Modelling the Trade Implications of Climate Mitigation Policy

Transcription

1 Modelling the Trade Implications of Climate Mitigation Policy International carbon pricing and trade flows JULY 2013 RIRDC Publication No. 12/104

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3 Modelling the Trade Implications of Climate Mitigation Policy International carbon pricing and trade flows by Tingsong Jiang, David Pearce, Catherine Tulloh and Lauren Retief July 2013 RIRDC Publication No. 12/104 RIRDC Project No. PRJ

4 2013 Rural Industries Research and Development Corporation. All rights reserved. ISBN ISSN Trade Implications of Climate Policy: International carbon pricing and trade flows Publication No. 12/104 Project No. PRJ The information contained in this publication is intended for general use to assist public knowledge and discussion and to help improve the development of sustainable regions. You must not rely on any information contained in this publication without taking specialist advice relevant to your particular circumstances. While reasonable care has been taken in preparing this publication to ensure that information is true and correct, the Commonwealth of Australia gives no assurance as to the accuracy of any information in this publication. The Commonwealth of Australia, the Rural Industries Research and Development Corporation (RIRDC), the authors or contributors expressly disclaim, to the maximum extent permitted by law, all responsibility and liability to any person, arising directly or indirectly from any act or omission, or for any consequences of any such act or omission, made in reliance on the contents of this publication, whether or not caused by any negligence on the part of the Commonwealth of Australia, RIRDC, the authors or contributors. The Commonwealth of Australia does not necessarily endorse the views in this publication. This publication is copyright. Apart from any use as permitted under the Copyright Act 1968, all other rights are reserved. However, wide dissemination is encouraged. Requests and inquiries concerning reproduction and rights should be addressed to the RIRDC Publications Manager on phone Researcher Contact Details David Pearce GPO Box 2203 Canberra ACT In submitting this report, the researcher has agreed to RIRDC publishing this material in its edited form. RIRDC Contact Details Rural Industries Research and Development Corporation Level 2, 15 National Circuit BARTON ACT 2600 PO Box 4776 KINGSTON ACT 2604 Phone: Fax: Web: Electronically published by RIRDC in July 2013 Print-on-demand by Union Offset Printing, Canberra at or phone ii

5 Foreword Climate mitigation policy, both in Australia and overseas, is one of the more complex policy areas to evolve in recent years. The introduction of a carbon price within the Australian economy has led to debate, especially regarding costs, benefits and indirect effects. This research addresses one aspect of this issue: the potential economic implications of mitigation policies for agricultural trade. This is important given the complexity of the economic interactions involved. Also, the modelling framework applied in this research provides a useful tool for understanding the potential trade implications of climate mitigation policies applied domestically, as well as by trading partners. One of the key findings of the research is the extent to which economywide interactions within a particular economy will have a major influence on trade outcomes. In particular, many of the economywide effects of climate policy (reduced real wages and changed real exchange rates) can more than mitigate some of the otherwise adverse trade consequences for the agricultural sector. This report is an addition to RIRDC s diverse range of over 2000 research publications and it forms part of our Global Challenges R&D program, which aims to collectively addresses challenges, whether impediments or opportunities, to improve the profitability and sustainability of Australian agriculture. Most of RIRDC s publications are available for viewing, free downloading or purchasing online at Purchases can also be made by phoning Craig Burns Managing Director Rural Industries Research and Development Corporation iii

6 About the Authors Tingsong Jiang is a Director at the Centre for International Economics (CIE) an applied economics research and consultancy firm. He is a specialist in global economic modelling and has used a range of models to address emerging global issues. David Pearce is Executive Director at the CIE. His work has a particular focus on climate policy related issues and he has undertaken analyses for a wide variety of government and private organisations. Catherine Tulloh and Lauren Retief are both Senior Economists at the CIE and have in recent years applied their research skills to a diverse range of contemporary policy issues. iv

7 Contents Foreword... iii About the Authors... iv Executive Summary... ix Introduction... 1 Objectives... 2 Methodology Overview of climate policies in Australia and its trading partners... 4 Australian climate change policy... 4 Policies in trading partner countries... 6 General effects of climate change policy on agriculture Impacts of carbon pricing Effect of carbon pricing on Australian agriculture Implications of biofuel policies Effects of border tax adjustments Carbon labelling Qualitative framework How will mitigation policy influence trade outcomes? Economywide carbon pricing Offsets Border tax adjustments Biofuel policies Food miles Simulation framework Model revisions Baseline projections Policy simulation and analysis Qualification v

8 5. The simulated baseline Economic drivers Energy efficiency assumptions Climate change policy assumptions Carbon dioxide emissions in International trade in Simulated impact of global climate policies Modeling existing climate change policies Impacts of implementing the Copenhagen Accord targets Conclusions Links between climate policy and agricultural trade Issues for the sector to consider Appendix A: Climate change policy details New Zealand United States Canada European Union Japan China India Argentina Brazil Indonesia Thailand Malaysia References vi

