Chapter 13 Using international emissions reductions to meet Australia’s goals
The United Nations Framework Convention on Climate Change (UNFCCC) allows countries, including Australia, to use some international emissions reductions to meet their emissions reduction targets. The Government has stated its intention to achieve Australia’s minimum 5 per cent 2020 target domestically, but has not ruled out using some international emissions reductions to meet a 2020 target beyond 5 per cent.
There are benefits and risks to using international emissions reductions to help meet Australia’s emissions reduction goals. Potential benefits include lowering the cost of meeting Australia’s target, reducing competitiveness concerns and supporting broader Australian foreign and trade objectives. However, there are also risks – in particular, that international emissions reductions are not genuine and that using international reductions could detract from the task of transitioning Australia’s economy to a low-emissions future.
The Authority recommends a balanced approach that retains the possibility of using some genuine international emissions reductions to meet our emissions reduction goals. This would help lower Australia’s emissions reduction costs, while still allowing risks to be responsibly managed.
Stronger targets could be achieved by purchasing some international emissions reductions. Moreover, the Government could consider using genuine international emissions reductions to complement domestic efforts to achieve Australia’s minimum 5 per cent commitment.
Chapter 10 showed that Australia can achieve strong emissions reductions at relatively small cost using a mix of domestic and international emissions reductions. Chapter 13 takes a closer look at the role of international emissions reductions in achieving Australia’s emissions reduction goals. It discusses:
- the potential benefits and risks of using international emissions reductions; and
- the amount and sources of international emissions reductions available to Australia.
Climate change is a global phenomenon – the atmosphere does not care where emissions are created or where they are reduced. From an environmental perspective, there is no special merit in reducing emissions in one country over another; it is the quantity of reductions that matters. This principle is recognised in the international climate framework, including the Kyoto Protocol, which allows countries to meet their targets through both domestic emissions reductions and by purchasing emissions reductions created in other countries.
The role of international emissions reductions in meeting Australia’s goals is a policy choice and is the subject of much discussion in Australia. The Government has stated that Australia’s 5 per cent 2020 target should be achieved domestically; it has not ruled out the possibility that stronger targets could be met in part through international emissions reductions. The details are currently under development.
The Authority has considered the consistency between the use of international emissions reductions and the Authority’s guiding principles from the Clean Energy Act that measures to respond to climate change must (among other things) be economically efficient, environmentally effective, support the development of an effective response to climate change and be consistent with our foreign policy and international trade objectives.
13.2 Benefits and risks of using international emissions reductions
Using international emissions reductions to help meet emissions reduction goals has benefits and risks. Using international emissions reductions can:
- create access to a wider range of cost-effective, environmentally robust mitigation opportunities, lowering the overall cost of meeting Australia’s targets;
- help to address competitiveness concerns for industry; and
- support international action by contributing to the development of broad and deep international markets and supporting low-emission activity in developing countries.
But using international emissions reductions could also:
- risk spending money on emissions reductions that are not genuine;
- introduce price risks that could detract from Australia’s transition to a low-carbon economy.
Many submissions discussed Australia’s use of international emissions reductions to meet its goals; all business groups and almost all non-government organisations supported some use of international emissions reductions. For example, the Australian Chamber of Commerce and Industry noted that:
The decision to link Australia’s carbon price mechanism to overseas carbon markets … allows carbon to be abated more cost effectively for any given target and cap by providing access to lower cost forms of abatement (Issues Paper submission, p. 10).
Notwithstanding this support, a variety of stakeholders have raised concerns with the use of international emissions reductions, including that low prices will delay Australia’s domestic economic transition to a low-emissions economy, that low-emissions research and development will be adversely affected and that international emissions reductions are not genuine. The Climate Institute raised both the benefits and potential adverse effects of international prices in its submission:
... the development of ambitious carbon market coalitions provides an opportunity for Australia to be more ambitious in its emissions reduction commitments … [Carbon] markets offer the opportunity to drive substantial private sector financing in developing nations. However, there are risks associated with links to global markets. The current international market is immature. While this remains the case and global prices are low (or subject to substantial political risks), Australian investors may commit to long-term assets that are excessively emissions intensive. As a result, the nation risks deadweight losses from stranded assets and will have to spend on more costly abatement later on (Issues Paper submission, p. 25).
