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7 The Impacts of the Emissions Trading Scheme

This chapter covers the likely impact of emissions trading on:

  • New Zealand’s emission levels
  • macroeconomic performance
  • prices for affected goods and services, notably electricity and liquid fuels
  • various sectors of the economy
  • New Zealand households
  • the net Kyoto liability of the New Zealand government.

7.1 Measuring the impacts of the NZ ETS

Because an ETS would be a new regulatory instrument in New Zealand, it is difficult to forecast its impacts to a high degree of accuracy. We can, however, draw on overseas experience and our knowledge of the New Zealand market in estimating the impacts the scheme will have.

7.1.1 Impacts of an ETS versus impacts of international climate change agreements

First of all, it is important to understand the distinction between the general impacts of New Zealand’s obligations under international climate change agreements and the specific impacts of an ETS. For example, New Zealand’s obligations under the Kyoto Protocol mean that, from 2008, New Zealand must pay a price for all emissions over our agreed allocation based on 1990 emissions levels. Based on April 2007 policy settings, New Zealand faces a Kyoto deficit of 45.5 Mt CO2-e, which has a value of $683 million at $15/t CO2-e and $1.1 billion at $25/t CO2-e. The cost of the deficit will be incurred by New Zealand as a sovereign nation, and could be distributed across taxpayers, emitters and consumers.

When we consider the impacts of an ETS, the key question is not the total cost to New Zealand of our emissions obligations, but how distributing that cost affects our emissions levels, our behaviours, our macroeconomic performance, the performance of sectors within the economy, and the wellbeing of households. The alternative (the base case against which impacts of an ETS should be assessed) is not the absence of any Kyoto obligations, but rather a scenario in which they are met by the taxpayer in their entirety.

7.1.2 The difficulty of modelling the impacts of a price-based measure

Determining the impacts of the NZ ETS on emissions levels and individual firms and consumers requires estimates of the effect of the ETS on prices and the responses that consumers and firms make to price changes: that is, predicting the wide-ranging behavioural change that is the desired outcome of an ETS. The difficulty in modelling the impacts of an ETS is that, although consumer responses to discrete price changes can be readily modelled, the ETS provides firms that are “points of obligation” with a flexible range of options for responding to the price signal (indeed, that flexibility is one of the chief advantages of an ETS). Those firms can manage an ETS liability by:

  • purchasing units from other New Zealand unit holders; or

  • purchasing international units; or

  • in some instances, reducing their emissions through investing in abatement strategies (eg, in energy efficiency, or in plant and equipment with lower emissions levels);75

  • reducing their emissions by reducing production; or

  • any combination of the above.

There is also added uncertainty relating to whether and to what extent firms that face emissions costs under the ETS will pass these on to consumers through higher prices, and whether any price increases that are passed on are significant enough to prompt a reduction in consumption.

Given the number of variables, modelling the impact of an ETS can only realistically give a general sense of the direction of change. Any projections of the amount of that change need to be treated with caution. This is true of all attempts internationally to model the impacts of climate change policies. Professor William Nordhaus of Yale University, the builder of one widely cited model known as DICE (for Dynamic Integrated Model of Climate and the Economy), said recently:

At the outset, it must be emphasized that models such as DICE are primarily tools for understanding the behavior of complex systems. They are not truth machines. The results convey a spurious precision that does not accurately reflect the modeling, behavioral, and measurement errors and uncertainties. At the same time, integrated assessment models provide an essential discipline by ensuring that assumptions and conclusions are internally consistent and that the consequences of alternative assumptions or policies can be mapped out.76

The government has commissioned a number of modelling exercises throughout the climate change policy development process, and will continue with these exercises through the process of finalising and implementing the ETS. The results presented below represent the best available data at this point in time.

The costs and benefits of introducing an ETS have been analysed through the policy development process. The findings of this process are outlined in the Emissions Trading Scheme’s Regulatory Impact Statement as is standard practice for government initiatives of this nature.

7.2 Impacts on New Zealand’s emissions levels

International experience is that market-based schemes tend to have a better track record at reducing pollution at lower cost than other regulatory options.77 Market-based schemes provide a long-term price signal to which firms can respond in determining business strategies and investment plans. Introducing a price on emissions automatically increases the returns on emission reduction strategies. International experience suggests that there are often a large number of low-cost options for reducing emissions (so-called “low-hanging fruit”) that will be uncovered with the incentive of an emissions price.

