This information was provided to the Multi-Party Climate Change Committee for information. They use the example of the Australian Government’s formerly proposed Carbon Pollution Reduction Scheme (CPRS) to illustrate a number of design features that would have needed to have been settled when taking a carbon pricing model and developing it to the point where it could be implemented. This material is illustrative only, and does not represent a statement of the Australian Government’s preferred position.
- CPRS design overview
- Scheme caps and gateways under the CPRS
- Transitional fixed price period and price caps under the CPRS
- Household assistance and fuel tax adjustment
- Emissions-intensive, trade-exposed assistance
- Electricity sector adjustment scheme
- Sectoral treatment under the CPRS
CPRS design overview
The CPRS was a cap-and-trade emissions trading scheme (ETS) designed to commence with a one-year period in which the carbon price was set at $10/t CO2-e.
Under a cap-and-trade scheme, at the end of each year, liable parties were to be required to surrender one emissions unit for every tonne of greenhouse gas that they had emitted in that year.
The total number of these emissions permits issued by the Australian Government would have been capped. Units would have been issued mostly by auction, but in some instances through direct allocation to businesses. Under the CPRS, the Australian Government would have allocated emission units equal in number to the level of the annual cap. The caps gradually were to become more stringent each year. It was the cap on carbon pollution that meant that the CPRS would have ensured Australia would have met its carbon pollution targets.
By capping carbon pollution at a level below that projected to occur under business-as-usual conditions, and requiring businesses to obtain permits to cover their own carbon pollution, the CPRS would have driven business demand for permits and so created a market price on carbon throughout the economy. (This government-induced limit was to be the same mechanism that ensured a price for water rights, taxi licences, fishing quotas and so on.)
- Businesses could sell permits to other participants if they had more permits than needed to cover their actual carbon pollution for a year—or could buy them at the Australian Government auction or from other businesses if they did not have enough.
Trade in emissions permits helps lower overall costs. The Australian Government did not know which businesses would have been allowed to emit and which would have reduced their carbon pollution to have achieved the overall best outcome for Australia. A cap-and-trade scheme would have allowed the market to answer this question. The capacity to trade emission permits would have moved emissions permits to those businesses that valued them most highly. Businesses that had cheap abatement options available to them would have preferred to reduce carbon pollution rather than buy emissions permits. In this way, the cheapest abatement would have been encouraged to occur first. In aggregate, the effect would have been that Australia would have met its carbon pollution targets at the lowest overall cost.
The CPRS was designed to cover around 80 per cent of Australia’s carbon pollution, including carbon pollution from stationary energy (that is, electricity generation and industrial fuel combustion) (52 per cent), transport (14 per cent), industrial processes (5 per cent) and waste (2 per cent), and fugitive emissions from coal mining, oil and gas extraction, and gas pipeline transport (7 per cent). All six greenhouse gases included under the Kyoto Protocol were to be covered by the scheme. Reforestation activities would have been eligible to generate permits under the CPRS on a voluntary basis.
Around 1000 entities would have been subject to mandatory obligations under these arrangements.
Major sources of carbon pollution excluded from scheme coverage were agriculture, legacy waste, and deforestation. Sources excluded from coverage were potentially able to create offset credits, subject to the development of robust methodologies, and where abatement could be counted towards Australia’s international targets.
International linking would have enabled liable parties under the CPRS to acquit international emissions units in Australia for compliance with their CPRS obligations, in place of Australian emission permits issued under the scheme. Allowing use of international permits would have reduced abatement costs (and so costs to the Australian economy) by ensuring that the cheapest abatement opportunities were pursued first, regardless of where they occurred in the world.
Only certain types of international units were to have been accepted into the CPRS, to maintain its environmental integrity. Flexibility to change the types of units accepted over time was included, to allow further types of units to be included, or to exclude units where their environmental integrity became in doubt. The CPRS included no quantitative limits on the number of international units that could be used.
While the overall macroeconomic impact of the CPRS was estimated to be small—annual economic growth was estimated to be reduced by less than one tenth of one per cent—impacts were recognised to fall disproportionately on some elements of industry and the community. Recognising this, the CPRS package included a number of assistance elements funded through the auction or allocation of permits and targeted at the household, community and industry sectors.