Dr Frank Jotzo (Issues Paper submission, p. 5) highlighted both short term risks and long term benefits from using international emissions reductions, and argued that policy measures such as a price floor should be used to counter the risks. He noted that being ‘part of an integrated system of international emissions trading when it exists will be in Australia’s longer term interest’ but argued that current European Union (EU) carbon prices are ‘below most estimates of the marginal benefit in terms of avoided climate change damages’ and as such ‘should not determine the level of effort within Australia’.
The Authority has considered the benefits and risks of international emissions reductions relative to meeting Australia’s targets purely domestically. For the potential benefits, the Authority has focused on lower costs to meet Australia’s goals; competitiveness concerns and broader foreign and trade objectives are also noted. For the potential risks, it has focused on environmental integrity and sustained low carbon prices. The next sections consider the benefits and risks in more detail.
13.2.1 Benefits of using international emissions reductions
Lowering costs to meet Australia’s emissions reduction goals
Allowing international emissions reductions would reduce the cost of Australia’s emissions reduction task, making it cheaper to attain any given target and increasing the target that can be achieved at a given cost. Industry groups were strongly supportive of access to international units for this reason. The Ai Group strongly supported international linkage of carbon markets, on the basis that it lowers the global cost of emissions reductions and broadens action. The Clean Energy Council supported using international emissions reductions to lower the costs of reducing emissions; the Australian Petroleum Production and Exploration Association argued that there should be no limits on the use of genuine international emissions reductions. At present, there are large volumes of genuine international emissions reductions available at low prices that Australia could use to contribute to its emissions reduction goals.
The direct benefits to Australia of using international emissions reductions depend on the size of the gap between:
- international carbon prices, which reflect global targets to reduce emissions and the opportunities to do so; and
- the carbon price or other price incentive required to achieve the national targets through domestic emissions reductions alone.
If the cost of emissions reduction is lower in other countries than in Australia, trade would lower the cost of Australia’s emissions reduction task.
If Australia was to achieve its unconditional 2020 emissions reduction target or the Authority’s recommended 15 or 25 per cent options domestically, it is likely to have a marginal cost of emissions reduction above the expected international carbon price. This is reflected in the carbon prices and corresponding domestic emissions reductions achieved in the modelling scenarios discussed in chapters 10 and 12.
Australia’s emissions reduction task over the period 2013–2020 for a 5 per cent target is estimated to be 593 million tonnes carbon dioxide equivalent (Mt CO2-e). In the medium scenario, 294 Mt of emissions reductions over the period to 2020 are achieved domestically at an effective carbon price rising to around $27 per tonne (in real terms) by 2020. In the high scenario, 494 Mt of domestic emissions reductions are achieved over the period to 2020 at an effective carbon price rising to around $65 per tonne by 2020.1 This indicates that, if Australia’s unconditional 5 per cent target was to be achieved through domestic emissions reductions alone, carbon prices may need to be more than twice as high in real terms in 2020.
Helping to address long term competitiveness concerns
By equalising carbon prices (or incentives) across countries, international trade in emissions reductions helps to reduce industry competitiveness concerns. In turn, these benefits can reduce barriers to setting stronger emission reduction goals, and help foster joint (and potentially more stable) political commitment to action on climate change.
Contributing to broader foreign and trade objectives
Direct Government purchases of international units can be tailored to meet other Government objectives, including foreign or trade objectives, and to support its broader climate change and development objectives. For example, the Government could target purchases towards projects and programs that also strengthen environmental governance in countries in our region. There are accreditation schemes, such as the Gold Standard program, which identify projects that benefit the economy, health and welfare of the local community hosting the emissions reduction project.
Other countries and organisations tailor their purchase of international units to meet broader objectives. For example, in the third phase of the European Union Emissions Trading System (the EU ETS), the EU will not accept Clean Development Mechanism (CDM) units from new projects unless they are established in least developed countries. The World Bank has established a number of funds to purchase CDM units from projects which promote sustainable development and ‘learning by doing’ by stakeholders (World Bank Group 2013).
13.2.2 Risks of using international emissions reductions
It is important that international emissions reductions are genuine; otherwise, the environmental integrity of Australia’s action is compromised.
