Anthropogenic climate change is real, but even if you don’t agree, putting a price on carbon makes good economic sense. David Donovan talks carbon economics.

by managing editor David Donovan

I believe that global warming is real. Or to put that a different way, I am convinced that anthropogenic (human induced) climate change is a real phenomenon and must be tackled as a matter of urgency. Furthermore, I believe putting a price on carbon is an appropriate and necessary response and a carbon tax is a good intermediate step before a trading mechanism – such as an ETS – is introduced. But beyond all that, even if you are sceptical about global warming, introducing a price on carbon is a good idea that will have positive economic benefits for every Australian, even those on low incomes, and it will provide a competitive advantage and open up cheaper funding and new sources of investment capital for Australian businesses.

That’s what I think, now let me explain why.

CLIMATE CHANGE IS REAL

Firstly, anthropogenic climate change is real. Scientific projections can never be 100 per cent certain, but climate scientists are at least 90 per cent certain that global warming over the last 50 years has come about through humans pumping billions of tonnes of carbon dioxide into the Earth’s thin atmosphere. And there is no question that humans have greatly increased the amount of carbon dioxide in the atmosphere. Before the industrial revolution, the amount of carbon dioxide in the atmosphere was 280 parts per million by volume — it is now 390 ppmv. It’s going up rapidly too — in 1960 it was only 315 ppmv. And between 2000 and 2009 is rose by an average of 1.9 ppmv per year.

Some people say that because carbon dioxide is a natural gas, there is no need to worry if there is more of it in the atmosphere. Of course, CO2 is indeed a naturally occurring substance – just like cyanide or methane. As my high school chemistry teacher said, everything is poisonous in high enough concentrations.

The greenhouse effect is real and scientifically provable. It is the process by which thermal radiation from the planet’s surface is absorbed by atmospheric greenhouse gases and re-radiated in all directions. Since some of this re-radiation goes back towards the surface, energy is transferred to the surface and the lower atmosphere. As a result, the temperature there is higher than it would be if direct heating by solar radiation were the only warming mechanism.

An example of what can happen when concentrations of CO2 become too high in an atmosphere can be seen by looking at our solar system. Extending from the sun, the three inner planets of the solar system are Mercury, Venus and then Earth. Of these planets, Earth is the farthest away, with a perfect life-forming temperature of 15⁰C. Mercury is closest to the sun and has an average temperature of 167⁰C. Logically, you would expect Venus to have a temperature in between 15⁰C and 167⁰C. However, though Venus is much further away from the sun than Mercury, it is almost three times as hot at the innermost planet, with an average surface temperature of 464⁰C.  The reason for this is that the Venusian atmosphere is almost all CO2, while Mercury has virtually none of the gas. Venus is a cautionary tale about what can happen with a runaway greenhouse effect — the atmosphere on Venus acts like a heat trap and it has permanent hurricanes of over 300 kilometres per hour engulfing the entire planet.

As mentioned earlier, CO2 concentrations on Earth are almost 40 per cent higher than they were before industrialisation and, if we continue on our current trajectory, they could reach three times this concentration by the end of the century. In line with this, the Earth’s climate has been observed to have warmed by 0.8⁰C. Current efforts to control climate change are aimed at trying to stabilise global warming at less than a 2⁰C change, which experts suggest should prevent many of the more calamitous effects of global warming. Whether this can be achieved would appear to depend on what action we take now and how precipitately we take it.

Of course, there are many people in society who are sceptical of or who do not believe in anthropogenic climate change. These people are encouraged in this belief by a vigorously active misinformation and smear campaign by the fossil fuel lobby that is a carbon copy (excuse the pun) of those run by the tobacco lobby during the 1960s and 1970s, when detailed scientific information began emerging about the horrendous health impacts of smoking. In fact, some of the same scientists who were once paid by Big Tobacco are now, today, being paid by Big Oil and and Big Coal to create “astro-turf” organisations designed to spread misleading information and muddy the water about climate change. With the exception of these “cash for comment” scientists, virtually no climate change sceptics have any scientific qualifications. “Lord” Christopher Monckton is a classic example of the entirely unqualified “expert” spreading wilful misinformation to counter the overwhelmingly persuasive science of climate change, even so far as alleging a vast worldwide Orwellian conspiracy by established climate scientists. There is no conspiracy.

THE ECONOMIC ARGUMENT FOR PRICING CARBON

Denying climate change is much like denying that tobacco smoking causes cancer. The science is overwhelming, yet most of us can point to someone we know who smoked a pack–a-day and somehow lived to be 90. Likewise, since the weather is unpredictable, climate change deniers will often find and be able to point to a particular statistic which helps them cast doubt upon the science, ignoring the overall trend. Intuitively, though, we all appreciate that the emission of carbon smog into the air from fossil fuels cannot possibly be beneficial to the environment, just like breathing dirty smoke into our lungs cannot possibly be good for our health. Even before the science on tobacco smoking became conclusive, the negative health effects were well appreciated by most rational people. There is undoubtedly a cost to pollution and the fact that major polluters have so far not needed to pay for such a cost is a massive market failure, since there is currently no economic advantage in not polluting.

