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Australia’s ‘carbon budget black hole’: fact or political fiction?

Discussion of the federal budget has featured much doom-mongering. This is exemplified by forecasts of a A$6-8 billion black hole in 2015-16, when the carbon tax switches to an emissions trading scheme…

Is the falling carbon price as dangerous as everyone is saying? caribb/Flickr

Discussion of the federal budget has featured much doom-mongering. This is exemplified by forecasts of a A$6-8 billion black hole in 2015-16, when the carbon tax switches to an emissions trading scheme linked with Europe. The government estimates revenue will be A$2.5 billion lower than previously forecast, thanks to revised projections for European carbon prices included in the forward estimates.

The Coalition is framing the election as a referendum on the carbon tax, and emphasising this so-called “carbon budget black hole”.

Should we take these forecasts and related claims about the near-collapse of the European carbon market seriously?

It’s been high before; it can be high again

How quickly we forget that two years ago the EU carbon price was above A$20 per tonne (and well above this price in 2006 and 2008). Around the time it was A$20 per tonne the government was negotiating a starting carbon price. The updated Garnaut Review recommended a starting price of $20 to $30 a tonne, and a price towards the lower end was agreed by the multi-party climate change committee.

When the Australian carbon price package was initially negotiated, no one forecast the current price, or a major market crash. (Although as the package passed our Houses of Parliament late 2011 some analysts were warning that the market could crash in the near-future.)

Previously, Treasury modelling projected a European price of A$29 in 2015-16. Consequently, in the legislation, the Australian carbon price has been scheduled to move towards this price in the lead-up to linking with Europe.

Now – with the European carbon price at A$3-$4 a tonne – some experts are confidently telling us that the price will remain around current levels or continue falling to closer to A$2.

According to a Reuters poll, most experts think it will be A$8.50. Treasury’s latest forecast is slightly higher, forecasting a price around A$12 a tonne in 2015-16.

All these forecasts express the current zeitgeist. They project forwards the current pessimism about Europe and its carbon market.

Reasons to be sceptical: human biases and political motivations

Forecasts are shaped by the interpretations and biases of whoever made them. Psychological studies have revealed many cognitive biases that affect how we predict the future.

Harvard’s Daniel Gilbert calls one set of biases “presentism”, because imagined futures often look “so much like the actual present". How we feel now affects how we view the past and imagine the future.

A striking example is that by manipulating the temperature of the room peoples’ views on global warming are influenced. Similarly thirst levels impacted forecasts of drought and desertification. Our brains have evolved to focus on near and immediate events or threats. Some scientists suggest natural selection played a role in developing such traits.

Zeitgeist bias” explains that forecasts often tell us more about the time they were created than the future they were intended to shed light on. It’s hard to see and think beyond current issues and preoccupations.

For these reasons management practices like scenario planning try to break the mental habit of thinking the future will look much like the present. Sometimes it will, often it won’t.

Political commitments and ideologies are perhaps also at play. Australian economist Paul Frijters argues the Australian Treasury made a serious mistake by relying on “the politically-motivated projections” of the European Commission. Now, vested interests and politicians opposed to the carbon tax enthusiastically promote forecasts of budget “black holes”.

It is also commonly argued that political interference shapes modelling and forecasts, particularly those of the Australian Treasury. That is, “he who pays the piper calls the tune”.

Reality checks

In early 2011, no one forecasted the recent market crash. Similarly no one knows what the European carbon price will be in 2015-16.

While the media loves an uber-confident pundit, this misses the reality that the future is not yet written and is still uncertain.

Many factors contributed to the price crash, including a surplus of emissions permits and a range of economic factors. The European carbon price peaked pre-GFC and has since declined, as the slump slowed industrial activity and contributed to depressed prices. The perilous state of the EU economy also complicates political processes to reform the EU Emissions Trading Scheme.

Similarly, many factors will influence the future price of carbon permits. For example, we know politically there are plans to reintroduce legislation to address the over-supply of permits. This is intended to be a precursor to more fundamental reforms (see options being considered). The economic recovery process will also shape demand-side factors.

There are limits and risks to basing a decision or policy on a particular forecast. This lesson was learnt long ago in the business world. It should be learnt in Canberra. The Gillard Labor Government, instead, has tended to turn shaky projections into solemn promises.

