Nevertheless, it could remain cost-effective for Australia to use some international emissions reductions to help meet its target.

Box 10.2: Impact of innovation on the outlook for emissions and costs

The international analysis presented in the modelling shows that the cost and availability of low-emission technologies affects the cost of achieving global and national emissions reductions. For example, higher technology learning rates in the electricity and transport sectors would allow environmental objectives to be achieved with lower carbon prices and smaller reductions in Gross World Product. On the other hand, if carbon capture and storage proved commercially unviable, or construction of additional nuclear capacity was halted globally, carbon prices would need to be higher to achieve a given environmental goal, resulting in larger reductions in Gross World Product (The Treasury and DIICCSRTE 2013).

If the domestic technology costs are different to what is assumed in the modelling estimates, Australia’s emissions outlook would also be different. As shown in the electricity sector sensitivity analysis, if technology costs for solar are lower than expected, then annual emissions could be about 50 Mt lower from the mid 2030s onwards compared to the medium scenario. This would reduce reliance on imported emissions reductions (ACIL 2013, p. 65).

10.5 Longer term economic implications of 2020 targets

The modelling results show the economy continues to grow in the period beyond 2020 even as carbon prices rise to achieve deep cuts in emissions.

Chapter 8 discusses the benefits of a long term emissions budget to 2050, and what that budget implies for 2020 targets. A weaker 2020 target may cost slightly less to achieve in the near term but would use more of the national budget available to 2050, and stronger targets would be required beyond 2020. In contrast, a stronger 2020 target may cost slightly more in the near term but retains more of the national budget for use beyond 2020.

The international carbon price is currently much lower than the projected long-run price consistent with limiting global warming to no more than 2 degrees. This suggests the carbon price could increase rapidly in the future, if the level of future action becomes clearer and stronger. In that case, it would be more efficient for Australia to have a stronger 2020 target, and buy more international units in the period to 2020, while prices are low. This would leave more of the national emissions budget available for the period beyond 2020, when prices could be much higher.

Of course, there is a risk that international action will not strengthen and carbon prices remain very low. In that case, stronger near term targets may not be more efficient than weaker targets. On balance, however, given very low current prices, and the trend of strengthening international action (discussed in Chapter 4), the Authority considers it is more likely that prices will rise and stronger near term action will prove cost-effective.

There is also a broader global rationale for taking stronger action sooner. As outlined in Chapter 3, delaying action reduces the chances of limiting global warming to no more than 2 degrees. Previous analysis showed that delaying action increases the long-run economic costs, because more emissions reductions must be achieved in less time to achieve the same environmental outcome (Commonwealth of Australia 2008). Luderer et al. (2013) quantify the costs associated with delaying coordinated global action from 2015 to 2030. They find that delay to 2030 not only increases the lowest feasible temperature goal that can be secured with a likely probability, but sharply increases the transitional costs associated with achieving the temperature goals that do remain feasible. For example, starting coordinated global action in 2030 rather than 2015 sees the short term change in growth associated with a likely chance of avoiding 2.1 degrees of warming become comparable to that of the Global Financial Crisis. Submissions to the Issues Paper also highlighted the costs of delaying action (for example, AGL Energy Limited Issues Paper submission, p. 2). 

In summary, there are good economic reasons for Australia to take on stronger 2020 targets now.

Chapter 10 has assessed the economic implications of achieving different 2020 targets by first assessing the emissions reduction task to 2020, and then estimating the economic costs of achieving different targets. It then examined the impacts of achieving greater domestic emissions reductions. Chapter 11 will draw together the preceding analysis and make recommendations on Australia’s emissions reduction goals.

1 All dollar amounts (prices and costs) reported in this Chapter are 2012 Australian dollars, unless otherwise stated.

2 One important qualification applies – under the current legislation, liable entities can use international units to meet up to 50 per cent of their liability. This limit could become binding if Australia adopted a 25 per cent target (see discussion in Chapter 14), leading to higher domestic carbon prices and associated economic costs. Direct Government purchase of some international units would alleviate this risk. The caps recommended in Chapter 14 assume some Government purchase, so the 50 per cent limit should not bind.

3 Figures may not add due to rounding.

4 Australia could use its carryover from the first commitment period of the Kyoto Protocol to close this gap and meet the 5 per cent target. The Authority considers, however, that the carryover should be used to strengthen Australia’s target (see Section 8.7).

5 The high scenario in The Treasury and DIICCSRTE modelling assumes Australia achieves a 25 per cent target; the GDP result therefore reflects both the impact of the higher carbon price and a small additional impact from the purchase of international emissions reductions. The effective carbon price is the weighted average of the Australian carbon unit and the Kyoto unit prices; see Box 10.1.

6 The Authority compared projections for the period 2008-2012 from annual projections published between 2004 and 2007, to Australia’s actual emissions in 2008–2012.