9 Tables Table 2.1 Change in output in key sectors in Australia due to emissions trading, 2050, compared to reference case Table 2.2 Change in output in key sectors in Australia due to the Clean Energy Future Policy, 2020 and 2050, compared to reference case Table 3.1 Summary of impacts of climate change mitigation policies Table 4.1 Aggregation of regions and sectors of the RIRDC version of GTAP-E model Table 5.1 Growth assumption of key economic variables from 2004 to 2020 % Table 5.2 Energy efficiency improvement for selected sectors % pa Table 5.3 Actual and projected greenhouse gas emissions in EU-27 by EEA Table 5.4 Projected carbon dioxide emissions: 2004 and Table 5.5 Share of Australia s CO2 emissions by source: 2004 and Table 5.6 Regional exports and imports: 2004 and Table 6.1 Sectoral output, consumption and trade for Australia Table 6.2 Summary of Copenhagen targets and implemented shocks Table 6.3 Change in emissions and carbon price of implementing Copenhagen targets Table 6.4 Impact on sectoral output and household consumption in Australia Table 6.5 Impact on exports and imports in Australia vii

10 Figures Figure 2.1 Changes in value added following the introduction of a carbon price relative to business as usual in Figure 3.1 Interactions between climate change, climate policy and trade Figure 5.1 Share in world carbon dioxide emissions: 2004 and Figure 5.2 Projected annual growth of real GDP and CO 2 emissions from 2004 to Figure 5.3 Changes in terms of trade between 2004 and Figure 5.4 Annual growth in Australia s exports and imports Figure 5.5 Composition of Australia s exports Figure 5.6 Composition of Australia s imports Figure 6.1 Carbon dioxide price and changes in emissions for existing policies Figure 6.2 Impact on real GDP of existing policies Figure 6.3 Equivalent variation of existing policies Figure 6.4 Impact on terms of trade of existing policies Figure 6.5 Price impacts of existing policies Figure 6.6 Impact on domestic demand of existing policies Figure 6.7 Impact on imports of existing policies Figure 6.8 Impact on exports of existing policies Figure 6.9 Impact on real GDP of implementing the Copenhagen targets Figure 6.10 Equivalent variation of implementing the Copenhagen targets Figure 6.11 Impact on terms of trade of implementing Copenhagen targets Figure 6.12 Impact on CPI of implementing Copenhagen targets Figure 6.13 Impact of implementing Copenhagen targets on Australia s domestic demand Figure 6.14 Impact of implementing Copenhagen targets on imports Figure 6.15 Impact of implementing Copenhagen targets on exports Figure 7.1 Many interactions leading to trade implications viii

11 Executive Summary What the report is about This report considers the potential agricultural trade implications of global policies introduced to reduce greenhouse gas emissions. The global policy landscape is complex, and it is important to be able to analyse potential implications of policy options for Australian agricultural industries. Who is the report targeted at? This report is targeted at individuals and organisations dealing with the design of climate policy from the agricultural perspective as well as those charged with managing strategic responses to policy developments, both nationally and internationally. Background Agriculture will be both directly and indirectly influenced by greenhouse gas mitigation policies. One of the channels of effect will be through changes in trade in agricultural products. As a highly trade exposed sector, Australian agriculture could stand to both gain and lose from the economic changes brought about by mitigation policies. As countries increasingly commit to greenhouse gas reduction targets, and as policies to that end are progressively implemented, the process of reducing emissions will itself result in a major economic transformation for the countries involved. At the very least, energy systems (based on carbon sources) will need to change. This will have flow-on implications for all sectors of the economy, including agriculture. Predicting the net impact of these factors is a challenging task. Because trade changes essentially involve economywide considerations within an economy as well as economywide comparisons between economies, one of the major tools for analysis is multi-country economywide modelling. Such modelling can help identify potential effects of emission mitigation policies on trade for Australian agriculture. Aims/objectives The purpose of this project is to analyse emerging climate policies in Australia and around the world with a view to understanding the trade implications of these policies particularly for agricultural trade. A particular purpose of this project is to use quantitative analysis (supplemented with qualitative assessments as appropriate) to analyse the trade implications of climate policy. The resulting information will be useful for stakeholders and rural policy makers in both developing new policies and in planning for the implications of existing policies. ix

