Emissions trading scheme announced

24 September 2007

On 20 September the New Zealand Government unveiled its comprehensive emissions trading system (ETS) covering all sectors and all greenhouse gases to help “transform our economy in a way in which [we] can give our businesses a competitive advantage”.

It has set an ambitious set of medium to long term goals including:

• 90% renewable electricity by 2025 (about 70% currently);
• 50% emission reduction per capita in transport sector by 2040;
• 250,000 hectares of new forest planted by 2020;
• Carbon neutrality in the public sector by 2025; and
• Leading the world in widespread introduction of electric vehicles.

Carbon neutrality is expected to be achieved first in the electricity sector by 2025, followed by all stationary energy (electricity generation and industrial heat and process emissions) by 2030. In the transport sector the date for carbon neutrality is 2040.

In the shorter term, implementing the ETS is expected to nearly halve New Zealand ’s Kyoto Protocol deficit for 2008-12 from 45 to 25 million tonnes of CO₂ equivalent.

Details of the policy announcement, the framework ETS report, engagement/meeting opportunities and numerous background documents are available on www.climatechange.govt.nz.

Of particular interest, three two-day emissions trading workshops will be held in Wellington , Auckland and Christchurch .  These will include a focus on forestry and agriculture in the ETS on Day 2.  You can attend both days or just one (but will need to register by Tuesday 25 September).

• 1 and 2 October Westpac Stadium, Wellington    
• 4 and 5 October Chateau on the Park, Christchurch
• 8 and 9 October Aotea Centre, Auckland

Emissions trading scheme summary

The framework document outlines the reasons for establishing an ETS rather than a simpler emissions charge. It states one of the benefits of a price based measure is that it will “discover” emission reduction opportunities. Key features are:

Cap and trade: Emissions trading requires participants to surrender units for their greenhouse gas emissions. A capped number of units are distributed – some allocated free, others sold by the government at auction. All can be traded amongst those who want to increase or decrease their emissions. The scheme will operate on an economy wide basis – so emissions may increase in one area if there are reductions in another.

Participants: The obligation to account for emissions will be imposed on a relatively small number of participants in each sector – typically, operators high in the supply or production chains.

International: The ETS will operate within Kyoto and each unit will be fully comparable to a Kyoto-compliant unit in the international market. Linking internationally is a safety valve that will ensure the cost of emissions in New Zealand does not rise above the world price. This enables access to emission reduction opportunities offshore.

Administration: Ownership of units will be recorded with a central registry. Participants will be expected to monitor their own emissions, but an administering agency with audit and inspection powers will verify compliance. Participants will face penalties for non-compliance.

Timeline: Monitoring of forestry emissions (deforestation) and sinks will begin from 1 January 2008, with the first compliance period running for two years.

The transport sector will join the scheme from January 2009 because compliance will apply only to a small number of firms high in the supply chain.

The stationary energy sector (electricity generation and all other energy except transport fuel) will join the scheme in January 2010.

High emissions industrial processes – mainly the metal, mineral and chemical industries in New Zealand – will be brought in at the same time, subject to exclusions where the amounts emitted are too small to justify the scheme.

A January 2013 start date for agriculture is proposed.

Allocation: To create both the price incentive to decrease emissions and the price disincentive against increases in emissions, the number of units allocated by gift or sale must be less than total sector emissions. No free allocation is proposed for electricity generators. For those big emitters who are facing competition from overseas firms not yet facing emissions pricing, free allocations of up to 90% of their 2005 stationary energy and process emissions are proposed. New sources that begin emitting during the period of the free allocation will not qualify for free allocations.

Consultation and legislation: The Government says consultation on the five climate change and energy discussion documents made it clear that there is a high level of support for emissions trading. “The Government is now committed to providing opportunities for detailed engagement with interested parties, such as industry, consumer groups, NGOs and Maori, to ensure the final design of the scheme is fair and can be implemented effectively.”

General impacts

The macroeconomic impact of the ETS on New Zealand will largely be driven by the nature and stringency of international agreements. For the first commitment period of the Kyoto Protocol (2008–12), Climate Change Minister David Parker claims the macroeconomic impacts will be negligible. He says modelling indicates that meeting our Kyoto commitments with a linkage to international trading markets will have an overall impact of less than 0.1% of GDP by 2012 compared with underlying growth forecasts in the order of 2% per year.

Industry groups have been seeking the report on which the Minister is basing his claim on but it appears no recent research has been undertaken.