Among market-based options, an ETS is generally regarded as effective at reducing emissions because:

  • multiple emission reduction opportunities are identified

  • emitters can choose whether to make emission reductions in their own operations or to pay the price of emission units and support emission reduction activities elsewhere

  • emissions trading places a value on abatement opportunities that are yet to be realised, and creates opportunities for entrepreneurs to identify these and to find innovative ways of realising them.

Under an internationally linked scheme, New Zealand “points of obligation” will not be confined to taking advantage of domestic emissions reductions, but will be able to purchase international units (which represent emission reductions in other countries). Therefore, an important variable in determining the impact of an ETS on New Zealand’s domestic emissions will be the cost of domestic emission reduction options relative to offshore emission reductions.

With that caveat, preliminary modelling does give a general picture of potential outcomes for domestic emissions under an ETS.

7.2.1 Emissions from electricity

Preliminary modelling work on the electricity sector (see Figure 7.1) indicates that:

  • in the short term, price-based measures may only lead to a moderate emission reductions relative to the base case, irrespective of the emissions price (due to lead times in bringing new renewable generation on line)

  • over the long term, emission price levels of around $15 to $25/tCO2-e would keep emissions from the electricity generation sector at about current levels through some moderating of demand growth and encouraging new investment in renewable generation (this represents an improvement over the business-as-usual base outlook, which projects steady growth in electricity sector emissions).

Figure 7.1: Electricity sector CO2 emissions under different carbon price scenarios

Source: Ministry of Economic Development, June 2007

In light of these results, the government is considering further measures to encourage additional reductions in emissions from electricity generation in the short term. This will include a variety of demand-side strategies to encourage more energy-efficient choices by consumers (including building codes and standards for electrical appliances).

7.2.2 Emissions from transport

The impact of the ETS on transport emissions will occur through the moderation of demand that is expected to result from increases in the price of fuels. However, because fuel use is highly inelastic, emissions are likely to drop only by a small percentage. For every 10 per cent increase in petrol price, medium- to long-term demand is expected to fall by 3 per cent. The use of diesel for the heavy fleet is assumed not to respond to price because they will pass the increased costs through to customers. Combining these two assumptions gives the following overall emission reductions, relative to business as usual (ie, no emission pricing).

Table 7.1: Emission reductions in the transport sector

  Emission price
$15/t CO2-e $25/t CO2-e

Transport sector emission reductions over the medium to long term with emission pricing (relative to business as usual)

0.3%

0.6%

However, these modest reductions are insignificant compared with the growth expected in transport emissions due to rising population and economic growth. Emissions are expected to have grown over current levels by over 40 per cent by 2030, with most of this increase coming from increased diesel use as a result of increased economic activity. Once again, the ETS will be only one measure among a range of measures that the government will take to address the need to reduce transport sector emissions. These are noted in section 6.2.

7.2.3 Emissions from forestry

In the absence of effective deforestation controls, and assuming no expectation of future controls, the Ministry of Agriculture and Forestry (MAF) estimates that deforestation in the first commitment period would be approximately 41 million tonnes78 CO2-e (slightly less than 10 per cent of New Zealand’s projected emissions over this period). The exact amount depends on the quality of the land and the carbon in the trees being harvested. The most “convertible” land would be most affected (land with foregone expected profits of conversion up to $10,000/ha, and more in exceptional cases). MAF estimates that up to 280,000 hectares of exotic forest is at risk of deforestation based on land-use classifications and 2006 prices, excluding land in government ownership, subject to a Crown Forest Licence, or in the Lake Taupo catchment. These exclusions amount to 166,000 hectares.

It is likely that little of this deforestation would occur if the forestry sector were exposed to the full cost of emissions.

The devolution of credits for new forests should increase afforestation. This is because devolved emission units (with associated liabilities) for afforestation are expected to increase forestry internal rates of return. However, the amount of increase is highly dependent on assumptions on a discount rate and future emission price. As long as investors expect the emission price to increase at a rate less than the investor’s discount rate, the internal rate of return on a new forest will increase. At a constant price of $15/tCO2, the internal rate of return increases from 6.4 per cent to 8.5 per cent for a radiata pine investment.

7.2.4 Emissions from agriculture

The non-CO2 emissions from agriculture will be brought into the ETS from 2013. Prior to that date there will be two impacts under the ETS that have flow-on effects for emissions in the agricultural sector.