12 Methods used There are three components to the methodology used for this report: a review of available literature on the implications of mitigation policy for agricultural trade; a review of policies currently being adopted, or proposed, for major trading partners and competitor economies; and quantitative analysis using a global general equilibrium modelling framework of the broad implications of current and proposed mitigation policies. Results/key findings Greenhouse gas emission mitigation policies may directly and indirectly affect agricultural trade in many ways. Relative price changes between different economies will result in direct economic affects. Economywide interactions within an economy (that is, resource movements between sectors induced by changes in real wages and the real exchange rate) will also deliver direct affects. These two mechanisms typically interact to determine the impacts on Australian agriculture of mitigation policies including carbon pricing or related measures that induce costs of abatement within economies. The ways in which the core mechanisms combine are likely to vary depending on the specifics of the policies adopted to reduce emissions relative to the levels they would achieve in the absence of the policy interventions. The main analytical tool used here a global economywide model was used to represent the potential carbon price implications for the various targets proposed within the Copenhagen Accord 1. While not able to fully represent the full range of policies, this approach indicates a few broad conclusions: 1. While carbon policies change relative prices between economies, the magnitude of these changes are composed of many elements and are difficult to predict in advance; 2. Initial changes in relative prices between economies are modified by intersectoral or economywide effects within economies. In particular, changes in real wages and the real exchange rate lead to resource movements between sectors within a particular economy, thus modifying some of the initial relative price differences between economies; 3. These economywide effects may offset the initial trade implications of carbon pricing; 4. The simulations presented here indicate that the net effect of international mitigation action is to increase exports of most Australian agricultural products (relative to the baseline or business as usual level of exports). 1 Since the Copenhagen UN climate change conference in 2009, further meetings have been held in Cancun, Durban and Doha. However, the Cancun agreements and the Durban meetings did not result in any new pledges by individual countries to specific emission reductions. Quantitative targets under the second commitment period of the Kyoto Protocol agreed to at Doha have not been finalised, and will not incorporate all countries that made commitments under the Copenhagen Accord. x

13 Implications for relevant stakeholders: Results presented here provide some broad guidance about appropriate sectoral responses to climate policy outcomes. Several possibilities emerge: adjustment to a carbon price requires flexibility in domestic and international markets. Factors which inhibit adjustments, such as inflexibilities or constraints in factor or product markets are likely to both increase the cost of mitigation policy and reduce the offsetting benefits for the agricultural sector; responses to mitigation policy could be profitably addressed towards identifying and working to remove such constraints; the introduction of additional trade barriers along with core mitigation policies around the world could significantly increase the cost of mitigation policies; less transparent mitigation policy mechanisms (those involving constraints that do not emerge as a clear price effect) may also increase the cost of mitigation and make the overall implications for agricultural trade considerably less certain. Finally, the analysis undertaken in this report has led to the development of a modelling tool that will remain useful for ongoing analysis as the international policy situation continues to evolve. xi

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15 Introduction As international climate negotiations continue, countries are increasingly committing to achieving particular levels of domestic mitigation over time. Overall, global targets to keep climate change within 2 degrees have been proposed, with a range of countries making individual commitments to achieve a variety of mitigation targets. The process of reducing emissions will itself result in a major economic transformation for the countries involved. At the very least, energy systems (based on carbon sources) will need to change. This will have flow on implications for all sectors of the economy, including agriculture. These implications will arise on both the supply and demand sides of the economy. On the supply side, mitigation policies will change relative costs of production (including transport costs) which will create an impetus for changed production techniques and technologies. On the demand side, changed incomes and prices will lead to changed demands for a range of products effectively a relative decrease in demand for carbon intensive products (that is, those covered by mitigation measures) and a relative increase in demand for less carbon intensive products. As a consequence, agriculture will be both directly and indirectly influenced by global greenhouse mitigation policies. One of the channels of effect will be through changes in trade in agricultural products. As a highly trade exposed sector, Australian agriculture could stand to both gain and to lose from the economic changes brought about by mitigation policy. The drivers of changed trade patterns resulting from carbon mitigation polices are complex. They depend on a range of factors including: the extent of mitigation targets within particular economies; differences in the cost of emission reduction (the cost of abatement) between economies; the nature of the particular policy instruments used to achieve the targeted reductions in emission; the resulting (that is, after mitigation policies are in place) relative price changes (for commodities and factors of production) within a particular economy; the resulting relative price changes (for commodities and factors of production) between economies; and the relative flexibility of the agriculture sector (that is, its ability to respond to price changes) between different economies either those undertaking the abatement, or those exporters with an ability to respond to changes in world prices. Predicting the net impact of these various factors is a challenging task. Because trade changes essentially involve economywide considerations as well as economywide comparisons between economies, one of the major tools for analysis is multicountry economywide modelling. Such modelling can help estimate the magnitude of the different effects of emission mitigation policies on the trade prospects for Australian agriculture. 1

