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Issue 30: October 2008
Background to Australia's Proposed Emissions Trading Scheme Print E-mail

02_intro.jpgIn this comprehensive article, David Russell QC discusses the United Nations Framework Convention on Climate Change, the Kyoto Protocol, the Stern Review, the Bali Declaration and recent Australian developments including the Garnaut Climate Review, the final report for which was published on 30 September 2008.


(a) The United Nations Framework Convention on Climate Change

In recent years, the widely acknowledged concern expressed, not only at official levels1 but in the mass media in forms ranging from opinion pieces through films such as Al Gore’s “An Inconvenient Truth”2 to popular literature3, that anthropogenically generated phenomena (and in particular greenhouse gases (“GHG”) are responsible for potentially detrimental changes in the world’s climate4, have led to increasing support for the view that existing public policy instruments are inadequate to address the issue.

The underlying issues in relation to this inadequacy have three leading sources:

  • The “tragedy of the commons” or absence of persons with a proprietary interest in protection of the environment as a common good5;
  • Negative externalities, or failure of the economic system to attribute costs to those whose activities damage the environment6; and
  • Incapacity of the law to extend familiar principles (e.g. doctrines such as that enunciated in Rylands v. Fletcher7 in a common law context) which might have dealt with the problem earlier.

These concerns were articulated in an international context by the Intergovernmental Panel on Climate Change (“IPCC”)8 became the subject of an international agreement in the form of The United Nations Framework Convention on Climate Change (“UNFCC”), adopted in New York in 1992.

The UNFCC sets an overall framework for intergovernmental efforts to tackle the challenge posed by climate change. It proceeds on the basis that the climate system is a shared resource whose stability can be affected by industrial and other emissions of carbon dioxide and other greenhouse gases. The Convention enjoys near universal membership, with 189 countries having ratified.

Under the Convention, governments:

  • gather and share information on greenhouse gas emissions, national policies and best practices;
  • launch national strategies for addressing greenhouse gas emissions and adapting to expected impacts, including the provision of financial and technological support to developing countries; and
  • cooperate in preparing for adaptation to the impacts of climate change.

The Convention entered into force on 21 March 1994.

smokestacks.jpg(b) The Kyoto Protocol

As GHG emission levels continued to rise around the world, the view was increasingly held that only a firm and binding commitment by developed countries to reduce emissions could send a signal strong enough to convince businesses, communities and individuals to act on climate change. Member countries of the UNFCCC therefore began negotiations on a Protocol – an international agreement linked to the existing Treaty, but standing on its own.

After two and a half years of intense negotiations, the Kyoto Protocol was adopted at the third Conference of the Parties to the UNFCCC (COP 3) in Kyoto, Japan, on 11 December 1997. The Protocol shares the objective and institutions of the Convention. The major distinction between the two, however, is that while the Convention encouraged developed countries to stabilize GHG emissions, the Protocol commits them to do so. The detailed rules for its implementation were adopted at COP 7 in Marrakesh in 2001, and are called the “Marrakesh Accords.”

Because it will affect virtually all major sectors of the economy, the Kyoto Protocol is considered to be the most far-reaching agreement on environment and sustainable development ever adopted. However, any treaty not only has to be effective in tackling a complicated worldwide problem, it must also be politically acceptable. Most of the world’s countries eventually agreed to the Protocol, but some nations chose not to ratify it. Following ratification by Russia, the Kyoto Protocol entered into force on 16 February 2005. Australia ratified the protocol on 3 December 2007. The United States has not done so.

Of the countries which have ratified the Protocol to date, 35 countries and the EEC are required to reduce greenhouse gas emissions below levels specified for each of them in the treaty. The individual targets for Annex I Parties are listed in the Kyoto Protocol’s Annex B. These add up to a total cut in greenhouse-gas emissions of at least 5% from 1990 levels in the commitment period 2008-2012.