The household assistance package was designed to provide cash payments equivalent to around half the revenue raised from the CPRS to compensate low and middle income households for the increase in the cost of living that was estimated to result from the CPRS. Assistance was also to be provided to small businesses and the community sector through grants made under the Climate Change Action Fund (CCAF) to help these organisations improve their energy efficiency and hence manage the transition to a low pollution economy.
Assistance to heavy emitting industries was to be provided in the form of free permits and targeted to those sectors that were likely to face significant short-term impacts from the introduction of the CPRS, such as brown coal electricity generators (the Electricity Sector Adjustment Scheme), underground gassy coal mines (the Coal Sector Adjustment Scheme) and emission-intensive, trade-exposed (EITE) industries. These assistance measures were designed to be transitional with support phasing out over time. These measures were also carefully designed to ensure that industries in receipt of such assistance would have had incentives to reduce carbon pollution over time.
Australian Climate Change Regulatory Authority
An independent regulator, the Australian Climate Change Regulatory Authority (ACCRA) would have been established to administer the CPRS, the National Greenhouse and Energy Reporting System, and the Renewable Energy Target. Integration of these functions was expected to improve regulatory outcomes, streamline administration of related legislation and reduce regulatory burdens.
Scheme caps and gateways under the CPRS
The CPRS was a ‘cap-and-trade’ scheme. It involved setting a national scheme cap for a particular year and issuing Australian emissions permits up to the level of that cap. Each emissions permit represented one tonne of carbon dioxide equivalent.
Detailed scheme cap numbers for each relevant financial year were to have been specified in regulations.
In setting both caps and gateways (see below), the Minister had to have regard to Australia's international obligations under the United Nations Framework Convention on Climate Change and the Kyoto Protocol. Other matters that could be taken into account when setting the national scheme caps and gateways were:
- the principle that fair and effective global action to stabilise atmospheric concentrations of greenhouse gases at around 450 parts per million of carbon dioxide equivalence or lower was in Australia’s national interest
- progress towards, and development of, comprehensive global action under which all major economies committed to substantially restrain carbon pollution and advanced economies took on reductions comparable to Australia
- economic implications associated with various levels of national scheme caps, including implications of the price of Australian emission permits
- the extent of actions voluntarily taken to reduce Australia’s carbon pollution
- estimates of carbon pollution that was not to be covered (directly or indirectly) by the CPRS
- the most recent report (if available) from the independent reviews that were to be conducted under the legislation on whether national targets relating to carbon pollution should be changed or extended; and such other matters (if any) as the Minister considered relevant.
Caps were generally to have been set five years in advance.
There was provision for a default scheme cap in the event that no scheme cap had been set for the year 2016–17 or later.
Scheme caps would have been lower than the emissions path required to meet the national targets, because some sources of carbon pollution were not covered by the CPRS.
To provide further guidance to liable entities and participants in the carbon market more generally, national scheme gateways could be prescribed for years beginning on or after 1 July 2016. A gateway was a range, comprising an upper bound and a lower bound of emissions, expressed in terms of tonnes of carbon dioxide equivalent, for a particular year.
The Minister would have been required to take all reasonable steps to ensure that the scheme caps were within the range specified for the relevant year. The same considerations that were relevant in making decisions about national targets and the national emissions trajectory were relevant for setting caps and gateways. The diagram below shows the relationship between scheme caps and gateways.
Transitional fixed price period and price caps under the CPRS
Transitional fixed-price period in first year of scheme
The CPRS was to have commenced with a fixed price of $10 per tonne. This was a transitional measure. The fixed price was to be implemented by providing an unlimited number of Australian emissions permits to liable entities at a fixed charge of $10 per unit.
Fixed price permits could not be banked—that is, they could not be used for compliance in any subsequent year.
Transitional price cap
Full trading was to have commenced in 2012–13 with a price cap in place for four years. The price cap would have taken the form of access to an unlimited store of additional Australian emissions permits, issued at a pre-specified fixed charge, for financial years 2012–13 to 2015–16. The Australian Government’s intention was that the charge be set high enough so that its probability of use was low, while providing protection against major price shocks.