  • There will be a slower rate of conversion of forestry land to dairy farming as a result of applying the ETS to the forestry sector from 2008. This is likely to be the largest impact of the ETS in the short term.

  • There will be impacts arising from higher prices for electricity, other stationary energy and transport fuels. There is no readily available information at this stage to assess what impact these will have on agricultural production and hence sector emissions.

The significance of these impacts will be influenced by projected increases in world commodity prices for dairy products. For example, the government’s Kyoto emissions estimates associated with agricultural production (both non-CO2 emissions and CO2 from energy) increased by 5.8 Mt CO2-e in 2007 relative to 2006, primarily because of the higher level of dairy production and associated dairy processing coupled with changes to projected commodity prices for dairy products.

From 2013, once non-CO2 emissions from the agricultural sector enter the NZ ETS, emission reductions relative to business as usual will result from three main effects:

  • a slower rate of conversion of forestry land to other types of farm production

  • changes in on-farm practices that reduce emissions (eg, reducing nitrous oxide emissions through the use of nitrate inhibitors)

  • changes in the type and intensity of agricultural operations.

Through the Pastoral Greenhouse Gas Research Consortium, the agriculture industry is researching options for reducing agricultural emissions through improved practices and new technologies. The ETS will create further financial incentives to accelerate the introduction of such measures as they are developed.

7.2.5 Other emissions

Outside of the energy generation, transport, agriculture and forestry sectors, New Zealand has a range of firms whose production processes involve greenhouse gas emissions. As with agriculture, reductions in emissions from these firms will flow from either reduced output or the deployment of new technologies and improved management practices. The NZ ETS will provide a long-term price signal that firms will factor into decisions regarding new investments and major plant upgrades.

As discussed, it is very difficult to assess how firms will react to emission pricing, and this will vary from firm to firm, industry to industry. Direct emission reductions from New Zealand industry over the next 10 to 15 years under an ETS will be somewhat constrained by the nature of the existing facilities, although there are still promising opportunities to reduce emissions. These include:

  • switching from using coal to using gas or biomass for industrial heat, wherever possible

  • increasing the use of cogeneration in conjunction with industrial heat production (cogeneration technology allows heat that is generated for industrial processes to be used to produce electricity as well)

  • improving energy efficiency and other emissions management practices

  • investing in new technology as part of the cycle of capital stock turnover.

Over the longer term, new technologies are expected to allow for dramatic improvements in industrial energy efficiency and emission reductions in some areas.79 The actual level of emission reduction will be determined by the price of emissions relative to the cost of the abatement activities.

7.3 Macroeconomic impacts

The impact on New Zealand’s macroeconomy of any price-based emission reduction measure will be driven by:

  • the underlying impact of the international price of emissions, which is set by the stringency of international agreements (ie, the Kyoto Protocol and its successors)

  • New Zealand’s success in reducing emissions in a least-cost manner, and in assisting other countries to do so (hence capturing additional credits).

At a macroeconomic level, the NZ ETS would be expected to have an impact similar to that of a carbon tax if both measures reflected the same price of emissions and if revenues were returned to the economy. Modelling carried out to show the effort of introducing a carbon tax in New Zealand from 2008 to 2012 can therefore also cast light on the likely impact that an ETS would produce on the macroeconomy over this period.80

Modelling of the economic impacts of meeting New Zealand’s Kyoto Protocol commitment was undertaken as part of the government’s 2005 Review of Climate Change Policies by ABARE.81 ABARE modelled a series of different scenarios. The most comparable scenario showed that the impact in 2010 (taken to be a representative year for the first Kyoto period) for an internationally linked scheme including agriculture, with a price of emissions of $13/t CO2-e, would shave GDP growth by 0.04 per cent in that year relative to business as usual.

Infometrics82 carried out modelling to show the impact on GDP of placing a tax of $25/t CO2-e on all emissions (excluding non-CO2 emissions from agriculture), with the revenue recycled to lower company tax. A snapshot of the tax year 2011/2012 was taken to be representative of the first commitment period. The effect on GDP did not exceed a reduction of 0.1 per cent.

