Climate Change

26 Jun 2008

Paying the Cost of Carbon: An Update On New Zealand's Emissions Trading Scheme

The Select Committee report on the Climate Change (Emissions Trading and Renewable Preference) Bill (Bill) was released on 16 June 2008. It has been one of the most eagerly awaited Select Committee reports, with extensive submissions on the topic. With a slowing economy and a general election looming towards the end of 2008, a complex mix of economic and political considerations raise some interesting challenges if the Bill is to pass into law before the election. We examine the Bill and assess how the Select Committee report (and reaction to the report) will affect the implementation of the New Zealand Emissions Trading Scheme (NZETS). 

By way of a brief re-cap, the Bill proposes a form of cap and trade based emissions trading scheme for New Zealand which will eventually include almost all greenhouse gases and all industry sectors. The Bill also seeks to restrict new fossil-fuelled thermal electricity generation to boost the renewable electricity sectors (except where thermal generation is needed to guarantee security of supply). The Bill, as amended by the Select Committee, proposes to phase in the enrolment of industry sectors into the NZETS starting in 2008 with forestry and ending in 2013 with the introduction of agriculture and waste.

The NZETS is an integral part of the Government’s package of policy initiatives aimed at climate change and greater sustainability. By establishing a framework to put a price on greenhouse gas emissions, the NZETS seeks to "support global efforts to reduce greenhouse gas emissions" by reducing New Zealand’s net emissions below business-as-usual levels. It aims to achieve this by driving behaviour change and business innovation through price effects. 

Participation in the NZETS is mandated by reference to specific activities that broadly fall into the categories of forestry, liquid fossil fuels, stationary energy, industrial processes, agriculture and waste. Without attempting to list all such activities, examples of particular activities within these broad groupings include deforestation of pre 1990 forests; owning "obligation" transport fuels (which can include automotive diesel, motor and jet fuels) at a certain point in the supply chain; importing or mining fossil fuels such as coal or gas; producing other products such as steel, iron, gold; importing or manufacturing synthetic fertilisers containing nitrogen, dairy processing of milk etc.

Unlike some emissions trading schemes which are "intensity" based, (i.e they identify permitted tonnes of CO₂ per unit of activity) the NZETS imposes absolute obligations on participants to surrender an emission unit for each tonne of CO₂ (or CO₂ equivalent) resulting from activities for which they are responsible.

Select Committee Amendments to the Bill

The Select Committee report recommended over 1,000 changes to the Bill; the majority technical, but a number substantive including the two changes in Government policy thinking announced by the Prime Minister in May - deferring the introduction of transport fuels and extending the period for phase out of the free allocation process. The National Party and the Green Party both seek further changes to the Bill as a condition of any support for the Bill through the House. 

Changes to the Staged Entry Dates of Different Industries

The NZETS is now proposed to apply to the transport fuel sector from 2011 (not 2009). The delayed entry has principally been driven by a desire to help reduce inflation pressures, although Government has also justified its policy shift on the basis that current high oil prices are doing much of the job for which the NZETS was designed: moderating fuel consumption and incentivising consumers to switch to more efficient fuel modes and public transport. The minority view of the Green Party is that there should be a phased entry for this sector from 2009, as there is no evidence that the effect on inflation will be any less after the proposed delay. 

Other proposals for changed entry dates include the importation of hydro fluorocarbons (HFCs) and per fluorocarbons (PFCs) (used in a range of industrial processes from industrial refrigeration to fire suppressing equipment) which will enter the NZETS in 2013 (not 2010) at the same time as sulphur hexafluoride. The significant impacts for industry, especially the primary and food manufacturing sectors, of HFCs and PFCs coming into the NZETS was of particular concern to the National Party. Complexities created by the number of participants was an influencing factor in the Select Committee recommendation. The Select Committee was also persuaded by a number of submissions advocating more time be allowed to develop non-greenhouse gas alternatives and programmes for collection and destruction of HFCs, as well as allowing firms time to develop their capacity to participate. 

There is also a change in the date by when the Government will have to decide whether  the NZETS will apply at either a production level or at a farm level for the agriculture sector. The Government's ability to bring a farm level point of obligation into force will now expire on 30 June 2010. The agriculture sector will still be coming into the NZETS in 2013.

Earlier Reporting

Balancing out the impacts of later entry for the industrial processes and transport fuel sectors, are proposals for both voluntary and mandatory early reporting of emissions ahead of full participation. Early reporting obligations are also proposed for the agriculture and waste sectors. There will now be voluntary reporting of emissions two years before each sector is subject to the NZETS and mandatory reporting the year before the sector is subject to the NZETS. Mandatory reporting means that participants are subject to penalty for failure to report, but would not have to surrender units for their emissions. This early reporting framework is expected to incentivise and prepare the sectors ready to respond to the price of carbon ahead of actual participation.

Delay in Phasing Out Free Credits

The subject of free allocations was one of the more hotly debated topics during the Select Committee process. At a policy level, free allocations are essentially a transition device to reduce adjustment costs, compensate for stranded assets, address equity concerns, avoid loss of economic capacity and minimise economic leakage as well as economic regrets. In particular, the free allocations are a key mechanism by which the NZETS permits emissions without any corresponding price effects.

