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4 Core Design Features

This chapter covers the essential design features of the emissions trading scheme, including:

  • the sectors and greenhouse gases that are covered
  • when each sector will be brought into the scheme
  • which parties will have obligations under the ETS
  • how the obligation is defined
  • the unit of trade
  • international linkage
  • the quantity of New Zealand emission units to be issued
  • the possible inclusion of offsets
  • the design of the emissions trading market
  • establishing an emissions unit register
  • compliance, enforcement and the administering agency
  • future evolution.

4.1 Introduction

Emissions trading schemes share three generic features in that they all:

  • set the quantity of emissions and allow the market to set the price

  • place an obligation on entities to monitor and report their emissions, and surrender some form of instrument (often called a permit, allowance or emission unit) to cover their emissions

  • allow trading of the units.

That leaves a large number of design features to be determined, including:

  • which sectors and greenhouse gases are included in the scheme

  • the timing of entry for various sectors

  • which parties will have obligations to participate under the scheme

  • how the core obligation is defined

  • the unit of trade

  • international linkage

  • the quantity of emission units to be issued

  • whether offsets are allowed and under what rules

  • the design of the emissions trading market

  • establishing an emission unit registry

  • compliance and enforcement measures (including the role of an administering agency)

  • the process for future evolution and modification.

This chapter examines each of these in order, and identifies the in-principle decisions that have been made by the government and the priority areas for engagement. The chapter includes a series of text boxes. These are used to provide background on specific issues that are pertinent to emissions trading, and to explain in some detail the reasoning behind particularly important parts of the policy design and the government’s preferred options.

Another important design feature is the mechanism for the allocation of emission units into the market. This design feature is addressed at a broad level in chapter 5, and at a sectoral level in chapter 6.

4.2 Which sectors and gases the NZ ETS will cover

During the recent consultation on the government’s Discussion Paper on Measures to Reduce Greenhouse Gas Emissions in New Zealand Post-2012, many submitters responded to a question on which sectors could and should be included in a NZ ETS. Virtually all submitters emphasised the need to include as many sectors as possible to encourage liquidity in the market. However, perceptions of what is possible varied widely. Several submissions simply suggested that a NZ ETS should be as broad as possible, but did not specify any further details.

In the government’s view, equity, environmental integrity and economic efficiency suggest that an ETS should have the broadest possible coverage, for the following reasons.

  • There is little justification on equity grounds for any sector to be excluded, and hence subsidised by other sectors and by the taxpayer.

  • Environmental integrity suggests that an emissions price should be applied to all emissions above a de minimus level.

  • An emissions trading scheme operates most efficiently when there are a sufficient number of participants and many units available for trade.

  • A broader emissions trading scheme creates greater opportunities to realise least-cost options for reducing emissions.

Another question in the discussion document asked whether the same price of emissions should apply across all sectors of the economy in the long term. The majority of submissions responding to this question felt that it should.

The government has made an in-principle decision that the NZ ETS will include all major sectors and all greenhouse gases specified in the Kyoto Protocol over time. Minor exceptions will be allowed for emission sources below a de minimus threshold. This decision aligns with the overall objective of the NZ ETS by ensuring economic efficiency, equity and environmental integrity.

4.3 Timing of entry for various sectors

Although the government recognises that it is desirable to include as many sectors and gases as possible in a NZ ETS, it also recognises that some sectors will be ready to participate earlier than others due to technical and administrative capabilities. There is therefore a need for a phased approach for sectoral entry into the NZ ETS.

Internationally, most emissions trading schemes have adopted a phased approach. The first phase of the European Union Emissions Trading Scheme (EU ETS) began in 2005 and included carbon dioxide (CO2) emissions from large emitters in the stationary energy and industrial processes sectors. This included approximately 12,000 installations with obligations, representing approximately 45 per cent of CO2 emissions in the European Union. The European Commission has indicated that it intends to expand the scheme during its second commitment period (2008 to 2012) to include domestic aviation emissions. The Commission has also indicated that beyond 2012 it intends to include more sectors and other gases in the EU ETS.