It is important to note that these estimates are against a business-as-usual benchmark. For example, the ABARE results do not say that the economy will be 0.04 per cent smaller than it is today. What they mean is the economy will be 0.04 per cent smaller than it would have been in 2010 if the price of emissions had not been increased. The Treasury is forecasting that, over the coming few years, real GDP will grow by about 2 percentage points a year. This means that, while New Zealand’s Kyoto Protocol commitment might reduce growth somewhat, we will still be wealthier as a nation than we are now.83

The ETS is a measure for distributing emissions costs in a way that attempts to maximise the uptake of mitigation opportunities and ensures that the least-cost opportunities receive priority. While it is difficult, if not impossible, to measure with any accuracy the economy-wide impact of an ETS versus, say, an emissions tax, the design and operation of an ETS will clearly result in greater efficiency across the economy in decisions on emissions choices and, hence, a reduced impact on GDP relative to other measures.

The advantages of an ETS will, of course, not be fully realised during the implementation period, when the taxpayer is still bearing emissions costs that will eventually become the responsibility of sectors. However, even during the implementation period, an ETS will provide greater certainty to firms about the future costs and opportunities resulting from their emissions, and will influence their long-term investment decisions. By accepting the responsibility of managing their own emissions (rather than having them met by taxpayers), participants in the ETS have an opportunity to derive additional value through emissions abatement and trading activities. In other words, an ETS will foster an “industry” in reducing emissions and trading the units that are freed up as a result.

7.4 Microeconomic impacts

The implementation of a NZ ETS will impact widely across the economy as the prices of goods and services change to reflect the cost of the emissions associated with their production. This price signal is the key driver of emission reductions under emissions pricing. An ETS will reduce the returns to some activities at the margin, meaning that the prices received by producers for each new unit of production they sell will be reduced.

7.4.1 Free allocation and other forms of assistance

This change of price incentive at the margin is precisely the aim of the scheme; however, the government wishes to avoid forcing changes on New Zealand firms and households at an unreasonable pace. For this reason, the government has designed the ETS with a number of features and complementary measures that will moderate the impact of the scheme. These include:

  • free allocation of emission units in some sectors on the basis of recent historical emissions, while leaving an incentive for firms to avoid increasing emissions at the margin

  • programmes to make it easier for people to increase the energy efficiency of their houses

  • additional policy measures to reduce the financial impacts of higher electricity prices so that low- and modest-income households are not disadvantaged while still ensuring that incentives for energy efficient use remain

  • delayed entry into the scheme for some sectors (which essentially means taxpayers will fund the cost of their emissions in the interim).

The nature and extent of the measures that will be implemented will be the subject of further engagement, so it is not possible to give a detailed analysis of the impact of the ETS on households and firms. The aim, however, is to preserve sufficient pressure for behavioural change, while enabling firms and households to make a smooth transition to lower emissions.

7.4.2 Indicative changes to energy prices

Some indicative price changes under an ETS, to give a sense of magnitude, are shown in Table 7.2 relating to energy prices. It is important to note that these do not account for any assistance or compensation packages. These changes would be the same under a carbon tax set at the corresponding emission price.

Table 7.2: Examples of energy price increases under emissions pricing

  Emission price scenarios
$15/t CO2-e $25/t CO2-e

Liquid fuels (transport)

   

Petrol cents/litre GST inclusive (% increase over current price)

3.7c (2.5%)

6.1c (4%)

Diesel cents/litre GST inclusive (% increase over current price)

4c (4%)

6.7c (7%)

Electricity

   

Wholesale cents/kwh (% increase over business as usual)

0.7c (9%)

1.4c (19%)

Retail cents/kwh GST inclusive (% increase over business as usual)

1c (5%)

2c (10%)

Other fossil fuels

   

Wholesale gas $/GJ (% increase over business as usual)

$0.8 (11%)

$1.4 (18%)

Retail gas $/GJ (GST inclusive) (% increase over business as usual)

$0.9 (2%)

$1.7 (4%)

Wholesale coal $/GJ (% increase over business as usual)

$1.5 (40%)

$2.5 (67%)

Retail coal $/20kg bag (increase over current price of $9 a bag)

$0.9 (10%)

$1.5 (17%)

Note: GJ = xxx.

The measures to assist producers and consumers in making the transition to emission pricing are detailed elsewhere in this document.

7.4.3 Impacts on households

The implementation of a NZ ETS will have a wide impact across the economy as the prices of goods and services change to reflect the cost of the emissions associated with their production. This price signal is the driver of emission reductions under emissions pricing. Table 7.3 indicates the impact on households of the above energy price increase scenarios. This impact would be lessened by rebates and other forms of assistance, the details of which have yet to be determined.

