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4.1.1 “Decoupling” emissions and growth – what are the prospects of reducing emissions (or slowing their growth) without reducing output?

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Summary

This section investigates the prospects for New Zealand to reduce emissions growth without reducing economic growth.

It concludes that:

  • New Zealand’s scope for reducing gross emissions without reducing output is limited by our comparative advantage in emissions-intensive industries and our already high proportion of renewable energy
  • although there is some potential in productivity improvements (eg, with respect to electricity efficiency), this does not represent a panacea for reducing the level of emissions in the long term.

The scope for New Zealand to “decouple” emissions growth from economic growth depends on a number of factors, including:

  • the composition of future economic activity (ie, structural change)
  • the resulting level of energy demand
  • the fuel mix through which future energy demand is met
  • productivity improvements (with respect to emissions-producing processes)
  • the availability and uptake of emissions-reducing technologies and innovation.

The opportunities around innovation, technology and research are discussed in detail in Section 4.3. In this section, we look at the projected level and composition of economic growth under business-as-usual assumptions. [Note that in our discussion on the structural composition of GDP, we use projections by NZIER. The business-as-usual GDP projections used in the preparation of the Government’s net emissions position projections are sourced from the Treasury. For the purposes of this discussion, the variations in growth rate assumptions are not significant. ]

Structural change

NZIER’s industry GDP projections show New Zealand’s services sector becoming relatively more important over the next 15 years, at the expense of both the manufacturing and primary sectors (NZIER, 2005).

However, this is only part of the story. What matters for emissions levels is the level of activity within these sectors. The following charts show the projected level of activity in selected industries. The expected growth in the (emissions-intensive) transport sector is particularly marked. NZIER (2003a) concludes that decoupling of household transport use and economic growth is unlikely to occur in the next 50 years.

Figure 21 - Real GDP – Agriculture ($ millions, 1995/96 dollars)

This graph shows that the Real GDP of agriculture is projected to increase.

Source: NZIER Quarterly Predictions March 2005

Figure 22 - Real GDP – Selected Manufacturing Industries($ millions, 1995/96 dollars)

This graph shows that the Real GDP of selected manufacturing industries (Food, Beverage & Tobacco; Wood & Paper Products; Metal Products) is projected to increase.

Source: NZIER Quarterly Predictions March 2005

Figure 23 - Real GDP – Transport($ millions, 95/96 dollars)

This graph shows that the Real GDP of transport is projected to increase.

Source: NZIER Quarterly Predictions March 2005

Notes: It should be noted that this definition of “transport” refers to the economic industry of “transport and storage”. This includes companies whose main purpose is transportation (such as delivery companies). It excludes transport consumption by other companies, and personal (household) vehicle use. It thus underestimates the total level of transport activity in the economy.

To make a significant departure from these projected industry trends would imply the New Zealand economy moving away from its areas of comparative advantage. New Zealand’s comparative advantage lies in primary production, and a selection of manufacturing industries. Many of these are, by their very nature, energy intensive (eg, dairy processing, and cement and steel manufacturing). This is a feature both of our resource endowments and economic development.

Although the economy has diversified over recent years, a sudden or substantial structural shift – to the less energy-intensive services sector – is unlikely, with change continuing to be gradual. Although New Zealand’s manufactured exports grew strongly in the early and mid-1990s, there is now greater competition from Asian manufacturers, particularly China. However, there may be niche markets in which New Zealand can work. The growth of China will work on the demand side as well, fuelling global demand for our exports (in particular, primary products).

There are some service-sector industries, such as tourism, where it is projected we will continue to expand. But New Zealand’s comparative advantages are likely to remain in (energy-intensive) primary-related sectors. In this respect, our potential for substantial declines in energy intensity may be more modest than that of other developed countries. A key factor likely to impact on the degree of structural change is that of prices, particularly electricity prices. As noted above, relatively cheap electricity has helped shape the development of New Zealand’s economic structure. The cheap hydro sources have now largely been exploited. Combined with the introduction of the carbon tax, we are likely to see rising energy prices over coming years. This may create an incentive for structural adjustment. However, any fundamental structural responses to rising electricity prices will be gradual.

There is also the question of how energy-intensive our service-sector industries are. We know that a key component of tourism, for instance, involves transporting international visitors from Auckland down the country through our “top five” destinations. With our long, narrow geography, this suggests that even this service-based industry is likely to be relatively emissions intensive. This compares with service-sector growth in, for instance, the United Kingdom, which has been focused in low-emissions industries such as finance.

Moreover, as Panayotou (2003) notes, while production patterns of developed countries tend to grow cleaner over time, consumption patterns continue to be as environmentally burdensome as ever. This points to a tension between decoupling from structural economy change and further coupling from income (and hence consumption) growth.