If Australia’s carbon price is not repealed, policy-makers face a choice. They could “wait and see”. Or instead they could modify legislation and policies so they have more flexibility.

Commentary on the European carbon price is mostly politically opportunistic. We simply don’t know if the planned linkage with Europe will generate a budget “black hole”. Those saying it’s a certainty have political motivations. In fact, a Coalition Government may have a larger carbon budget hole to deal with if it wins office.

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35 Comments sorted by

  1. Chris Riedy

    Associate Professor at University of Technology, Sydney

    Thanks for pointing out the perils of projection Stephen. I particularly liked your observation that 'the media loves an uber-confident pundit'. It is too rare to see politicians or thought leaders expressing doubt and uncertainty about the future in public. Yet the only certainty seems to be that our forecasts will be wrong. An honest appraisal of diverse future pathways is needed as a basis for robust and resilient policy, but rarely makes a good sound bite.

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    1. David Arthur

      resistance gnome

      In reply to Chris Riedy

      Gday Prof Riedy, would you be so good as to explain how and why any emission trading scheme might be superior to a revenue-neutral fossil fuel consumption tax?

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    2. Georg Antony

      analyst

      In reply to Chris Riedy

      Wrong is alright, we have all been there. What is not alright is reckless, strategic, tendentious, pre-judged, politically-motivated.

      The modelling on the impact of GHG management appears to have only used the single scenario of coordinated international action (as distinct from feel-good 'commitments'), and a CO2 high price logically flowing from that. This scenario was questionable then and is looking shakier with every passing day.

      Now, I am pretty sure that there was more modelling with more acknowledgement of downside risk, or at least suggestions to do so. However, this was discarded when shaping the official position based on a desired political outcome. Hence, basic model parameters were effectively derived by working backwards: not the best way of forecasting.

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  2. David Arthur

    resistance gnome

    The obvious solution is to abandon the Clean Energy Futures package, and replace it with a consumption tax on fossil fuel (FFCT). The fundamental flaw of emission trading is that it cannot give pricing certainty. As with every other traded commodity, emissions permit trading will only compound the price instability that gave us the GFC.

    The economically efficient way to price carbon is via a fossil carbon consumption tax, implemented as a surcharge on the GST.

    * Administratively efficient…

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    1. Gary Murphy

      Independent Thinker

      In reply to David Arthur

      Any price is better than none - but I can think of a couple of reasons why a fixed emissions price would be better:

      1. It would give business more certainty. A fixed price would enable business to be more confident about what emission reduction methods would be viable.

      2. It would allow deeper cuts to be made without further political action. The cap and trade method suffers in that after some initial emission reductions have been made the price drops and it becomes uneconomic to make more until the cap is reduced. A fixed price would make it economic to make large reductions without further political action.

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    2. David Arthur

      resistance gnome

      In reply to Gary Murphy

      Good points Gary.

      A fixed price that is increased slightly each year, the revenue from which is used to fund cuts to, say, company and income taxes, with some used for benefit increases so that welfare recipients are no worse off, would result in an ever-increasing range of low/zero emission technologies becoming economically feasible.

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    3. Doug Hutcheson

      Poet

      In reply to David Arthur

      Don't forget the effect of reducing the number of free permits over time, compounding the effect of raising the price of available permits. In other words, increasing the cost of the 'trade' part of the equation, while reducing the 'cap' part, is how fundamental drivers for change will be implemented.

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    4. David Arthur

      resistance gnome

      In reply to Doug Hutcheson

      "increasing the cost of the 'trade' part of the equation, while reducing the 'cap' part, is how fundamental drivers for change will be implemented."

      No Doug, no!

      Costs of the "trade" part of the equation are purely and solely the brokerage taken by the self-serving finance sector.

      Further, "capping" emissions is no more and no less than old-school, Soviet-style centralised planning: just because it is being promoted by the shiny suits doesn't make it "free market", they're just promoting…

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    5. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to David Arthur

      Hi David,

      I would encourage you to read another piece I recently published here and some of the research and papers it links to (i.e., via the hyperlinks in the text). You state: "the real way to limit fossil fuel use is to simply increase the cost relative to alternatives". It is quite possible this is the wrong way to go and, instead, that the real way to limit fossil fuel use is to decrease the cost of alternatives relative to fossil fuels - i,e, the opposite approach.