The specific commitments of the Annex I parties include the following:

(Article 3.1)

The Parties included in Annex I shall, individually or jointly, ensure that their aggregate anthropogenic carbon dioxide equivalent emissions of the greenhouse gases listed in Annex A do not exceed their assigned amounts, calculated pursuant to their quantified emission limitation and reduction commitments inscribed in Annex B and in accordance with the provisions of this Article, with a view to reducing their overall emissions of such gases by at least 5 per cent below 1990 levels in the commitment period 2008 to 2012

(Article 3.3)

The net changes in greenhouse gas emissions by sources and removals by sinks resulting from direct human-induced land-use change and forestry activities, limited to afforestation, reforestation and deforestation since 1990, measured as verifiable changes in carbon stocks in each commitment period, shall be used to meet the commitments under this Article of each Party included in Annex I. The greenhouse gas emissions by sources and removals by sinks associated with those activities shall be reported in a transparent and verifiable manner and reviewed in accordance with Articles 7 and 8.

In addition to mandating reductions in GHG emissions, the Kyoto Protocol foreshadowed elements of an Emissions Trading regime through a Clean Development Mechanism (“CDM”) whereby parties to the Protocol might satisfy their obligations by acquiring credits from other nations either in respect of emissions reduction or what is now referred to as carbon sequestration. The Protocol provides:

(Article 6)

For the purpose of meeting its commitments under Article 3, any Party included in Annex I may transfer to, or acquire from, any other such Party emission reduction units resulting from projects aimed at reducing anthropogenic emissions by sources or enhancing anthropogenic removals by sinks of greenhouse gases in any sector of the economy, provided that:

(a) Any such project has the approval of the Parties involved;

(b) Any such project provides a reduction in emissions by sources, or an enhancement of removals by sinks, that is additional to any that would otherwise occur;

(c) It does not acquire any emission reduction units if it is not in compliance with its obligations under Articles 5 and 7; and

(d) The acquisition of emission reduction units shall be supplemental to domestic actions for the purposes of meeting commitments under Article 3.

The lack of progress in implementation of the objectives of the Protocol is usually attributed to two factors, both of which have counterparts in the construction of domestic GHG emissions abatement regimes. These are:

• The effective grandfathering of existing emissions; and

• The non-participation by developing economies whose relatively less advanced capital structure is more dependent on greenhouse-gas emitting technologies.

The inevitability of the emergence of these factors can be traced to the commitments contained in Annex B of the Protocol, which lists the Party Quantified emission limitation or reduction commitments as a percentage of the base year or period:

Australia 108
Austria 92
Belgium 92
Bulgaria* 92
Canada 94
Croatia* 95
Czech Republic* 92
Denmark 92
Estonia* 92
European Community 92
Finland 92
France 92
Germany 92
Greece 92
Hungary* 94
Iceland 110
Ireland 92
Italy 92
Japan 94
Latvia* 92
Liechtenstein 92
Lithuania* 92
Luxembourg 92
Monaco 92
Netherlands 92
New Zealand 100
Norway 101
Poland* 94
Portugal 92
Romania* 92
Russian Federation* 100
Slovakia* 92
Slovenia* 92
Spain 92
Sweden 92
Switzerland 92
Ukraine* 100
United Kingdom of Great
Britain and Northern Ireland 92
United States of America 93

* Countries that are undergoing the process of transition to a market economy.

It will be observed that neither India nor China has committed to any level of GHG emissions, on the basis that to do so would limit its industrialisation and resultant economic modernisation and rise in living standards. In response the United States has refused to ratify the Protocol on the basis that to do so would commit it to a reduction in its citizens’ living standards9 without necessarily addressing the overall problem to any significant degree.

icewall1846370.jpg(c) The Stern Review

In 2005 the United Kingdom government commissioned a Review by Sir Nicholas Stern10, Head of the Government Economics Service and Adviser to the Government on the economics of climate change and development, on the Economics of Climate Change (“the Stern Review”). Sir Nicholas presented his report to the Prime Minister and the Chancellor of the Exchequer on 30 October 200611. It was not the first benefit-cost analysis of climate change ever published12 but it was the first such analysis to be issued with the imprimatur of a major government. Not surprisingly, it has been significantly influential throughout the world.