Table 7.3: Impacts on households of energy price increases from emissions pricing

  Emission price scenarios
$15/t CO2-e $25/t CO2-e

Average increase in household energy expenditure (eg, electricity, coal, natural gas and transport fuels) per annum84

$100-$200 pa

$170-$330 pa

Approximate % of total household expenditure

0.3%-0.5%

0.5%-0.8%

There will also be second-order price effects on the cost to households of purchasing some goods and services beyond the energy-related costs described above.

7.4.4 Impacts on agriculture

New Zealand’s agricultural products compete in a market characterised by a high degree of product homogeneity and a high number of sellers. As a result, the sector is a price taker: it is unable to fully pass increased production costs on to consumers.

The government has decided in principle to delay the sector’s entry into the NZ ETS until 2013 and to develop a range of measures to assist the sector to make the transition to a lower-emissions mode of production. This is important not just for climate change reasons. Looking to the future, the sustainability of New Zealand agricultural products will most likely be an important factor in maintaining and/or expanding access to premium export markets. The participation of agriculture in the ETS may be an important element in countering negative messages, such as the current “food miles” debate in Europe.

The level of free allocation can be used to offset the reduction in profits caused by emission pricing. Theoretically, free allocation should not change the impact on production levels, but in practice this would depend on how the allocation were distributed to the sector, how participants choose to manage that allocation as an asset, and the way in which prices are transmitted to farmers.

Table 7.4 shows how providing the agricultural sector with a free allocation based on 90 per cent of their non-CO2 emissions in 2005 would affect their payout in 2013 relative to a business-as-usual scenario.85 This assumes that free allocation is directed to the points of obligation (ie, the dairy or meat processor) and is fully reflected in the payout. These impacts do not reflect the effect of increases in energy costs from emissions pricing. The following numbers are subject to considerable variability, and should only be used to give a sense of the magnitude of any possible impact.

Table 7.4: Possible impact of a free allocation scenario for agriculture

 

Emission price scenarios: grandparenting at 90 per cent of 2005 emission levels in the year 2013

Agricultural production (change in average payout relative to business-as-usual scenario)

$15/t CO2-e

$25/t CO2-e

Dairy

–1.0%

–1.6%

Beef

–0.2%

–0.3%

Sheepmeat

–0.70%

–1.2%

Venison

–0.1%

–0.2%

7.4.4.1 Impacts on horticulture, vegetable and arable sectors

The horticulture and vegetable sectors will be impacted by cost increases from CO2 and nitrous oxide emissions. The sectors most affected will be those that rely on significant energy consumption for greenhouses and/or cool stores. These include forms of vegetable production and flower/nursery production. Increased costs for cool storage will affect pip fruit, kiwifruit and other fruit and vegetable growers.

Nitrogen fertiliser inputs comprise 15 to 20 per cent of production costs for the arable sector (the second largest single farm expense), which includes grain and specialty seed production and seed multiplication for export. The estimated price of nitrogen fertilisers is projected to increase by 7 per cent once nitrogen fertilisers enter the scheme in 2013, assuming a price of $15/tCO2-e. Free allocation could moderate this price impact.

7.4.5 Impacts on forestry

Landowners with pre-1990 forests, particularly those whose land has potential in other uses, will see a reduction in land value and economic opportunities as a result of the introduction of deforestation liabilities. This will be partly balanced by a free allocation of emission units to the affected landowners. Owners of post-1989 forests, and owners of land suited to afforestation, will have a substantial new opportunity in the ability to derive additional income through the ETS. Because the future emission price is uncertain, this opportunity comes with risks. These risks can, however, be managed, with some credits held aside in anticipation of future liabilities.

There are also implications for forestry operations. As new forests enter the ETS, forest managers will add carbon storage and management to their list of objectives. There could be an evening out of the age distribution of the post-1989 forestry estate, so that forest owners have credits from new forests to offset liabilities from forests being harvested.

Like all other industries, forestry and related industries will see increased energy costs. This, too, is an opportunity for the industry, with timber residues increasing in value as a source of renewable energy. This will have implications for timber production and supply.

7.4.6 Impacts on other major emitters

A price on greenhouse gases will result in emission reductions across industry. The precise volume of reductions and their location are difficult to predict, but one of the benefits of a price-based measure is that it will “discover” emission reduction opportunities.

