Economic prosperity improves in a low-pollution future. Even ambitious emission reduction goals have little impact on growth in Australia’s economy and in household incomes.
Large reductions in emissions do not require reductions in economic activity, because the economy restructures in response to emission pricing.
Real household income continues to grow, although households face higher prices for emission-intensive products, such as electricity and gas.
Broadly based market-oriented mitigation policies reduce the cost of achieving emission reduction goals. Exempting emission sources from emission pricing increases costs.
Early global mitigation reduces long-term costs. Strong global action towards low stabilisation levels provides insurance against climate change uncertainty.
There are advantages to Australia acting early if emission pricing expands gradually across the world. Economies that defer action face higher long-term costs, as more emission-intensive infrastructure is locked in place and global investment is redirected to early movers.
Australia’s mitigation costs are higher than most developed economies due to its large share of emission-intensive industries. Differentiation of developed countries’ national emission reduction targets could help reduce differences in mitigation costs between countries.
Participation in global emissions trading is important to minimising Australia’s costs.
Australia’s costs will be affected by progress in low-emission technologies, particularly carbon capture and storage, which will affect future demand for Australia’s coal resources.
Australia’s comparative advantage will change in a low-emission world. Impacts on Australian producers will depend largely on their emission-intensity relative to other producers.
Lower demand for Australia’s emission-intensive commodity exports could generate benefits for other export-oriented and import-competing industries through its impact on Australia’s exchange rate.
Allocation of some free permits to emission-intensive trade-exposed sectors, as the Government proposes, eases their transition to a low-emission economy. Shielding redistributes costs from shielded to unshielded sectors, and could redistribute costs amongst shielded sectors.
Emission pricing will accelerate the development and deployment of new low-emission technologies.
This chapter covers the macroeconomic, sectoral and distributional impacts of different emission trajectories on the Australian economy. It analyses the global economic and mitigation policy context, then sets out the implications for different sectors and households.
Box 3.1: The reference scenario: starting point for analysis
The reference scenario is a major determinant of mitigation costs, because it determines the scale of the mitigation task.
Important global trends in the reference scenario include strong global economic growth; rising per capita incomes; slowing population growth over the century; continuing reliance on fossil fuels for energy (although the competitiveness of renewable energy sources improves over time); and falling emission intensity of the global economy from 0.7 kg CO2−e/US$ in 2008, to 0.6 in 2020 and 0.4 by 2050.
As a result, the reference scenario projects strong growth in global greenhouse gas emissions from roughly 42 Gt CO2−e in 2008 to 57 Gt in 2020 and over 100 Gt by 2050.
Australia sees similar trends: rising per capita incomes and population; declining emission intensity of the economy, from 0.6 kg CO2−e/A$ of GDP in 2006, to 0.3 kg CO2−e/A$ in 2050; and rising national emissions, which grow from around 580 Mt CO2−e in 2008 to 770 Mt in 2020 and more than 1,000 Mt by 2050.
Australia’s emissions growth to 2020 in the reference scenario is stronger than Australia’s most recent official projections (DCC, 2008b). This is largely due to different sector productivity and stronger economic growth assumptions in the reference scenario, and the absence of new mitigation policies, such as the planned increase of the Renewable Energy Target.
Global emissions in the reference scenario are significantly higher than the reference scenario in many other studies. This increases the overall global mitigation task and associated costs.
All four policy scenarios modelled achieve sustained economic growth while substantially reducing emissions. From 2010 to 2050, real GNP per capita grows at an average annual rate of 1.1 per cent in the policy scenarios, compared to 1.2 per cent in the reference scenario. By 2020, real GNP per capita is around 9 per cent above current levels, compared to 11 per cent in the reference scenario. By 2050, real GNP per capita is 55-57 per cent above current levels, compared to 66 per cent in the reference scenario.
Change from reference
Source: Treasury estimates from MMRF.
Emission pricing has slightly smaller impacts on Australia’s GDP. From 2010 to 2050, real GDP per capita grows at an average annual rate of 1.2-1.3 per cent in the policy scenarios, compared to 1.4 per cent in the reference scenario. Change in real GDP is not a complete measure of the economic impacts of emission pricing, as it does not include income transfers associated with international emissions trading.
