Climate change: market failures spread like wildfire

July 26, 2008

Less than a fortnight after the release of the Rudd government's Carbon Pollution Reduction Scheme green paper, the potential losers are howling at the spectre of lost profits while the potential winners - global investment banks, hedge funds and commodities traders - are rubbing their hands at the thought of making millions from the permits to pollute that the scheme will create.

Most importantly, as the detail of the scheme sinks in, it is clear that it will create a whole new series of market failures to add to what Sir Nicholas Stern called the biggest market failure of all: the global warming threat itself.

After the cautiously positive reception their scheme got from the big corporations, to whom PM Kevin Rudd and climate change minister Penny Wong listened so carefully, it must have been galling to be attacked by heavy industry because its free permits to pollute aren't proposed to be tax exempt.

More galling still to be told by Woodside Petroleum's CEO Don Voelte that the scheme endangers $60 billion of investment in liquefied natural gas. That's because Woodside's LNG production process puts the company below the threshold for assistance to trade-exposed industries (1500 tonnes of carbon dioxide equivalent for every $1 million of revenue).

Having set up their exemption for the most greenhouse gas intensive industries, Rudd and Wong have created a "perverse incentive" for all firms just under the threshold to increase the greenhouse gas intensity of their production process (or to lobby fiercely for the threshold to be reduced).

The Australian Financial Review's Alan Mitchell explained the dynamic on June 21: "When a government signals that it is prepared to consider subsidising industry, it sets off a powerful dynamic. The CEO of every company that conceivably could qualify for a handout immediately swings into rent-seeking mode ... Voelte could not afford to let the economic rent cart go past without making a lunge for the goodies."

Indeed, for as long as this exemption lasts, any new carbon-intensive industry can now be set up to take advantage of the reward: Australia, as much as China or India, becomes a potential "pollution haven". That's market failure number one.

Next comes public transport, which appears unlikely to receive the dollar-for-dollar reduction in fuel excise to be extended to motorists and the trucking industry. According to Daniel Bowen, president of Victoria's Public Transport Users Association, the increased burden for public transport users, depending on the final price of carbon, could be as high as $50 a week (a repeat of the pattern following the introduction of the GST). Market failure number two.

Then there is the arrangement for international aviation to be excluded from the scheme, even as domestic aviation is included (unlike in the European Union scheme which is to include flights to and from Europe after 2012). This creates an incentive to make "domestic air travel" an extension of more damaging long-haul international air travel. Market failure number three.

The private power industry, even though it won its own Electricity Sector Adjustment Scheme from the Rudd government, also rapidly joined the chorus of corporate special pleading. Not content with privileged access to taxpayer millions, the industry has again been demanding that state governments eliminate caps on retail electricity prices.

Australian Power and Gas CEO Jim Myatt even raised the spectre of the California blackout crises of 2001-02: "If we get this issue where the wholesale [electricity] market drives up and people ... can't pass it through to the retail base, you get this wedge, the California [situation] where you do have retailers who are price-capped and a runaway wholesale market with no risk mitigation in between", he was quoted as saying in the July 23 AFR.

The private electricity generators are also demanding full compensation for the devaluation of their coal-fired power stations. Economic modelling commissioned by the Energy Supply Association of Australia (ESAA) purports to show that cutting emissions by 20% on 2000 levels by 2020 would see the retirement of three of the four major power plants in the La Trobe Valley, all coal generation in South Australia and one major plant in Queensland and NSW.

A good thing? Not for shareholder value. The ESAA is concerned that early retirement of power stations could reduce company income flows and put loan repayments at risk unless government steps in with adequate compensation and the removal of retail price caps - socialising generator losses while guaranteeing their gains. Market failure number four.

Lastly, the Rudd-Wong proposal does nothing in one area where energy efficiency gains are most readily achieved: building design and retrofitting. According to Stefan Preuss, the sustainable design manager for Spowers Architects: "The government's policy is relying on the secondary effects from rising electricity prices [but] the potential is greater and cheaper than any other sector. A kilowatt of electricity that is being saved due to improved building cost does not have to be produced." Market failure number five.

As a true believer in "the market", the Rudd government is now having to wear the consequences of its beliefs. Inevitably, too, it will yield more ground to most of the special pleading of the powerful corporations that dominate it.

On July 24, four days after Woodside's Voelte made his "lunge for the goodies", Rudd said: "I am confident there is a way forward through this partnership with the industry. And we are looking, for example, for submissions from the industry on the specific data requirements we have in terms of carbon intensity."

We can also put money on the Rudd government abandoning the one fig leaf of democracy its proposal contains: the suggestion that the scheme's cap on emissions be set by parliament. Here too "the market" will rule, with the creation of a carbon bank along the lines of the Reserve Bank, an institution to take tricky decisions about caps, compensation and exemptions out of the hands of people potentially vulnerable to public opinion.

[Dick Nichols is the national coordinator of the Socialist Alliance.]

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