Large energy users with significant direct or indirect emissions contribute a small, but significant, proportion of New Zealand’s emissions. They have a clear financial incentive to limit energy use even without a price on emissions. However, previous government initiatives, including the Negotiated Greenhouse Agreements programme, have resulted in these large firms identifying additional opportunities to reduce energy use and thus emissions. A price on greenhouse gases, whether faced directly or via an increase in energy prices, will result in additional incentives to identify low-cost opportunities to reduce emissions.

There are a number of recognised barriers to energy efficiency and other emission reduction action in some sectors. For example, such efforts are hampered for commercial buildings because of a lack of information about energy use and incentives that fall awkwardly between building owners and users. In these circumstances, additional government interventions may be required, but the price on emissions reinforces these interventions and makes them more effective.

In addition to having differing potential to respond to an emission price by improving efficiency and reducing emissions, major emitters will vary in their ability to pass emission costs to their customers. For this reason, the government is proposing transitional assistance to major emitters to support their adjustment to emission pricing. The government’s rationale for which firms should be eligible to receive assistance, the appropriate level of assistance, and the mechanism for delivering assistance is detailed in chapter 5 on ‘How emission units are allocated’. The government will engage with major emitters on the impacts of the NZ ETS and the options for transitional assistance.

7.5 Impacts of the NZ ETS on the Kyoto net position for 2008–2012

7.5.1 Background on the Kyoto net position

To comply with its international obligations for the first commitment period of the Kyoto Protocol (2008-2012), the government needs to retire one Kyoto emission unit86 to match each tonne of its net emissions (ie, measured net of Kyoto-eligible forest carbon sinks). The government will receive a free allocation of Kyoto assigned amount units (AAUs) equal to five times its 1990 emissions (excluding emissions and sinks in the land use, land-use change and forestry sector). The difference between New Zealand’s assigned amount and its projected emissions from 2008 to 2012 is registered in the Crown financial accounts as a liability. The value of this liability is calculated using the projected cost of purchasing Kyoto emission units internationally to cover the Kyoto deficit. The government’s Kyoto net position and the associated financial liability are updated annually.

Under a most likely emission scenario, reflecting policies in place as of April 2007, New Zealand’s net position is projected to be a deficit of 45.5 million units over the first commitment period of the Kyoto Protocol.87 This deficit is calculated as follows (see Table 7.5).

Table 7.5: Projected balance of emission units over the first commitment period (million emission units)

 

Upper scenario

Most likely scenario

Lower scenario

Emissions

     

a Projected aggregate emissions

 

405.4

 

Energy (excluding transport)

103.0

92.8

86.1

Transport

84.7

80.1

76.7

Industrial processes

22.3

22.2

22.1

Solvent and other product use

0.3

0.3

0.3

Agriculture

228.3

203.1

180.0

Waste

7.3

7.0

6.7

b Assigned amount units

AAUs

309.5

309.5

309.5

c Emissions to be covered (b–a)

 

–96.0

 

Projection of removal units

     

d Removals via forests

57.0

79.0

119.3

e Deforestation emissions

–41.0

–21.0

–21.0

f Net removals via forests (d+e)

RMUs

16.0

58.0

98.3

g Balance (c–f)

 

–38.0

 

h AAUs allocated to projects

7.5

7.5

7.5

Balance of units (g–h)

 

–45.5

 

Note: One emission unit is equivalent to one tonne of greenhouse gas emissions converted to carbon dioxide equivalents by the global warming potential.

MAF has provided a most likely scenario for deforestation of 21.0 Mt CO2-e. This scenario is based on the government’s current policy to cap the Crown’s deforestation liability for pre-1990 forests at 21.0 Mt CO2-e. A deforestation survey undertaken in 2006 indicated that deforestation is likely to exceed the 21.0 million tonne cap in the absence of policy interventions under current market conditions. The 2006 deforestation intention survey indicated that forest owners currently intend to deforest about 50,000 hectares during the first commitment period of the Kyoto Protocol. This area would generate deforestation emissions of approximately 41.0 Mt CO2-e. If the upper deforestation scenario of 41.0 Mt CO2-e is used in determining the deficit on the Crown’s accounts, the deficit will be 65.5 million units.

