Climate Change

Cap finally added to NZ’s cap-and-trade scheme

The decade-in-the-making strengthening of the ETS is finally upon us, but now questions are being raised over whether the scheme will actually make a difference, Marc Daalder reports

The Emissions Trading Scheme (ETS), New Zealand's take on a cap-and-trade carbon market, will finally have the eponymous cap on the number of units in the market.

On Tuesday, Climate Change Minister James Shaw announced the final version of regulations that Cabinet will approve after a bill strengthening the ETS passes through Parliament in the coming days.

"An effective Emissions Trading Scheme is a key part of what needs to be done. Unfortunately the rules set by previous governments left the scheme too weak to have any real impact on reducing our emissions," Shaw said.

"A good example of this is the fact that until now the ETS has been a cap and trade system without a cap. This has meant that emissions permitted under the scheme were, in effect, unlimited. I am delighted to say we are finally changing that. The changes I have announced today will better translate our emission reduction targets into a predictable emission price, which will incentivise our biggest polluters to invest in the transition to a clean, climate-friendly economy."

New regulations for ETS

The regulations set out a provisional emissions budget of 354 million tonnes of CO2, or the equivalent amount of another greenhouse gas, to be emitted over the five years from 2021 to 2025. This budget will be replaced by an official emissions budget for 2022-2025 that will be released by the Climate Change Commission in February.

The provisional budget will cap the number of carbon credits in the market at 160 million over the next five years, with each unit representing the right to emit one tonne of CO2-equivalent (CO2e).

Of these 160 million New Zealand Units (NZUs), 43 million will be freely allocated to emissions-intensive trade-exposed industries like New Zealand Steel or the Tiwai Point Aluminium Smelter. Another 90 million will be auctioned into the market and the remaining 27 million will have to come from stockpiles of NZUs built up in preceding years.

The remaining 194 million tonnes (Mt) of CO2e will be emitted outside of the ETS, largely by agriculture which is not expected to be included until 2025.

Auctions within the carbon market are expected to be conducted somewhere between new price floors and ceilings announced as part of the regulations today. The floor will be $20 per tonne and the ceiling will be $50. Both will increase by 2 percent a year to account for inflation.

In the year until the new regulations come into effect, the fixed price at which emitters can purchase unlimited NZUs from the Government will rise $10 to $35 a tonne.

Significant reforms to the forestry sector's involvement in the ETS have been pushed off by a year as the industry grapples with Covid-19. They will come into effect from 2023.

Emissions budget criticised

The provisional emissions budget that the Government has created has swiftly come under criticism, with Greenpeace NZ chief executive Russel Norman telling Newsroom it allows for far more emissions in the coming five years than the country can afford, from an ecological perspective.

"It's a huge increase from 2005 and it's well over the Paris target. If the Paris target is 60 million tonnes of CO2e in net emissions, over 10 years, this is roughly 70 for the first five years. It's quite a significant increase over what they've agreed to and what New Zealand has committed to under the Paris Agreement," he said.

"It just demonstrates that they don't have the policies in place to cut emissions."

The budget allows for 354 Mt CO2e in net emissions over the next five years, but the Government's commitment under the Paris Agreement is to only emit around 601 Mt CO2e in net emissions by 2030. This would imply the Government would have to drastically slash emissions in the second half of the decade, to 247 Mt CO2e over the five years or an average of 49.4 Mt CO2e a year, on average.

Such a move is unlikely, Shaw freely admits. Instead, it is likely that New Zealand will have to purchase credits from the as-yet-unfinished global carbon market called for in the Paris Agreement, to offset the shortfall in emissions reductions.

"It doesn't get you to the NDC [the Paris Target]. And that's because the NDC, when National came up with it, were planning for up to 85 percent of it to be met with offshore units. So the assumption that we've got, and we built this into the Zero Carbon Bill, is that some of it will be met by offshore units, but ultimately that's the last resort not the first resort," he said.

Nonetheless, Shaw defends the way in which the provisional budget was created, saying it was a practical output.

