A pop quiz on climate

National’s electric vehicle policy is not just silly and ineffective, it is emblematic of a wider climate policy problem, says Eric Crampton

Last week, National proposed a series of policies to increase the uptake of electric vehicles.

Suppose it works exactly as promised and the number of electric vehicles quadruples in the next three years. How will this affect New Zealand’s greenhouse gas emissions in 2023?

I’ll give you a minute to think about it while providing a refresher on the Emissions Trading Scheme (ETS), New Zealand’s primary policy instrument for reducing greenhouse gas emissions.

It has taken some time to mature, but the ETS is now a reasonably well-functioning carbon market. In its first incarnation, buying international carbon credits of dubious quality was the cheapest way to offset domestic emissions. It was not a great way of running things, but where New Zealand’s trade competitors also allowed those credits, New Zealand roughly paced other countries.

Once trade in dodgy credits ended, the ETS became a cap-and-trade system without a real cap. The Government would simply create more credits at $25 per unit. And because non-forestry participants in the ETS got a two-for-one deal, the maximum ETS price was $12.50 per tonne emitted. It put a price on greenhouse gas emissions, and that certainly helped, but that version of the ETS would have a hard time achieving the reductions the Government wants.

The current incarnation of the ETS is much stronger. The cap-and-trade scheme now has an actual cap on total credits and net emissions available in the system: 32 million units are available in the system in 2021, reducing to 30 million in 2025.

Previously, the Government capped prices by simply creating new credits at an ETS price of $25 per unit. Now, its cost-containment reserve will require the Government instead find real emission mitigation activities, whether at home or abroad, to “back” any credits created when prices hit a trigger price of $50 per unit in 2021, with the price cap rising by 2 percent each year.

Under a cap-and-trade scheme with a binding cap, every credit purchased and used within the system is a credit unavailable to anyone else.

The Ministry for the Environment estimates that every litre of petrol burned releases about 2.45 kilograms of carbon dioxide equivalent emissions. Petrol companies are required to purchase ETS credits for every litre sold. So, when the ETS price of carbon is $35 per tonne, as it is now, a litre of petrol carries $0.086 in carbon charges. Forty litres of petrol will include ETS credits to cover the 98 kilograms of expected emissions – costing about $3.43 at current prices.

And by now you should have worked out the answer to the opening quiz question.

If National’s policy works exactly as intended, tripling electric vehicle numbers and reducing the use of petrol vehicles, total covered emissions in 2023 will be 33 million tonnes: exactly the same as they would be without the electric vehicles.

Every litre of petrol that goes unused because someone flipped to an electric vehicle means 2.45 kilograms of emissions are available for purchase by someone else, somewhere else in the system. Perhaps those emissions credits will be used by industrial heating processes; perhaps they will be used in agriculture. But they will be used by someone. The binding cap is binding.

So, what good is a push for electric vehicles?

National costs its policy at $93 million over four years, including the fiscal cost of exempting EVs from fringe benefit tax and $38m over four years by electrifying the Government’s car fleet. But the figures ignore the costs of exempting EVs from road user charges (RUC), the costs imposed on other commuters by allowing EVs to impede bus lanes and the (presumably) minor cost of a new EV licence plate scheme. The Regulatory Impact Statement for the 2016 EV exemption from RUC costed the policy at just over $550 per vehicle per year. So, a fleet of 80,000 EVs getting a free ride on road user charges means the National Land Transport Fund loses revenue of $44m per year.

The ETS is a far more effective way of reducing emissions. Suppose the real costs of National’s policy really were around $23 million per year, even though we know that the cost of the RUC exemption alone is much higher than that, and that there will be real costs when Teslas bung up bus-priority lanes.

For $23m per year, at a carbon price of $35/unit, the Government could buy and retire just under 660,000 carbon credits in the ETS – effectively tightening the cap and reducing net emissions instead of achieving net nothing. Those purchases would push up the price of ETS credits, encouraging everyone in every sector covered by the ETS to adjust in their own ways to avoid those costs. Maybe some would shift to electric vehicles as petrol prices increased, but other sectors would also change – it is hard to predict who will find it easiest to reduce their own carbon footprint, and price increases in the ETS encourages those best able to adapt to be the first ones to do so.

National’s EV policy is just a little silly, and on recent polling has little chance of becoming policy.

But it is emblematic of a broader problem.

The Government requires the Climate Change Commission to publish sector-by-sector emissions budgets, plotting each sector’s anticipated progress toward net zero. The point of a real ETS is that that budgeting is unnecessary. Neither the folk at the Commission, nor anyone else, can really predict which sectors will move first to reduce emissions as prices in the ETS increase.

If one sector overshoots its budget and another undershoots, that is not evidence that one sector has failed or that it needs regulatory attention. Under a binding ETS, it is precisely what we should hope for if the costs of mitigating emissions vary sector-by-sector. There should be greater reductions in the sectors where it is cheap to mitigate emissions and there should be smaller reductions – or even increases – in tougher sectors. So long as the cap is binding, every tonne emitted by one sector is a tonne not emitted by another.

National’s policy misses the broader point of having an ETS. Unfortunately, so too does the Climate Change Commission’s remit to set sector-by-sector carbon budgets.

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