Ensuring high levels of environmental integrity is more complicated for international emissions reductions than for reductions that occur in Australia. The Government can set its own rules to govern domestic projects and monitor compliance relatively easily. For example, offsets from the Carbon Farming Initiative are subject to a strict set of rules to ensure their integrity. Australia has less control over emissions reductions projects in other countries, making it more difficult to assess, monitor and address environmental integrity and fraud issues. Australia must work with other governments to establish effective governance arrangements that accommodate different legal frameworks and approaches. The reliance on third-party governance arrangements increases the risk that international emissions reductions Australia uses to meet its target are not environmentally credible.
This risk can be mitigated by only allowing international emissions reductions from sources it considers credible. For example, Australia may choose to allow CDM units (generated under the Kyoto Protocol) because the CDM is a long-established mechanism, and has detailed rules and governance arrangements to ensure the integrity of its emissions reductions. The governance of the CDM has been strengthened recently – standards and requirements for eligible projects are now more stringent, to ensure emission reductions are real, measurable, verifiable and additional to what would have occurred without the project. The CDM project cycle involves extensive accreditation and third-party certification, and ultimately approval from the CDM Executive Board.
A wide range of projects from many different developing countries generates CDM units. If there were concerns about the environmental integrity of a particular project type, Australia could choose not to accept those units and only purchase units from projects it considered credible. For example, the EU currently excludes nuclear energy, afforestation or reforestation activities, projects involving the destruction of industrial gases, and hydroelectric projects have to comply with international criteria and guidelines from the World Commission on Dams (European Commission 2013). Australia also adopted these rules for compliance under the carbon pricing mechanism.
For international emissions reductions beyond the CDM, the Commonwealth Government could negotiate with other governments to establish rules for ongoing monitoring of projects and reductions – Japan and Norway have been exploring such agreements with developing countries.
Another concern of using international emissions reductions is the risk of fraud. For domestic projects, the Clean Energy Regulator is empowered to address fraud and manages fraud risks in line with the best practices of the Australian Government Investigations Standards. In an international context, Australia must work with other governments to address fraud. The risk of fraud is no different from other, more traditional, markets. Governments put in place a range of measures, similar to those in financial markets, to mitigate the risk of fraud.
In conclusion, while there are environmental integrity and fraud risks associated with the use of international emissions reductions, they are manageable. Australia can draw on its experience working with foreign governments in other contexts to establish systems to mitigate these risks.
What if international carbon prices are ‘too low’?
There are many different risks with the future path of carbon prices in Australia. The issues are complex and a full investigation is not possible for this first Targets and Progress Review. By way of preliminary analysis, the Authority has focused on risk that is caused or exacerbated by allowing the use of international emissions reductions. Specifically, it considers the risk that, if international prices were to rise rapidly and unexpectedly from their current low levels, Australian investments in long-lived, high-emissions capital could become stranded.
For its preliminary investigation, the Authority has focused on the electricity sector to illustrate more general points. The electricity sector is currently the largest contributor to Australia’s emissions, has a large emissions reduction task and is characterised by long-lived assets, and therefore the potential to ‘lock in’ emissions (see Section 12.4.3). Comparing projections of the Australian electricity sector under different carbon prices illustrates the large differences in activity and infrastructure between scenarios these are.
Large differences between the capital investment profiles in the electricity sector under low and high price scenarios are a potential signal that sustained low carbon prices, driven by our use of international emissions reductions, could make any eventual price increase disruptive for the sector and the economy. Conversely, if the electricity sector is projected to look similar under both scenarios, the consequences of sustained low prices may be less serious.
Even if there was a disruptive price increase that would not have occurred without allowing international emissions reductions, and some high emissions assets were stranded as a result, it would not necessarily mean that the investment was privately or even socially suboptimal. This is because there is a benefit to having the higher emissions infrastructure during the period of low carbon prices as well as a cost if prices rise unexpectedly. In turn, this means that a full assessment of the best investment from a social point of view would need to compare the expected net benefits over time for the higher and lower emissions infrastructure. Here, the Authority has focused on the first step of this analysis, namely comparing the electricity generation infrastructure between scenarios.
Modelling conducted by ACIL Allen Consulting (2013) for the Treasury and the Department of Industry, Innovation, Climate Change, Science, Research and Tertiary Education (DIICCSRTE) suggests that higher price incentives could drive several important differences in the sector. Comparing the high scenario to the medium scenario shows:
- Lower electricity demand. Electricity generation (as generated) is estimated to be almost 6 per cent lower in the high scenario in 2020 and 9 per cent lower in 2030.
