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1 Introduction

1.1 Background

In early December 2007, the Government introduced into Parliament the Climate Change (Emissions Trading and Renewable Preference) Bill (“the Bill”) to provide the statutory framework for a New Zealand Emissions Trading Scheme (ETS), and to restrict the use of fossil fuels for electricity generation. The Bill was referred to the Finance and Expenditure Committee, which invited written submissions on the Bill by 29 February 2008, and will proceed with oral hearings.

The objective of the ETS, as stated in the “General policy statement” in the Bill, is as follows:

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.

As the Bill is drafted, the ETS will be implemented in a staged manner across the economy, such that all major emitting sectors are included by the start of 2013. It will be linked internationally to the Kyoto trading market in order to ensure liquidity and reflect the international price of emissions in the New Zealand economy. To support the economic transition into emissions trading, free allocation of emission units will be given to the forestry, industry, and agriculture sectors, but not to fuel suppliers or electricity generators, who can pass emission costs down the supply chain. Transitional support will also be provided to households and businesses outside of the ETS.

The ETS is a market-based mechanism that is designed to operate in conjunction with pre-existing environmental legislation and policies, such as the Resource Management Act 1991 (RMA) and the New Zealand Biodiversity Strategy (NZBS). Through the use of price signals, the ETS will result in changes to land and natural resource use, patterns of economic activity and operational practices. These changes will, in turn, affect the natural and physical environment in positive or negative ways.

In addition to the ETS, the Government has also announced a range of other new climate-related initiatives. These include legislation for a preference for renewable energy for electricity generation and a Biofuel Sales Obligation, as well a range of other initiatives in relation to forestry, agriculture and energy. These are outlined in material released by the Government in October 2007 at the same time as the report ‘The Framework for a New Zealand Emissions Trading Scheme’. These measures are in addition to previously existing climate change policies.

With input from the Climate Change Leadership Forum and other stakeholders, the Government decided to conduct further work with regard to assessment of the environmental effects of the ETS and closely related aspects of the new sectoral policies and measures. Such assessment will help ensure that the ETS has broad environmental integrity designed into the scheme from the start, and is broadly consistent with the Government’s overall sustainability goals. The outcome from such environmental assessment can be considered by policy makers prior to finalising the design of the ETS and complementary measures, and balanced against other considerations driving the implementation of the ETS.

As a first step in an environmental assessment, the Government’s Emissions Trading Group contracted a team of consultants3 to prepare a scoping report on the environmental effects of the Government’s ETS and closely related new measures (hereafter referred to as “ETS-plus”). The scope and methodology for this scoping report are attached as Appendix 1.

Section 1.3 below describes the ETS-plus policy package.

1.2 Context and purpose of this report

The ETS is an all gases, all sectors policy measure, affecting businesses and households directly or indirectly, designed to enable a variety of different responses in order achieve the Government’s objectives at least cost in the long term. It is important to note that the ETS-plus package is intended to drive behavioural change across the economy. ETS-plus aims to reduce New Zealand’s net emissions, in conjunction with global efforts to stabilise atmospheric concentrations of greenhouse gases, and to move the economy onto a lower emission trajectory at the lowest economic cost over the long term.

This scoping report aims to identify, at a high level, potential environmental effects of the ETS-plus that are likely to arise as a result of the ETS and related measures during the period 2008 to 2020. The report then identifies possible response measures to address these effects, and suggests terms of reference for possible further investigations of particular areas of concern or uncertainty.

The purpose of assessing environmental effects is not to assess whether or not to implement an ETS. In keeping with its international obligations, the Government has a degree of short-term ambition in emissions reduction, with an ETS being the preferred tool for finding most of those emissions reductions. In the absence of an ETS, the Government would likely implement alternative regulatory and policy measures to accomplish its policy objectives, including meeting New Zealand’s commitments under the Kyoto Protocol (and any successor agreement) and its objectives under the New Zealand Energy Strategy. Any such alternative policies would also be expected to have some flow-on environmental effects, both positive and negative.

New Zealand entities with emissions obligations under the ETS can satisfy these obligations by choosing the least costly combination of directly reducing emissions or purchasing domestic or international emission units (where doing so is consistent with supporting and encouraging global efforts to reduce emissions). For instance energy suppliers will purchase emission units, domestically or offshore, to account for the emission obligations associated with energy consumption that continues after energy efficiency and conservation efforts.

Complementary measures can help to reduce the reliance on international units, because relying on such units could lead firms and households to embed long-lived high emission technology and infrastructure into the economy and defeat the long term objective. For example, given that agriculture does not enter the ETS until 2013, it is important that changes start being made now, to avoid embedding a land use pattern that is unsustainable and costly to reverse. Similar considerations apply to transport – both the fleet and the nation’s transport infrastructure, and to buildings. In some cases, the current price signal cannot be relied upon to alter decisions that have significant long term consequences, eg, capital investments and patterns of land use that last for decades rather than a few years. Complementary measures can help address this.

