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Part 2. Beyond Kyoto CP1 - 2025

Following the procedure for 2011/12, we prepare a BAU scenario for 2024/25 which acts as a benchmark against which other scenarios can be compared. The same macroeconomic closure rules are adopted. We continue with the previous scenario numbering.

  • Scenario 4 – Replication of Scenario 1 extended to 2025.
  • Scenario 5 – Analogous to Scenario 2, but with methane and nitrous oxides emissions included. No free allocation.
  • Scenario 6 – As in Scenario 5 with the carbon price at $100/tonne.

Three sensitivity tests are examined in Part 3:

  • Scenario 7 – As in Scenario 6 with a lower international allowance with regard to New Zealand’s emissions.
  • Scenario 8 – As in Scenario 6 with a absorption of the carbon price by emissions intensive exporters.
  • Scenario 9 – As in Scenario 6 with international trade prices reflecting international action to reduce GH emissions.

Note that emissions of methane and nitrous oxide are treated as process emissions, implying that reductions in output are the only way to reduce such emissions. Therefore, to the extent that technological change induced by the ETS could reduce emissions, the model’s results will overestimate costs.

Scenario 4

Government purchases emissions units from offshore, financed by higher personal income tax. The amount involved is $1540m per annum (emissions of 111.6 Mt CO2e3 less an assumed 50 Mt of international allowances4, at $25/tonne).

Table 3 shows the results. Not surprisingly, with the greater flow of funds offshore the fall in private consumption is much larger than in Scenario 1; 1% compared to 0.2%. The adjustment on the current account is primarily on the export side; exports increase by 1.3% and imports decline by 0.6%, following a 0.8% decline in the real exchange rate to boost competitiveness. The terms of trade fall by 0.6%.

Emissions increase slightly (0.3%) on BAU because of the expansion in exporting industries, which tend to be more carbon intensive than those that sell predominantly to households.

Scenario 5

Uniform carbon charge of $25/tonne on all emissions including methane and nitrous oxide. No free allocation or other concessions.

The carbon price reduces CO2e emissions by 4.0% or 4.7 Mt, comprising a 5.3% fall in CO2 emissions and a 3.0% fall in CH4 and N20 emissions. Thus the cost of units to be bought offshore is lower at about $1400m.

Private consumption declines by 0.7%, notably less than the fall observed in Scenario 4. This outcome contrasts with the 2012 scenarios (Scenarios 1 and 2) where the imposition of a carbon price does not alleviate the reduction in private consumption, although it does affect international purchasing power.

The difference in Scenario 5 of course, is that the carbon price is more widely applied, generating more revenue for government and thus lowering the pressure on income taxes. Indeed incomes tax rates decline by 2.3%. That this does not moderate the fall in private consumption even more is because of the reduction in real wage rates (0.7%) following the rise in prices caused by the carbon price.

Scenario 6

As in Scenario 6 with a carbon price of $100/tonne.

At a price of $100/tonne the cost of purchasing emission permits on the world market is approximately $4700m per annum. It would be considerably more were it not for the larger reduction in emissions, which fall by 13%.

Real private consumption falls by 2.2%, in spite of a significant income tax reduction. At current prices, but allowing for the projected growth in real income between now and 2025, this corresponds to about $800 per person in 2025. The absolute increase in private consumption per capita over the period is projected to be about $12,100, in comparison to the BAU absolute increment of $12,900. In terms of growth rates the figures are 2.4% pa in the BAU and 2.3% pa in Scenario 6. This is shown in the following graph.

Table 3: Macroeconomic Results

View macroeconomic results (large table)

Table 4 – Gross Output

View gross output (large table).

Private Consumption per Capita

Private Consumption per Capita between 2007 and 2025

Although the real exchange rate declines, it is not enough to counter the effect of the carbon price on export competitiveness. Hence the adjustment in the external balance is once again dominated by a reduction in imports.

With the carbon price extended to agricultural methane and nitrous oxide emissions, Meat Processing and Dairy Processing both see substantial falls in output relative to BAU. Relative to 2006/07 though, the reductions in implied growth rates are about 0.8% and 0.5% per annum respectively. See Table 4.

Oil Refining output falls by 11.7% as the carbon price now applies to both oil combustion and to emissions released from refining itself. Similarly, with no free allocation Basic Metals output also declines. In contrast the Wood Processing and Pulp & Paper industries see an increase in output. For these industries, which are not particularly emissions intensive in comparison to say Dairy Processing and Basic Metals, the reduction in the real exchange rate outweighs the cost impact of the carbon price. Although not shown in the table, other industries that benefit from a carbon price, in the sense that their gross output is higher than under BAU are Fabricated Metal Products, Machinery & Appliances, Other Manufacturing, and non-traded industries such as Education.

3 The model’s projection of emissions in 2024/25 without a price on carbon are about 10% above MfE gross projections, (due primarily to faster growth in emissions from agriculture and transport), but below MFEs net emissions. Regardless, given the uncertainties in these projections, the models emission projection represents one of the many plausible/sensible projections that could be used.

4 The level of allowances that NZ will receive under international agreements is subject to the outcome of future international negotiations. For modelling purposes, this scenario assumes a level that would be broadly consistent with a path that reduces emissions by 50% of 1990 levels by 2050.

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