Saturday, September 27, 2008

Small voice with big ambitions

Climate change forecasts by scientists are having a dominant influence on policy throughout the world.

Politicians and economists have popularised some of the more sensational scientific concerns regarding climate change.  Dengue fever, malaria and the loss of the Great Barrier Reef are key features of the debate in Australia.

The Labor Government has claimed ownership of the climate change issue.  Prime Minister Kevin Rudd is in New York trying to persuade other leaders to follow the path to increased energy costs that he wants Australia to travel.  The Turnbull Opposition, perhaps energised by Julia Gillard's claim that it is "an inelegant mix of climate change deniers", looks set to outflank Labor from the left.

Andrew Robb, previously a logical and safe politician, seems to have a leading role.  He has called for retrofitting of buildings to reduce greenhouse gas emissions -- surely one of the most expensive approaches available -- and he has called for Australia to learn from Singapore's water recycling initiatives.

Singapore is a city of comparable size and population to Melbourne but has four times the annual rainfall.  But, unlike Melbourne, Singapore is a stand-alone political entity with a hinterland, Malaysia, with which it has had political tensions.  Five years ago, then Malaysian prime minister Mahathir Mohamad said he wanted to renegotiate at a "fair price" what it charged Singapore for water, pointing out that Hong Kong paid China 260 times what Malaysia was charging Singapore.

If Melbourne follows Singapore on water, costs will be increased fourfold, with no carbon reduction benefits.

Costs and benefits must be central in any action to reduce carbon emissions.  Ross Garnaut suggests Australia would incur an 8% loss in income if no action is taken.  Such estimates are only made possible by grafting onto the warming forecasts future costs that are amplified by discount rates that are, at the very least, unorthodox.

The costs of measures to mitigate carbon dioxide emissions tend to be hidden by the nature of economic analysis and modelling.  But Australia already has a huge drain of resources to accommodate fears of climate change.  These amount to about $3 billion a year and include:

  • Taxes to subsidise non-commercial research and "demonstration projects".
  • Standards to require uneconomical expenditure on insulation.
  • Specific incentives to use uncommercial power sources like wind.

The sacrifice to real income such measures entail is masked by national accounting conventions.  The policies in place involve three sorts of costs.  The first are costs to consumers of the higher taxes and from being forced to use less efficient energy.  The second are impacts on business of the higher costs of energy as inputs into production and new investment decisions.  The third are the riskscreated for new investments in fossil fuel, especially those involving coal.

Energy saving standards and renewable energy requirements force consumers into using inefficient energy sources and to incur increased housing costs, both of which result in a reduction in real income levels.

The effects of taxes and other emission reduction regulatory impositions are even more invasive for producers than for consumers.  Those producers using fossil fuel energy see costs increase.  For those exporting or competing with imports, these costs go straight to the bottom line.  Hence, a 10% cost increase, even where energy comprises only 2% of overall costs, still has an appreciable effect on profit.

For energy producers, especially those considering investment in coal-generated electricity, the risk of retrospective taxation is too great.  This prevents new investment.  The corollary is a progressive increase in price as demand gradually outstrips supply or as higher-cost new generators are commissioned.  Aside from risks of power outages, this means costly marginal plant becomes the supply setting price.  Already the shortfall in new coal-based electricity supply has brought a 60% increase in wholesale electricity prices over recent years.

Australia is also, perhaps uniquely, pursuing inconsistent policy directions with regard to coal.  At the same time as new coal-based electricity facilities are virtually banned and existing generators are encouraged to be phased out, activity is under way to expand coal exports, especially from Queensland.  The burning of the coal domestically or overseas has identical effects (if any) on climate change, yet one is considered to be a pariah activity and the other is supported.

Carbon mitigation policies lead to lower levels of real wealth and have contributed to wider economic woes as consumers and producers alike make adjustments.  The cost impost forced by emission control policies has doubtless contributed to economic slowdowns as a result of the pervasive and largely unsubstitutable nature of electricity within modern economies.

Australia has more to lose than almost any other country from costs imposed by carbon dioxide emission restraints.  Cheap coal-based electricity has been the bedrock on which much of our industrial development rests.  Smelting industries in particular gravitated to Australia after the 1970s oil price hikes but low-cost electricity has helped the competitiveness of all our tradeable goods industries.  While we might speculate on the long-term costs of global warming on Australia, the short-term costs of increasing the price of electricity supplies are evident.

With 1% of world gross domestic product, we are not particularly influential within world councils.  And while we have many well-qualified scientists, few of these are considered to be world authorities on climate change.  Accordingly, it is pure hubris for Australia to try to take the lead in abatement activity.

Any measures to mitigate Australian emissions should be made contingent upon actions from the rest of the world.  Further, the focus should be a single instrument, a tax or tradeable right.  We should also ditch inefficient emission reduction instruments measures like mandatory renewable targets and we should dismantle regulatory barriers, especially to nuclear facilities.


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