New Zealand presents a unique context for phasing the introduction of an ETS. Our stationary energy sector contributes approximately 23 per cent of total greenhouse gas emissions and the industrial processes (non-energy) sector contributes approximately 5.6 per cent. The ETS would directly involve about 80 major firms in these sectors. In contrast to the EU and other developed nations, approximately 49 per cent of New Zealand’s emissions derive from agriculture, while forestry offsets the equivalent of approximately 32 per cent20 of our total emissions. Given the significant contribution of the non-energy sectors to New Zealand’s emissions balance, and to avoid distortions in the economy, it is important that they be included in the scheme as early as possible.

4.3.1 Introduction of all sectors through a staged approach

The government has decided in principle that individual sectors will enter into the NZ ETS through a staged process based on sectors’ preparedness for trading, administrative feasibility and consideration of price effects through the economy. This document proposes dates that the government believes are achievable. Consistent with the interim objective, all sectors will have entered the scheme no later than 1 January 2013. Figure 4.1 and Table 4.1 present the approach for introducing sectors into the NZ ETS.

Figure 4.1: Timeline for the entry of sectors into the NZ ETS

The forestry sector will be the first to enter the scheme, with landowners assuming unit obligations for eligible deforestation emissions and the opportunity to earn units for eligible afforestation activity as of January 2008.  The stationary energy and industrial process sectors will assume unit obligations under the scheme in January 2010, followed by the liquid fossil fuels (mainly transport) sector in January 2011. The final sectors to enter the scheme – agriculture, waste and synthetic gases – will assume unit obligations in January 2013.  Later entrants to the scheme (ie, the liquid fossil fuels, agriculture, waste and synthetic gas sectors) will have an “on ramp” into the scheme through voluntary reporting starting two years before their unit obligations commence, and mandatory reporting starting one year before their unit obligations commence.

 

The forestry sector – including emissions from deforestation (defined under the Kyoto Protocol as conversions of forested land to other uses) and eligible removals from afforestation – will be the first to enter the NZ ETS. A price signal is needed in this sector as early as possible due to forest owners having a degree of flexibility to bring forward deforestation if there are incentives to do so. Reduction of deforestation is likely to be one of the lower-cost options for reducing New Zealand’s greenhouse gas emissions in the first commitment period of the Kyoto Protocol. It is important that this substantial carbon sink is managed. Extensive consultation has already taken place with the forestry sector, and many stakeholders and Māori have expressed a desire for the government to devolve credits (and liabilities) for afforestation as soon as possible.

The government has decided in principle that landowners’ liability for deforestation emissions, and the option for landowners to receive emission units (with liabilities) for eligible afforestation, will commence on 1 January 2008. Because the NZ ETS legislation will be enacted after this date, the forestry sector will have an initial compliance period of two years and will not have to surrender emission units until the end of 2009, once other participants have entered the scheme and the ETS infrastructure is in place. The government will release a more detailed technical document for engaging with the forestry sector so that landowners will clearly understand their obligations under the scheme.

The liquid fossil fuels sector (primarily transport) will be the next entrant because the administrative requirements for trading in this sector are relatively simple, measurement of emissions is straightforward, there will be few participants with unit obligations, and costs can be easily passed through to consumers. Pairing the forestry and transport sectors together by the end of the first compliance period will facilitate cross-sectoral trading.

The next stage of the NZ ETS will bring in stationary energy (eg, coal, natural gas and geothermal energy) and the industrial processes sector. Medium-to-large emitters in these sectors generally have good emissions data and have been involved in preparations for the previously proposed carbon tax. The potential number of participants with unit obligations in these sectors would be few. The characteristics of emitters in this sector would be more varied compared with the liquid fossil fuels sector, however, justifying a later entry date. However, the government has decided in principle that emissions of SF6 will enter the ETS on 1 January 2013 because of an existing memorandum of understanding between the Crown and major users.