The level of the price cap in the first year of operation was to be $40 plus five per cent real growth for each of the years 2010–11 and 2011–12. The price cap would have continued to rise by five per cent in real terms after this (using the Consumer Price Index).
Household assistance and fuel tax adjustment
Rationale household assistance package
The introduction of a carbon price into the economy would have increased the price of emission-intensive goods relative to other goods. This would have increased the cost of living of households if they chose to purchase the same bundle of goods they consumed before the introduction of the carbon price.
The purpose of household cash assistance was to assist households to manage the shock of the introduction of a carbon price, by providing households with help and time to switch to a lower carbon lifestyle. Those households with the least capacity to adjust—low-income households—were the highest priority for assistance.
In the absence of assistance, the introduction of a carbon price would have had a disproportionate impact on low- and some middle-income households as these groups generally spent a greater proportion of their income on emissions-intensive goods, such as electricity and gas. Lower income households were also less able to quickly adjust to the effects of a carbon price by substituting to other less emissions-intensive goods and services and by investing in energy efficiency improvements (such as solar hot water heaters).
High income households were expected to be more able to manage these price rises and were more able to adjust their spending to reduce their use of emissions-intensive goods.
Household assistance policy commitments
- Low-income households, pensioners, seniors, carers and people with disability were to receive additional support, above indexation, to fully meet the expected overall increase in the cost of living flowing from the CPRS.
- Middle-income households would have received additional support to help meet the expected overall increase in the cost of living flowing from the CPRS.
- Motorists were to be protected from higher fuel costs from the CPRS by ‘cent-for-cent’ reductions in fuel tax for the first three years.
How the household assistance package works
The CPRS design was to provide upfront assistance delivered to households through existing Australian Government transfer payments and tax offsets on the basis of Treasury’s modelled impacts of the CPRS on different household types.
- For example, pensioners, seniors, carers and people with disability were to receive additional support, above indexation, to fully meet the expected overall increase in the cost of living flowing from the CPRS, through payments such as the Age Pension, Disability Support Pension and Carer Payment etcetera.
The provision of assistance through a cash payment would have preserved the carbon price signal faced by households, while compensating for the cost of living impacts. The preservation of the price signal ensured incentives to reduce carbon pollution were maintained since households would have benefitted from behavioural changes to reduce their carbon pollution.
- For example, under a carbon price, the cost of lighting in an average house would have risen slightly. If assistance was provided to the consumer—in the form of a cash payment—to compensate for this rise, the householder would have had to retain incentives to reduce their electricity usage and save them money.
CPRS impacts on households
Modelling undertaken by the Treasury estimated that the CPRS would have resulted in a total increase in the cost of living of around 1.1 per cent over the first two years of the CPRS. This rise was made up of two components:
- 0.4 per cent in 2011–12—based on a $10 per tonne fixed carbon price in 2011–12
- 0.7 per cent in 2012–13—based on a flexible carbon price in 2012–13, which was estimated to be $26 per tonne.
The average overall increase in cost of living for households was estimated to be $624 once the CPRS was fully up and running (originally by the middle of 2013), or about $12 per week. However, the Australian Government’s household assistance package was designed to provide 90 per cent of households with assistance worth $660 on average to offset those costs.
Household food prices were estimated to rise by less than one per cent over these two years. Household electricity prices were estimated to rise by seven per cent in 2011–12 and 12 per cent in 2012–13. Gas prices were expected rise by four per cent in 2011–12 and seven per cent in 2012–13.
A closer look at a certain type of household
The chart below shows an example of how a certain type of household’s cost of living was expected to be affected before assistance (the solid line), and after assistance (the dashed line) depending the household’s level of private income. In particular, the chart shows:
- Households with private income less than around $100,000—for this household type—were expected to have the costs of the scheme fully met from assistance.
- Even higher income households were to benefit from the assistance package in this example.
- Actual impacts would have been expected to be lower than those shown here for any household that undertook behavioural changes to reduce their carbon pollution.
