1. Where Australia's Climate Policy Should be Heading Warwick J McKibbin Australian National University & The Lowy Institute for International Policy, Sydney & The Brookings Institution, Washington DC Presentation prepared for Canberra Business Council Lunch August 7,2008

2. Overview Climate Science and Policy Lessons from Kyoto Why Prices Matter Post Kyoto Policy What Australia Should Do

3. What do we know? Climate is a complex system that is always changing Average global temperatures have risen 0.6 degrees in the past century Natural variability and human induced change coexist We are pumping enormous amounts of greenhouse gases into the atmosphere Increasing evidence that there is a warming problem Policy uncertainty is causing economic losses

5. Climate Science “Science” does not tell us exactly what the global concentration target should be - but it guides us Even if we knew the concentration target, “Science” does not tell us which of the many global paths for emissions should be followed for a given concentration target Even if we knew the global path for emissions “Science” has nothing to say about what target an individual country should follow

6. Climate Change Policy Is all about managing risk and dealing with climate uncertainty It is not about picking an arbitrary target and hitting that each year no matter what

7. Climate Change Policy Should be about enabling the whole society to manage the risks associated with climate change Should be about creating long term institutions and clear policy frameworks that can steer the global economy towards a less carbon intensive future Should be about creating a system that all countries find in their own self interest to be involved

8. What is Needed A change in the behaviour of energy users Technologies to reduce carbon emissions Technologies to reduce energy demand and increase energy efficiency

9. The Role of Prices

12. The Role of a Price on carbon The relevant carbon price is the long term carbon price Long term credible carbon prices are crucial for encouraging –Demand side management –The emergence of alternative technologies –The adoption and diffusion of alternative technologies

13. Lessons from Kyoto Experience A system of rigid targets and timetables is difficult to negotiate because it is a zero sum game It is problematic for countries to commit to a rigid target for emissions under uncertainty about costs Even the most dedicated countries may be unable to meet their targets due to unforeseen events out of their control

14. A Reality Check on the Global Debate Countries will develop their own systems There will never be a global market for permits because permits are like money – they are the promise of a government to hit an emission target

15. Permit Trading Systems Require a permit to emit carbon Government either –limits the supply of permits and a market determines the price given the scarcity of supply –or sets a price that permits can be bought from the government (a tax)

16. The McKibbin Wilcoxen Hybrid Aim –Impose a long term carbon goal for the world and distribute across economies –Generate a long term price for carbon in each country to guide energy related investment decisions –Keep short term costs low –Provide a way for corporation and households to manage climate risk –Each country adopts nationally and cooperate globally

17. Components of the Policy Long-term permits –A bundle of annual permits with different dates that the permits can be used –Quantity of permits over time is the long run goal –Supply is fixed (and diminishing) and allocated to households and industry –Traded in a market with a flexible price

18. Components of the Policy Annual permits –Must be acquitted against carbon emissions in the year of issue –Expire in year of issue –Elastic supply from national government –Price fixed for five (or ten) years and then reset given information available –Act as a “safety valve” to cap the cost each year

20. Carbon price In any year companies will use a mix of an annual coupon from the long term permit and annual permits printed by the government for a fixed price to satisfy their emissions The price of annual permits will be fixed

21. Climate Policy is like monetary policy Need clear long term targets (not necessarily timetables) with an independent agency charged with reaching those targets at lowest cost to the economy Need clear long term prices to drive investment Need fixed short term prices to minimize costs

22. Coordination of National Markets Independent but coordinated via fixed carbon price (P) Japan US EU Australia P

23. An Illustration Use the G-Cubed multi-country model

24. The G-Cubed Model –Countries (10) United States Japan Australia Europe Rest of OECD China India Eastern Europe and Former Soviet Union Oil Exporting Developing Countries Other non Oil Exporting Developing Countries

25. The G-Cubed Model –Sectors (12) – Electric Utilities – Gas Utilities – Petroleum Refining – Coal Mining – Crude Oil and Gas Extraction – Other Mining – Agriculture, Fishing and Hunting – Forestry and Wood Products – Durable Manufacturing – Non Durable Manufacturing – Transportation – Services –Capital Producing sector

26. An illustrative example Generate a baseline of the model from 2003 Generate a target path for emissions reduction to reach a global target of peaking emissions by 2028 and to be 60% below 2002 emissions by 2100. Impose an arbitrary but approximately equal burden across countries

31. What if the world gets it wrong Example of high growth in China and India

33. Conclusions Dealing with climate change uncertainty will be a major change to the Australian and global economy Still a great deal unresolved about where the world is heading It is critical to get the balance between long run environmental issues and short run economic costs right.

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