"There's kind of two things that come together: I'll describe them as the top-down approach and the bottom-up approach. The top-down approach is what has to happen [to meet our net zero by 2050 commitment]. The bottom-up approach is the 'what's possible' approach. That relies on a pretty good understanding of the industries that we have in New Zealand, what technology is currently available and able to be rapidly commercialised in any given five-year period," he said.

"And of course because this is the period 2021 to 2025, that basically means what's ready to go today. What can we roll out in the next five years? There can be no magic science. That might be 2030 and beyond, but right now you've just got to go with what's around. And that's why the provisional emissions budget is reasonably shallow at this point. You combine those two things - what's possible and what has to happen - and basically gives you the answer that you've got."

If met, the provisional budget would represent 15 Mt CO2e in reductions over the five-year period from where emissions were previously forecast to be.

What is it good for?

While this debate concerns all of the country's emissions over the coming years, just 45 percent of these emissions are covered by the ETS. This inevitably raises the question of whether the ETS is useful at all.

Increasingly, environmentalists and climate economists are arguing for a holistic approach to climate change that puts the ETS to use but doesn't rely on it as a crutch to avoid implementing other, radical policies.

David Hall, a Senior Researcher at AUT's The Policy Observatory who specialises in environmental policy, points to a chart in the Government's own consultation document for the ETS reforms that shows, under a $100 per tonne carbon price, even the wealthiest homes would only pay an extra $12 a week. That's not enough to incentivise cutting high-emitting behaviour if the Government doesn't introduce other policies that make the transition to a low-carbon economy easier.

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Carbon pricing is a blunt instrument. In order to truly change household behaviour through pricing alone, the carbon price would have to rise to astronomical levels. "If the price is really driving people to shift out of high-emissions projects and activities, then the result is a huge amount of stranded assets," Hall told Newsroom in February. That would hurt low-income households the most and wouldn't be the most efficient way to decarbonise the economy.

While some Government officials have previously argued that the ETS will be the main or even sole tool needed to help New Zealand meet its emissions reduction targets, Shaw said that wouldn't happen.

"There is no chance. No chance - zilch - that you'll do it just with the ETS. And I think that's a significant shift in thinking. If you went back even to the last government frankly, if you went back to the 2000s, the market purists would say, 'All you need to do is get the price right and change will happen'. Every country where change has actually happened, the emissions price - whether it was an ETS or a carbon tax - has been part of the solution, but often at the margins. In the UK, they think that the ETS played about a 10 percent role," he said.

"What has previously been described by Treasury as 'complementary measures' are actually - you need to do everything. You need to pull every single lever you have."

Norman agreed that the impact of the strengthened ETS would be marginal and laid this at the feet of agriculture's exclusion from the scheme.

"It'll have a marginal effect, but while our single biggest polluting sector, agricultural methane, is not included in the ETS, then obviously it can only ever have a marginal effect. The decision the Government made to exclude agricultural methane emissions from a price for the ETS means that any changes they make to the ETS, even if they're in the right direction, will have a marginal effect because a third of our emissions are outside it," he said.

When asked whether the Government was, in his words, pulling every single lever they had, Shaw said, "Not yet".

He said this term of Government was about creating the framework for stronger policy action in the future. 

"This Parliamentary term has been primarily about the high-level frameworks - the Zero Carbon Act, the ETS reforms, the Climate Change Commission, the five-year emissions budgets, all of that kind of stuff. We haven't completely finished that work programme, there's a little bit of tidy-up to do next year but it's a fraction of the work programme of this Parliamentary term," he said.

"So then the question is: What's next? And what's next is your 'complementary measures' at the industry level. Really getting down in transport and energy, in building and construction, in horticulture, in dry-stock farming, in dairy, you know, what are the shifts that need to happen and can happen and then, what can the Government do to support those shifts?"

Norman said this explanation doesn't cut the mustard.

"When you look at the big picture - are the Government's policies working to cut emissions? - when you look at their own provisional emissions budget for the next five years, the answer is plainly no," he said.

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