16 Objectives The purpose of this project is to analyse emerging climate policies in Australia and around the world with a view to understanding the trade implications of these policies particularly for agricultural trade. A particular purpose of this project is to use quantitative analysis (supplemented with qualitative assessments as appropriate) to evaluate the trade implications of climate policy. The resulting information will be useful for stakeholders and rural policy makers in both developing new policies and in planning for the implications of existing policies. In particular, the objectives of the project are to: collate and summarise emerging climate policies in Australia and in key trade partner and competitor countries (from the perspective of agricultural trade); draw out the pathways by which emission mitigation policies will lead to changes in trade patterns; understand the implications of mitigation policies for relative prices and costs, both within and between different economies; analyse, using appropriate qualitative and quantitative frameworks, the implications of these relative price and cost changes for trade in key agricultural products; and draw policy and strategic implications from the perspective of the rural sector. 2

17 Methodology There are three components to the methodology used for this report: a review of available literature on the implications of international mitigation policy for agricultural trade; a review of policies currently being adopted, or proposed, for major trading partners and competitor economies; quantitative analysis using a global general equilibrium modelling framework of the broad implications of current and proposed mitigation policies. Details of the global model used in the report (the GTAP model), and the adjustments made to the model for this project, are set out in chapter 4. Because the trade implications of climate policy are essentially economywide in nature, the modelling framework chosen is a global general equilibrium (or economywide) model. This means that the model covers not only agriculture (or broad agricultural sectors), but it also covers other sectors in the economy. This allows the interaction between sectors within an economy to be captured. Further, the model is multicountry, allowing it to capture interactions between economies. Because the implications of climate mitigation policy are likely to be of interest to the agricultural sector on an ongoing basis, we have chosen a modelling framework that is in the public domain. This means that a range of parties could make appropriate arrangements to access the model and conduct a range of ongoing experiments to consider the emerging implications of mitigation policy. The selection of models for economic analysis particularly analysis that is as complex and uncertain as international climate policy inevitably involves a range of trade-offs. Unfortunately, no model captures all features of the problems. The trade-offs made for this project are set out in more detail in the modelling chapters. 3

18 1. Overview of climate policies in Australia and its trading partners In this section, the climate change mitigation policies in Australia and key trading partners are summarised. Focus is given to those policies that affect the agriculture sector in particular. Broader climate change policies are also listed as these policies can affect the wider economy including the price of inputs to the agriculture sector. Furthermore, most of the expected changes in trade patterns are likely to arise because changes in costs of production will differ between countries, changing relative prices. For that reason, it is important to understand climate change policy in Australia s key competitors and trading partners as well as those policies implemented domestically. Australian climate change policy Economywide policy Australia has in place an unconditional target of 5 per cent below 2000 levels by In addition, the government has announced further emission reduction targets of: between 5 and 25 per cent below 2000 levels by 2020 depending on the degree of international action taken; and 80 per cent below 2000 levels by Recent discussion of Australia s climate change policy has been dominated by an emissions trading scheme. In 2011 the government introduced the Clean Energy Legislative Package, the centrepiece of which is a carbon pricing mechanism 2. The Clean Energy Legislative Package was introduced after the proposed Carbon Pollution Reduction Scheme (CPRS) was defeated in the Parliament in Some aspects of the new scheme are similar to the proposed CPRS, however, as discussed in the next chapter, the implications for the agriculture sector are significantly different. The carbon pricing mechanism under the Clean Energy Future package: commenced in July 2012; will initially impose a fixed price on emissions (similar to a carbon tax), later shifting to a conventional cap and trade emissions trading scheme where the permit price is determined by market interactions; the fixed price was initially set at $23/t CO 2 -e and will increase annually; covers sectors including stationary energy, transport, industrial processes, fugitive emissions and emissions from non-legacy waste; exempts agricultural and land sector emissions; excludes the combustion of biomass, biofuels and biogas; 2 Full details of the Clean Energy Future Package are available at 4

19 effectively omits fuels used by motorists and light commercial vehicles and off-road use of transport fuels for businesses in the agricultural, forestry and fisheries industries; and allows the use of international offsets, to a certain extent once the shift has been made to full emissions trading in Assistance will be provided to approximately per cent of emission-intensive trade-exposed industrial activities such as steel, aluminium, cement and zinc manufacturing. The Clean Energy Package includes transitional assistance measures (free permits) for emission intensive and trade exposed sectors, starting at either 66 or 94.5 per cent depending on the emission intensity of the sector, and declining at a rate of 1.3 per cent a year. That is, more emissions-intensive, trade exposed industries would receive up to 94.5 per cent of the average carbon costs in the first year. Agriculture policy As the on-farm agriculture sector has been excluded from the carbon pricing mechanism, a complementary policy has been introduced for farmers, foresters and landholders the Carbon Farming Initiative (CFI). The Initiative establishes an offsets scheme that provides incentives for landholders to reduce carbon pollution. It establishes approved methodologies for generating offsets that are recognised as genuine and registered in a central registry. Offsets generated under the Initiative can be sold into the carbon pricing mechanism market as well as the voluntary market. Other policies Other federal-level climate change policies include: a renewable energy target of at least 20 per cent by 2020; formation of the Clean Energy Finance Corporation which invests in cleaner energy sources; programs to support energy efficiency initiatives by businesses and industries; and the Land Sector Package which includes the Biodiversity Fund, the Indigenous Carbon Farming Fund, the Regional Planning for Natural Resource Management Climate Change Fund and the Land Sector Carbon and Biodiversity Board. The most significant state-based climate change program was the NSW Greenhouse Gas Reduction Scheme. It operated between 2003 and 2012 and was a mandatory scheme for electricity retailers in NSW and ACT under which they met emission benchmarks by using low emission electricity generation or undertaking abatement projects. The spot price reached a maximum of just under $15 in 2006, but the price collapsed with the introduction of a national carbon pricing mechanism (IPART 2012). Australia does not have a national biofuels target, but biofuels attract a tax offset that effectively nullifies the excise taxes that apply to other fuels. New South Wales has blending mandates of 6 per cent for ethanol and 2 per cent for biodiesel. 5