Stabilising at lower concentration levels requires faster cuts in global emissions and higher emission prices. Stabilisation at 550 ppm requires an initial emission price of A$23/tCO2−e in 2010 in nominal terms (A$20 in 2005 dollars). The starting price is 40 per cent higher to achieve 510 ppm (CPRS −15 scenario) and 110 per cent higher to achieve 450 ppm (Garnaut −25 scenario). Higher emission prices generally result in higher aggregate economic costs.
Emission pricing produces a one-off rise in the consumer price index (CPI) of around 1-1.5 per cent for emission prices in the CPRS scenarios, which start at around A$23-32/tCO2−e (A$20-28 in 2005 dollars). Emission pricing is expected to have minimal implications for ongoing inflation; however, changes in coverage (such as extending the Carbon Pollution Reduction Scheme to agriculture in 2015) could produce additional smaller increases in the CPI at that time.
Large reductions in emissions do not require reductions in economic activity because the economy restructures in response to the emission price. Demand shifts from emission-intensive products such as coal, aluminium, beef and road transport towards lower-emission products such as renewable energy, wood products, chicken and rail transport. The emission intensity of production falls, so that, for example, the metals processing sector produces more iron and steel per unit of emissions. Production methods switch to less emission-intensive technologies and processes, such as electricity generation moving from conventional fossil fuel technologies to renewable sources and carbon capture and storage.
Box 3.2: Comparison of costs with other studies of mitigation policy
A number of recent studies explore the potential economic impacts of mitigation policy on the Australian economy.
Different assumptions, model parameters and analytical scope (how economic interactions between the global, national and sectoral scales are handled) all drive cost estimates. In addition, cost estimates are strongly affected by emission levels in the reference scenario (which varies across studies), as this determines the scale of economic restructuring required to achieve any given emission reduction goal. Other key assumptions include technology availability and cost, and mitigation policy design, including emission reduction targets.
This report’s results are within the range of previous estimates. All studies find that even very substantial emission reductions can be achieved while maintaining robust economic growth.
Change from reference
- Mitigation task is the difference between emissions in the reference and policy scenarios.
- Climate Institute results are for 2030 (not 2020); Concept Economics results are for 2030 (not 2050).
Source: Treasury estimates from MMRF; Climate Institute (Hatfield-Dodds et al, 2007); Allen Consulting Group (2006); ABARE (Ahamaad et al, 2006); and Concept Economics (2008).
The economy’s response to emission pricing allows large reductions in the emission intensity of production, so incomes continue to rise while emissions fall. The emission intensity of the Australian economy falls from 0.3 kg CO2−e/$ of GDP in 2050 in the reference scenario to less than 0.15 kg CO2−e/$ of GDP in the policy scenarios.
Note: Australian dollars, 2005 prices. Actual emissions and emission allocations differ due to permit banking and international permit trade.
Source: Treasury estimates from MMRF.
While impacts are small at an aggregate level, larger impacts occur at a sectoral level.
All sectors covered by the emission price could reduce emissions (Chart 3.2). Low-emission technologies play an important role in some sectors, such as electricity generation and transport. Changes to management practices, production inputs and processes allow significant emission reductions in agricultural and industrial sectors over time.
The particular mix of mitigation activities projected reflects the assumptions made regarding supply-side opportunities to reduce emissions, and demand-side responses to changes in relative prices. These opportunities and responses are uncertain, particularly over the long term, so are impossible to accurately predict. This is why creating mitigation incentives across the whole economy is more efficient than targeting specific emission sources or sectors. Broadly-based market-oriented policies, such as emissions trading, allow the market to respond as new information about mitigation opportunities becomes available.
CPRS −5 scenario
Source: Treasury estimates from MMRF.
Developments in the global economy will significantly affect Australia’s mitigation costs. Global mitigation efforts will create costs, such as through reduced demand for Australia’s coal exports, and benefits, such as through accelerated development of low-emission technologies. The global emission price also will affect Australia’s emission price through international emissions trading.
Putting a price on emissions breaks the link between global economic growth and growth in emissions. All scenarios modelled show robust global economic growth, while growth in emissions is dramatically reduced. Australia’s aggregate mitigation costs, as a share of GNP, are higher than the world average. Australia has relatively less potential to reduce emissions at low emission prices, so participation in the global emissions trading market is important to minimise Australia’s costs. The timing of global action and rate of progress in developing low-emission technologies also affect Australia’s overall costs.
