How does the carbon tax work?


The Steel Industry uses coal because it is cheap relative to other fuels and appears to typically generate between 2 and 3 tonnes of carbon dioxide equivalent (CO2) per tonne of raw steel produced. Scientists have now alerted Governments to the connection between CO2 emissions and global warming and the potential dangers this brings to the world, so there has been a worldwide move to encourage businesses to reduce their CO2 emissions.

Economists almost universally, recommend putting a price on carbon as the most efficient way to achieve this. There are two ways to price carbon. One involves involves Governments putting a levy or carbon tax, on polluters for each tonne of CO2 they produce. The other involves Governments determining the aggregate quantity of carbon emissions permitted by issuing tradeable permits. This is called an Emissions trading scheme or ETS because the market effectively sets the price of carbon. The new Australian scheme will start with a carbon tax and move later to an ETS. The ETS will not be totally market based as the Government has established a carbon price floor below which its price will not be allowed to fall. There are also provisions that aim to promote market efficiency and prevent market manipulation. In both systems however the market does the heavy lifting.

An effective carbon price will make the costs of coal and other dirty fuels more expensive relative to alternative cleaner fuels and over time should encourage business to move towards the latter. A base price of $A23/tonne/CO2 increasing annually is likely to achieve this in Australia. Pricing carbon will belatedly level the playing field between clean and dirty energy by making the polluters now pay for the costs to the community that they create, and previously avoided.

The Australian steel industry appears to have a capacity of about 8mtpa. If future capacity usage falls to say 50% as a result from its withdrawl from most of its export markets, crude steel production will be approximately 4mtpa. With with an average of say 2.5tCO2/per tonne raw steel produced, this output would generate approximately 10mt of CO2 annually. At a starting unit carbon tax rate of $23/tCO2 this will attract a carbon tax of $230 million annually to the industry before transitional Government assistance. This assistance will be equal to 94.5% the tax, and is subject to an annual reduction of 1.3%. There will also be assistence of $300 million over 5 years under the Steel transformation plan. The net effect of the tax will result in a small annual cost to the industry. The net affect of both the tax and the industry assistance is likely to make the industry better off.

The timing of the tax appears to be unfortunate as the industry is already suffering from the effects of the mining boom which has increased coal and iron ore prices substantially and has pushed the $A exchange rate to high levels. This challenge to the industry is likely to continue while the mining boom continues and is independent of the whether carbon is or is not priced. As other trade exposed industries are also suffering from the abnormally high exchange rate the Government will have to seriously address this issue quite seperately from the challenges the carbon tax is aimed to address. Briefly I think that a more complete resource rent tax should be applied to the mining industry and the proceeds used to help exchange affected industries like steel weather the "mining boom" storm. This issue is put aside for now.

The long run effect of the carbon tax on the industry’s profitability will depend on an interplay of two main forces namely how the prices of clean energy move relative to those of dirty energy and the industry's response to the carbon tax package. It is likely that pricing carbon will encourage clean energy innovation and make the costs of clean energy competitive relative to dirty energy. The likely response of the industry to this and the carbon package is another thing and will depend on the strategic options available to the industry over time. In all cases a likely first step will be to try to recover as much of the tax as it can by increasing prices to customers. Optional industry responses after that are likely to include:

First, do nothing and play the best game possible with the hand that it has. This is high risk stuff from the viewpoints of all stakeholders and because of this is an unlikely course of action.

A second would be to move production overseas to a country that does not price carbon or source steel requirements from overseas. Steel is of strategic importance and has been a part of our history so any sensible Government would discourage this option.

A third would be to continue to use coal but sequestrate the carbon in the emissions. My understanding is that there are high hopes for this technology but it is likely to be a long way off.

A fourth and most likely course of industry action would be to try to avoid the affects of the carbon tax by moderating current practice. The most obvious way to do this would be to invest in and upgrade current operations to clean energy and, or alternatively by building new cutting edge steel plants to do the same, perhaps with Government assistance that could include overtures to the mining industry to increase the pitifully low quantity of Australian steel used in mining projects. The type of clean energy used would depend on its relative cost effectiveness compared to other fuels. If either is done successfully the gains would include, savings in the carbon tax, efficiency gains and an improved ability to compete on the world stage.

The pollution problem is just one of many challenges confronting the nation in a quickly changing world. So perhaps this is a good time to drop old ideas and introduce new ones such as, replace competition within the industry with cooperation perhaps supported with a compact with the Government.

The plants of the two main steel producers in Australia are ageing so perhaps a fifth option is for the industry to rationalize itself. Perhaps through a merger and/or a joint venture of the major players to update of the industry’s technology, capacity and future strategy. The objectives would be to increase efficiency, lower costs, avoid the carbon tax, and enhance its  ability to compete on the world stage. One steelmaker already has its own source of ore and perhaps this could be expanded and shared as part of any joint commercial deal.

The Government could play a role by levelling the playing field. It could tangibly recognize that the reluctance of some countries to bite the global warming bullet is a major cause for concern, given what is at stake for the world. It may consider a policy of giving a subsidy, equivalent to the carbon tax, to trade exposed exports and put a temporary levy equal to the carbon tax on imports from countries that do not price carbon, until they do. Although interference in markets may be anathema to some free market purists it would be in a good cause namely our contribution to preserving the planet. It raises an interesting dilemma doesn't it? Is the maintenance of free market principles more important than action to save the planet?

Brian Harrisson
17th July, 2011