Underlying the Stern Review’s recommendations is the conclusion that13:

Climate change presents a unique challenge for economics: it is the greatest and widest-ranging market failure ever seen. The economic analysis must therefore be global, deal with long time horizons, have the economics of risk and uncertainty at centre stage, and examine the possibility of major, non-marginal change. To meet these requirements, the Review draws on ideas and techniques from most of the important areas of economics, including many recent advances.

The benefits of strong, early action on climate change outweigh the costs

The effects of our actions now on future changes in the climate have long lead times. What we do now can have only a limited effect on the climate over the next 40 or 50 years. On the other hand what we do in the next 10 or 20 years can have a profound effect on the climate in the second half of this century and in the next. No-one can predict the consequences of climate change with complete certainty; but we now know enough to understand the risks. Mitigation - taking strong action to reduce emissions - must be viewed as an investment, a cost incurred now and in the coming few decades to avoid the risks of very severe consequences in the future. If these investments are made wisely, the costs will be manageable, and there will be a wide range of opportunities for growth and development along the way. For this to work well, policy must promote sound market signals, overcome market failures and have equity and risk mitigation at its core. That essentially is the conceptual framework of this Review.

The Review argues for a comprehensive emissions control strategy of quite dramatic proportions14. Amongst the more important of his conclusions for present purposes are the following15:

Agreeing a quantitative global stabilisation target range for the stock of greenhouse gases (GHGs) in the atmosphere is an important and useful foundation for overall policy. It is an efficient way to control the risk of catastrophic climate change in the long term. Short term policies to achieve emissions reductions will need to be consistent with this long-term stabilisation goal.

In the short term, using price-driven instruments (through tax or trading) will allow flexibility in how, where and when emission reductions are made, providing opportunities and incentives to keep down the cost of mitigation. The price signal should reflect the marginal damage caused by emissions, and rise over time to reflect the increasing damages as the stock of GHGs grows. For efficiency, it should be common across sectors and countries.

In theory, taxes or tradable quotas could establish this common price signal across countries and sectors. There can also be a role for regulation in setting an implicit price where market-based mechanisms alone prove ineffective. In practice, tradable quota systems – such as the EU’s emissions-trading scheme – may be the most straightforward way of establishing a common price signal across countries. To promote cost-effectiveness, they also need flexibility in the timing of emissions reductions.

Both taxes and tradable quotas have the potential to raise public revenues. In the case of tradable quotas, this will occur only if some firms pay for allowances (through an auction or sale). Over time, there are good economic reasons for moving towards greater use of auctioning, though the transition must be carefully managed to ensure a robust revenue base.

The global distributional impact of climate-change policy is also critical. Issues of equity are likely to be central to securing agreement on the way forward. Under the existing Kyoto protocol, participating developed countries have agreed binding commitments to reduce emissions. Within such a system, company-level trading schemes such as the EU ETS, which allow emission reductions to be made in the most cost-effective location – either within the EU, or elsewhere – can then drive financial flows between countries and promote, in an equitable way, accelerated mitigation in developing countries.

At the national – or regional – level, governments will want to choose a policy framework that is suited to their specific circumstances. Tax policy, tradable quotas and regulation can all play a role. In practice, some administrations are likely to place greater emphasis on trading, others on taxation and possibly some on regulation.

Although it is arguable that there are aspects of both the reasoning16 and the conclusions17 reached by Sir Nicholas which may be questioned, there can be little cause for doubt that these views will prove to be very influential in establishing a framework for future government policy responses.

(d) The Bali Declaration

The Kyoto Protocol runs to 2012. International negotiations are currently under way to develop a successor framework to the Kyoto Protocol. Current plans envisage such a plan to be agreed at the 2009 UNFCCC conference in Copenhagen.

