The robustness of any estimate of the likely effects of the CPRS on any part of the economy is driven largely by the application of an appropriate analytical framework which allows for the possible uptake of abatement technologies and activities, possible changes to management practices, scale of operations, input and output mixes, and likely changes to consumer preferences, in response to an emissions price. The strength of estimates also depends on how accurately the actual design features of the CPRS, including its transitional assistance measures (fuel tax arrangements, EITE assistance), are accounted for.

The appropriate framework for assessing the effects of the CPRS is a computable general equilibrium (CGE) framework, which incorporates important interactions between various parts of the economy, possible changes in production and consumption decisions in response to changes in policies and prices, and accounts for any direct and flow-on effects of the CPRS on the economy and any sector of interest. The CGE analysis usually involves a complex system of equations to represent various interactions in the economy and requires extensive real-world data sets.

Recently, ABARE has published its analysis of the likely long-term CPRS effects on agriculture, focusing on the possible effects in 2020 and 2030, using its dynamic global CGE model, GTEM (Ford et al. 2009). The results of this analysis show an estimated production increase of grains of around 5 per cent in 2030 relative to the baseline case (no CPRS) and production decline of around 8 per cent for beef cattle and sheep meat.

In the short run (e.g. in 2011), unlike in the long run, market participants may not be able to adjust fully and flexibly to changes in policies and prices. Therefore, to assess the short-term effects of a policy such as the CPRS, substantial refinements to ABARE’s GTEM framework, where parameter values and economic environments (in technical terms, model closures) are currently set for long-term policy simulations, would be required. Work on such refinements is currently in progress. In the meantime, an initial impact analysis has been undertaken for assessing the potential immediate effects of the CPRS at the farm level in 2011 and 2015. Given the nature of the estimation methodology, the results presented in this paper should be viewed as upper bounds of possible effects as these do not (at this point) include any changes in production and consumption activity in response to policy and price changes. Some of the likely future responses to price changes (particularly beyond 2011) include:

• changes in input and output mixes by farmers in response to changes in relative prices of inputs, products and profitability
• changes in technologies or management practices which reduce emissions in response to the introduction of an emissions price
• changes in consumption and associated effects on prices and production levels which would occur as consumers switch from more emissions intensive to less emissions intensive substitutes (e.g. from red meat to grains) in response to changes in the relative prices of commodities under the CPRS.

Even if the agriculture sector is not a covered sector under the CPRS, agricultural producers will face increased input costs associated with the use of electricity, fuels and freight and may face lower farm-gate prices for their goods from downstream processors. These will have implications for the economic value of farm production.

The major energy intensive inputs used by agricultural producers and processors which are identified and analysed in this paper include electricity, fuel and freight. As outlined in the White Paper and in draft legislation, agricultural producers will receive a CPRS fuel credit for the first three years of the CPRS to offset the increased cost of fuel as a result of the CPRS (DCC 2008). Heavy on-road transport will also receive a fuel credit for the first year of the scheme.

The production of fertiliser and chemicals is an energy intensive process, therefore, domestic fertiliser and chemical producers will face significantly higher input costs. If producers could pass on their increased input costs then the price of these goods would increase. However, the scenarios analysed in this paper assume no increase in the price of fertiliser or chemicals to reflect that these are highly traded products. International producers which export to Australia are assumed not to face the same increase in input costs and therefore, international competition will mean domestic producers are unlikely to be able to drive up the price of fertiliser and chemicals in Australia.

The agricultural (food and fibre) processing sector will be included in the CPRS from the commencement of the scheme in 2011. Therefore, agricultural processors with emissions of more than 25 kilotonnes of carbon dioxide equivalent (kt CO₂-e) will be required to purchase permits for their emissions and will face increased costs for their inputs. These emissions and costs will mostly be associated with wastewater management, transport and electricity usage. The processing sector is highly trade exposed and so it is expected that the full extent of increased costs will not be passed on to consumers. It is likely that some of these increased costs to the processor will be passed on to agricultural producers in the form of lower prices paid for the inputs to the processing sector such as wool, livestock and milk, etc. The extent of the cost-price pass-through depends on a range of complex interrelated factors, and is purely an empirical issue.

Determining the extent to which prices paid to farmers will decline is a difficult task for a number of reasons including:

• not all processors will be above the 25 kt CO₂-e emissions threshold
• there is limited information about the emissions and cost structure of processors
• there is limited understanding of the degree of cost-price pass-through downstream to wholesalers and consumers and upstream to agricultural producers. Understanding the degree of cost-price pass-through requires extensive data analysis and econometric estimates of supply and demand.