The agriculture21 sector will be a later entrant into the NZ ETS. This sector includes nitrous oxide from fertiliser use, and both methane and nitrous oxide from agricultural livestock. This sector faces technical difficulties associated with measuring emissions. Given the substantial proportion of greenhouse gases emitted by the agricultural sector, however, it is critical that it is included into the NZ ETS. The government recognises that there is a case for including agriculture into the ETS prior to 2013 and options (albeit with weaknesses) are technically available. The government intends having discussions with the agricultural sector as to whether there are opportunities to reduce emissions in the sector prior to 2013, acknowledging the existing investment in research to reduce emissions through the Pastoral Greenhouse Gas Research Consortium.

The waste sector will also be a later entrant into the NZ ETS. This is largely because Parliament is currently considering the introduction of a waste levy via the Waste Minimisation (Solids) Bill, and this levy would create similar (but not identical) incentives to the inclusion of waste into a NZ ETS. The government will engage with the waste sector on the interaction between the levy and the NZ ETS. Finally, emissions from the waste sector are small in comparison with emissions from other sectors and are decreasing over time.

Table 4.1 summarises the staged entry of sectors into the NZ ETS.

Table 4.1: Staged entry of sectors into the NZ ETS

Sectors

Commencement of obligations

End of initial compliance period

Forestry (includes deforestation of pre-1990 forest land and afforestation post-1989)

1 January 2008

31 December 2009 (first compliance period is 2 years)

Liquid fossil fuels (mainly transport)

1 January 2009

31 December 2009

Stationary energy (includes coal, natural gas and geothermal)

1 January 2010

31 December 2010

Industrial process (non-energy) emissions

1 January 2010

31 December 2010

Agriculture (includes pastoral and arable farming and horticulture)

1 January 2013

31 December 2013

Waste

1 January 2013

31 December 2013

Other sectors

1 January 2013

31 December 2013

Where feasible, participants with unit obligations will commence reporting for a period of time (eg, six or 12 months) before assuming unit obligations under the NZ ETS.22 The aim is to build capacity and ensure effective administrative arrangements during a period in which there will be no penalties for non-compliance.

The government intends to engage extensively with sectors to assess their preparedness to enter into the NZ ETS according to the timeframe outlined above. The government holds particularly strong views on the importance of early introduction of the forestry and liquid fossil fuel sectors, as noted above, and seeks further input on how to stage the introduction of other sectors for the most effective operation of the NZ ETS as a whole.

4.4 Parties with unit obligations under the NZ ETS

4.4.1 Context

There will be three types of participants in the NZ ETS:

  1. participants with obligations to surrender units to the government to cover their direct emissions or the emissions associated with their products
  2. participants that receive freely allocated emission units, that receive emission units for eligible afforestation, or that hold other emission units that can be traded to other parties (such as participants in Projects to Reduce Emissions)
  3. other participants that engage in trading activities to take advantage of market opportunities.

This discussion focuses on participants with unit obligations (type 1). These participants will be obliged to monitor and report emissions and obtain and retire emission units to match their emissions. They are often referred to as “points of obligation”.

It is not necessary to place the point of obligation on the entity that emits greenhouse gases. This is because the price signal from the ETS will flow across the market supply chain, influencing decisions by the producers or consumers, regardless of whether they actually surrender emission units themselves. Consequently, the government can choose different points of obligation while still meeting the objectives of an ETS.

There are four main criteria for determining the most suitable points of obligation for each sector.

  • Costs: are the costs of administering the system, and the costs of compliance for participants, kept to low levels?

  • Coverage: does a proposed point of obligation capture as many of the sector’s emissions as practicable?

  • Feasibility: is it feasible to monitor and verify the emissions at each point of obligation?

  • Incentives: does placement of the point of obligation create appropriate incentives to reduce emissions while not unduly deterring worthwhile economic activity and investment?