The December 2007 Bali conference developed the agenda or framework for the post-Kyoto negotiations. The likely cornerstone, agreed at Bali, is that developed countries take on quantitative commitments, while developing countries are to undertake “measurable, reportable and verifiable” mitigation actions, but not with quantitative, national commitments and emissions trading. Sectoral approaches to mitigation, incentive mechanisms to reduce tropical deforestation, and a broadened CDM are expected to expand the reach of a post-2012 framework.

The differentiation of the position of developed and developing countries continues the framework outlined in the UNFCC itself18.

Critics of the outcome of the Bali conference noted that no new targets for emissions reduction were set19 notwithstanding calls for that outcome by prominent climate scientists20.

(e) Australian Developments

On 10 December 2006 the then Prime Minister announced the establishment of a joint government-business Task Group on Emissions Trading. Its terms of reference noted that “Australia enjoys major competitive advantages through the possession of large reserves of fossil fuels and uranium”, and that “in assessing Australia’s further contribution to reducing greenhouse gas emissions, these advantages must be preserved”. Against that background, the Task Group was asked to “advise on the nature and design of a workable global emissions trading system in which Australia would be able to participate”, and to “advise and report on additional steps that might be taken, in Australia, consistent with the goal of establishing such a system”.

dryearth1730597.jpgThe Task Group was chaired by the Secretary of the Department of Prime Minister and Cabinet, Dr Peter Shergold. The other members comprised four other departmental heads, including those of Treasury and Foreign Affairs and Trade, together with seven private sector notables. It reported, as required, on 31 May 2007, and concluded – among many other things – that “two threshold decisions were needed”, namely21:

  • “Whether Australia, which makes only a very small contribution to the world’s emissions of greenhouse gases, should commit now to a longer-term emissions constraint ahead of a comprehensive global agreement”.
  • In the event of an affirmative answer to that first question, the nature of “the emissions reduction mechanism to which Australia should commit”.

As to the first question, “the Task Group has concluded that Australia should not wait until a genuinely global agreement has been negotiated”. As to the second, “the Task Group is firmly of the view that the most efficient and effective way to manage risk is through market mechanisms”, and that “an Australian emissions trading scheme would allow our nation to respond to future carbon constraints at least cost”.22

Following delivery of the Report, the Prime Minister announced that Australia would indeed go ahead to set up its own emissions trading scheme. Pursuant to that process, it would also adopt during 2008 a target for the reduction of CO2 emissions.

The Garnaut Climate Change Review is an independent study by Professor Ross Garnaut, commissioned by Australia's State and Territory Governments on 30 April 2007.

The Review examined the impacts of climate change on the Australian economy, and recommend medium to long-term policies and policy frameworks to improve the prospects for sustainable prosperity.

A number of forums were held around Australia to engage the public on various issues relating to the Review. An Interim Report was released on 21 February, and a further report on the proposed design of an Australian Emissions Trading Scheme (ETS)23 was released on 20 March.

The Interim Review concludes that Australia is particularly at risk from the consequences of climate change24:

There are several reasons why Australia is likely to be more exposed to the impacts of climate change than other developed countries. First, our climate is already hot, dry and variable. Second, the sensitivity of our temperate agriculture assumes special importance because of the large role that agriculture plays in the Australian relative to other developed economies. Third, our terms of trade are highly sensitive to economic performance in Asian developing countries that are vulnerable to climate change. Fourth, our close proximity to fragile developing countries which seem to be disproportionately exposed to damage by climate change introduces special geo-political risks.

The changes in Australia’s GHG emissions profile contemplated by the Review are major:

Whichever global budget is advocated by Australia, it is clear that there will be a requirement for large cuts in Australia’s emissions budget, as part of an effective international agreement.

