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2 The Context for New Zealand’s Emissions Trading Framework

This chapter covers:

  • the importance of a credible response by New Zealand to the global challenge of climate change
  • the importance of measures that address the economic drivers of greenhouse gas emissions
  • the overall objectives of New Zealand’s response to the problem of global emissions.

The government’s decision to proceed with an ETS is driven by considerations central to its agendas for sustainability and economic transformation, including:

  1. the imperative to contribute to global efforts to reduce climate change
  2. the fact that greenhouse gas emissions are currently embedded in our economic system as an unwelcome by-product of economic activity (which normal market mechanisms have failed to control)
  3. the need to assess New Zealand’s options to address the problem of climate change with a view to:
    • effectively reducing our own emissions levels below business as usual
    • assisting the international effort to agree on effective climate change policies
    • ensuring that solutions impose the least cost on our economy and way of life.

2.1 The climate change imperative

Over the last century the Earth’s climate has been changing at an increasingly rapid rate. It is largely recognised that human activity is the reason for this unprecedented rate of global warming, in particular the increasing volume of emissions of greenhouse gases in our atmosphere. The effects of this are already visible, and the changes ahead of us are likely to be much larger and to happen more quickly than any recent natural climate variations.

Climate change is a global phenomenon, which could affect almost every aspect of the future quality of life of the Earth’s inhabitants. The scientific consensus is that, even with a concerted global effort to reduce greenhouse gas emissions, there are likely to be changes in temperature and rainfall patterns, increases in the number of significant wind and storm events, and an increased risk of flooding and coastal erosion.

The potential impacts of climate change in New Zealand are substantial. The volume of the Intergovernmental Panel on Climate Change (IPCC) Fourth Assessment Report entitled Climate Change 2007: Impacts, Adaptation and Vulnerability14 confirms that the effects of climate change are already being felt in New Zealand. Since 1950 there has been 0.3-0.7°C warming across the Australia-New Zealand region as a whole, with more heat waves, fewer frosts, more rain in southwest New Zealand, less rain in north-eastern New Zealand, a rise in sea level of about 70 mm, reduced seasonal snow cover and ongoing glacial shrinkage. The IPCC report suggests that the most vulnerable sectors for New Zealand are natural ecosystems (affecting our forest and agricultural sectors), water security and coastal communities. Climate change could also have socioeconomic impacts, influencing migration and economic development.

Our best hope is for the international community to move collectively to reduce greenhouse gas emissions, and for individual nations to invest in measures to mitigate the impacts of climate change on their own populations. One of the world’s pre-eminent scholars of the economics of climate change, Professor William Nordhaus of Yale University, recently said:

Global warming is a serious problem that will not solve itself. Countries should take co-operative steps to slow global warming. There is no case for delay. The most fruitful and effective approach is for countries to put a harmonised price, perhaps a steep price, on greenhouse gas emissions, primarily those of carbon dioxide resulting from the combustion of fossils fuels.15

2.2 Greenhouse gas emissions and the economy

Climate change is happening because of increasing levels of emissions of greenhouse gases. But why are levels of emissions increasing? And what is the best practical method of reducing them?

At the simplest level, emissions are increasing because of increasing levels of the human activities that cause them: more electricity is being produced from coal- and gas-fired stations, more factories are emitting gases directly and more cars are being driven. Greenhouse gas emissions are a by-product of things that are valuable. The economic challenge of climate change is not to eliminate emissions, for to do so would also eliminate many things that we value. Rather, the challenge is to find ways to decouple growth in emissions from growth in economic activity, and thereby reverse the trend of increasing concentrations of greenhouse gases and reduce the risk of serious climate change impacts.

One of the basic principles of economics is that people will undertake activities up to the point where the additional benefits of one more unit of the activity just equal the additional cost. In many cases, all the costs and benefits of an activity accrue to the person doing the activity, be it buying an apple, investing in a factory or saving for a rainy day. When either a cost or a benefit accrues to someone other than the individual doing the activity, an “externality” is said to arise, because some party external to the decision-making is affected by the decision. The decision-makers will still seek to equalise the costs and benefits they face, but they will generally not take into account the costs and benefits to others. This leads to a disconnection between private costs and benefits and social costs and benefits, where “social” means the sum of all private costs or benefits.

Externalities are one example of “market failures”: cases where the operation of free markets does not lead to the highest attainable welfare. The Stern Review16 called climate change the greatest example of market failure we have ever seen. There are many ways to correct market failures, and in responding to climate change we can draw on our extensive experience of assessing which of these ways works best and in what circumstances.

Three common methods used by governments to address climate change market failures are regulations, taxes and emissions trading. Regulations involve placing legal restrictions on activities that cause greenhouse gas emissions. They are often costly to comply with and to administer, and they are not always very effective because it is difficult to design regulations that achieve the right balance of costs and benefits, and hence result in the right level of emissions.