3.2.1 The global costs of stabilisation
Mitigation costs vary depending on the nature, horizon and stringency of the global stabilisation target, and the emission pathway travelled to reach it. The global environmental objective is the key determinant of emission prices and aggregate global costs. Lower stabilisation levels, which reduce the risks of dangerous climate change, generally increase mitigation costs. Global costs at 2020, as a share of gross world product (GWP), increase by 50-100 per cent as the stabilisation goal shifts from 550 ppm to 450 ppm; however, this premium narrows over time, so that by 2050 the costs of achieving 450 ppm are around 30-60 per cent higher than those of 550 ppm.
From 2010 to 2050, real GWP grows at an average annual rate of 3.3-3.4 per cent in the policy scenarios, compared to 3.5 per cent in the reference scenario. By 2050, emissions are 65-80 per cent lower than in the reference scenario, while GWP in 2050 is 2.7-4.3 per cent lower (Chart 3.3).
Per capita level
Change from reference
Note: GWP is aggregated using purchasing power parity values. GTEM estimates a 2.7-4.3 per cent reduction from reference scenario GWP in 2050.
Source: Treasury estimates from G-Cubed.
Box 3.3: Setting targets in an uncertain world
The ultimate global environmental objective is uncertain. Even if a stabilisation target is agreed as part of the post-2012 international framework, it may change in the future as understanding of the costs and benefits of mitigation action improves. Stronger mitigation action in the short term helps preserve the option of pursuing lower stabilisation levels, and could be a cost-effective strategy in the face of uncertainty.
Stronger global mitigation action accelerates cost reductions in low-emission technologies, which helps reduce future costs, even if stabilisation goals are relaxed. In contrast, weaker global mitigation action produces higher short-term emissions, which then require faster emission reductions if stabilisation goals are subsequently strengthened. This suggests economic benefits may flow from setting low stabilisation goals at the global level. Weaker global action may prove costly in the long term. This result accords with previous studies of the ‘option value’ of stronger mitigation action (Yohe et al, 2004).
Stabilising at lower concentration levels requires faster cuts in global emissions, and higher emission prices (Chart 3.4).
Note: Price in 2005 US dollars.
Source: Treasury estimates from GTEM.
Note: All dollars are US 2005 prices; GWP is aggregated in purchasing power parity. Emissions in the reference scenario are actual emissions from GTEM.
Source: Treasury estimates from GTEM and G-Cubed.
Lower stabilisation levels involve tighter constraints on total global emissions, and generally imply lower national emission trajectories and higher national mitigation costs. In the unified global action (Garnaut) scenarios (which allocate emission rights on a per capita basis), stabilisation at 550 ppm implies targets for Australia of 10 per cent below 2000 levels in 2020, and 80 per cent in 2050; whereas, stabilisation at 450 ppm implies targets of 25 per cent and 90 per cent below 2000 levels in 2020 and 2050. To achieve 450 ppm, the associated costs to Australia (as a share of GNP, compared to achieving 550 ppm) increase by around 30 per cent at 2020, and around 25 per cent in 2050.
3.2.2 Australia’s economic costs compared to other regions
Mitigation costs will vary widely across economies, both in terms of aggregate economic costs (as a share of GNP) and the marginal cost of reducing each tonne of emissions.
Aggregate costs and marginal costs have different determinants. Aggregate costs largely depend on the share of energy- and emission-intensive industries in the economy (as this determines the extent of economic restructuring required), while marginal costs depend on the nature of emission reduction opportunities in the economy. Some economies, such as Japan, have relatively low aggregate costs but high marginal costs, while others, such as China, have relatively high aggregate costs but low marginal costs. Australia’s costs, both aggregate and marginal, are relatively high.
Differences in aggregate economic costs are relevant to assessing the comparability of each country’s effort, an important factor in international negotiations on the post-2012 mitigation framework.
Among Annex B countries, Australia is likely to face relatively high mitigation costs as a share of GNP. Australia’s costs reflect its large share of emission- and energy-intensive industries and dominance of low-cost coal in electricity generation, compared to the United States, Japan and the European Union. Canada and Russia are also fossil fuel producers, and face comparable or higher aggregate mitigation costs than Australia.