Some in the United Kingdom and in New Zealand have suggested that the point of obligation be placed on individual consumers. While there are many variants of this concept, the basic idea is that individuals would be granted a quantity of emission units and would be charged for the emissions in the goods and services they consume. This scheme has some attractions from the point of view of making the environmental effects of individual decisions more transparent. However, it would involve considerable compliance costs and the government does not consider this to be a desirable option.

4.4.2 Minimising the number of participants with unit obligations

In accordance with the criteria outlined above (costs, coverage, feasibility and incentives), the government prefers to place the point of obligation so as to limit the number of participants, facilitate scheme administration, and provide appropriate incentives to change behaviour and reduce emissions. Figure 4.2 presents an overview of where the government prefers to place the point of obligation in the market supply chain for each sector.

In the energy sector (including liquid fossil fuels and stationary energy), this will generally mean that participants with unit obligations will be located at the point of fuel supply, production or import. In this case, the participants with unit obligations will be expected to consist of five firms in the liquid fossil fuels sector and approximately 45 firms in the stationary energy sector (including coal, natural gas and geothermal). However, the government is open to engaging with these sectors on the possibility of a hybrid approach, whereby the primary point of obligation would remain at the top of the fuel supply chain, but large energy users (such as electricity generators or major industrial producers) could also opt in as direct points of obligation. This would entail “carving out” these firms’ emissions from the emissions attributed to the upstream points of obligation. This approach would be more complex to administer, but may be of interest to some large energy users.

In the industrial processes sector (which consists of non-energy emissions from industrial production) the appropriate point of obligation would be the industrial producers themselves, which are the direct source of process emissions. This would involve approximately 35 firms in the industrial processes sector.

In the forestry sector the appropriate point of obligation for emissions from deforestation of pre-1990 forest land would be the landowners. However, it may also be appropriate for this obligation to be transferred if the landowner can prove that control over land-use decisions had been delegated to a third party when the deforestation occurred. In the case of post-1989 afforestation, emission units (with associated liabilities) would be awarded to landowners or to the forestry right holders, as appropriate, if they opted to receive them.

Figure 4.2: Points of obligation to surrender units in each sector

At least 1,000 owners of pre-1990 exotic forest land will have potential obligations if they deforest their land.23 Any number of participants may choose to take on credits and obligations for post-1989 forests, and to report at key points such as when claiming emission units for sequestration, harvesting, or selling land. The number of these participants could be anywhere in the range of 2,000 to 9,000 by the middle of 2009 (assuming owners of existing post-1989 forests would be the first to opt in). However, most forestry participants would have infrequent reporting and compliance obligations.

In the agricultural sector the options present greater complexities. In the case of nitrogen fertilisers, selecting an upstream point of obligation at the level of fertiliser producers would be consistent with the criteria identified above. This could involve approximately 10 firms. In the case of livestock emissions, options for the point of obligation include farmers (the upstream point), sector bodies (a midstream point) and meat/dairy processors (a different midstream point). Placing the point of obligation at the processor level would reduce administrative complexity, resulting in approximately 25 firms holding obligations. Placing the point of obligation at the farmer level would increase the number of ETS participants dramatically. The government wishes to engage with the agricultural sector to assess the administrative and technical feasibility of placing the point of obligation at different points of the agricultural supply chain, and the impact of this decision on the effectiveness of incentives to reduce emissions.

In the solid waste sector the appropriate point of obligation would be landfill operators, which are located at the point of emission. This would involve approximately 60 participants.

Without counting the forestry sector, and using a processor-level obligation in the agricultural sector, there would be approximately 170 firms serving as the points of obligation in the NZ ETS. This means that the majority of firms in New Zealand would not need to participate directly in the scheme. Nonetheless, the goods and services they purchase would include the cost of emissions at the margin. In other words, the price signal would be transmitted throughout the market, influencing the decisions that drive emissions. Table 4.2 summarises the proposed points of obligation by sector.

Table 4.2: Participants with unit obligations under the NZ ETS

Sector

Participants with unit obligations

Forestry (includes deforestation of pre-1990 forest land and afforestation post-1989)

Landowner in most instances

Liquid fossil fuels (mainly transport)

Preferred: oil companies

Alternative: as above, with an option for the users of jet fuel for domestic purposes (ie, airlines) to voluntarily opt in to become participants with unit obligations.