This market failure is precisely what putting a price on carbon will help to address. Even if you don’t believe in climate change – even if you are prepared to ignore all the science or just focus on the dissenting information prepared by the fossil fuel lobby or their paid experts – there is a strong economic imperative in the Government’s new policy on climate change. Indeed, the only argument for not acting on climate change is if you believe that the world will one day, soon, decide that climate change is in fact not real and that action – including all that which has already been taken by so many countries around the world – is unnecessary.

That’s just not going to happen.

There is international agreement – even by major emitters such as the USA and China — that climate change is real and is a huge threat to the planet. Virtually every nation is looking at ways to mitigate this threat and the universally accepted method now seems to be putting a price on carbon. In the European Union, there has been an emissions trading scheme for several years and it has caused absolutely no deleterious effects to that massive economy. Indeed, the UK recently announced that it would cut its greenhouse emissions by 50 per cent by 2027 on 1990 levels and this caused barely a flutter of public interest, let alone alarm, in that country. It should also be noted that several US states have carbon taxes, similarly without destroying their economies. There is without doubt a degree of hysteria over putting a price on carbon that is not borne out by what has happened around the world in practice.

The global trend towards action on greenhouse gases is ineluctable. We can either begin to implement a scheme now, and restructure our economy in advance of the inevitable global agreement, or we can wait until we are forced to act by global pressures and sacrifice any advantage we will receive by the early transitioning of our economy to its inevitable green future.

And there will be major advantages in “carbon proofing” our economy. For one thing, limiting our reliance on oil, given the declining supply of this fossil fuel and its commensurately increasing cost, makes sound economic sense. Even without putting a price on carbon pollution, we should be taking steps to move our economy away from this source of energy. In Australia, of course, we have an abundant alternative source of energy in our vast stores of coal — where we have reserves that are estimated to last for 400 years. Coal is, however, one of the most carbon polluting forms of energy, so that only by putting a price on carbon will mining and energy companies be encouraged to invest in the research and development necessary to turn it into a “green” source of energy, such as through the carbon storage and capture processes that could potentially make coal a relatively low emissions product. But only by putting a price on carbon is this achievable because these energy and resource companies are currently the world’s worst investors in R&D — the eight biggest average a mere 0.15 per cent of revenue on R&D, although these companies are amongst the world’s most profitable businesses (B. Jaruzelski and K Dehoff, The Customer Connection: The Global Innovation 1000, Booz Allen Hamilton, New York, 2007). As far as mining and energy companies are concerned, all you need it seems are bigger drills and shovels — and they will keep thinking that unless there is an economic imperative to innovate and limit emissions. By implementing a carbon tax on the worst 1,000 polluters in Australia, innovation and carbon mitigation will be given an economic imperative.

Far better to encourage such investment now than to have the imperative placed upon us by external agents, as is likely to happen if we do not act very soon. For instance, it is highly likely that economies that have already imposed a price on carbon, such as the EU, will in the near future put a carbon tariff on imports from countries that do not price carbon so as to negate any competitive disadvantage experienced by their home-grown industries against products from irresponsible nations. Furthermore, while coal is at the moment a relatively sought after commodity worldwide, the writing is on the wall for the industry and there is no question that demand for coal will fall in the future as other nations move to limit their dependency on dirty coal-fired power stations. China, for example, is investing an incredible amount of money into research into renewables, as are many other nations around the world.

What sort of shock will our economy endure if we wait until the transition to our inevitable carbon neutral future becomes a global necessity? There is no question that renewable energy is the future for energy production in the world economy, so it makes abundant sense to act now to stimulate our domestic renewables industry so as to develop a head start, or a comparative advantage, in this burgeoning market. There is not much sense in having a quarry economy if no-one wants what you’re digging up and demand for coal is certain to fall in the future. We have a plenty of coal, but we also have plenty of sun, hot rocks, desert, wind, and tides — the energy resources of the future. We are limited only by our imagination and our willingness to act.

Some people might say, worrying about the future is all very well, but the future is far away — yet implementing a carbon tax will increase the cost of living for Australians now, in the immediate future, as soon as it comes in. And, in its zealously effective scaremongering, the Coalition has greatly encouraged this perception. As a former accountant, and one that has worked in the mining industry, I feel assured that a carbon tax, especially one set at the relatively modest level of between $20-$30 a tonne that has been widely mooted by the Government as being the likely entry-point – will have negligible or no impact on the cost of living of ordinary Australians, especially given the tax breaks the Government has presaged.

Australia should seek to develop a value-adding first world, rather than a “quarry”, economy

The reason for this is twofold.

Firstly, under the National Greenhouse Energy Reporting Act 2007, major Australian polluters have been required to account for their carbon emissions and report to the Government since 2008. Consequently, the future cost of compliance for any carbon tax should be negligible. In addition, the companies that have been reporting under this scheme for the last few years – which would include all of the 1,000 major polluters covered by the carbon tax – will almost certainly all have already implemented a “shadow carbon price” as part of their prudent risk management strategies. In other words, since they will have been expecting a carbon price since at least 2010 (the timing for the Rudd Government’s planned, but then scrapped, ETS) these companies will have already priced in an internal price for their carbon emissions which would feed into the prices they sell for their products. Any gains they have made since 2010 as a result of the Government not yet acting would simply be regarded by them as a windfall. This conclusion is supported by Tony Wood from the Grattan Institute who, on ABC’s 730 last night, said energy companies would have been factoring in a cost for carbon “…for 10 years at least”.