Differentiating national emission reduction targets, by taking account of the existing structure of national economies, could help narrow the differences in aggregate mitigation costs.
This report explores two approaches to determining national contributions to global mitigation: a per capita contraction and convergence approach (Garnaut scenarios); and a simple multi-stage approach (CPRS scenarios). The multi-stage approach reduces costs for Australia, Canada and Russia, relative to the per capita allocation, and increases costs for the European Union and Japan to a limited extent.10 This outcome is a result of Australia’s relatively high per capita emissions, which means that a per capita approach results in a more stringent emission reduction target in Australia, compared to the multi-stage approach.
While the level of impact changes, the overall pattern of relative costs is the same for the two approaches (Chart 3.5).
Change from reference
Source: Treasury estimates from GTEM.
All Annex B countries achieve strong growth in real GNP per capita in all policy scenarios. While Russia and the transition economies incur the greatest aggregate costs relative to the reference scenario, their real GNP per capita growth is strongest (albeit from a lower base), and it grows to more than three times current levels by 2050. Real GNP per capita in all other regions increases by 52-80 per cent from current levels in the policy scenarios, compared to 54-85 per cent in the reference scenario.
Both the per capita and multi-stage approaches seek to take account of the different responsibility and capacity of developing countries. Even so, many developing countries face similar or higher mitigation costs as a share of GNP than developed countries, because of the larger contribution of emission- and energy-intensive industries to their overall economies.
3.2.3 Australia’s marginal costs and international permit trade
Whether, and how much, international trade in emission permits is allowed will affect Australia’s costs in achieving any given emission trajectory.11 The pattern of international permit trade depends on the allocation of emission rights and the relative marginal cost of mitigation (the cost of reducing an additional tonne of emissions) in each region.
International trade can reduce the cost of achieving emission reduction targets because it allows mitigation to occur wherever it is cheapest. Trade does not compromise the environmental objective, because Australia’s ‘excess’ emissions are offset by lower emissions in economies that export permits.
The global analysis suggests Australia’s marginal costs are higher than many other economies for three key reasons.
- Australia’s abundant low-cost fossil fuels make low-emission electricity generation technologies less competitive. As a result, Australia needs higher emission prices to reduce emissions in its electricity sector.
- Agriculture comprises a larger share of Australia’s economy, and has fewer mitigation options than many other sectors. Australia is projected to retain a comparative advantage in agriculture in a low-emission world, and so maintains agricultural output, with the associated emissions.
- Like most other developed economies, Australia’s pre-existing energy-efficiency standards are higher than in developing economies. Any reduction at the ‘margin’ is thus more costly.
This means it is cost-effective for Australia to import permits to meet its emission target. Australia’s gross emissions are generally higher than the national trajectory, and Australia’s emission trajectory therefore represents its net emissions after trade. Australia is projected to import more permits over time (Chart 3.6). Imports plateau when carbon capture and storage technologies are widely deployed, driving significant emission reductions in Australia’s electricity generation sector.
CPRS −5 scenario
Source: Treasury estimates from MMRF.
This highlights the importance of establishing a robust and efficient global market that allows all economies to access low-cost mitigation. Linking the Carbon Pollution Reduction Scheme to market-based schemes elsewhere in the world would equalise marginal costs across economies, and help reduce the cost of Australia’s contribution to the global mitigation effort (DCC, 2008a; and Prime Ministerial Task Group, 2007).
The multi-stage (CPRS) scenarios explore the potential costs of trade restrictions. Permit trade is capped until 2020 at 50 per cent of mitigation effort.12 This has no or negligible impact on Australia’s costs, depending on the model, because Australia meets its obligations through a mix of domestic mitigation (at the global emission price), permit banking, and trade to the allowed level. If the trade constraints were binding (if fewer permits were banked in the early years, or less domestic mitigation was available), the domestic emission price would rise to stimulate the additional mitigation required to meet the national emission cap. This would tend to increase aggregate mitigation costs.
While international emissions trading reduces the cost of achieving any given stabilisation goal, exempting emission sources (whether sectors, gases or regions) from the trading scheme increases costs. If mitigation from forestry activities is not included in the global framework, the emission price required to achieve 550 ppm could rise by 30 per cent, and global costs (as a share of GWP in 2050) could rise by around 25 per cent. Reducing deforestation and increasing reforestation could provide lower-cost mitigation.
