Financial market implications from the carbon tax

Bookmark and Share Economics & Deregulation, Deregulation Unit, Energy and Climate Change | Alan Moran
In Finance Magazine 22nd March, 2012

There are three main issues related to measures involving taxing emissions of carbon dioxide and other greenhouse gases. First, there is the science of global warming - how much if any warming is likely to occur as a result of human economic activity? Second, there is the economics of this how much damage might the warming cause, how much would it cost to prevent it? Third, there is politics - in a world of independent sovereign states all with different levels of emissions and different ways of abating those emissions costs, how is it possible to arrange for collective action to abate them?

The conventional view on the science of warming is that increased atmospheric concentrations of carbon dioxide and other greenhouse gases will bring an increase in average global temperatures of between two and five degrees celsius. The higher end of this temperature range is generally above the levels seen over mankind's 200,000year existence, although not especially high in the context of geological time. Higher temperatures along the lines forecast are estimated to bring net, though not disastrous, costs.

Many scientific authorities cast doubt on likely levels of warming, and point out that, contrary to forecasts, global temperatures have been stable since the late 1990s. The Massachusetts Institute of Technology atmospheric physicist Professor Richard Lindzen estimates the maximum temperature increase due to human emissions is around 1.2 degrees celsius, most of which has already occurred.

Australia in a global context
Emissions are closely associated with income levels. In per capita terms Australia has higher emissions than most other countries largely because unlike most other developed countries Australia is a net exporter of products such as aluminium and steel that incorporate greenhouse gases. Australia's consumption of greenhouse gas emissions is about average among the developed countries. The table below illustrates this for carbon dioxide.

Forms and incidences of carbon taxation
Australia already has the following emission restraining measures:

  • The Renewable Energy Target (RET) which requires renewables like wind and solar will supply 20% of electricity by 2020.
  • Regulations on energy use related to housing construction and domestic appliances.
  • Budget subsidies and grants for selected projects and technologies.

The Productivity Commission (PC) estimated the effect of Australia's RET and similar measures as at 2010 was equivalent to a tax of between $44 and $99 per tonne of carbon dioxide. The RET was then less than half way to its 20% target and cost $473 million to $694 million in 2009 -10. A further $1 billion has been spent by Commonwealth departments on climate change measures, which are budgeted to expand considerably as a part of carbon tax laws.

There are also regulatory standards on top of these effects. In the case of housing, regulations in the form of five or six star energy ratings impose a cost estimated by the PC at over $3 billion per annum.

The carbon tax
Central to the Federal government's Climate Change Plan is a carbon dioxide tax, starting at $23 per tonne in 2012 and eventually rising to $131 a tonne. A $23 tax increases the wholesale price of electricity by more than 50%.

Australia's carbon dioxide emissions were 578 million tonnes in 2010 and with the measures in place are expected to be 621 million tonnes in 2020. Even in 2050, with optimistic assumptions about new technologies, industry restructuring and a carbon tax of $131, Australian emissions are forecast to be 545 million tonnes and half Australia's emission reductions will be purchased from overseas. This involves Australia paying countries to abate their own emissions at costs estimated to be $57 billion in 2050. This exceeds the value of our current exports from coal and is more than twice the value of all our current agricultural exports.

Concluding comments
Present-day energy consumption is highly reliant on carboniferous fuels. Energy itself is, second to food, the basic building block of all human activities.

Unlike the case with oil, which experienced a form of new tax in the OPEC supply restraint in the 1970s, substitutes do not exist. Modelling the effects is therefore precarious.

Australian Treasury 2011 estimates show the carbon tax will bring a loss of average income per person of $2700 per annum (in 2010 dollars) by 2050. This amounts to 5% of income in that year, with a cumulative loss by 2050 of $40,000 per person. This relies on a global agreement being negotiated, which appears to be increasingly unlikely. The forecasts also assume:

  • A very rapid technological development of carbon capture and storage and renewables.
  • A continued expansion of coal and other energy exports despite carbon restraining measures overseas.
  • That Australian labour productivity growth will continue (in fact increase) from 1.4% a year between 2000 and 2010 to 1.6% thereafter.

This final assumption means the key input to future income levels is made notwithstanding policy decisions that close down the industries that enjoy the highest levels of productivity. These include the 80% of electricity that is coal-based, as well as smelting, iron and steel. And the policy is to replace these high productivity industries with low productivity industries like wind and solar.

These matters are of crucial concern to the financial services sector. Australia's decision to impose a carbon tax will mean where energy costs loom large, in some cases this could threaten the viability of firms. In addition, firms whose activities involve direct production of emissions will need to account for these and, in many cases, arrange for offsetting purchases of carbon credits from low carbon dioxide emitting suppliers. Financial service providers will need to understand details of the obligations (and opportunities) of new carbon tax laws.