Direct Action’s ERF: raising cost of emissions cuts three-fold

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The Emission Reduction Fund (ERF) was sold to the public as a cleverer, less intrusive way of delivering on Australia’s future greenhouse emissions targets. Teamed with a ‘Safeguards’ mechanism, it would obviate the need for an economy-wide emissions constraint, and the emergence of a broad based carbon price.

Hitting an economy-wide emissions target using a voluntary project based scheme that rewards reductions in future emissions output was always going to be a BIG ask: A bit like trying to fix the nation’s obesity problem by paying volunteers not to eat dessert any more – and claiming that the program is cost effective because you’re only funding those asking the least amount of money to go without. Not only does the ERF not focus on all emissions within the economy (and the current approach to Safeguards is unlikely to rectify this), it doesn’t even focus on all the emissions within the businesses that it is paying to generate abatement.

However, the ERF does require its participants to use sophisticated methodologies to determine their project’s baseline emissions and the quantity of potential emission reductions that can be bid into the government’s ERF auctions. Successful bidders enter into contracts with government to deliver the agreed abatement over time, and submit to stipulated reporting and verification requirements.

Sound expensive? It is. Reports from ERF participants and advisers suggest that total on-costs can reach $100,000 to $150,000 over the short life of an ERF project.

Analysis completed recently by Meta Economics shows that high transaction costs can reduce the supply of low cost abatement opportunities available to the ERF and drive up outlays under the ERF program. These concerns were raised by the Climate Change Authority in its December 2014 report highlighting lessons from the Carbon Farming Initiative.

Meta Economics’ modelling puts some numbers around these concerns.  It draws on activity level abatement cost estimates for Australia (as popularised in recent years by commentators such as McKinsey, ClimateWorks and Reputex) to model the least cost combination of projects required to deliver on Australia’s 2020 emissions target. Rather than ascending a ‘staircase’ of abatement actions, economy-wide emission targets are delivered by unlocking a variety of abatement opportunities available at different price levels.

Transaction costs under the ERF knock out many small abatement projects, and change the merit order of viable projects. Importantly, the ERF’s focus on emission reductions that are beyond ‘business as usual’ can also prevent it from unlocking the cheapest abatement of all – so-called ‘no regrets’ opportunities. This is abatement generated from actions that enhance productivity and reduce costs.

In an ideal situation in which transaction costs (such as contract negotiations, legal fees, reporting and audits) could be completely avoided and all ‘no regrets’ opportunities for were activated, Meta Economics’ modelling suggests that Australia’s 2020 emissions target could be achieved at a marginal cost of around $5 per tonne CO2e. That is the maximum price you would need to pay for a tonne of abatement. Net outlays required to pay for abatement beyond ‘no regrets’ action would total around $59 million.

Viewed on an economy-wide basis, the average cost of delivering the 2020 emissions target (projected to entail an emissions reduction of 126 million tonnes of CO2e in that year) is – $81.40 (ie. on average, the economic pay-offs from emission reduction outweigh the costs). These cost outcomes are shown in Figure 1, and provide an idealised benchmark for assessing the implications and performance of the ERF.

Figure 1Costs of delivering the 2020 GHG emissions target under ideal conditions

Figure 1 Costs of delivering the 2020 GHG emissions target under ideal conditions

Imposition of project level transaction costs under the ERF affect these outcomes significantly. The marginal cost of abatement under the ERF needed to deliver the 2020 emissions target increases to around $26.90 and net spending beyond the’ no regrets’ level increases to $1.65 billion. As indicated in Figure 2, the average cost per tonne increases but is still negative (ie. abatement is associated with a net benefit). However, this is only the case IF the ERF can drive ‘no regrets’ abatement on an economy-wide basis. Unfortunately, the design of the ERF works against that outcome.

Figure 2Costs of delivering the 2020 GHG emissions target with ERF transaction costs

Figure 2 Costs of delivering the 2020 GHG emissions target with ERF transaction costs

If the ERF only funds abatement that comes at a net cost to its owners, the modelling suggests that the marginal cost of abatement needed to deliver the 2020 target rises to around $40 per tonne and the total budget outlay will be around $3.02 billion – reflecting an average cost per tonne of about $24. This compares with the $2.55 billion budgeted. To date, the ERF has committed just over $1.2 billion to contracts that cover about 40% of the abatement need to hit the 2020 target.

And how might the ERF compare with a national emissions trading system (ETS)? Some idea of likely ETS transaction costs can be drawn from the now-defunct Carbon Pricing Mechanism.

Our modelling suggests that (IF unanticipated emissions growth outside the ERF can be avoided) government would need to spend somewhere between $1.7 billion and $3 billion to deliver on the 2020 emission target – and around $10 billion in potential efficiency gains would continue to languish. In contrast, net expenditures associated with achieving the emissions target under an ETS would be about $0.64 billion (including $168 million in profits for those selling abatement into the carbon market at a clearing price of $17.36 per tonne), with net efficiency gains worth about $9.7 billion likely to flow from economy-wide action.

An ETS mobilises resources on an economy-wide basis and crystallises the value inherent in the ability to emit greenhouse gases into the atmosphere. The ERF goes to considerable lengths to avoid this mobilisation, and forestalls the economy-wide innovation and opportunities associated with it. These are important issues for the emerging debate on government expenditure and how best to position the Australian economy for the challenges and opportunities that lie ahead.

Brett Janissen is Executive Director at Meta Economics Consulting Group.  The Meta Economics analysis of the ERF can be downloaded here.  

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