AGENDA PAPER: OPTIONS FOR COVERAGE OF AGRICULTURE
Canberra, 19 May 2008
1. Introduction
Agricultural emissions represent approximately 15 per cent of Australia’s total emissions. Agriculture is the dominant source of methane (primarily from livestock) and nitrous oxide (mainly from agricultural soils). Agricultural emissions are projected to increase to 93 Mt CO2-e in 2010 and 101 Mt CO2-e by 2020. Table 1 shows the emissions from agriculture as reported in Australia’s national (Kyoto) inventory for 2005.
While direct emissions from farming make up the bulk of emissions from agricultural sectors, these industries also produce emissions through energy use and land-use change.
2. Coverage
Agricultural emissions could be included within the scheme in one of three possible ways. Liability could be imposed:
• directly on farm businesses;
• indirectly, on ‘up stream’ inputs such as fertiliser and/or on ‘down stream’ food processors such as abattoirs; or
• via a hybrid of these approaches whereby the default point of liability would be up or down stream but farm businesses given the option of managing their emissions liabilities directly.
Consideration of the method of coverage of agricultural emissions involves judgment of the relative importance of two strongly competing coverage principles:
• The bulk of the sector’s emissions are produced by thousands of small farm businesses potentially making it costly and potentially inefficient to impose obligation on emissions at the entity level:
o Very few farm businesses would meet the minimum 25 kilotonne CO2-e threshold for reporting under the National Greenhouse and Energy Reporting Scheme, and indeed many of the emissions in the sector would be produced on entities with less than one kilotonne;
o This would suggest, with a certain fixed cost associated with entity compliance with the scheme (emissions estimation and permit management and the like), coverage of direct emissions in the agricultural sector would be orders of magnitude greater than those in other sectors (other things being equal); and
o Consideration of even low thresholds specific to the agricultural sector – which would be necessary to limit very excessive compliance costs – would necessarily bring some economic distortions given the competition
between farm businesses of different sizes throughout the sector;
• On the other hand, there is a relatively weak relationship between emissions at upstream and downstream points in the supply chain and direct farm emissions. That is, management action and enterprise specific characteristics can
significantly affect the actual emissions associated with production and input variables, such as meat or milk production or fertiliser consumption. This means that moving the point of liability away from the direct source of emission could reduce the efficiency of the carbon price signal, and potentially compromise the equity of the scheme (as broad emission defaults are applied).
3. Direct Obligation
Mitigation incentives
The scheme will be more equitable and efficient where emissions can be estimated accurately and cost effectively at the point of emissions because: the emissions liability matches the actual emissions at the site; and as a result there are more opportunities for individual entities to respond to the carbon price by changing their behaviour or
technology to reduce emissions.
Cost effectiveness
Compliance costs will include emissions estimation and reporting costs as well as those involved in holding, trading and acquitting emissions permits. There will be relatively fixed costs for all liable entities associated with establishing the necessary reporting systems, and with annual scheme obligations. Emissions estimation costs will vary
according to the number of covered activities undertaken on the farm, the complexity of estimation methods, and audit and record keeping requirements. There are around 130,000 enterprises in the land-based sector. These vary in scale from
‘hobby’ farms to large corporate operations. Table 2 shows indicative emissions by industry sub-sector and the approximate number of entities responsible for these.
Table 2 Agriculture Sector Profile (major industries)
Economic distortions
The number of liable entities in the scheme could be reduced by applying an emissions threshold to restrict liability to those entities that can be included practically and cost effectively. In this way, thresholds allow a balance to be struck between compliance costs and benefits of direct liability.
In the agriculture sector, thresholds would need to be set at a relatively low level to capture the majority of agricultural emissions. As an indicative example, covering about 80 per cent of direct emissions from the beef, sheep, dairy and wheat industries would require participation in the scheme of around 45,000 farm businesses.
Use of thresholds introduces the possibility of economic distortions between entities above and below the relevant threshold, because carbon costs are not imposed on below threshold entities. This could create incentives to change company structures.
4. Indirect liability
To achieve comprehensive coverage of all emitters (both large and small) where the costs of coverage are excessively high, an option is to cover emission sources indirectly. This could be achieved by requiring up or down stream entities, such as fertilizer distributors or food processors, to acquit scheme units for emissions from consumption of their products (upstream entities) or production of their inputs (downstream entities), using proxies of direct end use emissions. This is the approach that New Zealand has proposed for its emissions trading scheme.
Mitigation incentives
Provided that the link between the upstream activity and emissions is unbiased, from an economic perspective, incentives to reduce sectoral emissions will be present. However, as noted, these are likely to be more muted under an upstream approach. There is potential, though, to provide greater mitigation incentives through development of more differentiated emissions factors. Not all emissions sources could be captured via up stream and down stream activities. For example, breeding animals and animals slaughtered for on-farm consumption would not enter the supply chain and so could not be covered ‘downstream’.
Cost effectiveness
The costs of an indirect approach will depend on the number of liable entities, which in turn will depend on the number of covered emissions sources and the precise point of obligation. Overall costs would likely be significantly lower because there would be hundreds rather than thousands of liable entities. Development of an indirect approach to coverage would require identification of points of obligation that efficiently and comprehensively cover emissions from the sector.
Economic distortions
Indirect liability would avoid the problem of economic distortion between farms on either side of the emissions threshold because the up (or down) stream entities would supply to (or receive produce from) farms of all sizes.
It may be difficult to identify practical indirect points of liability for all emissions sources.
For example, breeding animals and animals slaughtered for on-farm consumption would not enter the supply chain and so could not be covered ‘downstream’.
5. Hybrid approach
A further option is for liability to be imposed indirectly (‘upstream’ and ‘downstream’) as a default option, but farm businesses given the option of reporting and managing their own emissions liabilities (accepting direct liability). This option could be a way of obtaining the advantages of both direct and indirect approaches.
The New Zealand Government is currently working with its agricultural sectors to explore the workability of such an approach.
Questions for stakeholders:
Stakeholders are invited to comment on the merits of each of the three approaches:
1. direct obligation;
2. indirect liability; and,
3. hybrid.
Stakeholders are also invited to offer suggestions, in relation to each option, on ways to:
- reduce the costs of scheme participation;
- cost effectively verify management practices that reduce emissions, such as timing of fertiliser
application; and
- maximise abatement incentives.
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