Fuel tax adjustment mechanism
Despite fuel used for transport being covered by the CPRS and consequently being subject to a carbon charge, the effect of this charge on fuel prices was to be offset over a transition period of three years, by a corresponding ‘cent for cent’ reduction of fuel excise. Consequently, motorists were to not face the impact of the CPRS on the price of fuel over the three-year transitional period due to the fuel tax adjustment. The Australian Government was to cut the rate of fuel tax on 1 July 2011 by 2.455 cents per litre. This reduction was to be based on the carbon charge on a litre of diesel. As diesel is more emission-intensive than petrol, petrol users were to receive more than cent-for-cent tax reductions.
Each year the size of the cut to fuel tax was to depend on the current carbon price, which would have been established by the market under flexible trading conditions from 2012–13 onwards.
From 1 July 2012, the Australian Government was committed to assess the adequacy of the fuel tax cut every six months for two years and make further cuts to fuel tax, if necessary, depending on the movements in the carbon price.
The fuel tax credit was designed to ensure that selected sectors of the economy, including households, did not pay a carbon price on the fuel they purchased over the transition period.
As part of the 24 November 2009 agreement with the Opposition, the Australian Government also committed to providing a ‘CPRS fuel credit’ to the forestry industry. Prior to the negotiations, the tax credit was only to be applicable to the agriculture and fishing industries for the first three years of the scheme and to the heavy on-road transport industry for the first year of the scheme. A fuel credit was to be provided to these industries, as these businesses paid no effective fuel tax and so would not have benefitted from the cut in fuel tax. Other sectors—including mining and marine transport—that did not pay fuel tax were not to receive the CPRS fuel credit.
Any fuel tax adjustment mechanism was to be designed and applied consistently with Australia’s international trade obligations.
Emissions-intensive, trade-exposed assistance
Australia’s adoption of a carbon cost before other countries may have had an adverse effect on businesses that had emissions-intensive production processes and were trade-exposed (either as exporters or because they faced actual or potential import competition). This was because these firms may have been constrained in their ability to pass on the carbon cost because they were price takers on the world market.
Under the CPRS, the EITE assistance program was designed to provide free permits to businesses carrying out activities that were formally assessed as being emissions-intensive and trade-exposed. The rationale for providing this assistance was to:
- reduce the likelihood that Australian businesses or production may relocate overseas (so called ‘carbon leakage’) in the period before broadly comparable carbon constraints applied internationally, and
- provide support for these industries’ transition to a carbon-constrained economy.
The EITE assistance program was carefully designed to ensure that firms in receipt of free permits maintained strong incentives to reduce their carbon pollution.
First, allocations were to be based on the historical industry-average emissions intensity of production multiplied by the level of production. This approach was important in three respects:
- Basing allocations on the historical emissions intensity meant that firms would have had to face strong incentives to reduce their carbon pollution as they would have stood to benefit from any reduction in carbon pollution that occurred.
- Setting the industry average as the basis for allocations meant that firms which were relatively less emissions-intensive would have been rewarded for the early action they would have undertaken to reduce their carbon pollution.
- Basing allocations on a per unit of production basis meant allocations would have been adjusted in proportion to future production levels. For example, as firms expanded or contracted (that is, assistance was linked to production and was uncapped overall). This would have meant that firms had upfront certainty about their future allocations in the medium- to long-term and this certainty was provided to support their consideration of investment decisions about future levels of production.
Second, the level of EITE assistance was to commence at 94.5 per cent and 66 per cent of the industry-average emissions intensity and then reduce by 1.3 per cent per annum. This provided certainty to firms about their potential level of allocations and provided increased incentives to look for opportunities to reduce carbon pollution.
Third, the EITE assistance program was designed to ensure that it would not provide an operational subsidy to EITE businesses. This was delivered through a policy to place a maximum cap on allocations at 100 per cent of their combined direct emissions of carbon pollution and carbon pollution associated with electricity use.
Fourth, the importance for there to be a review to assess the ongoing need for EITE assistance over time was recognised. A five-year review (originally established for 2014) was to consider, among other things, the consistency of the EITE program with the overall rationale for the scheme. It was also to include an assessment as to whether broadly comparable carbon constraints were applying internationally.
Details of the EITE assistance program
The EITE assistance program was to provide assistance on the basis of EITE ‘activities’ deemed eligible by the Australian Government.