      See: https://theconversation.com/climate-action-under-an-abbott-government-13953

      Cheers
      Stephen

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    6. David Arthur

      resistance gnome

      In reply to Stephen McGrail

      Thanks Stephen.

      David: increase the cost of fossil fuel use relative to alternatives
      Stephen: decrease the cost of alternatives relative to fossil fuel use

      ie logically identical.

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    7. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to David Arthur

      What I'm suggesting is that alternatives to the dominant policy paradigm - 'increase the cost of fossil fuels (by internalising externalities, reforming subsidies, etc) to help alternatives to be competitive and grow' - may be needed as it's proving to be a difficult road politically.

      For example, an alternative paradigm may focus more on enabling greater technological development (rather than giving a helping hand to current alternatives), so the cost comes down and energy prices don't have to rise so much when pursuing emissions reductions.

      To some extent it's a chicken-or-egg problem, as greater adoption of renewables etc will provide greater scale and can be expected to bring down the cost of production. However, there are good reasons to question the assumption that "we have all the technologies we need" - a common claim that is made by environmentalists and climate action advocates.

      Cheers
      Stephen

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    8. David Arthur

      resistance gnome

      In reply to Stephen McGrail

      Thanks Stephen. What I'm suggesting is that increasing the cost of fossil fuels by taxing their consumption, AND using the revenue for across-the-board tax cuts and benefit increases, will overcome any and all broad political opposition.

      That leaves only the finance sector, who stand to NOT make a fortune out of emission trading, as the only people who still object to a fossil fuel carbon tax.

      You're a lecturer in technology - you should understand how incremental adoption of existing alternative…

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  3. Mark Lawson

    senior journalist at Australian Financial Review

    The author is quite correct to point to the problems with forecasting and he restates the well recognised principle that forecasts say far more about the concerns of the forecasters than they do about the future. The study of forecasting systems is an established business subject, incidentally.

    However, there is also no question that pricing carbon through ETS systems is proving vastly more difficult than first thought, and the carbon price in the European ETS in particular has been characterised by wild swings. Although it may have been 20 euros two years ago, two years or so before that (the exact period I'd have to work out) it had fallen to zero.

    In fact, carbon prices usually collapse, as shown by the history of the two carbon exchanges (one in the US, one in Aus) and three multi-state US trading schemes.

    Faced with that history, Treasury should have guessed low in the first place and now has no option but to guess low. Hope for high but guess low.

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    1. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to Mark Lawson

      Hi Mark,

      Agree with much of your comment, although I would suggest "forecasting system" is almost an oxymoron given it's not exactly a science. I believe the head of the Treasury has called for a review of its forecasting systems due to their inaccuracies during the Labor Government - you might like to investigate and report on this, it would be an interesting story.

      Re: the EU ETS I think you are referring to the first trading period which was "hampered" by the over-provision of emissions permits. This was caused by a lack of baseline data and regulators having to rely on estimates from industry, which led other countries (e.g. Australia) to place a very high importance on having good baseline data.

      Funnily enough, Tony Abbott is on record as suggesting a carbon tax is a better option that an emissions trading scheme because of the issues you raise. We certainly are learning as we go, but it has ever been thus with complex policies like these...

      Stephen

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    2. Mark Lawson

      senior journalist at Australian Financial Review

      In reply to Stephen McGrail

      Stephen - sure, basically the ETS is still really in start-up phase but the treasury should really have known better that to forecast such a high price even back then. Also, sorry, but I agree with Tony Abbott. What they should have done is start with a low tax and built on that, if and when there was real progress internationally in pricing carbon. Maybe they could switch to a trading system later, when they are more stable, but as it is they've managed to combine bad features of both systems.

      Lots of material has been written about treasury's forecasting.

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    3. Chris O'Neill

      Victim of Tony Abbotts Great Big New Tax

      In reply to Mark Lawson

      "The study of forecasting systems is an established business subject, incidentally."

      It was well enough established to fail to forecast the GFC.

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    4. Mark Lawson

      senior journalist at Australian Financial Review

      In reply to Chris O'Neill

      Yes, quite so, (almost) everyone got it wrong, particularly the economists who should have known better. Although forecasting is a business subject, following its disciplines often gives results people simply don't want to hear, or won't give the confident results they need for lobbying or public statements.. Also, even the best laid forecasts can be proved wrong but those involved learn something from the failures.