Under the 450 ppm and 550 ppm CO2-e stabilisation illustrative scenarios referred to earlier, if it were agreed that per capita emissions would converge by 2050, then Australia’s absolute emissions would have to be roughly 90 per cent and 70 per cent respectively below 2000 levels in 2050. These numbers are purely illustrative, as the exact allocations would depend on the rules adopted for emissions rights, the trajectory of emissions through time, future population growth in Australia and globally, and other variables.

Such targets exceed any foreshadowed in government announcements to date.

The final report of the Garnaut Climate Review was handed down on 30 September 2008 and may be viewed at www.garnautreport.org.au

It is against this background that the Australian Government’s Green Paper setting out possible parameters of an Emissions Trading Scheme has been published.

David Russell QC

Footnotes

  1. Most recently, the Reports of the UN Intergovernmental Panel on Climate Change (“IPCC”) released in Brussels on 5 April 2007 and Bali in December 2007.

  2. An Inconvenient Truth is an Academy Award-winning documentary film about climate change, specifically global warming, directed by Davis Guggenheim and presented by former United States Vice President Al Gore. A companion book authored by Gore has been on the the paperback nonfiction New York Times bestseller list since June 11, 2006, reaching #1 July 2. The film premiered at the 2006 Sundance Film Festival and opened in New York and Los Angeles on May 24, 2006. It is the third-highest-grossing documentary in the United States to date.

  3. e.g. Michael Crichton: State of Fear (2004) HarperCollins London

  4. That proposition, whilst widely accepted, is not universally so – see, e.g., The Great Global Warming Swindle

    http://www.channel4.com/science/microsites/G/great_global_warming_swindle/index.html, the Minority Report of the United States Senate Committee on Environment and Public Works (20 December 2007) http://epw.senate.gov/public/index.cfm?FuseAction=Minority.SenateReport#report, and note the observations on the “qualified and contested nature of the material” on the topic at page 8 of the Interim Report of the Garnaut Review

    (available from www.garnautreview.org.au) and the tentative nature of the observations at page 22:

    The Australian climate has changed notably over the past 50 years.

    Annual mean temperature in Australia has increased by up to 0.7°C since 1950. According to the IPCC, there is a greater than 90 per cent probability that the warming observed since the 1950s is due to human activities (IPCC, 2007c19). There has been a striking change in precipitation trends in Australia since the 1950s. North-west Australia has seen an increase in annual rainfall of more than 30mm per decade, while decreases along parts of the east coast have exceeded50mm. While it is not yet possible to attribute all the rainfall changes to anthropogenic climate change, some of the changes are likely to be at least partly due to increases in greenhouse gases (CSIRO and BOM, 2007). (italics supplied)

  5. Although not first to use the precise term, Aristotle captured its essence in his observation that: “That which is common to the greatest number has the least care bestowed upon it” – Politics 1261 b.34

  6. In the words of Sir Nicholas Stern: “Greenhouse gases are, in economic terms, an externality: those who produce greenhouse-gas emissions are bringing about climate change, thereby imposing costs on the world and on future generations, but they do not face the full consequences of their actions themselves.

    “Putting an appropriate price on carbon – explicitly through tax or trading, or implicitly through regulation – means that people are faced with the full social cost of their actions. This will lead individuals and businesses to switch away from high-carbon goods and services, and to invest in low-carbon alternatives. Economic efficiency points to the advantages of a common global carbon price: emissions reductions will then take place wherever they are cheapest.”

    It should be noted, however, that the issue has been identified for some time: see. e.g. J. E. Meade: The Theory of Economic Externalities: The Control of Environmental Pollution and Similar Social Costs (1973) Geneva: Sijthoff

  7. (1866) 1 Ex. 265; (1868) L.R. 3 H.L. 330

  8. The Intergovernmental Panel on Climate Change (IPCC) is an independent body founded under the auspices of the World Meteorological Organization (WMO) and the United Nations Environment Programme (UNEP). It assesses the scientific literature and provides vital scientific information to the climate change process.