Stationary energy (includes coal, natural gas and geothermal)

There are a range of options for discussion; for example:

Upstream points of obligation:

  • coal importer; coal miner (coal-mining licence and coal-mining permit holder)

  • gas importer; gas producer (petroleum permit or licence holder); gas processor

  • geothermal electricity generator or direct user for industrial heat

  • industrial producer that obtains used oil for the purpose of combustion

Upstream and midstream points of obligation:

  • a combination of upstream and midstream points of obligation, such as major users of coal and gas

Industrial process (non-energy) emissions

Material transformation: producers of steel, aluminium, cement, burnt lime, glass, gold and paper (note that production of urea, hydrogen, ammonia and methanol is covered in the stationary energy sector)

Lime fertiliser: producer

Loss of inert synthetic gases: electricity and refrigeration industry entities that import relevant synthetic gases

Agriculture (includes pastoral and arable farming and horticulture)

Synthetic fertiliser use:

(a) preferred: importers and producers of nitrogenous fertiliser

(b) alternative: farmer

(c) alternative: sector bodies

Enteric fermentation and manure management:

(a) preferred: processor/company

(b) alternative: farmer

(c) alternative: sector bodies

Waste

Landfill operator

Other sectors

To be determined

4.5 How the core obligation will be defined

4.5.1 Context

Within an ETS the term “core obligation” refers to the fundamental requirement to surrender tradable units to cover emissions, and to monitor, report and keep records of emissions.

The Kyoto Protocol is an international ETS. Under the Kyoto Protocol, New Zealand’s core obligation is to surrender one unit for each tonne of greenhouse gas (measured in CO2 equivalents) emitted during the commitment period. This is an example of an absolute-based obligation (ie, one unit for every tonne of CO2-e).

In defining the core obligation for a domestic ETS, the government has considered two sets of design features:

  • The choice between a core obligation defined on an absolute basis versus an intensity basis.

  • As a transitional measure, whether to apply a full obligation to surrender units versus a progressive obligation to surrender units (ie, a partial obligation that increases over time).

4.5.2 Absolute versus intensity-based obligations

Under an absolute obligation, a participant must surrender one emission unit for every tonne of CO2-e emitted. An alternative approach is an intensity-based obligation. Under this approach, emissions are surrendered on an intensity basis (ie, one unit for every tonne of CO2-e per unit of activity).

The intensity approach bases the surrender obligation on how a firm’s emissions per unit of production compare to a sector- or firm-specific benchmark. The basis for defining benchmarks typically includes best practice, best available technology, or some level of improvement over current practice. Under this approach, participants carry no obligation for emissions up to the benchmark level. They have to surrender units if their production intensity is worse than the agreed intensity benchmark. Therefore, as their production increases, their entitlement to emit also increases. This approach rewards participants for improving their efficiency, but places the liability for growth-related emission increases on the taxpayer (or other sectors of the economy) rather than on participants.

The Negotiated Greenhouse Agreement (NGA) model developed during the lead-up to the previously proposed carbon tax was an example of an intensity-based obligation that used a world’s best practice assessment as the basis for benchmarking.

An absolute-based obligation has three key advantages over an intensity-based obligation. First, it provides greater certainty as to the (global) environmental outcome because all emissions are covered by an obligation to surrender units. Second, it is relatively simple to understand and implement. Third, all participants face the same cost at the margin for emissions growth.