      Attempts to forecast the strength of the current solar cycle, for example, seem to have come a cropper.. so the scientists presumably learn something from this..

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    5. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to Mark Lawson

      On the Tony Abbott point perhaps he should adopt a revised lower carbon tax (as per his own arguments), e.g. $3-4 a tonne, to internalise the costs of his 'Direct Action Scheme'. I speculated about such a "partial repeal" option/scenario in an earlier piece for The Conversation.
      See: https://theconversation.com/climate-action-under-an-abbott-government-13953

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  4. James Hill

    Industrial Designer

    A well written article that other authors might seek to emulate for the edification of their readers.
    More articles of this calibre across the board would solve not a few problems with expanding the general public understanding of issues of importance.

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  5. John Newlands

    tree changer

    The Europeans have botched their ETS and Australia should remain at arms length until it is fixed. I believe a flexible CO2 price is the correct approach but it should be well founded. That is clearly not the case with free permits and cheap offsets of questionable physical merit. The EU should follow what works in the US NOx and SOx auction scheme
    http://en.wikipedia.org/wiki/Acid_Rain_Program

    It's extraordinary that DCEE's climate change factsheet says we must cut emissions 80% between 2000…

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    1. David Arthur

      resistance gnome

      In reply to John Newlands

      There may be advantages to price flexibility, but surely that applies if and only if price variations are only ever in the upward direction.

      SOx emission capping schemes only ever worked because decreasing SOx emissions that were subject to the cap were straightforward;
      1) Coal users could switch to low sulfur coal (eg Australian coal)
      2) Coal users are generally large utilities for which there is a straightforward engineering fix - bolt a precipitator on to the side of your exhaust header…

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    2. Gary Murphy

      Independent Thinker

      In reply to David Arthur

      "Now, this is the really clever bit: instead of setting Renewable Energy Targets, simply increase the RATE of FFCT each year, with offsetting cuts to other taxes."

      If you get rid of the RET - no renewables will be built until the price exceeds $50/t. Building electricity generation takes time and we need to start ASAP.

      We need an emissions price and the RET. The RET to ensure we start building renewables and the emissions price to make other cheaper emission reductions.

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    3. David Arthur

      resistance gnome

      In reply to Gary Murphy

      Simple: start the FFCT at $50/tonne CO2 - after all, that's only $183/tonne fossil carbon, and petrol excise at 38.14 c/L works out to ~$615/tonne fossil carbon on unleaded.

      Thereafter, continue raising the FFCT. Every time the FFCT is raised by $50, petrol excise can be decreased by 3.1 c/L (to avoid double dipping): noting that the tax is on fossil fuels only, this will be a large incentive to replace fossil fuels with biofuels (non-fossil, hence FFCT-free). Further, note that as petrol excise decreases, so too does fuel excise rebates.

      For comparison, the entire Australian taxation plethora (taxes, excises, and rates) would be replaced with a fossil carbon consumption tax of $889/tonne CO2 ($3,256/tonne fossil carbon)

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    4. David Arthur

      resistance gnome

      In reply to Stephen McGrail

      If all taxes were replaced by a fossil fuel carbon tax, if petrol excise at 38.14 c/L equates to $615/tonne fossil carbon, then $3256/tonne fossil carbon equates to fuel excise ~$2.01 per litre.

      That is, petrol prices would increase by ~$1.63 per litre.

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    5. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to David Arthur

      Thanks David, so - based on todays prices (here in Melb) - we would then pay ~$3 per litre. (It was about $1.40 last time I filled up). Yikes.

      Given the amount people shout and complain when fuel goes up by 10c or 20c, how do you think they'll react to $3 per litre fuel?!

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    6. David Arthur

      resistance gnome

      In reply to Stephen McGrail

      Stephen, don't forget that $1.63 per litre assumes that nobody pays income tax, company tax, GST, council rates, or any other government tax.

      Note, however, these numbers are illustrative only. I'm not actually arguing for complete replacement of the present system of taxes and charges with a fossil fuel consumption tax (FFCT), but rather for the following process.

      1. Start cutting taxes.
      2. Make up the revenue shortfall with a consumption tax on fossil fuel.
      3. Cut more taxes, and…

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    7. Gary Murphy

      Independent Thinker

      In reply to David Arthur

      Are you sure about that number? By my calculations $50/t equates to around 15c/L.
      1L = 1kg = 3kg CO2 @5c/kg = 15c/L.

