EY: How important is COP26 for Australia’s economy?

By Jo Masters, EY Oceania Chief Economist

The decisions made at Glasgow will be of global significance and critical to Australia

The world will be brought together in Glasgow over the coming days for the 26th United Nations Climate Change conference (COP 26). 

Much of the discussion so far in Australia has been about what target we will set. However, the decisions and commitments made from countries across the world – advanced and developing – will likely lay the foundations for one of the world’s strongest structural trends over the next three decades – the global pursuit of net zero emissions by 2050.

The hope is for significant decisions to be made at and post COP 26, which could reshape significant portions of the world economy and for Australia – a global commodity superpower – this will have impacts. 

Exports have long been an important aspect of Australia’s economic success story, with goods exports currently representing over 20 per cent of the economy. Non-rural commodity exports, which includes metals, minerals, fuels, ores and coal, are nearly 15 per cent of the economy. This represents a large share of Australia’s national income and underpins our standards of living.

During the COVID-19 crisis, trade has been a bright light in the Australian economy. Specifically, the lifting of value of commodity trade boosted national income at a time when record government deficits were published, and debt levels increased substantially. 

This raises several questions for Australia’s exposure to the global transition towards net zero: How exposed are Australia’s current exports? What have our trading partners committed to? How carbon intensive are our exports?

One thing is certain, the decarbonisation of the global economy that will be a feature of this summit is not economics as usual.

Decarbonisation is a global trend that impacts Australia

Many of Australia’s trading partners have already established a commitment to making significant steps towards decarbonisation. Australia’s top three goods export partners and biggest consumers of carbon intensive exports, China, Japan and South Korea have all announced targets to substantially reduce emissions over the coming decades. 

Globally, countries accounting for around 70 per cent of Global CO2 emissions and GDP have set net zero pledges in law, proposed legislation or have it in an official government document. For Australia, 82 per cent of goods exports go to countries with these commitments.

These are policy decisions that Australia will have little influence over while bearing a share of the consequences.

When classified according to the International Energy Agency’s Net Zero by 2050 report, advanced economies committed to net zero represents a larger share of global GDP but a smaller share of emissions. Developing economies committed to net zero represent a smaller share of global GDP, but a larger share of emissions. This means the commitments both advanced and emerging economies make – as well as their ability to meet them – are critical for the global race to zero and for the impact on Australia’s export base.

Some of these net-zero commitments are stronger – and therefore more predictable – than others. Some have been officially ratified, others will likely be ratified post COP 26. Some have detailed plans behind them, others do not.

Australia’s export base is exposed on both sides

The global shift towards decarbonisation and adoption of net zero targets will have affects on both the domestic economies of those adopting these targets, and of their trading partners.

While other reports have covered the individual emissions intensities of many of Australia’s individual non-rural commodity exports, EY has used the Global Trade Analysis Project database to identify the collective share of greenhouse gas emissions in the production of exported goods. This analysis demonstrates the risk to Australian exports, both through the future implementation of domestic net zero targets, but also as a proxy for the economic risk Australia faces from our trading partners as they broaden the scope of their emissions reduction targets.

Australia’s export base has become increasing reliant on high emission intensity goods. Currently around 85 per cent of the dollar value of Australian exports are in goods within the top 25 per cent of emissions intensity goods (during production), up from 55 per cent in the late 1980s.

The rising dominance of these exports reflects the emergence of China, following its introduction into the World Trade Organization (WTO), the rise of Asia more broadly and associated increased demand for our key commodities. These commodities are often both emissions intensive to produce in Australia, and for our trading partners to consume.

It’s not just the mined commodities that are considered high or very high emitters of greenhouse gases. These emissions intensive products include livestock and milk products for their very high contribution to methane emissions and wheat production for its high contribution to nitrous oxide emissions.

How Australia’s trade partners move toward net-zero is critical to the economic risk facing Australia

The question remains – where is the greatest risk to our economy coming from?

EY modelling shows that the majority of this risk is generated from international actions, rather than domestic decisions – perhaps not surprising given the export orientated nature of the affected industries.

EY’s model of the economic impact incorporates parameters that mirror the NGFS net zero scenario, where the whole world works together to reduce greenhouse gas emissions. The impact on Australian GDP of such a scenario is complex and depends on a variety of factors and assumptions including technology development and adoption, the types of policies employed to abate emissions and the timing of the changes.

This modelling focuses not on the quantum of the impact to GDP, but the economic risk created by the transition to net zero to our economy as it stands today – whether they are due to domestic or international decarbonisation policies.

Decomposing the risks to our current export base (assuming no change in technology) of such a scenario suggests that 64 per cent of the risks to GDP will come from abatement policies in our trading partners – both ‘advanced’ and ‘developing’ countries – with the remaining 36 per cent coming from how we tackle our domestic emissions.

The risks to the Australian economy are clearly uneven, with certain industries, communities and regions particularly exposed. Without mitigation or policy measures, the risks to employment are more heavily skewed to domestic actions, because it is relatively more labour intensive than the export orientated markets. This is a challenge explored in the Investor Group on Climate Change’s Empowering Communities report. In reality, there will be measures put in place by governments to assist affected regions – indeed how best to do this is already being actively debated.

While this modeling focuses on the risks, it is also worth considering that the transition towards net zero is likely to generate significant economic activity. The investment in developing and implementing new technologies, commercializing research and development and maximizing Australia’s advantages in clean and new energy sources could be a significant economic windfall, boosting our GDP.

A global journey to net zero

How Australia tackles the journey to net zero is critically important, but this analysis highlights that we need to have a close eye on what the rest of the world is doing, and any commitments made in relation to COP 26 must be considered as we plan the Australia of the future. 

Australia’s major trading partners – such as China, Japan, South Korea, the United States, and the European Union – may make additional commitments to climate action, and have the financial resources to credibly make the transition.

The commitments and actions from developing countries is perhaps less predictable because of their greater reliance on older technologies, but their choices and actions are also critically important for Australia. 

The first mover benefits of any economic change are significant, especially when the shift is going to be felt broadly across the economy.

Whatever the outcome of COP 26 and the remaining uncertainties, the economic impact of global decarbonisation is coming and will impact Australia’s export base. The earlier we prepare for this change, the better placed we will be as, and when, these shifts arrive.

EY is a gold sponsor of the #CMIsummit. View the full article on the EY website.
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