An intensity-based approach can be administratively complex. Benchmarking data are not readily available for many sectors and can be commercially sensitive. Developing a benchmark can be technically challenging for sectors with diverse inputs, outputs and operating conditions, raising difficulties around normalising factors to permit comparison of performance by different firms. The government’s experience with the NGAs suggests that determining an appropriate benchmark – or world’s best practice line – broadly across the economy would be time-consuming, costly and problematic. Furthermore, and importantly, intensity-based approaches provide insufficient incentives for firms to reduce aggregate emissions.24 As such, they are inconsistent with New Zealand’s obligations under the Kyoto Protocol and with the proposed objective of the NZ ETS.25

For these reasons, the government has decided in principle not to use an intensity-based approach to defining the core obligation. If international climate change agreements in the future were to include intensity-based approaches (eg, through so-called sectoral agreements in sectors such as steel, cement and aluminium), then it may well be appropriate to use an intensity-based approach in New Zealand for those sectors.

4.5.3 Definition of the core obligation

The government has decided in principle that the long-term core obligation under the NZ ETS will be a full obligation: participants with unit obligations will be required to surrender to the government one emission unit to cover each metric tonne of eligible emissions in a compliance period. However, the government recognises that progressive unit obligations may have merits in some circumstances.

Under a full obligation, one emission unit must be surrendered for each unit of emissions, and therefore each new marginal unit of production incurs the full cost of the associated emissions. New Zealand’s obligation under the Kyoto Protocol (as described above) is an example of a full obligation. Under a progressive obligation, participants initially are only required to surrender units for some percentage of their full obligation. For example, under a 50 per cent obligation, participants would be required to surrender one unit for every two tonnes of emissions. This approach is distinct from the intensity-based approach discussed above, under which unit obligations are indexed to the emissions intensity of specific products, rather than the amount of emissions. A progressive obligation may be increased with time, leading eventually to a full obligation.

Under progressive obligations, production increases would not face the full cost of emissions. This means that progressive obligations could be used as a transitional measure to provide for a more gradual adjustment to emission pricing. If progressive obligations are set to become full obligations over time, they can have the same influence on long-term investment decisions as a full obligation while reducing the short-term impact of emissions pricing. Progressive obligations may be particularly suited as transitional measures in the stationary energy, industrial processes and (possibly) agriculture sectors.

The downside of progressive obligations is that they would also drive less short-term behaviour change at the margin. As discussed in chapter 5, free allocation of emission units can be used to provide for a more gradual adjustment to emissions pricing by protecting firms’ profits while maintaining a full emissions price signal to influence marginal production decisions in the short term. For this reason, in cases where a gradual transition is considered desirable, the government generally favours the use of a full core obligation coupled with free allocation of emission units instead of progressive obligations. However, this is an important area for engagement with the various sectors.

The government wishes to engage with these sectors to explore the use of progressive obligations. Key considerations include the impact of progressive obligations on short-term emission reductions, long-term investment decisions, and the nature of the pass-through to consumers. This engagement will also relate closely to engagement on methods for the free allocation of emission units, discussed further below.

4.6 Unit of trade

4.6.1 Context

4.6.1.1 Units of trade under the Kyoto Protocol

Box 1: The United Nations Framework Convention on Climate Change and its Kyoto Protocol

The United Nations Framework Convention on Climate Change (UNFCCC) was launched at the Rio de Janeiro Earth Summit on Environment and Development in 1992. The Convention provides the basis for concerted international action to mitigate climate change and to adapt to its impacts. Its provisions were far-sighted, innovative and firmly embedded in the concept of sustainable development. The UNFCCC incorporated non-binding targets for industrialised countries to reduce greenhouse gas emissions to 1990 levels by the year 2000.

In response to the need for more urgent action, parties to the UNFCCC developed the Kyoto Protocol, which was finalised in 1997. The Kyoto Protocol sets individual, legally binding commitments for most developed countries (called Annex B parties) to curb emissions of carbon dioxide and other greenhouse gases.

New Zealand’s commitment under the Kyoto Protocol is to reduce greenhouse gas emissions to 1990 levels on average over the first commitment period from 2008 to 2012, or take responsibility for excess emissions by using the “flexibility mechanisms” such as emissions trading.