20 Policies in trading partner countries The economies that have been selected for analysis in this report are New Zealand, United States, Canada, the EU, Japan, China, India, Argentina, Brazil, Indonesia, South Korea, Malaysia and Thailand. These economies cover Australia s major agricultural export markets, the top agricultural exporters of Australia s major export products, and the major economies of the world. The key climate change policies of these economies are summarised in table 1.1, further details of the policies in each country (including sources for ongoing information) is included in Appendix A. Table 1.1 Summary of climate change policies Country Economywide policy Agriculture policy Other policies New Zealand Emissions trading started in 2008 and now covers all sectors except for agriculture. At this stage agriculture is not included but may be in the future. Aspirational renewable energy target of 90 per cent by United States A proposed emissions trading scheme that did not pass through the Senate, was to cover most sectors (not agriculture) and incorporate border adjustment taxes. Agricultural offsets were to be eligible under the proposed emissions trading scheme. Renewable fuel standard targets 36 billion gallons of biofuels by State and regional emissions trading programs have been implemented or proposed. 20 states have emission targets, and 32 states are members of regional initiatives that collaborate on the development of a range of climate change policies. California established a cap and trade scheme covering electricity and major industrial processes with the first compliance period starting in The Regional Greenhouse Gas Initiative (RGGI) places a cap on CO2 emissions from the power sector across nine US states. Canada Major policies (including any emissions trading scheme) will be aligned with US policy. 5 per cent biofuel content requirement for gasoline. Regulation to limit emissions from coal fired power generation and passenger vehicles and light trucks. Some state based carbon taxes on combustion emissions (in British Columbia and Quebec). Quebec has established a cap and trade system that covers electricity and selected industrial sectors. Alberta has an emissions intensity target for large emitters, and if not met the emitter must pay $15/t CO2-e to a technology fund. 6

21 EU Japan China Emissions trading scheme covering most industrial sectors (not agriculture) operating since Proposed emissions trading scheme has been put on hold. Consumption of fossil fuel attracts a carbon tax of 289/tCO 2 from October Research into the design of a national emissions trading scheme has started. Biofuels target of 10 per cent by Farming emissions to be 10 per cent lower than 2005 levels by Proposed legislation for carbon stored in forests and farm land to count towards targets. Renewable energy target of 20 per cent by Non ETS covered sectors to reduce emissions by 10 per cent compared to 2005 levels by Some individual countries have implemented complementary policies to the EU ETS such as carbon taxes on fossil fuels. - Renewable Portfolio Standard for electricity retailers. Voluntary emissions trading scheme for large business energy use emissions and a trail ETS have closed. Cap and trade schemes operate in Tokyo, Saitama and Kyoto. Encouraging better agricultural practices. Increase forestry cover by 40 per cent. India - 5 per cent ethanol requirement in gasoline. Reforest 6 million hectares. Argentina - Government assistance to improve agricultural practices. Transport fuels need to be blended with biofuels. Tax and subsidy benefits for forestry activities. Reduce emission intensity by per cent. Energy conservation and efficiency in the industrial sector. Seven provinces and cities have been selected as pilots to test emissions trading, the scheme in Shenzen started trading in June Increase renewable energy generation to 10 per cent by Energy intensity standards for industrial units and power stations and tradeable certificates Energy efficiency improvements for households and vehicles. Energy efficiency improvements. Support for wind farms. 7

