Climate Change

27 Nov 2008

Emissions Trading: A Change In Political Climate

One of the last acts of the Government, prior to the election, was to enact an emissions trading scheme (ETS) for New Zealand. Amid widely expressed concerns that the scheme had been rushed through with inadequate consultation, more than 1,000 amendments recommended by the Select Committee, and further amendments introduced at the third reading stage, the incoming National-led Government has indicated a complete review of the ETS. We take a look at the proposed review process, the ETS as currently enacted, and some of the issues likely to be debated.

Proposed Review Process

Emissions trading is a form of regulation aimed at reducing carbon-based emissions in the most economically efficient way, enabling an economic value to be put on both greenhouse gas emissions and reductions in emissions. The National Party went into the election earlier this month with a policy that broadly supported emissions trading as the best available tool to efficiently reduce greenhouse gas emissions across the economy. At the same time the National Party committed to introducing legislation amending the ETS in order to address the six major concerns it identified in its minority select committee report. National has now committed to undertaking a complete review of the ETS as part of its support agreement with the ACT Party, which campaigned on a policy of abolishing the ETS.

National has confirmed that it remains committed to retaining measures to address New Zealand's Kyoto obligations, by making amendments to the legislation that will balance environment responsibilities with economic needs. ACT has indicated it is not opposed to New Zealand adopting responsible climate change polices and would support legislation giving effect to such action if a rigorous select committee inquiry establishes a credible case.

A ‘special select committee’ is to be set up to review the ETS and any proposed amendments or alternatives to it, including carbon taxes, ‘in light of the current economic circumstances’. Pending the outcome of the review, National has agreed to pass legislation delaying the implementation of the ETS as it currently stands, repealing the thermal generation ban and any other necessary interim measures.

A draft terms of reference for the review, proposed by ACT but not at the time of publication yet agreed to by National, includes hearing ‘competing views on the scientific aspects of climate change’ and looking at the merits of a ‘mitigation or adaptation approach.’ It also includes looking at the merits of an ETS, as opposed to a carbon tax, and the timing of any future climate change interventions.

Other key issues likely to come under the microscope in the pending debate around an ETS for New Zealand include:

• balancing New Zealand's environmental and economic interests;
• alignment with the proposed Australian emissions trading regime, described as a Carbon Pollution Reduction Scheme;
• balancing interests of government and business, specifically the need for fiscal neutrality; and
• avoiding an exodus of business, through encouraging use of new technology, keeping industry obligations in line with foreign competitors and recognising the importance of small and medium enterprises.

In the remainder of this FYI we provide an overview of the key features of the New Zealand ETS as currently enacted.

Who Does the ETS Apply to?

As enacted, the ETS does not apply to every person or business that emits greenhouse gases. Only those who undertake one or more of the specified compliance activities are mandatory participants under the ETS and subject to the compliance obligations. 

A compliance activity may not be the actual source of the greenhouse gas emission - the ETS seeks to impose the compliance obligation as far up the supply chain as practical, with the aim of reducing overall compliance and enforcement costs. The expectation is that as price effects filter down the supply chain to direct emitters, this will provide an incentive to take steps to reduce emissions, resulting in an overall reduction of emissions.

Compliance activities fall into six broad sector headings - forestry, liquid fossil fuels, stationary energy, industrial processes, agriculture and waste.  Compliance obligations start at different times for different activities, generally by sector. The first sector to come within the ambit of the ETS was forestry with a start date of 1 January 2008. Other sectors progressively come into the ETS through to 2011.

The table attached to this FYI identifies the specified compliance activities and the dates on which they come within the scope of the ETS. There is no doubt many submitters to the special select committee will be seeking a review of what compliance activities should be subject to direct compliance obligations, in particular activities related to agriculture, and when such obligations should apply as part of any new look ETS.

The ETS also includes a number of optional activities within each sector. Anyone carrying out an optional activity can choose to become a participant and will be subject to the same compliance obligations as mandatory participants, for as long as they remain a participant. These voluntary participants can opt out, as well as opting in to the ETS, but may be subject to certain obligations when opting out. In many cases, optional activities enable participants to earn (rather than requiring surrender of) emissions units. Those optional participants who will have to surrender emission units will generally have chosen to participate in order to assume more direct control over the emissions costs imposed on their business, rather than simply be a price taker.

A Participant’s Obligations

Emission units are the ‘currency’ for the ETS. An emission unit may be an NZU, which is the domestic currency, or one of the approved international currencies. Approved international currencies are principally Kyoto currencies, such as certified emission reductions units (CERs) and emission reduction units (ERUs), but may also be any other currency recognised for the ETS from time-to-time. This would generally be a currency from another country's domestic emissions trading scheme. Emission units specifically excluded from the ETS are those deriving from projects involving nuclear energy.

The primary compliance obligation under the ETS is a requirement to surrender or redeem one emission unit for each tonne of greenhouse gas (measured in carbon dioxide equivalent emissions) emitted. An emission unit does not exist as a tangible object but it can still be owned, surrendered, transferred or assigned. 