- A less emissions-intensive electricity supply and faster falls in emissions intensity. With a higher price incentive, over the period to 2030 there would be:
- An earlier and sharper reduction in coal-fired generation, likely due to faster retirement of existing plant. For example, in 2030 black coal’s generation share is estimated to be 9 per cent in the high price scenario, compared to 47 per cent in the medium scenario.
- More coal generation with Carbon Capture and Storage (CCS), with CCS technology estimated to appear in 2030 with a high price (but in the mid-2040s in the medium scenario).
- Earlier increase in gas-fired generation, including with CCS.
- Substantially more renewable generation. While renewable generation to 2020 will be largely driven by the Renewable Energy Target, under the high scenario renewable generation reaches about 69 per cent in 2030 compared to 25 per cent in the medium scenario. Higher cost sources such as geothermal and solar thermal come online sooner and increase their level of generation more quickly.
This comparison shows that the main impacts of higher price incentives in the electricity sector to 2030 are more rapid uptake of wind, solar and gas-fired generation, and a more rapid and sharper drop in coal-fired generation.
Several stakeholders raised the prospect that suboptimally low international carbon prices would ‘lock in’ emissions-intensive generation assets. As Appendix D explains, the current over-supply of generation and flat electricity demand suggest that, even without a price incentive to reduce emissions in place, it is unlikely that new coal-fired plants would be constructed in Australia’s major grids until at least 2020. This suggests the risk of locking in new emissions-intensive generation plants is not material. Still, a low price incentive could make continued operation and retrofits of existing emissions-intensive plants viable.
Lock-in aside, there is also a concern that sustained low international prices could permanently hamper emissions reductions because they slow the development of critical low-emissions technologies. This is possible if low current prices create expectations of low future carbon prices, and reduce the likelihood of inducing the technological innovation necessary to make it feasible to limit global warming, relative to pre-industrial levels, to below 2 degrees.
While these risks are of concern, Australia is generally a technology taker, particularly in the electricity sector. Limiting access to international emissions reductions and driving higher domestic emissions reduction costs is unlikely to have any impact on the global rate of technological change.
The next Section discusses the sources of international emissions reductions available to Australia to help meet our emissions reduction goals.
13.3 Possible sources of international emissions reductions
If the Government chooses to purchase international emissions reductions to help meet Australia’s targets, there are several sources to choose from, including:
- purchasing units from UNFCCC and Kyoto Protocol market mechanisms, such as the CDM;
- creating its own bilateral offset mechanisms, whereby Australia works with another country to establish programs and projects that generate emissions reductions; and
- purchasing units from established emissions trading schemes; for example, the European Union.
Until 2020, the most reliable sources of units for Australia are established mechanisms, such as the CDM and the EU ETS. There is currently substantial, low-cost supply from these sources, which is highly likely to be able to meet projected demand from Australia for a 15 or 25 per cent target. Bloomberg (2013a) projects about 2 100 Mt of CDM units will be issued over 2013-20 with the price expected to hover around € 0.5 for the period. The EU carbon market is projected to have an oversupply of about 212 Mt of EUAs (Bloomberg 2013b).
Beyond 2020, there is a wide range of potential sources of units, including from new market mechanisms (for example, reducing deforestation programs), and emerging emissions trading schemes in, for example, China or the Republic of Korea.
13.3.1 UNFCCC and Kyoto Protocol market mechanisms
The Kyoto Protocol allows countries to meet their targets through the use of international emissions reductions including from the CDM and Joint Implementation (JI). The mechanisms have been successful at encouraging emissions reductions – over 1 350 Mt CO2-e emissions reductions and 800 Mt CO2-e of emissions reductions have been issued from each program respectively since their introduction (Bloomberg 2013). Countries have agreed to continue CDM and JI in the context of the Kyoto Protocol second commitment period, which runs from 2013–2020.
The Kyoto Protocol mechanisms have the advantage of experience. The first project was registered under the CDM in 2001. As discussed in Section 13.2.2, the rules and governance arrangements of the CDM help ensure emission reductions are real, measurable, verifiable and additional to what would have occurred without the project. Many countries source international emissions reductions through the CDM. For example, the EU accepts CDM units under the Kyoto Protocol for compliance in its emissions trading scheme and to count towards the EU target.
There may also be opportunities to source emissions reductions through units generated by new UNFCCC market mechanisms currently under negotiation. This could include programs aimed at reducing deforestation and forest degradation (REDD) in developing countries. These mechanisms are unlikely to begin generating significant quantities of credible units until after 2020.