22 Brazil - Regulation of a proportion of sugarcane harvest to be done mechanically (rather than through burning). Incentives for emission reducing agricultural practices. Biofuel target to increase ethanol consumption by 11 per cent a year to Providing technical assistance to other countries for ethanol production. Incentives to reduce deforestation. Indonesia Aims to voluntarily reduce emissions by 26 per cent from BAU by Forestry activities to stop illegal logging and increase plantation forestry, and incentives for forest protection. Encouraging low emission agricultural practices. Malaysia - 5 per cent biodiesel mandate (in selected regions) but has not been met. Efforts to plant trees and protect forests. Thailand - Favourable tax treatment for blended fuels. Ethanol consumption target of 9 million litres/day by per cent biodiesel mandate. South Korea Mandatory cap and trade program will start in 2015, design elements are being developed. Note: For more detail see the appendix. Energy efficiency improvements. Increase renewable electricity generation. Energy diversification and conservation efforts. Incentives for renewable energy investments. Energy efficiency standards. Encourage energy efficiency and renewable energy sources. - A range of other piecemeal policies are in place such as energy efficiency measures, encouraging increased renewable energy, and fuel switching. As shown in the table, the only countries with comprehensive economywide policies in place are New Zealand and the EU, both with emissions trading. Most of the other developed economies have at some stage proposed emissions trading schemes but have faced political opposition (US, Japan, Canada). Some regional, state or provincial schemes have been introduced in countries without economywide policies (such as the US and Canada); however, none of these directly affect the agriculture sector. Policies directly affecting the agriculture sector are mostly biofuel policies. In New Zealand there is still a possibility that agriculture may be part of the emissions trading scheme, in other economies agriculture may potentially be included but only through offset programs. In 8

23 developing countries there are incentive programs or government intentions to improve agricultural practices to lower emissions. Forestry is also a major focus of developing countries with incentive programs to try to limit deforestation and increase reforestation. Remaining policies are mostly renewable energy targets, or incentive programs for renewable energy or energy efficiency. 9

24 2. Literature on impacts of mitigation policy There are a growing number of studies on the potential impact of climate change on agricultural production and trade. There have also been some studies written on the implications of global climate change mitigation policies on production and trade in major economies and sectors. However, few of these focus on the agriculture sector. A number of studies look at the potential implications of specific types of policies such as biofuel policies and border tax adjustments. There are also a few reports on the implications of carbon labelling or food miles programs for agricultural products. General effects of climate change policy on agriculture A number of studies provide a general discussion of the areas in which climate change policy may affect agriculture (see Anderson 2010a and b; Murphy et al. 2010; Huang et al. 2011; Tourney and Gueye 2009; and Thomson et al. 2010). The key points arising from these studies include the following. Policy responses to climate change are likely to have significant effects on global agricultural production and its location across regions but there are great uncertainties around possible government policy responses both unilateral and multilateral including what responses will be adopted where and when. Where unilateral climate change mitigation is undertaken, concerns of leakage and competitiveness arise. These are potentially addressed through the use of border taxes, export rebates, or free permit allocations. The extent of leakage and competitiveness effects will depend on the type and size of the target, the sectors covered, the method of permit distribution, the flexibility of permit use and the extent offset credits are available. Carbon pricing will increase the cost of inputs. Higher input costs may limit the ability to compete on international markets. Producers may also face barriers to trade if domestic carbon policy is less robust than other countries 3. However, where agricultural emissions are not regulated, barriers such as border tax adjustments are not expected to be imposed on agricultural products. There are difficulties in implementing border tax adjustments on final consumer goods that have long production chains as information is required about the full production process to determine the carbon embodied in the product. Developing countries in particular are likely to see the information provision as a barrier to trade as they lack the capacity to gather that information. Alternatives to avoid this difficulty are to apply taxes only to primary products, or to apply a common tariff to all imports of a particular good based on the domestic emission intensity of production. This later option, however, does not allow for differentiation between efficient and less efficient producers. WTO issues around climate change mitigation policies (in particular border adjustment policies) are raised as important concerns that need to be addressed. Border adjustments could face opposition on grounds of WTO rules because they are similar to import tariffs, or if they act as export subsidies. Policies that provide subsidies to agricultural producers for the use of best management practices or other mitigation technologies could also be the subject of challenges by 3 Clearly, harmonised national policies linked by an international carbon price would remove any justification for introducing border tax adjustments. 10