Taxes and emissions trading are two priced-based measures for reducing emissions. They work by increasing the cost of activities – including production and consumption – that result in greenhouse gas emissions. Taxes increase prices directly by imposing an additional charge on activities that cause emissions. Emissions trading works by restricting the quantity of emissions, and allowing markets to set a corresponding price for those emissions and associated offset emissions (eg, forest sinks).

2.3 Reducing emissions below business as usual

It is the view of the New Zealand government that any future that is sustainable must involve broader and more stringent greenhouse gas emission reductions by all of the major emitting countries. This poses a unique challenge to global governance. Just as we have collectively inherited the achievements of previous generations in terms of economic growth, we have also collectively inherited a global environmental problem that has been a by-product of that growth. Our actions over the coming decades will determine the inheritance that we will pass on to generations to come. Failure to act could result in major disruption to economic and social activity, which the Stern Review suggests could be “on a scale similar to those associated with the great wars and the economic depression of the first half of the 20th century”17. Nevertheless, that action will require some significant adjustments over time, as to how businesses operate and invest, and how New Zealanders live.

There are four main climate change challenges for New Zealand. We need to:

  • control our own greenhouse gas emissions and reduce them relative to the current growth trend

  • support international initiatives for multilateral action on greenhouse gas emissions, principally through maintaining momentum on the implementation of the Kyoto Protocol and ensuring this momentum is carried through into whatever agreements emerge for the period after 2012

  • prepare for and adapt to the impacts of changes in our physical environment, by responding to the risks and taking advantage of the opportunities they present

  • achieve the above objectives at the lowest achievable long-term cost.

The full scope of the government’s response to these four challenges within the broader context of sustainability is detailed in the document New Zealand’sClimate Change Solutions (available at The remainder of this chapter addresses particular aspects of these challenges that are relevant to the government’s decision in principle to implement an ETS.

2.3.1 Reducing New Zealand’s own greenhouse gas emissions below business as usual

The first part of the challenge is to reduce our own emissions below business as usual. New Zealand’s total greenhouse gas emissions are small from a global perspective at around 0.2 to 0.3 per cent of global emissions. This is due largely to our small population. Nevertheless, on a per capita basis we are a high emitter by international standards. This is because the current drivers of our economic growth and our quality of life are emissions intensive. We are heavy users of personal motor vehicles compared with many developed countries, and our major primary production industries (particularly agriculture and forestry) are emissions intensive. As a result, we have the 12th highest per capita emissions in the developed world. Moreover, New Zealand’s greenhouse gas emissions are continuing to grow, with emissions across all sectors (excluding forest carbon sinks) for 2005 being 25 per cent higher than the 1990 level.

New Zealand has an unusual greenhouse gas emissions profile, in that nearly 49 per cent of New Zealand’s greenhouse gas emissions result from agriculture (excluding agricultural energy use). This contrasts with other developed countries where, on average, 12 per cent of emissions are from agriculture. Meanwhile, our energy sector contributes 43 per cent of emissions, which is a smaller percentage than other developed countries, due in large part to the fact that approximately 69 per cent of our electricity is generated from low- or zero-emitting renewable sources, such as hydro, geothermal, wind, solar, biogas and wood. Approximately 19 per cent of total emissions, and 45 per cent of energy emissions, come from transport.

Figure 2.1 sets out the various sources of New Zealand’s emissions (excluding emissions and sinks from forestry)

Figure 2.1: New Zealand's greenhouse gas emissions, by sector, 2005

Source: Ministry for the Environment, 2007, New Zealand’s Greenhouse Gas Inventory 1990-2005. Ministry for the Environment: Wellington.

The magnitude of the challenge can be seen if we examine the business-as-usual projections of our emissions levels and compare these against our commitments under the Kyoto Protocol and realistic scenarios for New Zealand’s commitments under successor international agreements.

Figure 2.2 shows forecast emissions to the year 2050, broken down into the various emission sources. Under business-as-usual activity reflecting policy settings in April 2007, emissions sources are projected to grow steadily, with emissions from harvesting or deforestation of post-1989 forest causing a significant peak during the period from 2020 to 2030.

Figure 2.2: New Zealand’s projected emissions through 2050

Note: The dark line depicts net projected emissions (ie, emissions by sources minus removals by forest sinks). This figure uses forest definitions applied under the Kyoto Protocol, and assumes policy settings in April 2007. Projections of deforestation emissions have not been forecast past 2030. An analysis of forest land suitable and available for conversion indicates there are about 280,000 hectares. At the rate of deforestation assumed in this figure, all of this land would be deforested by 2033. Source: Analysis by the Emissions Trading Group based on projections supplied by the Ministry of Economic Development, Ministry of Agriculture and Forestry and Ministry for the Environment.

