Tuesday, December 2, 2008

A comment on Fixing the Floor in the ETS

Dr Richard Denniss recently published a research paper for The Australia Institute. Despite its promising title, there is no solution for fixing the ‘floor’ in the ETS to be found in this document. In fact, it takes tentative steps towards teasing out the mechanisms through which the economy and environment interact, but in the face of reality, jumps back on the feel good, greenwash, drive a hybrid, hold hands and be nice to each other bandwagon.

Let me explain.

The story woven by Denniss is that energy and emissions conservation efforts by households will be rendered ineffective due to the proposed emissions trading scheme (ETS). For example, if households reduce their electricity demand through efforts to conserve, the electricity producer now needs to produce less electricity, and can then sell some of their emissions permits to other polluters. Hence the ETS provides a floor on emissions that cannot be passed, as permits can always be traded to other potential polluters.

However, the fundamental assumption in the paper is that households can reduce their greenhouse gas emissions by simply changing their purchasing behaviour and embracing energy efficiency. If you have read my previous blogs you would know that this is an ineffective strategy.

While the paper provides an interesting insight for many, the major flaw is that Denniss acknowledges the flow-on effects from the ‘after ETS’ scenario, without any reference to flow-on effects in the ‘before ETS’ scenario. As an Associate Professor in economics, Denniss should know that these type of flow-on effects would appear without the ETS due the price mechanism. Taking the above example in the 'before ETS' scenario, a reduction in electricity demand should reduce the price of electricity, and subsequently increase electricity demand by others (because of the Law of Demand - lower the price, the more we buy). Therefore, the actions that are supposed to be rendered ineffective by the ETS are already ineffective.

Blake Alcott has a very interesting paper that debunks conservation as an effective way to reduce energy consumption and subsequent greenhouse gas emissions.

In short, as I have mentioned many times in this blog, to truly reduce resource consumption you must restrict the supply. In the case of greenhouse gas emissions, the ETS does exactly that. Individuals actions mentioned in the paper are presently ineffective, and will remain so under the ETS. However, there will now be the opportunity to buy emissions permits, restricting their supply to polluters if you wish to invest in behaviour that reduces emissions.

If the only pressure on emissions production is upwards, then the existence of a floor is clearly not an issue, as long as it also acts as a ceiling. If you think about is, most restrictive regulations that provide limits also act as floors with little criticism. Safety standards, town planning restrictions, and many other regulations provide no incentive to ‘outperform’. That is not their purpose.

It is time to stop the feel good ramblings and the government blame game and accept reality for a change.


  1. A comment from Paul.

    What about the reduction of emission over time? If there is an increase in energy conservation per household, the overall demand for energy (per household) is reduced, and according to your theory this would decrease the price of electricity (thus increasing demand). This is a fair enough assumption, however if the reduction in energy usage per household is reduced does it not defer the need for increased supply (increased emissions) over time?

    The price may drop, but it will also go back up again as demand increases thus inciting more energy efficiency, delaying the need for an increase in overall supply over time, and thus reducing emissions.

  2. if the general public make am effective effort to reduce electricity consumption - for whatever reason won't suppliers seek out new demand by reducing their prices??? keith

  3. Exactly my point. Which will result in no reduction to electricity supplied.

    This is apart from the fact that many of the actions that commonly are referred to as conservation in fact increase energy demand - eg, more efficient lighting.

  4. Nothing like a recession (I mean 'slowdown') to reduce consumption.....

    It all seems to come back to conservation/restoration not efficiency?

  5. Cameron,

    There are two problems with the ETS that compound the 'floor' problem and they are both related to the free permits.

    Firstly, the number of freebies issued will be based on an average of the emissions output by the major polluters between 2004-7, years when our economy was at close to maximum production.

    With the current and short/medium-term future economic problems that means for much of the initial 2010-20 period the very worst polluters (the 90%ers) will probably not only not have to buy a single permits, they may well be able to sell quite a few of the free ones too.

    The free permits are also, IMO, a major part of the 'floor' problem that prevents actions by individuals from having an impact on emissions as the sale of permits released by individual action will affect the market price.

    So my solution is to scrap the free permits and make the major polluters pay for every tonne of carbon they emit allowing them to pass on the extra cost and initially offset this from the additional income with a gradual reduction of the offset over several years (with allowances for low income earners, pensioners, etc).

    Or even better, use say 25-50% of it to build large scale wind and solar farms (and maybe geothermal plants too).

    Once a couple have been built sell shares to the public with a guaranteed return comparable to the ACT/QLD/SA/VIC feed in tariffs minus a small maintenance fee, and plow the proceeds back into new farms. This would be a lot more efficient than installing thousands of individual home systems. This would also give people a chance to invest in wind generation which, while cheaper than solar per watt, isn't really a proposition at the individual level.

    To prevent the carbon saved (and from all home systems) distorting prices reduce the number of permits issued by the same amount.

    And get rid of the stupid scheme to fix the max carbon price by flooding the market with extra permits whenever it rises above the limit. If a limit is needed, and I’m not convinced there is, then legislate it.

    BTW-scrapping the freebies would also close a loophole in the ETS that will allow polluters to use free permits from future years in the present. This has the potential to be rorted on a grand scale.