    The IPCC is best known for its comprehensive assessment reports, incorporating summaries for policymakers from all three Working Groups, which are widely recognized as the most credible sources of information on climate change. The First Assessment Report in 1990 helped launch negotiations on the Convention. The 1995 Second Assessment Report, in particular its statement that "the balance of evidence suggests … a discernible human influence on global climate", stimulated many governments into intensifying negotiations on what was to become the Kyoto Protocol.

  9. Critics of this approach no doubt would observe that the reduction in living standards is occurring anyway, as experienced by (inter alia) the residents of New Orleans following Hurricane Katrina.

  10. Sir Nicholas was appointed Second Permanent Secretary of the Treasury in 2003. An Oxford economist, he had previously served as World Bank Chief Economist and Senior Vice President.

  11. For the full text of the Review, see

    http:www.hmtreasury.gov.uk/independent_reviews/stern_review_economics_climate_change /sternreview_index.cfm

  12. see, e.g., Cline, William R Optimal Carbon Emissions over time: Experiments with the Nordhaus DICE Model (1992) Institute for International Economics Washington DC, Mendelsohn et al Country Specific Market Impacts of Climate Change (1998) 54 Climatic Change 553-569, Nordhaus and Boyer Warming the World – economic models of global warming (2000) MIT Press, Cambridge, Mass.

  13. Executive Summary, page i

  14. The Report of the Intergovernmental Panel on Climate Change released on 4 May 2007 concludes that global emissions need to be cut to between 50% and 85% of 2000 levels by 2050, conceivably involving a carbon price of between $US 20 and $US 100 per tonne of CO2

  15. Stern Review, Chapter 14: Key Messages (p.208)

  16. Of particular note here is the contention that an inappropriately low discount rate has been used in the modeling, inflating the figures involved – see, e.g., Stone (2007) at pp.23-4. A useful summary of the parameters of this debate can be found in the submission of the Productivity Commission to the Garnaut Review, at page 56:

    Since its release there have been many critiques of the Review’s approach to discounting. While some have supported the Review, many of the critiques contend that the discount rates used are too low, either because they are below market rates or because they imply that current generations should be prepared to make unreasonably large sacrifices for future generations that, even with climate change, are expected to be richer. ….

    It is to be expected that the debate on what discount rates to use to analyse climate change will continue. It is not possible to say that Stern (or for that matter, Nordhaus) is definitively right or wrong in their selection of discount rates. Based on the discussion in appendix A, however, it is possible to draw some conclusions.

    • The Review’s approach to discounting is based on particular ethical judgements about intergenerational equity that are not designed to be representative of wider opinion and that are different from the judgements of some other climate change analysts. Accordingly, it would have been preferable to present a range of results for different discount rates. Stern did this belatedly in a postscript to the Review, although the highest parameter values included equate to discount rates that are still below those advocated by some …

    • Under the Review’s approach, community wellbeing is claimed to be increased by forgoing current consumption in order to make climate-related investments that produce benefits in the long term. Whether these investments are superior to alternative investments is left unanswered by the analysis. This is one of the main criticisms that can be made of prescriptive approaches to discounting in general.

  17. see “Emissions taxes v. tradable quotas – an alternative view” below

  18. UNFCC Article 3 provides, inter alia:

    1. The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and respective capabilities. Accordingly, the developed country Parties should take the lead in combating climate change and the adverse effects thereof.

    2. The specific needs and special circumstances of developing country Parties, especially those that are particularly vulnerable to the adverse effects of climate change, and of those Parties, especially developing country Parties, that would have to bear a disproportionate or abnormal burden under the Convention, should be given full consideration.

  19. See Sydney Morning Herald, 15 December 2007: March for a climate accord falters

  20. For the text, see http://www.climate.unsw.edu.au/bali/

  21. Department of Prime Minister and Cabinet, Canberra, Report of the Task Group on Emissions Trading, pp.5-6.

  22. Ibid.

  23. Emissions Trading Scheme Discussion Paper

  24. At page 22

  25. At page 39



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