Under April 2007 policy settings, the government – and therefore taxpayers – would assume the Kyoto liability with the exception of deforestation emissions beyond the 21.0 million tonne cap covered by the government. It is important to note that the calculated deficit of 45.5 Mt CO2-e assumes that the government retains all of the credits for Kyoto-eligible afforestation (totalling 79.0 Mt CO2-e) and applies them to reduce the deficit. If the government were to devolve those credits to landowners, then the deficit would increase from 45.5 Mt CO2-e to 124.5 Mt CO2-e.

7.5.2 Possible impacts of the NZ ETS on the Kyoto net position

Implementing the NZ ETS would be expected to lower the Kyoto deficit by:

  • creating a further price-based incentive for emission reductions and removals by forest carbon sinks in New Zealand

  • devolving a significant portion of the remaining Kyoto liability from the government to the sectoral participants with unit obligations.

The government would still retain the responsibility for:

  • the sectors’ emissions prior to their entry into the NZ ETS

  • the sectors’ emissions below a de minimus threshold that are exempt from the scheme

  • emissions covered by units that are gifted to participants in the scheme

  • in the case of progressive obligations in selected sectors, the portion of emissions not devolved to participants with unit obligations

  • the government’s Kyoto unit commitments under other policies, such as Projects to Reduce Emissions, Negotiated Greenhouse Agreements and the Permanent Forest Sink Initiative.

Table 7.6 illustrates one possible scenario for devolving the emissions liability to sectors on the basis of their proposed date of entry into the NZ ETS. Under this scenario, the government carries the emissions liability for sectors’ emissions prior to their entry into the NZ ETS, and allocates free units to industrial producers totalling 15 Mt CO2-e per year from 2010 to 2012. This scenario also reflects the government’s prior commitments to the deforestation cap of 21 Mt CO2-e and to participants in Projects to Reduce Emissions. This scenario does not account for emission reductions in response to the NZ ETS, exemptions below a de minimus threshold for each sector, or the use of progressive obligations. The assessment of net units devolved to sectors (column 4) does not reflect the emission costs passed to downstream firms (eg, from electricity consumed); however, these costs are accounted for in the government’s free allocation to industrial producers.

Table 7.6: One indicative scenario for devolving emissions liability under the NZ ETS

Sector

Proposed date of entry into the NZ ETS

Year

Projected emissions(a) 2008–2012

Mt CO2-e

Emissions covered by sectors(b)
2008–2012

Mt CO2-e

Units covered by the government(b)
2008–2012

Mt CO2-e

Projected emissions by sector

       

Deforestation (high scenario)

1 January 2008

41

20

21

Liquid fossil fuels(c)

1 January 2009

99

80

19

Stationary energy (excluding liquid fossil fuels) 1 January 2010 74 12(d) 84(d)
Industrial processes 1 January 2010 22

Agriculture

1 January 2013

203

0

203

Waste

1 January 2013

7

0

7

Solvents and other products

1 January 2013

0

0

0

Subtotal

2008–2012

446

113

334

Government’s Kyoto emission unit balance

 

Government’s obligation for sectors’ emissions (shown above)

334

Projects to Reduce Emissions

8

Total government obligation

342

New Zealand assigned amount units

310

Government’s Kyoto net position

–32

(a) This reflects the most likely scenario for emissions in the absence of policies post-April 2007, including a NZ ETS.

(b) As a conservative scenario, this assumes zero emission reductions relative to business as usual.

(c) This includes liquid fossil fuels used for transport and stationary energy.

(d) This assumes total free allocation of 45 Mt CO2-e to firms in these sectors from 2010 to 2012.

Note: One emission unit is equivalent to one tonne of greenhouse gas emissions converted to carbon dioxide.

The remaining consideration to complete this scenario is the treatment of credits for Kyoto-eligible afforestation activities, which are expected to generate removals of 79.0 Mt CO2-e over the first commitment period. The government will receive Kyoto removal units (RMUs) for net forest carbon removals (ie, afforestation removals minus deforestation emissions) from 2008 to 2012. Because of the “netting” calculation, the government will receive fewer RMUs than actual removals from afforestation.

The government has decided in principle under the NZ ETS that landowners can opt to receive NZUs for post-1989 afforestation activities together with the associated liabilities for future emissions from harvesting or deforestation on that land. If landowners decline the credits and liabilities, they will accrue to the government. The government may choose to apply those credits towards improving its net position for the first commitment period, or to bank the credits to cover its future liability for harvesting or deforestation of that land.

