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Briefing for incoming Ministers:
All-Of-government Climate Change programme

Annex I:  Summary of the Emissions Trading Scheme

  1. The objective of the New Zealand Emissions Trading Scheme (NZ ETS) is:

That a New Zealand Emissions trading Scheme support and encourage global efforts to reduce greenhouse gas emissions by:

  • reducing New Zealand’s net emissions below business as usual levels and
  • complying with our international obligations, including our Kyoto Protocol obligations

while maintaining economic flexibility, equity, and environmental integrity at least cost in the long term.

What is emissions trading?

  1. Emissions trading is a market-based approach for achieving environmental objectives, where “emission units” are traded between participants. Those emitting greenhouse gases have to pay for increases in emissions and are rewarded for decreases.
  2. Emissions trading enables a flexible approach to reducing emissions, as participants are able to either reduce emissions, purchase units, or use some combination of the two.

Coverage and obligations

  1. The NZ ETS has an all-sectors, all-gases approach that takes advantage of all available emission-reducing activities, and results in the fairest approach to the sharing of costs.
  2. The emissions trading scheme covers the following sectors of the economy: forestry, liquid fossil fuels (largely transport), stationary energy, industrial processes, synthetic gases, agriculture and waste. 
  3. Participants are required to:
    • monitor, record and report activities that lead to greenhouse gas emissions in New Zealand, some of which will be the indirect result of their activities. For example, a coal producer would be required to surrender units for the coal it sells domestically, even though the actual emissions will occur when the coal is burned
    • surrender emission units equal to the amount of emissions associated with their activities in each compliance period.
  4. Participants may acquire emission units by receiving a free allocation from the government. In addition, participants and secondary market traders can acquire emission units by:
    • buying them from approved overseas sources
    • buying them from another participant or secondary market trader, either by entering into a direct bilateral contract with the other party, or trading through a broker or trading exchange
    • buying them from the government (although the government has no surplus units to auction at present).
  5. Participants may receive emission units for eligible removal activities including, but not limited to, owning eligible post-1989 forests, producing specified products with embedded emissions, or exporting synthetic gases contained in goods

Implementation of the NZ ETS

  1. The emissions trading scheme will be phased in across sectors between 2008 and 2013. There will be transitional assistance in the form of free allocation of units to the forestry, industrial, fishing and agriculture sectors and through funding for household energy efficiency to support their adjustment to emissions pricing.
  2. The emissions trading scheme will be linked to the international market in units accepted under the Kyoto Protocol, and will be able to support bilateral linkages to other domestic trading schemes in the future. The scheme is designed to be flexible to accommodate New Zealand’s future international climate change obligations.
  3. Further regulations will be developed to support implementation of the emissions trading scheme. For example, regulations will provide more detailed information on sectoral methodologies for calculating and reporting emissions and management of transactions under the New Zealand Emissions Unit Register.
  4. Implementation will involve some significant challenges and the operation will not be perfect from the outset.  There are no international examples for an all-sectors, all-gases ETS.  Wide consultation and working closely with stakeholders in each industry sector will be critical for successful implementation. 

Key features of the ETS model

Open access to international markets

  1. Allowing open access to international carbon markets – both on the buy and sell side – means that the price in the NZ ETS will be driven by the international price.  This will result in an efficient level of abatement occurring in New Zealand vis-à-vis international abatement, and treats carbon and emission reductions in the same way as other products are treated in the New Zealand economy.
  2. This feature of the NZ ETS is a key part of ensuring that we can meet New Zealand’s international climate change obligations at least cost in the long term.  Placing a cap on the amount of abatement that can occur internationally (as others are doing) would increase the cost of meeting the obligations set up by Kyoto – and its successors – for very little environmental gain.

Reflecting international policy settings in domestic policies

  1. Underpinning the key design elements is a philosophy of reflecting (as much as possible) international climate change settings in domestic policy.  Even if those international policy settings are not entirely suitable for New Zealand conditions, there is significant downside in moving significantly away from them. 
  2. This is most obvious in the area of the treatment of pre-1990 forests (deforestation).  Even though the international policy settings are not entirely appropriate from a New Zealand perspective, reflecting different policy settings in the domestic economy would come at significant cost for the taxpayer in particular, and for the New Zealand economy as a whole. 

Allocation of emissions units reflects the context in which the New Zealand ETS is developed

  1. The provision of free allocation is the most complex area of NZ ETS design, and it is also the most controversial.  Rules on free allocation have significant effects on both the equity (who pays and how much) and also the efficiency (the strength of incentives to reduce emissions) of the NZ ETS.
  2. There are strong reasons for keeping the current approach in the legislation to free allocation.  Providing free allocation comes at a significant opportunity cost.  Increasing the level of free allocation is the equivalent of raising taxes, other things being equal, to provide assistance to particular parts of the economy. 
  3. Further, the existing legislation sets out a balance between sectors (inter-sectoral equity) as industry and agriculture are treated in the same manner.  Adjusting that balance of generosity between sectors in any major way runs a risk of unravelling the balance that is currently built into the legislation.
  4. The overall approach in the legislation reflects the context of New Zealand’s emissions profile.  Slightly over 70% of New Zealand’s emissions are related to trade-exposed activities and New Zealand is likely to face increasing stringency in terms of international commitments into the future.  It is not in our long term interest to shelter particular sectors of the economy from the economic pressures that New Zealand faces, regardless of whether that sector’s competitors face the same price of carbon or not.
  5. The system is designed to reduce the risk of economic regrets (the loss of economic capacity that we may regret if there is a fuller international climate change agreement in the medium term)  while retaining an incentive to reduce emissions.
  6. The allocation of emissions units is critical in terms of the incentives that are created, and in ensuring that New Zealand does not suffer economic regrets as a result of the NZ ETS.  The allocation plans are the relevant vehicle for doing this – especially the allocation plans around industry and agriculture.  It will be very important not to try to over-engineer these allocation plans; free allocation is not designed to be a full or a perfect compensation and nor should it be.  The goal is to change behaviour. 

Keeping it simple

  1. There are a number of areas in the NZ ETS implementation process where there will be pressure to complicate the ongoing design of the NZ ETS.  This is understandable; firms will want design to reflect their particular circumstance as much as possible.
  2. The NZ ETS design should, however, be kept as simple as possible.  This is critical to build in as much clarity and workability to the processes going forward.  Areas where simplicity will be particularly important are in the allocation methodologies and plans, in the settings of the regulations on obligations. 

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