Through three “flexibility mechanisms”, Annex B parties can reduce the cost of meeting their commitments by funding lower-cost emission reductions in other countries. The three flexibility mechanisms are international emissions trading, the Clean Development Mechanism (CDM), and joint implementation (JI). Through the establishment of binding emission reduction commitments for Annex B parties and the flexibility mechanisms, the Kyoto Protocol created the foundation of an international emissions trading market in Kyoto emission units.

The Annex B (developed country) Parties to the Kyoto Protocol must retire Kyoto emission units to cover each tonne of their greenhouse gas emissions from 2008 to 2012. Some Kyoto emission units are allocated to Annex B countries for free, and others can be acquired by Annex B countries through the three Kyoto “flexibility mechanisms”. Each Kyoto emission unit has a value of one metric tonne of CO2 equivalent. Each of the Kyoto emission units is discussed below.

  • Assigned amount units (AAUs) are the units freely allocated to Annex B countries to match the level of their emission reduction or limitation commitment. These units can be bought and sold by Annex B countries using the international emissions trading mechanism.

  • Certified emission reductions (CERs) are generated by Clean Development Mechanism (CDM) projects that support sustainable development and reduce emissions or create forest carbon sinks in developing countries. Forestry CDM projects use special units reflecting the impermanence of forest sinks: temporary CERs (tCERs) and long-term CERs (lCERs).

  • Emission reduction units (ERUs) are generated by joint implementation (JI) projects that reduce emissions or create forest sinks in Annex B countries.

  • Removal units (RMUs) are awarded to Annex B countries on the basis of net removals by sinks in the land use, land-use change and forestry sector.

All of the Kyoto emission units can be used interchangeably by Annex B countries to meet their commitments from 2008 to 2012. Much of the Kyoto unit trading to date has focused on CERs, since the remainder of the Kyoto units (AAUs, RMUs and ERUs) will not be issued until the first commitment period begins in 2008. However, trading of these units on a futures basis is underway.

4.6.1.2 The primary domestic unit of trade

In a NZ ETS, the primary unit of trade would authorise the holder to emit one tonne of carbon dioxide equivalent (CO2-e). For the first commitment period (2008-2012), the government has two primary options for the unit(s) of trade in the NZ ETS:

  • devolving Kyoto units assigned to New Zealand

  • creating units defined specifically for the NZ ETS.

Using Kyoto units as the primary unit of trade would provide a clear and immediate linkage between the domestic New Zealand and international Kyoto trading markets. The definitions of Kyoto units are widely understood and are directly applicable to New Zealand’s Kyoto obligations. However, there would be drawbacks. For one thing, there are issuance and banking restrictions on Kyoto units during the first commitment period, particularly for the forestry sector (as discussed below). Another drawback is that the status of Kyoto units after 2012 is uncertain and depends on future international negotiations.

Creating a New Zealand Unit (NZU) specifically for the NZ ETS, which is backed by Kyoto units (either fully or partially), would enable the New Zealand market to be linked and aligned with the market for Kyoto units. This would give the government some flexibility to differentiate between trading rules for the domestic and international markets. This option is used in the EU ETS, and may be particularly important for the forestry sector because of complications associated with the Kyoto Protocol accounting rules for this sector.

4.6.1.3 The forestry unit of trade

4.6.1.3 The forestry unit of trade

Within the Kyoto Protocol, parties receive RMUs on the basis of net removals by sinks in the land use, land-use change and forestry sector (eg, afforestation removals minus deforestation emissions). These net removals are measured as stock changes on eligible land during the commitment period. RMUs cannot be banked (ie, carried forward) for use in the second commitment period. However, they can be exchanged with other Kyoto units, which can be banked. Parties must cancel Kyoto units (such as AAUs) held in their registry to cover net emissions from deforestation.

New Zealand has elected to receive RMUs after the conclusion of the first commitment period instead of annually. This means that New Zealand will be awarded RMUs on the basis of its 2014 submission covering the first commitment period, and cannot issue RMUs until the beginning of the true-up period expected to start in 2014.26 New Zealand will receive fewer RMUs than the actual (gross) afforestation removals during the first commitment period, because RMUs are awarded net of deforestation emissions. Since parties cannot bank RMUs, New Zealand will have the true-up period of 100 days to either retire the RMUs for compliance (thereby freeing up other Kyoto units that could be banked) or sell them to other parties wishing to retire them immediately for compliance.