25 foreign competitors under WTO rules. It is suggested however that if the policies are part of a comprehensive environmental program then they would be consistent with trade rules. Mitigation potential in the agriculture sector could be exploited under domestic offsets schemes. Income generated from offsets would help farmers cope with increased costs of inputs expected under emission regulations including higher costs for fuel, fertiliser, chemicals transport and machinery. Physical and climatic conditions in other countries may be more suitable for generating offsets, such as growing trees. Under a global climate change mitigation policy, developing countries are expected to be adversely affected because of the higher emission intensity of their production systems, particularly livestock. It is expected that there would be increased imports to Sub-Saharan Africa and reduced exports from South America. Decreased crop and livestock production is also expected from South America due to decreased deforestation and increased re-forestation driven by sequestration demand. A global emissions price leads to a cessation of deforestation and an expansion of forested areas. The use of crops for bioenergy increases predominantly in South East Asia particularly if agricultural productivity growth is high. If, however, there is no agricultural productivity growth, the area under crops increases and there is widespread deforestation. Therefore both agricultural productivity improvements and specific incentives to reduce land use emissions (that is, a carbon price) are needed to reverse the deforestation trend. Biofuel policies may encourage domestic biofuel production (through subsidies, tax benefits, import tariffs) or rely on imports to increase biofuel consumption. Developing countries, in particular Brazil, may have the opportunity to benefit from exporting biofuel products or inputs (for example, palm oil from Malaysia). A key implication of the biofuel policies are that food and energy product prices are closely linked. Areas of concern associated with the use of bioenergy include assessing the true lifecycle emissions associated with biofuel production, the cost effectiveness of biofuel subsidies, food price inflation and food security concerns. Increasing biofuel production on prime agricultural land would displace production of other agricultural products reducing production and/or decreasing productivity. Renewable energy targets are widely used (66 countries), targets in OECD countries are often supported by policies such as feed in tariffs, renewable portfolio standards, subsidies and rebates, and favourable tax treatment. Mitigation in agriculture can generate co-benefits such as improvements in water quality and increased productivity of the land. International trade of agricultural products can contribute to climate change through emissions associated with transport and distribution. Food miles labelling programs look to address these concerns and can affect the demand for imported agricultural products. These programs are voluntary and often implemented by supermarkets. Where full lifecycle emissions are not considered, these schemes can have adverse consequences. Using full lifecycle emission labels may reveal emission associated with food produced in Australia and New Zealand and consumed in Europe may have lower emissions than food produced and consumed in Europe. It was noted that food miles schemes are likely to grow and it is important that a common standard of calculating embedded carbon is used. Full carbon labelling schemes can provide opportunities to producers that adopt greener methods, such as organic farming. 11

26 Impacts of carbon pricing Ho et al. (2010) analysed the potential impact of the US acting unilaterally by applying a $10/t CO 2 -e tax on all emissions. They found that output from the US agriculture sector declined steadily over time to reach around 0.7 per cent below the base case in the long run. The most adversely affected industries were the gas industry, coal mining industry and petroleum refining (10, 8 and 5 per cent declines in output respectively). By contrast the services sector was projected to increase slightly compared to the base case. Mattoo et al (2009a) looked at the potential impacts of emissions trading on production in different sectors and regions of the world, including agriculture. Under each of the scenarios examined, global agricultural output declines relative to the base case, but by no more than 1 per cent. The greatest falls in production are expected in high income countries (particularly the US) while production in developing countries is expected to increase. Global agricultural exports, however, are expected to decline by a greater percentage, between 3 and 8 per cent depending on the scenario. Exports from the EU and Japan are expected to decline the most, while China, India and Russia are expected to increase agricultural exports. Effect of carbon pricing on Australian agriculture The CPRS With the possible introduction of an emissions trading scheme in Australia in 2008 under the CPRS policy, several studies were conducted to assess the impact the scheme would have on the economy and specific sectors. The studies have been reviewed and updated based on the current policy, however, examining the results of the initial studies into the CPRS can give some insights into the possible impacts that the CPRS may have had if implemented. Furthermore, comparing the studies on the CPRS with those for the current policy can show the impacts of the policy settings that were changed. The Treasury (Australian Government 2008) considered the impacts of the CPRS under assumptions of gradual global climate change action (that is countries were assumed to adopt a carbon price equivalent to the price in Australia at different stages between 2013 and 2025). Table 2.1 summarises the projected impact of emissions trading on Australian output of agricultural and other key industries in 2050, compared with the reference case (or baseline) in which carbon pricing is not in place. Table 2.1 Change in output in key sectors in Australia due to emissions trading, 2050, compared to reference case CPRS -5 CPRS -15 Garnaut -10 Garnaut -25 Per cent change from reference case Sheep and cattle Dairy cattle Other animals Grains Other agriculture Meat products Other food Chemicals Electricity supply Refinery Source: Australian Government

