Why Rudd should at least listen to Turnbull’s climate change idea: Kohler

The reason Frontier Economics was able to produce a complex 100-page report proposing a new way of handling emissions trading in just four weeks, and the reason Malcolm Turnbull and Senator Nick Xenophon were able to commission it knowing what they would get, is that Frontier already did it for the NSW Government.

It was handed to NSW Premier Nathan Rees last year, and then quietly buried… because it did not align with Federal ALP policy.

But the polarised politics of climate change in Australia (and everything else for that matter) mean that Frontier’s idea is now doomed to the scrap heap. It might have had a chance had the NSW ALP championed it, but not with Malcolm Turnbull behind it: yesterday’s derision from Kevin Rudd and his ministers before they read it will remain their position. In fact they will never read it.

Which is a pity, because it’s not a bad idea, and properly locates the discussion on climate change in Australia where it belongs: the Latrobe Valley.

Kevin Rudd called Frontier report the “magic pudding” because it proposes that we can have deeper cuts in greenhouse gas emissions with lower economic cost.

Everyone’s natural reaction to that is probably the same as Kevin Rudd’s: there’s no such thing as a free lunch. However, there is some rigour and sense to Frontier’s proposition.

By the way, don’t bother reading the report (available here). It is complicated and mysterious; I read much of it several times yesterday but came away none the wiser.

However, I also spoke at length to the firm’s leader on this project, Danny Price, and I now broadly understand it.

The essence of the Rudd scheme is a colossal transfer of wealth from the electricity generation sector – especially the Latrobe Valley – to households and large companies, via government compensation handouts.

That is achieved by putting an absolute cap on emissions, and then requiring the generators to buy 100% of their permits – apart from some free permits under what’s called the Electricity Sector Adjustment Scheme (ESAS).

An industry spokesman told me yesterday that this sector emits about 200 million tonnes of carbon per year and ESAS gives them a total of 130.7 million free permits (not per year – forever).

Danny Price’s complaint about this scheme, apart from the damage it does to the electricity generators, is that a “vast number” of businesses in Australia get no compensation and will suffer economic loss. All the compensation is focussed on households (voters) and large emission-intensive exporters.

As a result, the bulk of Australian employers will lose access to markets and cut their workforces.

The reason Price’s model produces a lower theoretical economic cost – down from $121 billion to $72 billion – is that it would mean a smaller rise in the price of electricity, and therefore share the “compensation” more broadly among Australian businesses.

Kevin Rudd’s CPRS does two things to electricity: it brutally freezes out the coal-fired electricity generators and produces a 20 to 30% increase in the electricity price.

The cash raised from selling permits – it’s effectively a new electricity tax – is recycled directly to households in the 2013 budget, in time for the 2013 election. And as we have written before, the CPRS is in fact Kevin Rudd’s 2013 re-election plan.

The problem is that the transition out of coal-fired electricity is high risk. The Rudd plan appears to be simply to let them go broke and shut them – that’s certainly the way they see it, and they are threatening a capital strike as a result.

Much of the response Business Spectator has had to these columns has been something like: “They would say that wouldn’t they” – pointing out that the generators are a vested interest group trying to protect themselves.

Quite true, but if the ESAS is inadequate and their complaints are simply ignored, there is a risk that the coal-fired generators will stop working, either properly or at all, before new gas-fired generation is ready to fill the gap.

It is not clear whether the Frontier Economics plan fixes that problem. It seems to increase the size of the ESAS from $3.5 billion to $8-10 billion, but it probably still leaves the Latrobe Valley brown coal generators in the lurch.

The essence of the idea is to separate electricity generation from the rest of Australian industry and put it under an “emissions intensity” arrangement rather than an absolute cap. That means it gets permits according to the intensity of emissions rather than the amount of them – working off a “baseline” or average intensity.

The baseline is 0.86 tonnes of carbon per megawatt hour. That’s the current generation industry average. The idea is that electricity generation below that intensity attracts free permits, even if the absolute amount of carbon being emitted increases, and above that level of intensity they must be bought.

The emissions intensity of the brown coal generators in the Latrobe Valley is currently 1.42 tonnes per megawatt hour.

That gap between 0.86 and 1.42 causes two problems: a big working capital cost because of the need to buy a lot of permits, and a big fall in the value of the assets. The inevitable result of this is that the owners of the plants will run them for cash, using the ESAS money to pay down debt.

Should they be let off entirely? Of course. But to minimise the transition risk, they should be negotiated with: an agreement needs to be reached that ensures Australia can move to gas-fired base-load power generation without damage to either our electricity generation or our reputation among international providers of capital.

At least the Frontier Economics scheme attempts to deal with this by removing the generators from the regime of having an absolute cap, and allowing them to get more permits if their output grows with the economy. It’s a step in the right direction.

It pays for this, in essence, by lowering the tax on electricity, which produces economic benefit, but reduces the new revenue that the Government will collect and recycle to households.

Which means that if Kevin Rudd ever does get around to reading and understanding the Frontier report, he still won’t like it.

This article first appeared on Business Spectator.