In the case of the Permanent Forest Sink Initiative, the government has decided to award Kyoto units to eligible afforestation activities. The most appropriate unit for this purpose is the AAU, because it can be issued before the true-up period and can be banked.

With regard to the unit of trade for crediting afforestation activities outside of the Permanent Forest Sink Initiative and devolving deforestation liabilities to landowners, the government has three options:

  • create a domestic unit specific to forestry activities

  • award RMUs for afforestation and devolve deforestation liabilities using Kyoto issuance rules

  • award NZUs for afforestation and devolve deforestation liabilities using domestic issuance rules.

The first approach would create a further domestic unit with differential market value. This may have the affect of clouding the transparency of emissions pricing in the domestic market and consequently would impact on market liquidity.

The second approach would not be desirable if landowners wished to sell their afforestation units for profit pre-2012, or bank them post-2012 to cover future deforestation liabilities or for speculative purposes. This is because Kyoto issuance rules would restrict their ability to sell the units pre-2012 (except via futures contracts for 2014 delivery) and to bank the units post-2012 (except via immediate exchange with AAUs in 2014). Because there would not be enough RMUs to cover the Kyoto-eligible afforestation, decisions would also be needed on which landowners received RMUs versus other Kyoto units. These practices would raise questions of equity, both within the forestry sector and between the forestry and other sectors.

As indicated below, the government is pursuing the third option.

4.6.2 Creation of a New Zealand Unit (NZU)

The government has decided in principle that the primary unit of trade in the NZ ETS will be an New Zealand Unit issued by the Crown. Any person/entity will be able to hold and trade NZUs. Participants will be able to carry over (ie, bank) NZUs for use in future compliance periods, but will not be able to borrow from future compliance periods.

For the first Kyoto commitment period, each NZU will be fully comparable to a Kyoto unit and will be backed by a Kyoto unit in the New Zealand Emission Unit Registry by the end of the true-up period. This enables participants in the NZ ETS to exchange NZUs for Kyoto units through the registry and sell them offshore.

NZUs will be allocated as the unit of trade for the forestry sector. Landowners liable for deforestation units will be able to surrender both NZUs and Kyoto units to fulfil their obligations. All NZUs issued into the NZ ETS for forestry activities will be backed by Kyoto units by the end of the true-up period for the first Kyoto commitment period.

The specific legal characteristics of the NZU must give holders sufficient certainty to trade and otherwise deal with the NZUs they hold. This involves a number of considerations, including the treatment of NZUs under the tax system. The government wishes to engage with stakeholders and Māori on the proposed legal characteristics of the units to ensure that they provide maximum certainty.


20 This figure reflects the total net removals by forest sinks as reported in New Zealand’s Greenhouse Gas Inventory 1990-2005, and does not reflect the more restrictive definitions of forest sinks eligible for credits under the Kyoto Protocol.

21 In the context of this document the agriculture sector includes pastoral and arable farming and horticulture.

22 For example, if a sector assumed unit obligations on 1 January 2009, it would submit a report in March 2009 covering emissions from 1 July 2008 to 31 December 2008.

23 The government will be issuing further detailed guidance on definitions and thresholds for the inclusion of forest land in the NZ ETS.

24 Under an intensity-based approach, it is possible for firms to grow their output, grow their emissions, and receive units from the government, all at the same time.

25 New Zealand’s Kyoto Protocol commitments are expressed in terms of aggregate volumes of emissions, not how efficiently we produce those emissions. This reflects the climate change challenge: it is the aggregate volume of emissions that is important from an environmental viewpoint, not the efficiency of their production.

26 Note that New Zealand will not be able to issue RMUs if an inventory adjustment exceeds a specified threshold for a single activity in a single year.