3.2.4 The benefits of early action and the costs of delay
Delaying mitigation action in the global economy will increase climate change risks, lock in more emission-intensive industry and infrastructure, and defer cost reductions in low-emission technologies. This will increase the cost of achieving any given environmental goal.
In a sensitivity analysis where global mitigation action is delayed by seven years, the short-term benefits of delay are quickly outweighed by the additional costs, as greater emission reductions are required in a shorter time to achieve the same environmental outcome. As a result, global costs as a share of GWP are about 10 per cent higher in 2050, and remain higher for the rest of the century. While forward-looking behaviour by firms, individuals, and investors may reduce the size of this effect, this will depend heavily on expectations regarding future mitigation policy.
Extended delay by some major emitters could make stabilisation at low levels impossible. For example, if Annex B countries reduce their emissions to zero by 2050, but other countries follow reference scenario emission levels, greenhouse gas concentrations would be over 650 ppm by 2050 and rising.
If emission pricing is introduced gradually, rather than in all economies at the same time, long-term costs are lower for early movers, and higher for economies that delay. The economies that defer emission pricing become more relatively emission-intensive, so when an emission price is eventually introduced, they face greater costs, particularly because global investment is redirected to early movers.
This is one reason why Australia faces lower costs under the multi-stage approach: while GDP impacts are marginally higher than in the unified approach at 2020, impacts are roughly 10 per cent lower by 2050, reflecting the benefits of greater inward foreign investment.
If global agreement is considered inevitable (at least in the long term), Australia could gain a relative advantage by starting to reduce emissions early.
3.2.5 The role of technology
Progress in developing low-emission technologies is important for reducing global and Australian mitigation costs. Faster technological progress will reduce costs; slower progress will increase costs relative to the central policy scenarios.
More optimistic technology assumptions reduce global costs (measured as a share of GWP) by about 20 per cent in 2050, compared to central technology settings. On the other hand, if carbon capture and storage does not prove commercially viable, global mitigation costs at 2050 could be 10 per cent higher than under central technology assumptions.
Australian costs are sensitive to technology assumptions, as technological progress will affect the value of, and demand for, Australia’s coal resources. Australia’s costs as a share of GNP in 2050 are 25 per cent lower under more optimistic assumptions, and 25 per cent higher if carbon capture and storage is not viable, compared to central technology assumptions.
Pricing emissions drives a structural shift in the economy from emission-intensive goods, technologies and processes towards low-emission goods, technologies and processes. As a result, growth slows for emission-intensive sectors, such as coal, gas, iron and steel, and livestock. Growth accelerates for low and negative-emission sectors, such as forestry and renewable energy.
Pricing emissions also changes Australia’s comparative advantage. Australia maintains or improves competitiveness where local production is less energy- or emission-intensive than production of the same good in other countries, such as for coal, and loses competitiveness where local production is more emission-intensive, such as for aluminium.
Lower demand for Australia’s emission-intensive commodity exports could generate benefits for other export-oriented and import-competing industries through its impact on Australia’s exchange rate. Impacts on non-traded low-emission sectors, such as services, broadly reflect the aggregate impact on the domestic economy.
Garnaut −10 scenario, change in gross output relative to reference
- Forestry output estimates are based on land area.
Source: Treasury estimates from MMRF.
Gross output, Garnaut −10 scenario
Level change from 2008
Change from reference
Source: Treasury estimates from MMRF.
Effects are broadly consistent across all the scenarios, although sectoral gains and losses are generally larger for lower stabilisation levels. This section presents results based on the unified global action scenario (Garnaut −10), because the assumption of unified global action simplifies the analysis and several sensitivity studies were based on this scenario. The discussion contrasts the results for the other scenarios where differences are important.
3.3.2 Impacts on emission-intensive sectors
Global demand for emission-intensive commodities falls in response to emission pricing. Where Australia has relatively low emission intensity of production, emission pricing improves its competitiveness and is likely to increase its share of global trade in that commodity. This could partially or wholly offset the effect of slowing global demand growth. Where Australia has relatively high emission intensity, competitiveness declines and Australia’s share of global trade is likely to fall (Box 3.4).