Secondly, since the cost of carbon has already been factored in and a price on carbon already passed on to consumers, at least in demand inelastic industries, the actual implementation of a carbon price should cause no increase in prices for consumers (unless, that is, particular companies decide to opportunistically price gouge customers). Indeed, since the likely carbon price will almost certainly be lower than the internal marginal cost – which, in my experience, most companies will have placed at somewhere between $40 and $60 a tonne – any lower price for carbon imposed by the Federal Government would be regarded by these polluters as a windfall in and of itself. Prices are unlikely to come down, but unless operators are unscrupulous, they should not go up. And if they do go up, the Government can mitigate any cost of living pressures through tax cuts, which will be funded through the carbon tax itself. And there should still be enough carbon tax revenue left over to fund further Government programs to find new renewable energy solutions.

Furthermore, when companies apply for funding from banks or private investors, they always need to provide detailed models forecasting their likely future profitability. And, since 2010 at least, and probably much earlier than that, these models have by necessity included a price on carbon — an inflated price, indeed, since businesses have had no way of safely determining what the Government’s response will eventually be. Therefore, a prudently inflated “shadow carbon price” has the effect of making companies appear less profitable in the future than they otherwise may seem to be if there had been certainty on a carbon price. These models have, in effect, understated the likely future earnings of Australian companies, discounting future cash flows and thereby understating the net present value of businesses. The effect of this is to make Australian businesses seem like riskier investments for banks and private investors, meaning they must pay a risk premium of a certain number of basis points above the banks’ best rate for debt capital. In other words, the lack of a carbon price causes Australian businesses to pay higher interest rates than countries that have surety about carbon pricing as well as making them comparatively less attractive as equity investments when compared against businesses from other countries that have certainty in their carbon pricing, such as European companies. This is almost certainly why most Australian businessman, including the CEO of mega mining company BHP, Tom Albanese, have been asking for action from the Government on a carbon price for some time.

By ending the uncertainty and implementing a relatively low carbon price, investment in Australian companies will be stimulated and financing costs lowered, thereby making these businesses more competitive and attractive to investors both at home and abroad. And by implementing a carbon price before moving to an emission trading scheme a floor should be able to placed on the market, thereby precluding the value of carbon falling too low to provide an incentive for investment in renewables, as has happened in Europe. In effect, counter-intuitively, implementing a carbon tax will stimulate an Australian economy that, apart from mining, is currently sitting in the doldrums waiting for the Government to remove this nagging source of sovereign risk. For the sake of our business competitiveness, the Government we must provide certainty in this area — in fact acting is already overdue as businesses have been waiting for the implementation of a price on carbon since 2010. We simply don’t have another moment to waste dithering on this important issue.

I should speak briefly about the Coalition’s “direct action” policy. In short, this policy is simply not economically feasible. It is a Clayton’s policy, as Malcolm Turnbull alluded to some weeks ago, that provides an illusion of progress while actually achieving very little. Whilst direct action on climate change might help mitigate climate change in the short term by targeting the “low hanging fruit”, or the worst sources of carbon emissions in our economy – maybe even limiting our emissions beneath the modest targets set at Kyoto, as is the Coalition’s goal — once these easy-fixes disappear and harder structural changes are required, the cost to the taxpayer would almost certainly become prohibitively expensive. Only by a market mechanism that encourages innovation, investment and responsible behaviour will the cost to consumers be able to be shared and minimised throughout the economy. A direct action, or command, mechanism is inherently inefficient. In fact, it is the sort of policy you can imagine being suggested by a socialist or a Communist command economy, not a modern liberal free-market democracy. The Coalition’s solution is not a long, or even a medium, term approach, unless they are advocating the taxpayer paying two or three times as much tax in the future than they do at present.

Climate change is real and the science is persuasive. But even if you personally don’t believe it’s real, the world is moving in only one direction — towards limiting carbon emissions via a market based approach. Direct government action on climate change is not economically sustainable beyond the short-term — only a market based approach can stimulate investment and innovation in renewable energy and encourage pollution mitigation widely throughout our society. The increase in cost of living pressures from a carbon price is not only greatly exaggerated, but almost certainly non-existent. Moreover, certainty about a carbon price will encourage investment and provide cheaper funding sources for the business community, providing a fillip for the economy as a whole. Our economy must begin to make the transition to a renewable future as soon as possible before such a future is imposed upon us to our massive financial detriment.

(David Donovan has worked as a financial accountant and finance analyst for some of the world’s major investment banks, commercial organisations and mining companies in Australia and the UK, including Merrill-Lynch, Barclays Capital, NatWest Global Markets, Mizuho, Viacom, UBS and Downer EDI Mining.)

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