      If you want to reduce the political obstacles - you have to keep the changes and costs to a minimum.

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    8. Doug Hutcheson

      Poet

      In reply to Stephen McGrail

      "Given the amount people shout and complain when fuel goes up by 10c or 20c, how do you think they'll react to $3 per litre fuel?" They will grumble loudly and find creative ways to reduce consumption. On the other hand, if we do nothing and global warming occurs as predicted, they will grumble loudly and find creative ways to reduce consumption. Either way, the desired effect is achieved.

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    9. David Arthur

      resistance gnome

      In reply to Gary Murphy

      Thanks Gary.

      38.14c/litre petrol ~ 38.14c/0.8 kg octane ~ 38.14c/0.6 kg carbon
      ~ 38.14c / 2.2 kg CO2 = $173 / tonne CO2.

      If fossil fuel consumption tax (FFCT) replaced all other taxes, it would be set somewhere around $889 / tonne CO2. Petrol prices would therefore increase by around 38.14 x (889/173) = 196 c/L; that is petrol prices would increase by ~$2 per litre.

      "If you want to reduce the political obstacles - you have to keep the changes and costs to a minimum." Correct - and that…

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  6. Lee Emmett

    Guest House Manager

    Labor and Greens put forward the current carbon price package in good faith, at the time, with the perfectly good logic that it would encourage industry to move towards renewable energy options. This has occurred.

    Like all commodities in markets, a carbon price will fluctuate. And to guess what the carbon price will be next week, next month or next year is just that - a guess!

    If we all knew what the price of a particular commodity would be on a particular date, we'd all be incredibly wealthy because we'd make good decisions about buying or selling, every time.

    In the real world, there are changes, uncertainties and nothing stands still.

    Tony Abbott is foolish if he thinks he or anyone else can predict a future price for a particular commodity: it's called ínsider trading' if someone profits from privileged information.

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  7. Gideon Maxwell Polya

    logged in via Facebook

    As explained below, missing from this analysis (and from related coverage by Mainstream media in Murdochracy, Lobbyocracy and Corporatocracy Australia) is the extraordinary dishonesty of the Gillard Labor Government's Carbon Tax arrangements that make coal, gas and oil production almost tax free - a scandal vastly bigger than the coal-related scandals considered by ICAC in Sydney.

    In short, the Australian Federal Government supports massive conventional natural gas and Coal Seam Gas (CSG) developments…

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    1. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to Gideon Maxwell Polya

      The article is about the politics and limitations of forecasting (specifically the need to better understand the inherent price and market uncertainties of a publicly traded commodity like emissions permits), not climate policy more broadly. But thanks for reading...

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    2. Gideon Maxwell Polya

      logged in via Facebook

      In reply to Stephen McGrail

      My comment was most definitely about "the inherent price and market uncertainties of a publicly traded commodity like emissions permits", albeit from a science-based perspective crucial to understanding the realities of the situation.

      Unfortunately neither the pro--fossil fuels and scientifically illiterate Coalition nor pro--fossil fuels and scientifically illiterate Labor (the Lib-Labs, the Liberal-Laborals) have any serious intention of "tackling climate change" and are both resolutely committed to unlimited coal gas and iron ore exploitation and to ignoring the absence of a carbon price reflecting the horrendous human and environmental cost of greenhouse gas pollution (e.g. see "Australian carbon burning-related deaths and carbon burning subsidies => minimum Carbon Price of A$554 per tonne carbon (C) or A$151 per tonne CO2-e": https://sites.google.com/site/yarravalleyclimateactiongroup/2011-carbon-burning ).

      Ignoring the science won't make the awful reality go away.

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    3. Stephen McGrail

      Research Fellow, Swinburne Institute for Social Research at Swinburne University of Technology

      In reply to Gideon Maxwell Polya

      Sure, I agree that the science should inform policy better than it presently does. I also appreciate that politics shapes and creates artificial markets like these, which is implicitly the point you're making (also a relevant point in terms of how these markets evolve into the future).

      However, I do think you're over-moralising in some respects. If you google some theory on "path dependency" and carbon lock-in you'll start to better understand the dilemmas policy-makers are confronting in responding to the issue.

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