In order to avoid imposing rapid change on the economy, the ETS will feature a range of measures aimed at smoothing the transition faced by some business sectors; for example, by free allocation of emission units for an initial period. Starting from 2013, that assistance will decrease on a linear basis until it is completely phased out in 2025. There will also be a number of measures to address non-price barriers to the uptake of low emissions technologies and practices. The Government believes the first price impacts will be an increase in the price of petrol of approximately 4c a litre from 2009, and household power bills are predicted to increase by 5% the following year.

However, price impacts on some industry sectors could be very significant. Depending on their individual allocations, they will to some degree be exposed to fuel and electricity price increases from January 2010 (as well as liquid fossil fuels price increases from 1 January 2009). Even though electricity generators will not be given free allocation in the ETS, it is expected that there will be enormous windfall gains to generators (with the SOEs returning these gains to the government as dividends). This is because the emissions price increase for the marginal thermal stations (such as coal-fired Huntly) will determine the wholesale electricity price for all generation.

The government no longer talks of competitiveness-at-risk firms, but rather industrial producers that “can not pass on emission costs because they are ‘trade exposed’ [and] may bear a disproportionate impact relative to other sectors of the economy”. The framework ETS document says that when designing transitional assistance measures it is useful to give joint consideration to the treatment of direct emissions from stationary energy, direct emissions from industrial processes, and indirect emissions associated with the consumption of electricity. It notes a further issue is whether to extend support to industry for increases in the price of land transport fuels. This may be important in certain industries such as fishing, forestry, cement and some parts of the mining industries but it would add considerable complications to the scheme.

Once the overall level of assistance to an industry sector is agreed, decisions are then needed on how to determine the level of allocation that particular firms should receive, and whether each firm’s allocation is calculated on the basis of historical emission levels or benchmarking.

Issues for the coal industry

There are a number of issues to be discussed in the engagement process between the coal industry and the Government, including options for points of obligation.

An upstream point of obligation would be limited to coal miners and coal importers (with the question raised as to whether private miners would be included).

Alternatively, upstream and midstream points of obligation would result in a combination of miners, importers and wholesalers and perhaps major users of coal. The Government wishes to apply the New Zealand ETS in a way that minimises compliance and administration costs, and captures the most emissions activities and sources. In the coal sector, it believes that costs are minimised and coverage is maximised through an upstream obligation at the first point in the supply chain. However, it is acknowledged that if midstream obligation results in monitoring only a small number of firms, ETS participation could provide consumers with a more appropriate price signal.

It is proposed that there be exemptions for exported coal, for coal-seam methane vented or flared (but not sold), and for (potential) emissions subject to carbon capture and storage. (Coal permit and licence holders do not own coal-seam methane and fugitive emissions are difficult to measure or estimate.) There will be stakeholder engagement on exemptions for activities that are too small to have a measurable effect on total emissions.

Other engagement issues to be discussed will be on the operational detail of how the ETS will apply to the stationary energy sector, such as the emissions monitoring methods employed and the determination of appropriate emissions factors.

The treatment of coal fired and other cogeneration will no doubt be the subject of discussion with respect to the 90% renewable generation target.

The key issues to be discussed for large stationary energy emitters will be on the operational detail of how the NZ ETS will be applied, such as the emissions monitoring methods employed, the determination of appropriate emissions factors and the criteria and mechanism for free allocation (especially the degree of targeting).

The key issue for perhaps hundreds of small to medium enterprises whose competitiveness may be placed at risk (including numerous coal users) will be whether a practical method can be found to provide transitional assistance.  In order to keep administration costs low, the government has suggested (Section 6.5.2) an annual emissions threshold of 50,000 tonnes of CO₂ equivalent (about 25,000 tonnes of coal, assuming relatively low transport and electricity emissions).  The majority of ‘trade exposed’ firms will be well below this threshold and will want to know whether they will be allowed to ‘opt in’ to the ETS, what criteria will be used to determine the level of free allocation and the transaction costs of doing so.  The costs of accounting for emissions, negotiating with officials and purchasing credits (perhaps using consultants’ expertise) may be too great to justify the level of assistance.  Equity issues are bound to arise for them compared with large firms that can justify the transaction costs.

In summary it will be reasonable to assume that no matter what the point of obligation (coal producer, wholesaler or user) the price impact of say a $15 per tonne CO₂ international price in 2010 will be around $30 per tonne of sub-bituminous coal (with comparatively small freight cost increases). Individual ‘trade exposed’ firms may have some degree of transitional free allocation to reduce this impact.