13.3.2 Bilateral offset mechanisms
The Commonwealth Government could explore opportunities with developing countries to establish emissions reductions projects and programs directly.
Several countries are exploring bilateral agreements, which allow emissions reductions generated in one country to be used in another. Japan is establishing the Bilateral Offset Credit Mechanism to allow domestic companies to obtain emissions reductions through the dissemination of low- emissions technologies and services to developing countries. The Norwegian Government has also indicated it intends to establish bilateral mechanisms in developing countries to generate emissions reductions to use for meeting its 2020 target.
Units from bilateral offset mechanisms could not currently be used to meet Australia’s second commitment period target under the Kyoto Protocol. They could be used to meet a more ambitious commitment under the UNFCCC.
13.3.3 Emission trading schemes
Over 30 countries and about 15 sub-national jurisdictions have emission trading schemes including the EU, California, Kazakhstan (in pilot form), New Zealand, Quebec, sub-national schemes in Japan and China, and the Regional Greenhouse Gas Initiative in the United States. Purchasing units from these schemes (and having them cancelled in the host country) would be a way of sourcing international emissions reductions.
Before 2020, the EU Emissions Trading System is the most likely source of credible units from a domestic or regional emissions trading scheme. The System has been in operation since 2005 and is one of the oldest trading schemes. It has established systems for ensuring a high level of environmental integrity. These units – provided they are backed with a Kyoto Protocol unit – could be used to meet Australia’s second commitment period target under the Kyoto Protocol.
Beyond 2020, there are likely to be opportunities to source international emissions reductions from emissions trading schemes in a wide range of countries, including, for example, planned schemes in China and the Republic of Korea.
13.4 Conclusions on risks and benefits of international emissions reductions
The Authority has considered international emissions reductions against its principles for climate change policy and concludes that:
- The benefits are potentially substantial – international emissions reductions can lower costs for Australia to meet its emissions reduction goals, helping us take on stronger targets at a critical time for international action on climate change. While there are extensive emissions reduction opportunities available in the domestic economy, the Authority’s analysis shows that Australia can achieve its goals at lower cost by using some international emissions reductions to complement domestic efforts.
- The risks are real but manageable – the main risks of using international emissions reductions are whether they are genuine, and whether international prices might create more disruption to the Australian economy than a carbon price determined purely domestically. The risks around environmental integrity can be addressed through robust governance arrangements and ongoing review of any units used to meet Australia’s target. The potential risks around excessively low international prices are also real in theory; however, at least in the electricity sector, they do not appear to be material in practice. Moreover, policy design can help Australia to keep the benefits of lower cost emissions reductions while mitigating sector specific risks of locking in emissions-intensive capital.
This suggests that, as long as the emissions reductions are genuine they should remain an option for helping to meet Australia’s target. The Government intends to achieve Australia’s minimum 5 per cent commitment domestically. Stronger targets could be achieved by purchasing some international emissions reductions. Moreover, genuine international emissions reductions could complement domestic efforts in achieving Australia’s minimum 5 per cent commitment in a cost-effective way. For example, the Government could consider establishing a strategic reserve of genuine international emissions reductions. Given the substantial benefits of trade in international emissions reductions both in general, and at this critical juncture in global climate action, the Authority recommends that Australia should keep international emissions reductions available as one way to meet its goals.
This analysis of the risks and benefits of international emissions reductions concludes the Authority’s review of the opportunities and challenges for Australia’s emissions reductions. The next and final part of the Review fulfils the Authority’s obligations under the Clean Energy Act to make recommendations about caps under the carbon pricing mechanism.
C.21 Using international emissions reductions to contribute to meeting Australia’s goals has substantial potential benefits and manageable risks:
- International emissions reductions can reduce the cost of meeting emissions reduction goals, helping Australia take on stronger targets at a critical time for international action on climate change.
- Governance risks are real; however, robust governance arrangements and ongoing review of the environmental integrity of emissions reductions provides effective risk mitigation for Australia.
- Policy design can mitigate sector-specific risks such as locking in new emissions intensive capital.
R.6 That the Government keep access to genuine international emissions reductions available where this is a cost-effective way of helping to meet its emissions reduction goals.
1 The effective carbon price is a weighted average of the Australian carbon unit price and the Kyoto unit price, with weight reflecting the Kyoto sub-limit.