Box 3.4: Sectoral impacts and structural adjustment
The difference between changes relative to the reference scenario, and changes relative to the level of current activity, are important in assessing structural adjustment needs.
The economy will adjust from its current structure. Mitigation policies will change the pattern of future economic activity, so the reference scenario economy of 2050 will not eventuate. Today’s economy, therefore, provides a useful reference point.
The policy scenarios project large reductions in the output of some sectors relative to the reference scenario. However, most of these sectors are projected to grow from current levels; the reductions relative to the reference scenario mean they grow more slowly than they would in a world without climate change.
Within sectors, some firms and regions could face a serious adjustment task, including early plant closures. The transition will need careful management. The Government is committed to supporting affected workers and regions where required, and has proposed special measures to manage impacts on emission-intensive trade-exposed sectors and coal-fired generators (DCC, 2008a).
In the medium to long term, employment and investment will move to other lower-emission sectors.
Australian output of key emission-intensive exports, such as coal, aluminium and meat products, grow more slowly than in the reference scenario in all four policy scenarios, as consumers across the world substitute towards lower-emission commodities. However, Australia’s share of global trade increases for coal, and is broadly maintained for iron and steel. Australia’s share of global trade falls for aluminium, given its relatively higher emission intensity of production in Australia.
Effective carbon capture and storage technologies are key to future demand for coal. Overall, across the four policy scenarios (which assume this technology is viable), Australia’s coal output grows relative to current levels. If carbon capture and storage is not viable, coal output falls from current levels (Chart 3.8).
Share of global trade
Source: Treasury estimates from GTEM.
Impact on competitiveness in a multi-stage world: the role of shielding
Coordinated global efforts help ensure any changes in Australia’s comparative advantage arise from real differences in the emission intensity of production, rather than from uncoordinated policy action. Competitiveness distortions may arise where Australia prices emissions before other economies: emission-intensive trade-exposed sectors (EITES) could move to other locations that are more emission intensive than Australia, but not yet pricing emissions. As a result, global emissions could rise, a process called ‘carbon leakage’.
The Government proposes transitional assistance for EITES when it introduces the Carbon Pollution Reduction Scheme to reduce carbon leakage and support the transition to a low-emission economy (DCC, 2008a). This transitional assistance ‘shields’ EITES from the full effect of emission pricing. Crucial features of the proposed shielding are that shielded firms face a strong incentive to reduce emissions, even if they obtain free emission permits, and that the level of shielding gradually declines.
The risk of carbon leakage and cost of shielding is explored in the CPRS scenarios, which assume Australia prices emissions ahead of many other regions.13
The results show little evidence of carbon leakage. Where shielding is removed, the emissions and output from EITES in non-participating regions do not increase. This suggests the emission prices in these scenarios are not high enough to induce significant industry relocation. Noticeable impacts only occur at much higher emission prices (roughly double the price of the CPRS −5 scenario).
Nevertheless, shielding does reduce the impact of emission pricing on shielded sectors in the initial years of the scheme. When shielding is applied, output of EITES falls relative to the reference scenario (reflecting the contraction in world demand), but at a more gradual rate. This effect is particularly significant for the aluminium sector. This suggests the shielding arrangements proposed in the Carbon Pollution Reduction Scheme Green Paper could ease the transition to a low-pollution future for the shielded sectors.
Shielding redistributes costs from shielded to unshielded sectors, through its impact on electricity prices (higher output in EITES brings greater demand for electricity, and so higher prices), and on permit trading (higher output in EITES means that Australia imports more permits to meet its emission target). Shielding also redistributes costs amongst shielded sectors, by diverting labour and capital from more to less competitive EITES.
Redistribution effects would be greater if shielding mutes mitigation incentives, if a greater proportion of permit revenue is devoted to shielding, or if more permits could not be imported (because international permit trade was more limited).
Both GTEM and MMRF are likely to overestimate carbon leakage and the relocation of production activities: the models are not forward-looking (so firms are assumed to take no account of the possibility of future emission prices in the new location), and do not account for adjustment costs associated with relocation. In reality, industry location reflects multiple factors, including access to skilled labour, legal and political stability, access to resources and quality of infrastructure. These factors suggest that fears of carbon leakage could be overplayed.
3.3.3 Impacts on low-emission sectors
Demand for low-emission goods and services increases, particularly where they provide an alternative to higher-emission commodities, or the emissions trading market creates a new source of revenue.