A further factor that may diminish any improvements from structural change is the prospect of increased capital intensification. The New Zealand economy is now close to full employment, with high labour utilisation rates and economy-wide labour shortages. As the population ages over the next few decades, pressure on the labour force will increase as the working-age population becomes an increasingly smaller percentage of the total population. This is likely to push up wages, making capital relatively more attractive to firms, and leading to increased capital accumulation. Notwithstanding that newer capital is likely to be more energy efficient, growth in the stock of capital is likely to place upward pressure on energy use.

Energy demand

Fuel mix

In terms of decoupling emissions from energy use from economic growth, sources of renewable energy need to be available – not only on an economically competitive basis, but also in a practical sense. Oxley and Macmillan (2004) note a number of particular drawbacks associated with various renewable energy sources. For example, wind requires back-up capacity, and connection to the grid at low voltage (which adds to the cost of systems control and operation). Wind also fluctuates randomly, providing variations in output that can cause problems to the power system and the electricity market. [Report by the system operator to the Electricity Commission (2005) “Manawatu wind generation: observed impacts on the scheduling and dispatch process.” < http://www.electricitycommission.govt.nz/opdev/comqual/windgen/ReportWindAnalysisFinal.pdf >] And while geothermal and biomass are competitive with respect to generation costs, their associated capital costs are likely to remain high. On this basis, Oxley and Macmillan predict a limited role for renewables in displacing fossil fuels.

The sources of new hydro generation in New Zealand look to be limited, as most of the major resources have already been developed. As a share of total electricity generation, the contribution of hydro is expected to drop from 65% to 56% by 2025 (see Figures 24 and 25, below).

Wind energy is expected to exhibit strong growth. While this growth is off a low base, it is expected to increase in relative significance, to comprise 5% of New Zealand’s electricity supply by 2025. A recent report commissioned by MED and EECA suggests that the technical and operational capacity could be substantially higher than this – up to around 20% of market share. [Energy Link and MWH NZ (2005) “Wind energy integration in New Zealand.” Report to MED and EECA, May 2005. < http://www.med.govt.nz/ers/electric/wind-energy/summary/index.html>]

Geothermal supply is expected to nearly double over the projection period, to comprise around 15% of electricity supply by 2025. However, the emissions gains from this growth look set to be offset by the decline in gas (from 21% to 15% of electricity supply). [MED is currently updating these projections. Preliminary results suggest that the growth in hydro will be weaker than previously projected, due to some projects being more expensive than originally anticipated (and hence will comprise a lower proportion of total electricity generation than suggested here). On the other hand, wind generation projections are likely to be scaled up, as technologies appear to be more cost-effective than previously projected.]

Figure 24 - Electricity Generation by Fuel 2000 (TWh pa)

This pie chart is for comparison with figure 25. The comparison is summarised above.

Figure 25 - Electricity Generation by Fuel 2025 (TWh pa)

This pie chart is for comparison with figure 24. The comparison is summarised above.

Source: MED Energy Outlook to 2025 (2003)

Productivity improvements – energy efficiency

The international evidence on the causes of decoupling is mixed. There is some evidence that energy efficiency has contributed to decoupling energy use from economic growth. However, there is also significant evidence that this decoupling is due to changes in economic structure, energy quality and the extent of value-adding in the economy.

It is important to note that even with decoupling, total gross emissions can still rise. Energy efficiency (and productivity improvements more generally) are not a panacea. Moreover, efficiency gains (eg, in the production sector) will make these goods relatively cheaper, increasing purchasing power and hence increasing demand. If these products are normal goods, then this income effect can result in a “rebound effect”, offsetting some of the gains from improved efficiency.

As discussed in Section 3.1.3, the latest data shows that New Zealand’s economy-wide energy-efficiency improvements were 1.85% over the year 2001/02. Efficiency gains came largely from the transport sector; gains were also recorded in the commercial and industrial sectors. Efficiency in the residential and primary sectors declined.

Although these estimates indicate we are currently on track with the annual targets under the NEECS [The NEECS target is for 2% energy efficiency gains per year (1.67% per annum on a compound growth basis).], it is not clear whether we can continue to achieve annual gains of a similar magnitude. Research by NZIER (2003b) suggests it would be challenging.

Because the new capital investment in any period represents such a small proportion of the total capital stock, the efficiency gains from new, more energy-efficient equipment will be gradual. And although the economy has diversified over recent years, gains from a sudden or substantial structural shift to less energy-intensive industries look to be limited. New Zealand’s comparative advantages are likely to remain in (energy-intensive) primary-related and niche manufacturing industries.

