This is a lost post that languished as an unpublished draft for over a year. As with most things with any resemblance to climate change policy the comment remains relevant a year later…

The ‘elephant in the bathroom may have farted’ post tells us that the possibility we all knew was there — that market forces can go in both directions — now seems likely for the Australian carbon market.

At the end of the fixed price period in 2015, the carbon price in Australia may well be considerably less than $24. The new estimate is $10 per tCO2e, a shortfall that would deliver a $4 billion budget ouch on forward projections for the government.

Late last year the Australian government decided to remove the collar on the carbon price originally proposed for the 2015-18 period, presumably to allow alignment with the EU carbon market. It also allowes Australian companies to buy up to 50% of their permit requirement from international credits. This means that the domestic carbon price is more likely to track international markets, hence the potential permit price of $10 at the end of the fixed price period in 2015.

Not quite what is supposed to happen if the policy is to work, not least for the nascent offset market.

Here are three big consequences of $10 tCO2e for carbon offsets.

Big consequence #1 — few offset activities are viable at $9/tCO2e

When the permit price is low, then carbon credit prices will be lower still, around 10-15% usually. This makes sense because why go to the trouble of buying an offset credit if it is the same price as a permit? The only time you might is when you have some desire to commit a random act of kindness or to get PR advantage from the co-benefits that offset credits can bring. So usually credits are cheaper than permits.

Reminder of what offset credits are all about — short version is that credits can be generated from activities that abate, reduce emissions or sequester carbon into the landscape [e.g. capturing and burning landfill gas, growing trees on degraded land, managing manure from piggeries] so long as the activity complies with a several important carbon accounting rules

A $9 carbon credit will severely limit the number of offset activities that can be financially viable whilst still complying with all the rules.

In energy, infrastructure, waste and land based carbon projects it will be very hard to cover activity, transaction and opportunity costs of project implementation from a $9 tCO2e return.

Big consequence #2 — revenue from offsets do not go to Treasury

When projected revenue is halved the last thing a government would want is for emitters to buy offset credits instead of permits. Large-scale emitters will act rationally and buy offsets if they are cheaper only this money goes to the offset provider and not treasury. This makes the fiscal hole deeper.

There is also the significant risk that too many offsets could further deflate the price by increasing supply. This was probably the main, but rarely stated, reason for why REDD [reduced emissions from degradation and deforestation] mechanisms that generate credits from protection of tropical forests have not been embraced — too much credit volume further depresses the carbon price.

So we can expect government to be much less enthusiastic about offset credits, at least the complaint kind that can be exchanged for permits. They will, of course, continue to promote and talk up voluntary offset credits, the ones you might buy to offset a flight or a company might purchase in order to be carbon neutral.

It should be no surprise that, despite the fanfare, Australia’s domestic offset scheme called the CFI is taking a very long time to get going.

Big consequence #3 — not enough pain to change behaviour

Remember that the climate change policy that puts a price on carbon was all about reducing greenhouse gas emissions from human activities by making it increasingly more expensive for emitters to carry on emitting under business as usual. Create sufficient pain in the hip pocket and there will be a change in behavior.

Emitters will become more efficient, saving energy themselves, or pass the price on to consumers who will become more frugal. If it the price continues to rise and efficiency gains are exhausted then it pays to make more substantial shifts in behavior, mostly toward alternative energy sources.

At $9 tCO2e for an offset there is not enough pain to make the change.

May 2014 Postscript

See what I mean?  A year on and offsets are still a pipe dream for all but a very few activities such as landfill gas capture that was already there anyway [so much for additionality].

And sometimes glacial pace of progress helps people forget the problem the policy was supposed to address.

Not good enough I say.