While the Select Committee did not accept arguments that New Zealand should move “in line” rather than ahead of trading partners to avoid undue economic impacts, it did make a number of recommendations in relation to the free allocation of New Zealand carbon credit units (NZUs), including:

• increasing the pool of free allocation NZUs available to some owners of pre-1990 forest, to address concerns of inadequate compensation.
• maintaining the pool of free allocation of NZUs for the agriculture, stationary energy and industrial sectors (capped up to 90% of 2005 levels) until 2018 (previously 2013), with a phase out between 2019 and 2029 in response to the high levels of concern that too early a phase out would erode the competitiveness of New Zealand firms by making them face the price of emissions not imposed on their international competitors.
• extending the range of specified emissions eligible for free allocation to the industrial sector to compensate trade exposed firms that use waste oil for stationary energy production in place of fossil fuels.
• clarifying that free NZUs can be allocated to new entrants or incumbents which have increased emissions (still within the global cap of available NZUs). The concern here was that the nature of the "absolute obligation" (to account for emissions) not stifle economic growth by encouraging emissions-intensive investment elsewhere. 

Responding to concerns that New Zealand should abandon the Government’s stated desire to be a leader rather than a follower in the matter of climate change by being the world’s first carbon neutral country and should move at the same pace as its main trading partners, in particular as to the breadth and scope of the NZETS, the Select Committee noted that where countries choose not to include some sectors in their emissions trading schemes the cost of emissions from sectors must still be carried by some part of society. By way of example, it identified that where transport fuels are not included in other schemes, such as the European Union scheme, this is balanced by other factors such as high fuel taxes in Europe and greenhouse gas oriented taxes. 

Absolute Obligation

The NZETS remains an "absolute" obligation. Some submitters had argued for an intensity based approach, that is, that participants should surrender units to cover only the portion of their emissions that exceeded the level that a firm operating at world’s best practice would have emitted when producing the same output. This was rejected by the Select Committee on the basis that it is inconsistent with the long term goal of a lower carbon economy. However, the National Party noted its concern that the incentives for industry to remain in New Zealand are limited.

Forestry Sector

In addition to an increased pool of NZUs available for free allocation to some owners of pre-1990 forests, the Select Committee has proposed allowing an offset mechanism for the deforestation of pre-1990 forest where some owners of pre-1990 forest land wish to deforest (ie, convert to another land use). Offset rights would occur where a deforesting pre-1990 forest owner plants in trees an equivalent carbon absorption area elsewhere. However such an offset mechanism is predicated on the current Kyoto Protocol rules being changed for the second commitment period to allow such a scheme to operate.

Assigned Amount Units

The NZETS requires a participant to surrender one unit for each whole tonne of emissions from their activities. A unit can include an NZU, a Kyoto unit, or an approved overseas unit (this could include certified emission reduction units (CERs), available on the international market, as well as Assigned Amount Units (AAUs)). There is no limit on the number of international units that can enter the NZETS, although the Government has announced its intentions to exclude CERs from nuclear projects. A lot of debate has occurred, however, around whether AAUs should be included. Concerns have been expressed that including AAUs will preclude the NZETS linking with other countries' schemes. There are also uncertainties about the market for AAUs which have tended to be traded principally at government to government levels. On the other hand, the costs of compliance for NZETS obligations are anticipated to rise significantly if access to AAUs is restricted. Seeking to balance these competing concerns, the Select Committee has proposed restricting use of AAUs so that AAUs imported into the NZETS in the first commitment period may not be used to meet NZETS obligations arising during any subsequent commitment period.

SMEs

The National Party had previously noted their desire that the NZETS recognise the importance of small and medium enterprise to New Zealand and not discriminate against them in allocating emission permits. The National Party minority report notes that no Select Committee decision was made and that the question has been left to regulations.

Carbon Capture, Storage and Removal

The Select Committee acknowledged that climate change is a fast moving area, and has amended the Bill to allow for carbon capture and storage activities once a domestic regulatory framework has been established and to allow for removal activities to be added (by Order on Council).

Restriction of New Fossil-fuelled Thermal Electricity Generation

The Bill also creates a preference for renewable electricity generation through a ten year "restriction" (previously a "moratorium") on new fossil-fuelled thermal electricity generation. However, the Minister of Energy may grant exemptions (to allow such generation) if the Minister is satisfied of a number of matters, including that the generation plant will use renewable sources; or the plant is replacing an existing plant, and the new plant will reduce emissions by at least 20%. As well, the Electricity Commission may grant a temporary exemption if generation is required to mitigate a present emergency. The National Party raised concerns at security of supply, and the effectiveness of the restriction, preferring instead a price signal of an emission trading scheme. The Green Party considered the exemptions too wide.

Response to the Select Committee Report

The Government has been struggling to maintain broad support for the Bill as both the National and Green minority reports criticised the changes (or lack of change) in the Bill. A majority of the Select Committee recommended that the Bill be passed (with amendments), but the National Party minority report proposed a number of changes, including:

• more modest reductions in emissions, to reduce the cost to families and businesses
• a fiscally neutral scheme (noting the "windfall gains" for the Government)
• alignment with any Australian ETS (a green paper is to be released in July 2008)
• steps to retain industry incentives to remain in New Zealand
• ensuring that SMEs were eligible for free allocation of NZUs
• a more flexible phase out approach
• a fresh engagement process with the forestry sector to address the "seriously deficient" provisions of the Bill relating to the forestry sector.

The Green Party minority report noted that the Green Party would not be supporting the Bill without substantive change, in particular referring to concerns at the delays in the application of the NZETS to agriculture and transport sectors and the amount of work left for regulation.

As at the date of publication, Labour is still in discussion with the Greens and New Zealand First. United Future and ACT have announced that they will not support the Bill. According to media reports, the Maori party has not yet formed a view, but general press releases from the Maori Party suggest that their support is unlikely (due to concerns of the fairness of the scheme for taxpayers).

The media reports on the Bill are also mixed and there is no set date for a second reading debate on the Bill. The progress of the Bill beyond a second reading is now uncertain.

Authors

Dave Trueman

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Elisabeth Welson

Partner - Corporate & Commercial

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Craig Nelson

Senior Associate - Corporate & Commercial

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