Thus, the purpose of the scoping study is to identify potential environmental benefits and priority areas or “pressure points”, and thereby identify where the ETS design and other aspects of the Government’s policy framework may need to be adapted to address any environmental sustainability concerns and opportunities arising from the ETS-plus.

1.3 Policy scenarios

For this report, effects of the ETS and closely related policy measures are being assessed against a base case scenario of environmental and resource management policies as of 1 January 2008.

In addition to the ETS itself, the policy scenario being assessed (ETS-plus) consists of the following “closely related measures”: the preference for renewable electricity generation capacity, the biofuel sales obligation, the Afforestation Grants Scheme, and a range of measures from the New Zealand Energy Strategy and the New Zealand Energy Efficiency and Conservation Strategy (NZEECS).

See Appendix 2 for a fuller description of the ETS-plus package being assessed.

The base case consists of all other existing policies and measures as of 1 January 2008 unless otherwise specified. Measures that are already established and funded – for example, the Permanent Forest Sinks Initiative – are in the base case scenario and their interaction with the ETS is assessed in that context.

Pending waste management policy is also in the base case category – on the assumption that Parliament will enact the Waste Minimisation (Solids) Bill, and that it is not driven primarily by climate change considerations. On the other hand, the scenario excludes policies that have goals or targets but no definitive measures,4 although measures to achieve these goals could form part of new policy responses to address environmental concerns.

Finally, of policies related to agriculture and forestry, only the ETS itself and the proposed Afforestation Grants Scheme are in the ETS-plus policy scenario; other measures in the Government’s Plan of Action on Sustainable Land Management and Climate Change are in the base case scenario. They have either already been confirmed or are sufficiently independent of the ETS to not be considered a “closely related measure”.

Appendix 2 also describes the elements of the base case scenario in more detail. Appendix 2 not a definitive list of all measures in the base case; rather it highlights some of the key measures affecting emissions that form part of the base case, and helps illustrate more clearly the distinction with the ETS-plus.

1.4 Emissions leakage

The possibility of “emissions leakage” was frequently raised by stakeholders during the workshop conducted for this project. “Leakage” occurs when policies that put a price on greenhouse gas (GHG) emissions, such as an ETS, lead to exported products becoming uncompetitive, or products imported from countries with less stringent climate policies being substituted for domestic products. This leads to changes in the international distribution of production and thus, the international pattern of GHG emissions—reducing them in countries with a carbon price and increasing them in countries without a carbon price and no emissions cap. Production and emissions thus decline in the countries with an emissions price, but with no net reduction in global emissions. Indeed, differences in efficiency or additional transport requirements could even raise net global GHG emissions (Greenhalgh et al, 2007).

A climate policy with a sole objective of reducing global GHG emissions would seek to minimise emissions leakage, but this comes at a cost to the economy in the short and possibly the long term as well. In the short term, minimising emissions leakage generally entails compensating trade-exposed industries for some or all of the cost of emission obligations, eg, through free allocation. This means that the cost of that industry’s emissions must be borne by the taxpayer or somehow cross-subsidised by other sectors through the ETS. There is a range of possible policy designs that seek to maintain an incentive to reduce emissions while avoiding leakage (ibid), but they all shift at least some of the emissions obligations onto other members of society. As part of the ETS design, the Government has proposed to give eligible trade-exposed industries a free allocation equal to 90% of their 2005 emissions (excluding emissions from liquid fossil fuels) from 2010 to 2013, declining to zero free allocation by 2025.

Policies to minimise leakage can also impose long term costs on the country by postponing the necessary transition to a carbon-constrained economy. The extent of this cost depends on:

  • the length of time that the industry is exposed to competitors who do not face a similar price of carbon (and therefore the duration of the assistance that the Government needs to provide), and

  • the magnitude and distribution of any social impacts of industries curtailing production if they are not sufficiently protected, and

  • whether the industry is likely to be competitive in the longer term if and when all countries are competing on the same basis.

Some emission-intensive industries may disappear entirely over time as low emission alternatives emerge, so even if a domestic company is competitive within its global industry, it is not necessarily in the country’s long term interest to protect it. Of course, none of these factors is easy to predict, which makes it difficult to determine the appropriate policy setting. Ultimately, leakage is most effectively addressed through international agreement regarding the treatment of trade-exposed industries, eg, through sectoral agreements that harmonise across countries the price of carbon for a given industry.

This study does not take a view as to whether, how or to what extent ETS design should seek to avoid emissions leakage. That is a matter for the Government to decide, in determining how to balance the various components of its objectives for ETS design. The terms of reference for this study call for an identification of the domestic environmental effects of the ETS-plus. However, because leakage has some implications for the broader environmental objective that ETS is targeting, the study notes where emissions leakage is more likely to occur, so that policymakers can then make a more informed decision about ETS design.

3 The team consists of Jim Sinner (Sustainable Business Group Manager, Cawthron Institute), Judy Lawrence (PSConsulting), Roland Sapsford (Sustainability Solutions) and Paul Blaschke (Blaschke and Rutherford).

4 For example, the goal of a 40% reduction in per capita CO2 emissions from transport by 2040.

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