These effects are evident in the forestry sector. Consumers substitute towards wood products (a low-emission good) and forests sequester carbon and generate credits for sale in an emissions trading scheme.14
Forestry’s expansion has flow-on effects for some agricultural sectors, particularly cattle and sheep grazing. These activities compete for land, so as forestry expands, livestock production contracts (relative to the reference scenario). This effect strengthens in the scenarios with lower stabilisation levels, as the higher emission prices make forestry even more profitable than competing land uses.
The modelling may overstate impacts on agriculture, as the MMRF model does not differentiate between different land types (high quality agricultural land versus marginal land). If forest expansion occurs predominantly on marginal land, agricultural output may be relatively less affected.
3.3.4 Flow-on effects
Global demand for Australia’s coal and aluminium falls in a low-emission world. As a result, Australia’s terms of trade — which measure the price of Australia’s exports relative to the price of Australia’s imports — fall relative to the reference scenario.
This in turn causes Australia’s exchange rate to depreciate, which improves the competitiveness of many other export-oriented and import-competing industries, including manufacturing. Wood products; textiles, clothing and footwear; non-meat food; motor vehicles and chemical manufacturing benefit from the lower exchange rate, and increase output relative to the reference scenario. Iron ore mining, dairy and grains also benefit from the lower exchange rate.
3.3.5 Technological transformation of electricity and transport
Electricity generation accounts for the largest share of Australia’s current emissions, reflecting the dominance of coal-fired technologies in Australia. Transport accounts for a smaller but significant share of national emissions. Pricing emissions will drive significant changes in the technology mix of both sectors, improving the competitiveness of renewable energy sources and more efficient technologies, and accelerating the development and deployment of new low-emission technologies.
The mix of future electricity generation technologies is highly uncertain. Demand levels and technology and input costs will play a crucial role and are difficult to predict. Fuel types are likely to shift, with emission prices driving the timing and magnitude of the shift. Conventional fossil fuel technologies will become less competitive; gas (significantly less emission intensive than coal) is likely to increase its market share in the short term; and renewable technologies will become increasingly competitive over time. From the mid-2020s, carbon capture and storage begins to replace conventional coal-fired technologies, including through retrofitting existing power plants (Chart 3.9).
CPRS −5 scenario
Note: This scenario includes the 45,000 GWh Renewable Energy Target.
Emission pricing could bring forward the retirement of some conventional fossil fuel plants, and stimulate construction of substantial new generating capacity. By 2050, renewables account for at least 40 per cent of generation across the policy scenarios, compared to just over 5 per cent in the reference scenario.
Australia’s electricity supply remains secure. Emission pricing and adoption of low-emission technologies increases the cost of electricity generation. As these costs are passed on to electricity consumers, demand falls. The combined effect of reduced demand and new plant construction ensures generation capacity meets projected demand in all scenarios.
The planned Renewable Energy Target of 45,000 GWh per year in 2020 stimulates extra renewable deployment in the short term, and brings forward additional domestic mitigation. This does not change Australia’s emission price, due to links between Australian and global emission permit markets. However, electricity prices increase slightly, resulting in slightly lower GDP in 2020. GNP is less affected, as the additional domestic mitigation means fewer permits are imported.
As low-emission generation technologies capture a larger share of generation, electricity becomes relatively less emission intensive than other energy sources. This leads industry, households and transport to replace direct use of fossil fuels with electricity. As a result, electricity demand increases strongly relative to the reference scenario after 2050.
The transport sector has relatively higher marginal mitigation costs than electricity, so delivers less mitigation in the short term. Nevertheless, emission pricing drives significant reductions in the emission intensity of transport, including through changes in the fuel mix, vehicle types and transport modes.
Emission pricing improves the competitiveness of lower-emission technologies, such as diesel, and reduces the competitiveness of synthetic fuels (liquid fuels derived from coal and natural gas). As a result, diesel’s share of road transport fuel demand increases from around 20 per cent in the reference scenario to 30 per cent in all policy scenarios at 2050; synthetic fuels’ share falls from around 10 per cent in the reference scenario to zero in all policy scenarios.