Given the lack of empirical estimates and analyses on the rate of cost-price pass-through in agricultural industries, a sensitivity around the potential effects of the CPRS has been undertaken assuming different rates of cost-price pass-through: 0, 20, 60 and 100 per cent. For example, in the case of 100 per cent cost-price pass-through, it is assumed that agricultural processors pass all of the additional costs associated with the CPRS back to agricultural producers through lower prices for agricultural inputs purchased. As it is unlikely that 100 per cent cost-price pass-through will occur, other things being the same, this represents an upper bound of the effects of the CPRS on agricultural producers.
The 60 per cent cost-price pass-through scenario roughly represents a situation where processors export the majority of their production taking prices set in the international markets as given, but have some control over prices charged for domestic sales. As processors are unable to adjust the price to international consumers for the majority of their production, approximately 60 per cent of the production cost increases associated with the CPRS is assumed to pass back to farmers supplying key commodity inputs to processors.

For each assumed cost-price pass-through rate, a set of three CPRS scenarios are analysed (table 1). The three CPRS scenarios are consistent with the government’s most recent policy announcement, and have been considered to examine the likely effects of the CPRS in:

• 2011 when agriculture is not included in the scheme
• 2015 when agriculture is not included in the scheme
• 2015 when agriculture is included in the scheme.

The analysis uses ABARE’s farm survey data on average input costs for the years 2003-04 to 2007-08 for six industries: wheat and other crops; mixed livestock–crops; sheep; beef; sheep-beef; and dairy. For a definition of these industries see Hooper et al. (2008). The input costs for fuel, freight, electricity and other costs were averaged for the five years for each industry. In table 2, the relative cost shares of each input for each agricultural industry are shown. For most of the agricultural industries, the highest share of input costs is fertilisers and fuels; electricity represents only a small proportion of farm input costs.

The government has stated that the emission price in 2011 will be capped at $10 per tonne of carbon dioxide equivalent (t CO₂-e). The price of emissions after 2011 will be determined by the domestic permit market (as well as rules around access to international markets) and will not be known until after the scheme commences. Therefore, for simplicity, the analysis undertaken here assumes an emission price equal to that projected by the Treasury (Australian Government 2008): a price of $20/t CO₂-e in 2010 (in 2005 dollars) increasing on average at 4 per cent a year. The financial information from ABARE’s farm survey data is recorded in 2007-08 dollars; therefore, to ensure consistency between the historical costs and the assumed emission price, the emission price was converted into 2007-08 dollar terms when the analysis was conducted.

The increase in the price of fuel in 2015 was calculated to be 10.4 per cent. This estimation was based on the carbon content of diesel fuel of 2694 grams of carbon dioxide equivalent per litre (NGGI 2007) and an average diesel price of 72.04 cents a litre for 2003-04 to 2007-08 (in 2005 dollars; ABARE 2008a). The increased price of freight is assumed to be equal to the increase in fuel prices, multiplied by the share of fuel in total inputs for the freight industry and is 1.9 per cent in 2015. The increase in the price of electricity, estimated to be 6.9 per cent in 2011 and 24 per cent in 2015, is based on an estimated average emission intensity of 834 grams of carbon dioxide equivalent per kilowatt hour and an average retail electricity price of around 10 cents a kilowatt hour (ABARE 2008b).

The assumed increase in the prices of inputs was applied to the average input costs over the period 2003-04 to 2007-08. As discussed earlier, it is assumed that agricultural producers do not change behaviour in response to changed input costs.

The agriculture sector may be required to participate directly in the CPRS from 2015 (the decision is to be made in 2013). Whilst the effects of coverage under the CPRS from 2015 have been modelled and compared with those under non-coverage, it is important to note that, according to the government’s policy statement, if agriculture is not included in the CPRS, the sector will face alternative measures which impose an equivalent carbon cost. The point of policy obligation has not been decided. However, in this analysis it is assumed that if agriculture participates in the scheme, agricultural producers will be required to purchase emission permits to account for the emissions which occur on-farm. The cost of these emission permits has been estimated using activity levels and average emission factors. In the context of the analysis undertaken here, the point of policy obligation will not affect the change in the economic value of farm production if it is assumed that the full cost of permits for on-farm production are passed to the farmer.

The activity levels have been determined using farm survey data averaged for the years 2003-04 to 2007-08. The activity level (e.g. the number of cattle and sheep held) was multiplied by the emissions factor for the activity (table 3) to determine the level of emissions associated with each activity for an average farm in each industry. It is expected that some agricultural activities will be eligible for emissions intensive, trade exposed assistance. In particular, it is expected that beef cattle, sheep, dairy and rice will receive the higher rate of transitional assistance. The high rate of assistance in 2015 will be 89.7 per cent. This rate of assistance includes the global recession buffer announced by the government in May 2009.

To determine the cost associated with purchasing required emission permits, the calculated emissions for each industry were multiplied by the permit price in 2015. The emission cost associated with beef cattle, sheep, dairy and rice was then adjusted by the percentage of permits which will be provided free as transitional assistance, to find the net emission cost. This was added to the emission costs associated with cropping, to find the total emission cost for the average farm in each industry. Finally, the emission cost was added to the total input costs for each average farm. The final estimated increase in input costs is the per cent difference between this final input cost and the initial input cost without the CPRS.