The details of the EITE program evolved over 2009 as part of the negotiations with the Opposition.
The following table provides a summary of the EITE assistance program that was proposed under the CPRS.
Form of assistance
Assistance would have been provided to new and existing entities undertaking an eligible EITE activity prescribed in regulations.
Permits would have been allocated at the start of each compliance period based on the individual entity’s previous year’s level of production, with a true-up to account for any over- or under-allocation the previous year.
Annual allocation would have been capped at the level of liable direct and indirect electricity and steam emissions from the facility (or facilities) at which the activity was carried out in the previous year (maximum cap on allocations).
Any EITE assistance must have been designed and applied consistently with Australia’s international trade obligations.
Scope of assistance
EITE assistance would have been provided in relation to:
Quantum of assistance
At the start of the scheme it was estimated that EITE industries would have been allocated around 28 per cent of permits in 2011–12, increasing to around 39 per cent in 2019–20.
Eligibility for assistance
Eligibility was based on average emissions per million dollars of revenue or emissions per million dollars of valued added for a given activity.
Time period for assessment:
Trade exposure assessed through quantitative or qualitative test:
Initial rates of assistance
Initial rates of assistance would have commenced at:
Carbon productivity contribution
Initial rates of assistance would have been reduced by 1.3 per cent per annum.
The allocative baselines for an activity were to be based on historic industry average level of carbon pollution per unit of production for all entities conducting activity.
New entities conducting an existing EITE activity would have received the same assistance as existing entities conducting the activity.
Activities new to Australia would have been able to apply for EITE eligibility with the assessment of eligibility and baselines made on the basis of international best practice.
Allocations to existing entities conducting EITE activities would not have been adjusted for allocations to new entrants.
Review of assistance
Under the CPRS, the EITE assistance program would have been reviewed by an independent body at each five year review point or at the request of the Minister.
The Independent Expert Review which was originally scheduled for 2014 was to consider:
The Australian Government would have provided five years’ notice of any material changes for any general modifications arising out of that review, unless required for compliance with Australia’s international trade obligations.
Liquefied Natural Gas supplementary allocation
Following negotiation with the Opposition, the Australian Government’s CPRS changes were outlined on 24 November 2009. They included an additional supplementary allocation of permits under the EITE assistance program for Liquefied Natural Gas (LNG) projects. This was to ensure that all LNG projects received an effective assistance rate of at least 50 per cent in relation to their LNG production. This supplementary allocation was to be in addition to the provision of EITE assistance that was to be provided to LNG projects if assessed as eligible under the EITE assistance program. It would also have been an ongoing measure, not a fixed-term transitional assistance program.
The LNG supplementary allocation was premised on the fact that LNG projects had a relatively wide dispersion in emissions intensities. In particular, many of the LNG projects that were being proposed or under construction would have had significantly higher (or lower) emissions intensity than the two LNG projects that were operating at the time that would have determined the EITE allocative baselines for the LNG activity.
Electricity sector adjustment scheme
Rationale for assistance
Electricity Sector Adjustment Scheme (ESAS) was designed to maintain investor confidence and support a smooth transition to a low carbon economy for the electricity generation sector. The broader ESAS package was also designed to support energy security.
Maintaining incentives for generators to reduce carbon pollution while safeguarding energy security
Assistance was designed to ensure continued incentives for abatement. This was achieved by allocating assistance based on historical energy and emissions intensity data of eligible generators, and restricting eligibility for assistance to coal-fired electricity generators that were in operation, or were committed to be constructed, as of 3 June 2007. Assistance was not tied to continued levels of output and associated pollution.
Assistance was also designed to ensure security of electricity supply and to avoid windfall gains occurring, while preserving incentives to reduce carbon pollution:
- assistance could have been paid to a generator even if it closed down if this did not lead to energy security problems, as assessed through annual Power System Reliability Test
- a windfall gains test was to be applied to a proportion of the assistance
- recipients could have continued to receive assistance if they retired existing high emissions plant and replaced it with new low-emissions generating plant.