Figure 2.3 compares the net projected emissions profile in Figure 2.2 to the level of New Zealand’s free allocation of emission units under the Kyoto Protocol (which applies to the period from 2008 to 2012). New Zealand must take responsibility for emissions above this level. The dotted lines with arrows illustrate the hypothetical impact of successor international agreements, which may result in New Zealand’s emission unit allocation remaining static, but could also involve a declining allocation in line with agreements to impose stricter constraints on global emissions.

Figure 2.3: New Zealand’s projected emissions through 2050 in the context of possible international agreements

Figure 2.3 illustrates the fact that, while the projected gap between New Zealand’s Kyoto allocation and expected emissions (under policy settings as of April 2007) is not great in the first Kyoto commitment period, that gap is likely to broaden significantly as emissions continue to rise and (potentially) New Zealand’s emission unit allocation under international agreements falls. The exact cost to the economy of bridging this gap will of course be determined by the future price of emissions, the rate of new technology development, and the extent of emission reduction commitments by other countries.

What these graphs demonstrate is that New Zealand, like many other countries, needs to engineer a major shift in its economy towards lower emissions or it will face very significant obligations in decades to come. For this reason, it is important to create the infrastructure of an ETS and implement it fully over the next five years. An early start will mean we are well positioned to gain traction on our long-term emission levels. Because New Zealand has an unusual greenhouse gas emissions profile, the design features of the NZ ETS will need to be tailored suit our national circumstances.

We have already taken the first steps to reduce our emissions below business-as-usual levels, including:

  • financial incentives (such as the Permanent Forest Sink Initiative and incentives to promote solar hot-water heating and better home insulation)

  • improved standards and codes (such as energy efficiency standards for new homes and household products)

  • direct regulation of major emission sources (such as the biofuels sales obligation)

  • public education (such as Energy Star efficiency labelling and Fuelsaver information on vehicle fuel efficiency)

  • joint investment in research for mitigation of agricultural greenhouse gases.

The government has also sought to lead by example and has committed itself to a goal of setting all 34 core public service departments on a path to carbon neutrality by 2012. Through the Govt3 Programme, the government is moving toward low-emissions options for its vehicle fleet, and most recently it has adopted a minimum Five-Star Green Star New Zealand rating for all new A-grade central business district office buildings and a Four-Star Green Star New Zealand rating for all other grades of offices being constructed to house government staff.

However, these emission reduction measures need to be underpinned by a significant and broad-based measure for incorporating the cost of greenhouse gas emissions into New Zealand’s economic system. Such a measure would harness the power of markets to shift investment patterns and consumer behaviour away from products and processes with higher greenhouse gas emissions towards lower-emission alternatives.

2.3.2 Maintaining international momentum on reducing greenhouse gas emissions

The second part of our challenge is to support multilateral progress towards reducing global greenhouse gas emissions. Acting alone New Zealand cannot solve the problem of climate change: our emissions only make up a tiny part of global levels. But that is not a reason for doing nothing. The successful implementation of a NZ ETS will contribute to global initiatives to reduce greenhouse gas emissions by:

  • strengthening New Zealand’s reputation as a nation that has upheld its commitments under the United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol to help reduce global emissions

  • making New Zealand a reference site for other countries considering emissions trading

  • helping to support the development of international emissions trading markets

  • providing a working example of emissions trading in the forestry and agricultural sectors that could be of particular interest to both developed and developing countries, and could help to inform the international climate change negotiations.

2.3.3 Minimising the long-term cost of emission reductions

The final aspect of our challenge is to achieve emission reductions at the lowest long-term economic cost. For that reason, New Zealand’s framework for emissions pricing needs to be carefully designed:

  • to provide certainty to investors, policy makers and taxpayers, while remaining flexible enough to be adapted over time

  • to focus on changing behaviour, so as to reduce emissions and enhance removals by forest carbon sinks, rather than merely transferring wealth from one portion of the economy to another, or from New Zealand to other countries

  • to facilitate innovation and the uptake of new technologies

  • to align New Zealand with progressive global leaders in reducing emissions, but not expose the country to a premature stringency of emissions pricing that threatens our economic competitiveness.

14 Intergovernmental Panel on Climate Change 2007, Climate Change 2007: Impacts, Adaptation and Vulnerability, Contribution of Working Group II to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change, Cambridge University Press: Cambridge.

15 Nordhaus W, 2007, The Challenge of Global Warming: Economic Models and Environmental Policy. Professor Nordhaus is a strong advocate of a harmonised international carbon tax. While this proposal can be justified in some models of climate change economics, it is not without its critics. There is currently no proposal for a harmonised tax on the agenda in international climate change forums.

16 Stern N, 2006, Stern Review: The Economics of Climate Change, Cabinet Office, HM Treasury. sternreview_index.cfm.

17  Stern, Stern Review: The Economics of Climate Change, pg vi