Further efficiency gains in the residential sector may also be constrained. Continued population growth, combined with trends towards smaller households and larger houses could swamp the impact of individual efficiency efforts and policies (such as improvements to the Building Code and the introduction of energy-performance standards on appliances). Income growth could also spur increased energy use per capita.

A bottom-up perspective – electricity efficiency

Macro-level, top-down analysis suggests that significant emissions mitigation through energy efficiency will be very difficult to achieve. On the other hand, bottom-up analysis of energy-efficiency potentials typically identifies a range of opportunities – in many cases, representing cost-effective potentials that would result in win-win outcomes for both economic efficiency (through improved productivity) and environmental outcomes. Why the apparent disjunct?

Top-down analysis relies on past trends to project future energy efficiency and energy demand. Bottom-up analysis, on the other hand, uses estimates of potential future savings to project future possibilities. These potentials are based on what makes economic sense – that is, estimates of measures whose benefits exceed their costs (over some time period). The key to unlocking the gap between the economic possibilities and what the market is actually likely to do is in understanding the barriers to uptake, and creating incentives for, behavioural change.

Potentials Analysis – Electricity Efficiency

The Treasury recently commissioned work to assess the potential for electricity savings from efficiency measures. [The quantitative analysis was undertaken for Treasury by Jonathan Lermit, a Wellington -based independent energy consultant.] This bottom-up analysis looked at measures according to electricity end use, and included both commercial/industrial and residential demand. Three scenarios were modelled:

  • possible – those measures that are cost-effective (ie, their direct implementation costs are less than the cost of investment in new generation and/or transmission capacity)
  • optimistic – a subset of the “possible” measures, which assumes uptake of measures that are relatively hard to encourage people to implement
  • realistic – assuming uptake of those measures that represent “low-hanging fruit” and are relatively easy to get people to implement.

The results showed that there is considerable potential for achieving load reduction via energy-efficiency measures. Economically justifiable measures represent around 22% of current consumption (built up over five years). The realistic savings are considerably lower, at around 6.5%. A comprehensive energy-efficiency programme that included all identified measures could be expected to reduce electricity demand growth from an average of 1.6% per annum to around 1.0% per annum over the next five years.

The chart below shows these projected savings against MED’s baseline electricity demand projections.

Figure 26 - Potential Electricity Efficiency Gains

Baseline vs All Measures Scenarios, GWh

This graph is summarised in the text above.

Source: MED, Lermit (2005)

The biggest potential gains in total demand reduction relate to motive power (more efficient motor drives), water heating, lighting and refrigeration. The best value-for-money measures are in:

  • lighting (replacing incandescent bulbs with compact fluorescents)
  • pumping (replacing constant speed drives and power pumps with variable speed drives)
  • electrical and refrigeration (replacing the existing stock of electrical and electronic equipment with more efficient models, and the existing stock of fridges with better-insulated models).

This analysis did not attempt to convert these potential electricity-demand savings into emissions reductions. It would be possible to apply emissions factors (based on MED’s projections of fuel mix) to do this extrapolation. As much of the additional electricity generation is expected to be delivered from new renewable fuels, the big gains in terms of emissions mitigation would be under the “possible” scenario, as this taps into existing generation sources.

Transport

Transport is particularly important from a climate change (and broader environmental) perspective, as it is rapidly growing and dominated by non-renewable fuels.

NZIER (2003a) considered the issue of decoupling transport activity, as measured by kilometres travelled, and economic activity in Zealand. Analysis of a variety of measures gave mixed results – possibly suggesting some decoupling since the mid-1990s at a modal level (although they note that it is difficult to draw firm conclusions). It is also difficult to draw conclusions on the basis of this analysis because kilometres travelled as a proxy for transport activity will not account for other factors that impact on emissions, such as engine size and efficiency and loading.

In regard to general drivers of growth in transport activity, the NZIER report concludes that increasing activity comes from growth of the commodity and tourism sectors, as well as increases in the number of vehicles in the fleet.

The following aspects of the generic drivers identified in Section 3.1.3 are likely to affect the future profile of New Zealand’s transport emissions:

  • demographic change – the proportion of the population aged 35 to 54 is projected to increase over the next few decades. This age cohort is characterised by higher-than-average spending on road transport
  • the domestic uptake of more fuel-efficiency technologies, which will depend on, inter alia:
    • the speed and extent to which fuel-efficiency improvements are incorporated in vehicles from source countries (and the profile of New Zealand’s source countries)
    • the potential for consumer preferences (eg, for larger, more powerful vehicles) to dilute gains from efficiency improvements, and the changing nature of these preferences
    • the rate of turnover of the fleet and the extent to which the second-hand market delays the benefits of technological advances
  • the introduction and uptake of biofuels.