The increased price of transport fuels accelerates the uptake of more efficient vehicle technologies, such as hybrids, as well as a shift towards smaller vehicles. By 2050, electric and plug-in hybrid vehicles supply about 25 per cent of the community’s transport needs, compared to around 2 per cent in the reference scenario. Higher road transport costs also stimulate a shift towards rail, particularly for freight.
Real household income grows strongly in all policy scenarios. Households face higher prices for emission-intensive products, such as electricity and gas. The share of household income spent on these goods is likely to fall over time.
3.4.1 Introduction of emission pricing
The initial household impacts of the two CPRS scenarios were modelled using Treasury’s price and distributional models. This modelling assumes the emission price is fully passed through to consumers, and consumers do not change their consumption of goods and services in response to changing relative prices. Both assumptions will tend to overestimate impacts, so these estimates are likely to represent an upper bound on initial consumer price impacts at a given emission price.
Based on the CPRS scenarios, the emission pricing is projected to lead to a one-off rise in the consumer price level of around 1-1.5 per cent, with minimal implications for ongoing inflation.15
Emission pricing will have the greatest impact on emission-intensive goods, such as electricity, gas and other household fuels. The average household is expected to spend an extra $4-5 per week on electricity and $2 per week on gas and other household fuels. This corresponds to an increase in electricity prices of 17-24 per cent and in gas prices of 11-15 per cent.
The Government plans to offset the impact of emission prices on emission-intensive petroleum fuel products through cuts in fuel taxes (DCC, 2008a), so the price of petrol does not increase when the scheme starts. Similarly, while sheep and cattle production is emission intensive, the price of meat products does not rise when the scheme starts, as the Government plans to exclude agriculture from the scheme in the initial years.
Lower income households are likely to be more affected by the introduction of an emission price than other households, as they generally spend a higher proportion of their disposable income on emission-intensive goods, and may be less able to substitute away from these goods. In the CPRS −5 scenario, a single pensioner household in the lowest quintile of disposable income faces an average price rise in 2010 of 1.3 per cent, while households in the highest quintile of disposable income face an average price rise of 0.9 per cent (Table 3.5).
The Government is committed to helping households adjust to the Carbon Pollution Reduction Scheme, including by increasing benefit payments and other assistance to low-income households through the tax and payment system. These measures, together with the automatic indexation of benefits to reflect changes in the CPI, will help minimise household impacts.
CPRS −5 scenario
- Income quintiles rank households from the lowest 20 per cent of disposable income to the highest 20 per cent.
- Principal source of income from wages and salaries.
** Represents those results for which the sample size is too small to produce statistically reliable results.
3.4.2 Household impacts over time
Real household income grows strongly over coming decades in all scenarios. Real disposable income per capita grows at an average annual rate of around 1 per cent in the policy scenarios, compared with 1.2 per cent in the reference scenario. As a result, it is about 7-9 per cent higher than current levels by 2020, and about 50 per cent higher by 2050 (compared with 10 and 60 per cent in the reference scenario).
The largest relative price increases occur for emission-intensive goods such as road and air transport, electricity, and gas used for heating. The relative prices of most products that comprise a large share of household spending (including services, communication, accommodation and housing) fall. Households substitute away from emission-intensive products as their relative prices change.
The share of household income spent on energy and other emission-intensive goods is likely to fall over time. Emission-intensive goods and services comprise a small share of household spending over time in the reference and all four policy scenarios.
Overall, impacts on household consumption broadly mirror the impacts on the overall economy: consumption continues to grow at a slightly slower rate (Chart 3.10).
Change from reference
10 All Annex B countries benefit from the multi-stage approach in the long term, due to the benefits of early action.
11 References to emission permits include approved project-based offset mechanisms such as credits created under the Kyoto Protocol’s Clean Development Mechanism.
12 Effort is defined here as the difference between reference scenario emissions and the national emission trajectory.
13 The Garnaut scenarios assume emission pricing is introduced in all economies at the same time, so no carbon leakage occurs.
14 The Carbon Pollution Reduction Scheme Green Paper proposes to allow reforestation activities to opt in to the scheme from its start in 2010 (DCC, 2008a).
15 These estimates differ slightly from those presented in the Carbon Pollution Reduction Scheme Green Paper as the Green Paper analysis was based on a hypothetical emission price of $20; whereas, this range is based on the modelled CPRS scenarios. In addition, the models used have been updated for new input-output data.