To the extent that afforestation credits are devolved to landowners or banked by the government to cover future liabilities, afforestation activities will have zero impact on the government’s net position for the first commitment period. To be conservative, this scenario assumes that the government applies zero RMUs toward its Kyoto compliance during the first commitment period.

Under the above scenario, the government faces a deficit of 35 Mt CO2-e over the first commitment period. This compares with a deficit in the absence of a NZ ETS of 124.5 Mt CO2-e if the government fully devolves afforestation credits to landowners, and a deficit of 45.5 Mt CO2-e if the government retains all of the afforestation credits for compliance in the first commitment period.

This scenario is not a realistic outcome, since emission reductions are expected to occur under the NZ ETS. However, it does provide a useful starting point for discussions and suggests that, in CP1 at least, the government will be in a net deficit position, even after the introduction of an ETS.

It is not at all clear how many forest sink credits will be available for use by the government in CP1. It is also important to consider that the government will receive increased revenue from implementation of the NZ ETS, particularly through increased profits to state-owned enterprises. The net fiscal impact of the NZ ETS on the government’s accounts will thus reflect broader considerations than the Kyoto net position.

7.6 Conclusion

The impact of an ETS is difficult to measure with accuracy, but international experience is that emissions trading schemes are effective ways of reducing emissions. They provide a clear, long-term signal that influences investment decisions and encourages the use of innovative, low-cost, abatement options as a first priority.

The government has recognised that the full impact of an ETS would create transitional problems, and as a result has adopted an ETS design that features a staged implementation, some free allocation of credits, and a range of measures that ensure the impact of the scheme is shared evenly across the economy.

It is nevertheless the government’s intention that, over time, the responsibility for managing New Zealand’s greenhouse gas emissions will be shifted as much as possible to those who make the investment and consumption decisions that cause those emissions. In time, it is likely that carbon will be regarded as a cost of production in the same way as electricity and labour currently are.


75 This option would not be available to those who merely import a product, such as fuel oil, and have little or no influence over its production and emissions content.

76 Nordhaus, W, 2007, The Challenge of Global Warming: Economic Models and Environmental Policy, p 81. http://nordhaus.econ.yale.edu/dice_mss_072407_all.pdf.

77 See, for example, Harrington W, Morgenstern RD, Nelson P, 1999, On the Accuracy of Regulatory Cost Estimates, Resources for the Future Discussion Paper, 99–18, Resources for the Future: Washington, DC. “The most flexible emission reduction polices involve substantial use of economic incentives, and we note that for all the economic incentive polices in our sample, the cost was overestimated or the quantity of emission reductions was underestimated”.

78 As noted previously, emissions from deforestation could be significantly greater than this amount if the forestry sector were to bring forward deforestation.

79 For a discussion of some of the technologies that are available, or will be available soon, see International Energy Agency 2006, Energy Technology Perspectives 2006,

http://www.iea.org/w/bookshop/b.aspx?Subject=Technology%20-%20RD, Chapter 7. Also see International Energy Agency 2007, Tracking Industrial Energy Efficiency and CO2Emissions,

http://www.iea.org/w/bookshop/b.aspx.

80 Modelling of this nature relies on assumptions, such as assuming costless and smooth transition. Thus care needs to be taken in interpreting results but they should give a sense of magnitude.

81 ABARE is an Australian government economic research agency that has been involved in modelling climate change policy since 1993.

82 Infometrics 2006, Issues Surrounding a Narrowly-Based Carbon Price Instrument, a report prepared for the Ministry for the Environment: Wellington. Infometrics is a privately-owned and operated NZ company. It offers a range of economic consulting and forecasting services on commercial terms to companies, businesses and government departments.

83 The government is currently conducting modelling of the macroeconomic impacts on the New Zealand economy of different carbon constraints for the post-2012 period.

84 Data from 2004 Household and Economic Survey, for a range of different household compositions, re-weighted for Treasury Taxmod, inflated to March 2007 using Taxmod (for income and population ) and disaggregated CP1 inflators (for the components of household expenditure, no volume changes).

85 This assumes that the costs to the agricultural sector are averaged across all production.

86 One emission unit is equivalent to one tonne of greenhouse gas emissions converted to carbon dioxide equivalents by the global warming potential.

87 Ministry for the Environment 2007, Projected Balance of Emissions Units During the First Commitment Period of the Kyoto Protocol, Ministry for the Environment: Wellington. www.mfe.govt.nz.