It’s critical that Australia gets to net zero at the lowest cost

22 October 2024 | Barry Sterland

Tackling the threat of climate change is “mission critical” for Australia. Our economic performance and living standards depend on how well we respond to this challenge today, and over the coming years.

The Productivity Commission has for many years emphasised the importance of climate change policy.

As our chairwoman Danielle Wood wrote last month, the commission has been encouraging governments to use market mechanisms as the best way to reduce carbon emissions since before we were known as the Productivity Commission.

And given the centrality of climate change to energy security, international competitiveness, and our future prosperity more generally, we now have a renewed and dedicated focus on these issues through our Climate Change and Energy work stream.

Addressing these challenges is not just a long-term issue – it is here and now. In the electricity sector, for example, there is an urgent need for significant new generation to ensure reliable energy as coal exits the system. Global capital markets and supply chains are increasingly demanding demonstrable progress on climate commitments. A medium-sized trading country like Australia needs to be part of these efforts.

There are many opportunities for Australia. We are blessed with an abundance of renewable energy sources and other inputs integral to the transition.

But there is no room for complacency. Even as the cost of many renewable and other net zero technologies has declined rapidly in the past decade, large new energy infrastructure is facing cost overruns, timing blowouts and social licence issues. Australia needs to invest hundreds of billions of dollars across all sectors over the coming decades to adapt to climate change and transition its energy systems.

Climate policies vary enormously in cost-effectiveness, can impose overlapping measures on some sectors, and leave policy gaps in others.

It’s critical that these investments are cost-effective. We must have enduring policy frameworks and instruments to drive the investment and innovation to achieve our energy and net zero goals.

Until recently, climate policy has been marked by a somewhat hodgepodge approach nationally – to quote our five-year productivity inquiry – marked by a broad range of often costly sectoral and sub-sectoral abatement measures.

Much has changed in the past two years to reset the climate agenda.

Climate change targets now have a legislative basis. There is an accountability framework involving review and independent assessment by the Climate Change Authority. And Australian governments are co-operating around climate and energy policy.

Key sectoral interventions have been introduced to accelerate the energy and net zero transition. They are both broader and include significant market features. The safeguard mechanism, for example, sets declining carbon emission limits for Australia’s biggest industrial facilities and allows emissions trading to achieve these limits efficiently.

Other measures such as the new vehicle efficiency standard for light transport introduce a welcome national approach to sectoral policies, with competitive market elements.

The national interest framework, designed to guide spending under the Future Made in Australia program, also has the potential to introduce rigorous analysis and discipline to public support for net zero technologies, if consistently applied.

These changes provide the prospect for policies to be more co-ordinated and track towards achieving abatement at lower cost across the economy, and for additional complementary policies to be assessed rigorously and contain appropriate off-ramps.

The commission also recognises that there can be a role for carefully considered complementary measures that address market failures beyond carbon pollution. For example, policy support for some emissions abatement activities by businesses today could create positive future “spillovers”, potentially reducing the overall cost of Australia’s pathway to net zero.

While the emerging framework is a clear step forward, we must grasp the opportunities to improve the effectiveness and efficiency of our climate and energy response over the next few years.

Climate policies still vary enormously in their cost-effectiveness, can impose overlapping measures on some sectors, and leave policy gaps in others – shortcomings which the sectoral planning process and ongoing national co-ordination must address.

Longer term, Australia needs to transition to better market mechanisms to provide predictable signals for investors to confidently invest and innovate in clean technology, and to minimise the costs of the transition. This approach should be at the core of our response to climate change.

As an example of the type of change needed, our five-yearly productivity inquiry recommended that the safeguard mechanism be expanded to cover more of our industrial sectors and capture facilities with lower emissions than currently covered by the scheme.

Similarly, we have drawn attention to the importance of moving to a more market-based approach to meeting electricity needs, following the completion of the capacity investment scheme. This would provide a more efficient pathway to meet the objectives of net zero, and deliver secure, reliable and affordable electricity to Australian households and businesses.

The pay-off from getting the policy settings right now will be least-cost, net zero energy and industrial systems that build on Australia’s advantages, are resilient to climate change and are fairer for current and future generations.