27 The table shows highly emission intensive industries (such as sheep and cattle, electricity supply and petroleum refining) are projected to produce less under emissions trading, however, output in other sectors is projected to be higher than under the reference case. Under the scenarios, Australia s exchange rate is projected to fall, improving the competitiveness of Australia s exports compared to the reference case. The fall is driven by decreased world demand for Australian energy products. A number of points need to be made about these findings: 1. Emissions from agricultural activities (in particular methane from livestock) were subject to carbon price in these simulations. This explains the reduction in output in livestock industries; 2. Non-livestock industries were expected to expand as a consequence of carbon pricing. This results from an economywide range of effects that are discussed in further detail in the modelling chapters of this report; 3. Some food based manufacturing industries were also projected to expand; 4. While the Treasury analysis did not report changes in agricultural trade, it is possible to infer from the published results that those industries with an increase in output also had an increase in exports. ABARE (Ford et al. 2009) also undertook modelling, focussing on the impact on the agriculture sector. They found that Australia s share of agricultural world exports is relatively unchanged compared to the reference case because of the transitional assistance assumed to be provided to ABARE (Tulloh et al. 2009) and RIRDC (Jiang et al. 2009) also looked at the potential farm level impacts of the CPRS. Both reports looked at the direct and indirect costs of the CPRS on farmers. If agriculture were covered by the scheme, around 60 per cent of the costs of the CPRS are direct costs but this varies between agricultural industries (Jiang et al. 2009). Overall RIRDC estimated costs would increase by around 17 per cent with a permit price of $25/tCO 2 -e in the beef industry. Farm costs, excluding the purchase of permits, increase by around 1 to 2 per cent as a result of increased electricity, transport and chemicals costs (Jiang et al. 2009). ABARE (Tulloh et al. 2009) found similar results with input costs increasing by around 1 per cent with a carbon price of $28/t CO 2 -e and total costs increasing by up to 2.5 per cent where agriculture is covered but provided with transitional assistance. The Clean Energy Future Package A number of studies have looked in detail at the Clean Energy Future package particularly the official Treasury study of the analysis. Because direct agricultural emissions are not covered in the revised package, the sectoral results are quite different to those that were expected under the CPRS: overall the Treasury analysis predicts that the carbon price will lead to an expansion of agriculture relative to where it would otherwise have been. Agricultural output results are summarised in table

28 Table 2.2 Change in output in key sectors in Australia due to the Clean Energy Future Policy, 2020 and 2050, compared to reference case Clean Energy Future 2020 Clean Energy Future 2050 Per cent change from reference case Sheep and cattle Dairy cattle Other animals Grains Other agriculture Meat products Other food Chemicals Electricity supply Refinery Source: Commonwealth of Australia 2011a Several points can be made about these results: first, all agricultural activities are projected to expand in the presence of a carbon price (compared with the reference or business as usual case). In contrast with the CPRS, this expansion includes livestock based industries; second, this expansion is not a consequence of the carbon farming initiative, as it is simulated separately in the Treasury analysis (and not part of the results presented here); third, the expansion of agricultural activities is a consequence of economywide effects, essentially the change in the real exchange rate (depreciation) as a consequence of changes in more emissions intensive industries; finally, while the Treasury analysis does not report changes in agricultural exports, it can be inferred from the published results that the industry expansions are also associated with an increase in exports. The magnitude of the expansion in agriculture in the context of overall changes in the economy is summarised in Figure 2.1. This shows that the biggest reductions in activity are in the construction, mining and services sectors. The expansion in agriculture is very small by comparison, and is smaller than other expansions including manufacturing and renewables. 14

29 $ million in Manufacturing Agriculture Gains Transport Electricity Mining Renewables Construction Mining Services Losses Utilities Trade Manufacturing Data source: CIE estimates based on Commonwealth of Australia 2011b. Figure 2.1 Changes in value added following the introduction of a carbon price relative to business as usual in 2020 Similar results to those prepared by Treasury were also found in a recent study for Meat and Livestock Australia (Meta Economics 2011). This study found that as a consequence of Australian carbon pricing, aggregate economywide exports would increase by 0.3 per cent (relative to the base case) in 2015 and by 0.7 per cent in Importantly, the analysis showed an increase in production of livestock industries following the introduction of the carbon price. Overall, the Meta Economics analysis shows a crucial difference between partial and general equilibrium modelling of the implications of the carbon price. Sector specific models that do not account for the economywide changes in real wages and the real exchange rate tend to overstate the negative impacts of the carbon price on sectors such as agriculture. Implications of biofuel policies The US and Brazil together accounted for over 90 per cent of fuel ethanol production in 2008 (Timilsina and Shrestha 2010). Other significant producers include the EU, China and Canada. Production of biodiesel is small compared to ethanol, although increasing at a faster rate. The biggest producers are the EU and US. In recent years production has started in other regions such as Brazil, Indonesia, Malaysia and Argentina. Trade in biofuels is only around one tenth of the volume of production. The greatest trade was the import of ethanol by the US from Brazil. Brazil is the largest exporter of ethanol, supplying the US and EU markets. The second biggest exporter is China which exports to Japan, South Korea and other Asian countries. The EU is the largest importer of biodiesel and Malaysia and Indonesia are the main exporters. Trade in biofuels is subject to tariffs to protect domestic production, subsidies to domestic producers or regulatory measures on imported products (Timilsina and Shrestha 2010). Fridfinnson and Rude (2009) examined the implications of biofuel policies for trade patterns. Significant biofuel policies are in place in the US (renewable fuel mandates, tax policy and direct payments), EU (biofuel consumption tax targets, fuel tax exemptions) and Canada (mandated biofuel content of fuel supplies). Fridfinnson and Rude found that: 15