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Further decisions on Emissions Trading Scheme changes announced

August 02, 2019


Partners Gerald Lanning, Sarah Scott
Special Advisors Mark Baker-Jones
Senior Associates Victoria Anderson, Joanna Lim

Climate change (inc Zero Carbon Bill and Emissions Trading Scheme)

Further changes to the New Zealand Emissions Trading Scheme (ETS) have been announced this week. These changes are part of a programme to make the ETS perform as it is supposed to do - as one of the levers that the Government can use to drive emission reductions across the New Zealand economy.

In this FYI we break down how these announcements will impact New Zealand business.

In summary - what you need to know

The key changes will:

  • Incentivise emission reductions in industry: gradually reduce free allocations so as to encourage various medium-to-high emitting industries to reduce their emissions - whereas this could result in a marginal cost increase for some emitters, it is intended to encourage innovation in lower emission production; and

  • Incentivise increased emissions offsets through new forestry: incentivise the planting of new forests through a simplified carbon accounting approach - this will ultimately provide emitters more opportunity to offsets their emissions.

There are also some operational and technical changes that are part of the announcement (detailed below).  

Incentivise emissions reductions in industry

The allocation of free NZUs for emissions intensive trade exposed activities will gradually reduce from 2021.

The free allocation covers a part of the emissions cost for eligible industries including aluminium, steel and cement production, and some horticultural activities, amongst others. Without the allocation, the concern is that these industries could lose market share or relocate production overseas and therefore displace production here with more emission intensive production elsewhere - so-called “emission leakage”.

Although it has always been the intention to phase-down allocations, this has, until now, been put on hold. The delay in reducing the rate has resulted in a greater allocation than initially anticipated. As a consequence, the urgency with which reductions must be made in order to meet New Zealand’s commitments has increased. Perversely, if the level of allocation remained unchanged and industry continued to reduce its emissions, which is happening in some cases, there would effectively be an over-allocation potentially countering any incentive to reduce emissions further.

The phase-down will occur through two complementary proposals:

  • a minimum phase-down rate, applied equally for all industrial activities; and

  • a legislated process that could set further phase-down rates for particular industrial activities that are at low risk of emission leakage.

The minimum phase-down rate will essentially be a set reduction in the allocation of NZUs of 1 per cent on current levels, gradually increasing to 2 per cent for the years 2031-40, and to 3 per cent for 2041-50. The phase-down rates will be subject to review by the independent Climate Change Commission established under the “Zero Carbon Bill” (ZCB). The Commission will make recommendations on any necessary rate changes.

The phase-down has been set at a rate that is not anticipated to have a material financial impact on the activities. The intention however is to encourage those entities to invest, where possible, in clean-energy low emission alternatives. This will obviously be more challenging for those activities that have few options for low emission production, such as is the case for steel production.

The positive outcome will likely be increased investment in research, development and adoption of low emission technology and production, including increased use of renewable energy. It will also enable New Zealand to not only reduce the cost of subsidisation that has been borne by the rest of the economy (although this has not been substantial), but it will also increase the prospect of New Zealand meeting its international and domestic emissions reduction obligations.

Incentivise increased emissions offsets through new forestry

Individuals can register certain forests in the ETS and receive NZUs for the carbon sequestered in the forests. To encourage the planting of new forests that provide additional carbon offsets through their removal of carbon from the atmosphere, the Government will take a new approach to accounting for the carbon in those forests.

Old system - stock exchange

The current approach to accounting for that carbon, known as carbon stock change, requires a participant to the ETS to account for, and repay, any loss of carbon in their forest, where, for example, that forest is harvested, even if that loss is temporary. This method of accounting has caused problems for the forestry industry because it fails to take into account the sequestration that will occur once the forest is replanted.

New system - averaging accounting

An alternative to carbon stock change accounting is averaging accounting. Under averaging accounting, the participant is allocated NZUs for new forest growth up until their forest reaches its long term average carbon stock. Very simply, when the forest is harvested, the participants would not be required to repay NZUs as long as they replant.

Implementing the new system

The major decisions surrounding forestry seek to remedy the problem, by:

  • requiring all forests registered from 1 January 2021 to use averaging accounting, and forests registered in 2019 and 2020 will have the option to use it. Note that for now, forests registered in the ETS before 2019 cannot transition to averaging accounting (but this will be reviewed in 2021). The distinction in treatment is to encourage new forests, as this may have the biggest impact on New Zealand’s carbon footprint;

  • allowing foresters using averaging accounting to ‘relocate’ a forest elsewhere without paying back emissions units, so long as they replant a forest with the same carbon storage;

  • avoiding foresters using averaging accounting having to pay back NZUs after natural disasters, such as forest fires or major storms, provided they replant in four years; and

  • having a number of ways that Permanent Forest Sink Initiative members could transition to the ETS.

Specifics as to how average accounting might be applied were identified by Te Uru Rākau in August last year (see here) but specific regulations will be consulted on later this year.

These changes to the system should provide further incentives for increased forestry and carbon sequestration over the long-term.

The Government has announced that it will also investigate ways to incentivise the processing sector to produce more long-lived wood products. Using long-lived wood products is a form of climate change mitigation. Certain wood products store carbon long-term although eventually the stored carbon will be released at the end of the product’s lifetime. The creation of long-lived wood products, which replace materials that require emission intensive production, can add to reductions in overall emissions.

Operational and technical changes

The latest decisions also record that the Government will tidy up redundant Kyoto Protocol units that remain in the New Zealand emissions trading register.

All New Zealand-issued Assigned Amount Units held in private accounts will be cancelled and replaced with an equivalent number of NZUs. All other privately held Kyoto emission units from the first commitment period of the Kyoto Protocol will be cancelled. These units have not been eligible for surrender since June 2015.

This is largely a tidying up exercise and should be of no surprise to participants.

Under the current regime, participants can be fined if they fail to comply with the ETS requirements, for example, failing to surrender sufficient NZUs. The current announcement confirms that a new surrender/repayment penalty announced as part of the May 2019 tranche two decisions will be a cash penalty set at three times the carbon price.

A further amendment will resolve a technical issue that prevented some NZ ETS participants with late or amended emissions returns from accessing the fixed price option (FPO). The FPO gives participants the option to pay a fixed amount, currently $25, in lieu of surrendering an NZU.

For more information, assistance with making a submission, or to discuss how these developments will impact your operations, please get in touch with our contacts above.