Other compliance obligations for ETS participants include:

• monitoring emissions by collecting data; calculating emissions (using set calculation methods); and keeping records of emissions. Verification of data collection and calculations may also be required by regulation;
• emissions reporting; and
• maintaining a holding account with the New Zealand Emission Unit Register (units can only be received and surrendered through a holding account).

Failure to comply with any of these obligations is an offence carrying a monetary penalty. Failure to surrender any or sufficient emission units also carries a make-good obligation. Offences committed with intent to deceive or evade obligations under the ETS also carry potential imprisonment consequences. Directors and managers of a company may have personal liability in certain circumstances.

Monitoring and Reporting Emissions

Participants must monitor and report annually on greenhouse gas emissions associated with compliance activities. An emissions return recording details of greenhouse gas emissions (measured in carbon dioxide equivalent emissions) for the previous calendar year is to be filed no later than 31 March. The number of tonnes of carbon dioxide equivalent emissions equates to the number of units that the participant must then surrender.

Participants whose primary compliance obligations to surrender emission units start in or after 2011 must monitor and report on emissions for compliance activities in the preceding calendar year. Participants in some sectors can opt to voluntarily monitor and file an emissions return one year ahead of the compulsorily requirement to do so. These sectors are liquid fossil fuels, agriculture, waste and both industrial and removal activities relating to SF₆ hydro fluorocarbons (HFCs) and per fluorocarbons (PFCs). An emissions return:

• records the participant’s activities;
• calculates emissions/removals resulting from the participant’s activities;
• assesses how many emission units are to be surrendered by the participant; and
• must be signed by the participant.

 Additional information to be provided in an emissions return may be required by regulation.

Holding Accounts and Surrendering Emission Units

A participant is required to have a holding account in the New Zealand Emission Unit Register (NZEUR) for surrendering, transferring and receiving emission units.

The Crown has a large number of accounts in the NZEUR, including:

• a cancellation account (from which units cannot be further transferred);
• a retirement account (to which the Government transfers Kyoto units to offset its own obligations under the Kyoto Protocol. Kyoto units cannot be further transferred from this account);
• a surrender account; and
• a conversion account (used to convert domestic emission units (NZUs) into assigned amount units).

To surrender an emission unit, a participant must apply to the Registrar to transfer emission units from its holding account into the Crown's surrender account. The Registrar must then seek a direction from the Minster of Finance as to whether or not the units can be transferred, and once directed by the Minister, the Registrar will then transfer the unit into the surrender account.

Participants may also transfer emission units to overseas registries - for example, if a participant has sold units to an overseas purchaser so that an overseas purchaser can account for its own liability under a separate ETS. Again, the same process is followed, except that the unit is transferred to the Crown's conversion account so that the NZU becomes an ‘assigned amount unit’ before it is transferred.

Free Allocation of Emission Units

The ETS legislation, as currently framed, includes a free allocation framework aimed at ensuring the cost burden of the ETS is shared fairly across the economy. A number of general principles are identified in the legislation as the basis for determining free allocations. 

These include:

• avoiding outcomes which might lead to economic regrets, significant regionally-concentrated job losses and perverse behavioural incentives, including decisions relating to investment;
• new entrants to a sector or industry should be treated in a similar manner to those already operating in that sector or industry;
• certainty and consistency; and
• minimising administrative and compliance costs.

The process for determining how the free units are allocated requires an allocation plan to be prepared by the Minister of Finance for each of the four groups identified for free allocation - pre-1990 forest owners, trade exposed industry, an Innovation Fund (to facilitate innovative technologies) and agriculture. There is no requirement for recipients of free allocations to be ETS participants.

Allocation plans are to have regard to the enacted general principles, any other general principles the Minister considers appropriate and the specific principles for free allocation to the particular group also included in the ETS legislation. An allocation plan must explain who is eligible for the free allocation of emissions units and how many free emission units they will get. Draft allocation plans are to be made available for public consultation before being finalised. Free allocations are to be phased out from 2018.

It is inevitable that free allocation and other mechanisms to assist trade exposed businesses as well as equitable cost sharing will receive a high degree of attention as part of the special select committee review.

Conclusion

The change of government following the election has provided the immediate impetus for a wide-scale review of the ETS, encompassing a consideration of any viable alternatives. Similar reviews of climate change and emission reduction policy are, however, also being undertaken in a number of countries as a result of uncertainty caused by the global economic crisis.

The business community in New Zealand will undoubtedly welcome the opportunity for further debate on the broader issues of an emissions trading scheme. Environmental groups, on the other hand, have branded National's suspension of the ETS as ‘a step backwards in environmental policy’.

Notwithstanding that emissions trading is promoted as the lowest cost solution to compliance with Kyoto Protocol obligations, the current economic environment combined with associated uncertainties as to the price of carbon and the transitional costs and risks associated with the establishment of an ETS, are all serving to magnify the process   concerns around the perceived haste with which the current legislation was pushed through. It is these concerns that underlie much of the scepticism and opposition to the operation of the New Zealand ETS.

One thing that is certain, is that the outcome of the ‘special select committee’ review will be awaited with interest at a time when the exercise of balancing environmental obligations and economic considerations is perhaps more challenging than ever before.

Authors

Elisabeth Welson

Partner - Corporate & Commercial

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Michelle van Kampen

Senior Associate - Public Sector

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