Quantum of Electricity Sector Adjustment Scheme assistance
The ESAS provided for free allocation of up to 228.7 million permits over ten years (delivering around $7.3 billion of assistance in nominal terms, or $6.1 billion in real 2008–09 dollars). Allocations under ESAS would have been equivalent to around 13 per cent of projected coal-fired generator permit liabilities over the first five years of the CPRS, and 9 per cent over the second five years of the CPRS.
The ESAS allocation formula weighted assistance by the extent to which the emissions intensity of an individual generator exceeded a threshold emissions intensity of 0.86 tonnes of CO2-e per megawatt hour generated.
This approach meant that a significant portion of assistance went to privately owned emissions-intensive brown coal-fired generators in Victoria and South Australia.
The ESAS package as discussed included the Energy Security Assurance Mechanism and the Low Emissions Transition Incentive. The Energy Security Assurance Mechanism ensured provisions existed to deal with any residual systemic energy security risks, and the Low Emissions Transition Incentive facilitated investment in replacement low emissions electricity generation while meeting overall energy security requirements.
Sectoral treatment under the CPRS
ELECTRICITY (36% of carbon pollution)
Fossil fuel combustion for electricity generation
ESAS: 228.7 million permits ($7.3bn) over 10 years.
Aluminium, iron and steel, non-ferrous metals
EITE assistance: 94.5% for highly emissions intensive; 66% for moderately emissions intensive.
Medium to large mining and manufacturing
TECAP: $1.1bn over two years.
Business (SMEs), community sector organisations, workers, regions communities and agricultural sector
CCAF Streams 1–3: $1.7bn including $150m set aside under Stream 2 for food processing.
Household assistance through tax and transfer system targeted to low and medium income households.
OTHER STATIONARY ENERGY (16% of carbon pollution)
Combustion of fossil fuels to produce heat or steam including consumption of gas for domestic heating
|Petroleum||EITE assistance: 94.5% for highly emissions intensive; 66% for moderately emissions intensive.|
|Business (SMEs), community sector organisations, workers, regions communities and agricultural sector||CCAF Streams 1–3: $1.7bn including $150m set aside under Stream 2 for food processing.|
|Households||Household assistance through tax and transfer system targeted to low and medium income households.|
|TRANSPORT (14% of carbon pollution).
Combustion of fossil fuels across all transport modes (road, domestic air and domestic maritime)
|Heavy on-road transport||CPRS fuel credit scheme for one year.|
|Agriculture, fishing and forestry||CPRS fuel credit scheme for three years.|
|Households||Cent for cent reduction in fuel tax for three years (permanent change to excise rate).|
FUGITIVE EMISSIONS (7% of carbon pollution currently, expected to be 9% at 2020)
Carbon pollution associated with the extraction, processing and distribution of oil, natural gas and coal
|Oil and gas, including LNG||EITE assistance: 94.5% for highly emissions intensive; 66% for moderately emissions intensive; ‘top up’ for LNG—minimum effective assistance of 50%.|
|Gassy underground coal mines||
CSAS: 9.72m permits ($1.23bn) set aside over 5 years.
CCAF Stream 4: Coal Sector Abatement Fund—$270m over five years.
INDUSTRIAL PROCESSES (5% of carbon pollution)
Carbon pollution from chemical, mineral or metal processing or from use of synthetic greenhouse gases
|Iron and steel, cement, aluminium (PFCs), ammonia, ammonium nitrate, magnesia||EITE assistance: 94.5% for highly emissions intensive;
66% for moderately emissions intensive.
|Synthetic greenhouse gas importers||No assistance.|
WASTE (2% of carbon pollution)
Methane from landfills wastewater processing
Closed waste facilities, and legacy emissions excluded from coverage.
Coverage of small landfills within close proximity of large landfill.
(RF+DF = 5% of carbon pollution)
|Positive impacts on forestry sector||Reforestation eligible to earn permits on voluntary basis.|
|DEFORESTATION (DF)||Excluded from coverage|
|AGRICULTURE (15% of carbon pollution)||Excluded from coverage||
Eligible to earn offsets on voluntary basis.
R&D agricultural abatement ($50m development and on-farm testing).
 Other than in the first scheme year, which was to have had an unlimited number of fixed-price permits available and, hence, no cap. This would have been equivalent to having a carbon tax in place for the first year.