Abbott’s $4 billion climate budget blow-out

CORRECTED VERSION - 5.36PM, August 15

Analysis by Sinclair Knight Merz and Monash University's Centre for Policy Studies finds the Coalition faces at least a $4 billion budget blow-out if it is to deliver on its 5 per cent emissions reduction target by 2020. What’s more, this is based on some very favourable assumptions.

Most notably this includes slashing forecasts of Australia’s likely business as usual emissions, even with a carbon price abolished, due to factors such as major drops in demand for gas and electricity, and reduced land clearing.

This reduction in Australia’s underlying future emissions without the carbon price, represents an incredible stroke of good luck for shadow climate minister Greg Hunt. Now, rather than having to explain how he’ll manage to acquire 755 million tonnes of CO2 abatement over 2014 to 2020 based on the last official government emission projections, he now only needs to acquire 370 million.

Nonetheless, as you’d expect, Hunt disagrees with the $4 billion budget blow-out. He told Climate Spectator:

“The Coalition is confident that it will achieve the five per cent emissions reduction under Direct Action and within the current capped budget. The Emissions Reduction Fund is unchanged and we believe there is an ever increasing range of abatement available.”

Tony Abbott today repeated this claim about being "confident" the budget is adequate to meet the target.

However the Coalition is as yet unwilling to provide detailed supporting evidence for why it is so confident its budget is sufficient to achieve the target. All we have is the aging 2010 election policy platform.

This draws on a few handfuls of non-binding letters from assorted lobby groups and companies pleading for special deals, many of whom were aggrieved with the government’s ETS design. What’s more, some of the sources they cited in support of their costing – such as Ross Garnaut on soil carbon – don’t actually agree with the Coalition’s estimates.

By contrast SKM has been developing data on Australian abatement supply costs over a decade using a wide array of sources. Its work is used by a range of energy market participants to inform real investment decisions. While SKM, like any other forecaster, certainly isn’t infallible, their analysts aren’t the only specialist carbon market modellers who have sceptical views about the Coalition’s costings. For example the work of Danny Price from Frontier Economics, contrary to Hunt’s assertions, does not support the Direct Action model.

Probably the only reputable analyst that would suggest the Coalition budget might be sufficient is Energetics. But Energetics’ senior executive Jon Jutsen has said publicly that the Coalition’s process for acquiring abatement won’t work effectively to capture the low cost abatement they’ve identified in energy efficiency.

Three assumptions that suggest $4 billion blow-out is conservative

The reality is that an incredible amount would need to go right in implementation of Direct Action for the budget blow-out to be contained to just $4 billion. Yet SKM has assumed that things go very much to plan.

1. Can government really outwit bidders?

Firstly, SKM assumes that the government would be able to fool abatement providers into making bids which reflected their own individual costs of supplying abatement, rather than the market clearing price. That would mean the government could pay bidders widely varying prices for delivering an identical product in a tonne of CO2 abatement.

Yet in most markets suppliers come to learn at least roughly what prices their competitors are offering, and what prices customers are willing to pay. They then price their own product accordingly, rather than just in reference to their own costs.

It’s like when you offer your house for sale. You don’t price it based on what you paid for it plus a bit more to give you a tidy profit. Instead you look at what people paid for similar houses in the surrounding area. Irrespective of whether you paid $50,000 or $500,000 for your house, if other people are selling similar homes for $700,000, that’s what you’ll ask for.

The government might like to wrap the whole process in commercial-in-confidence clauses to keep the price it’s paying each provider secret. Nonetheless the information will inevitably leak out to the market over time. That’s exactly what happens in the gas contracts market, and there’s no reason to expect abatement acquisition would be any different.

2. Can the carbon price be replaced with a baseline and credit auction program within just nine months?

SKM assumes the Coalition manages to have the carbon price repealed and its program fully operational by July 2014. For such a complicated and ambitious initiative, this would be a remarkable achievement in bureaucratic and parliamentary efficiency.

The Howard government’s less ambitious and sophisticated carbon reduction programs of LETDF, GGAP and the Renewable Energy Target took far longer to roll-out. The one major abatement program that achieved a similar rapid roll out involved insulation and that was simpler than Direct Action.

3. Will successful auction bidders deliver on time and on budget?

Importantly SKM assumes the program will not encounter problems with bidders failing to deliver on promises. A critical challenge with Hunt’s auction design is that he is seeking to procure delivery of abatement in advance of it being available.

The history of past abatement project support programs is that delivering significant abatement projects takes time and is subject to uncertainty. Blind bidding processes, at least in early rounds, tend to encourage low ball optimistic bids from proponents who later encounter problems implementing projects on time and budget. How this might unfold is that four years into the program and with only three years left to 2020 the government comes to realise it faces a major abatement shortfall. Trying to make up this shortfall in such a short period of time is inevitably expensive.

Yet SKM’s modelling is that the program achieves an average cost of abatement of $24 per tonne of CO2 without any late surge in costs, in spite of the allocated budget being inadequate.

Time for the Coalition to reveal their cards

The Coalition has been repeatedly saying it will reveal its budget costings and detailed explanations of policies in “good time before the election”.

If Greg Hunt and Tony Abbott are so confident then they surely must have gathered some detailed evidence that explains why other experts could be so wrong.

When will they share this with the rest of us?

CORRECTION: An earlier version of this article stated in the third paragraph that the abatement that needed to be acquired by the Coalition had been revised down to 275m tonnes of CO2. This should have read 370m.