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Brief Counsel

ETS - the rules of engagement

10 December 2009

After being lovingly sculpted to fit the contours of the Australian Carbon Pollution Reduction Scheme (CPRS), the ETS was left standing at the altar when Kevin Rudd was unable to get his legislation over the line.

Until Australian emitters start paying a price for carbon, the ETS will be vulnerable to political lobbying because the competitive disadvantage arguments which drove the harmonisation agenda are as strong as they ever were. 

But, even allowing for the instability created by the non-passage of the CPRS, business needs to work with the ETS as it is now.  There is no other sensible basis on which to plan as a response to the scheme’s obligations is demanded now.  For many, for example, the obligation to register as a participant in the ETS and monitor emissions commences on 1 January 2010. 

This Brief Counsel discusses where next with the CPRS, how the ETS Mark II will work and the compliance requirements for key sectors.

What next with the CPRS

The Australian constitution provides for the Government to trigger a double dissolution of Parliament if a major piece of legislation is defeated twice.  Kevin Rudd could have exercised this power after the Senate voted down his CPRS Bill last week.  Instead, he has said that he will give the Liberal Opposition time to heal their divisions over the summer and will re-present the Bill when the Senate resumes in February.

The chances of the Liberals voting for it then are zero.  If, as is likely, the Bill again fails Rudd could dissolve Parliament and go to the country early (he has said he is keeping all his options open).  But he could just as easily decide to run his full term as Australia is due to go to the polls toward the end of 2010 anyway.

Either way, the CPRS will not be passed as is.  It will be either browner or greener, depending on the political complexion of the next Parliament.  And over time, it is likely that the New Zealand ETS (and particularly the free allocation mechanism) will be modified to reflect the new Australian scheme and developments in multilateral international agreements.  But, in the meantime, you will need to work with the ETS in its current form.  

The ETS Mark II

The amendments to the 2008 model of the scheme - ETS Mark I – came in three tranches.  They were – in order of ascending significance – the Government Supplementary Order Paper, the negotiated deal with the Māori Party and the Bill as it was referred to the select committee.

The Government SOP ran to more than 100 pages and reflected National’s response to the submissions, given the committee’s failure to produce a majority report.  Most of the changes are technical or relate to the decision-making machinery of the Act.  The redrafted provisions generally introduce a more principled approach with greater guidance on the exercise of broad regulation-making powers.  These changes will be important to the way the next stages in the process – consultation and regulation making – play out.

Māori Party wins 

The main concessions the Māori Party won were:

  • a Treaty of Waitangi clause creating an obligation on the Crown to consult with iwi over the allocations to pre-1990 forest land, the fisheries sector and agriculture; the point of obligation for agriculture, the setting of emission reduction targets under the Act and the five yearly reviews required by the Act

  • rights for five iwi to farm trees on (and collect the carbon credits from) around 35,000 hectares of Crown land

  • increased free allocation to fishing quota owners during the transition phase

  • further exploration of Crown-iwi partnerships to encourage afforestation, and

  • Māori representation on the special advisory group on agriculture and in international climate change negotiations.

Timeframe for sectors to enter the ETS

​Sector Voluntary reporting​ Mandartory reporting​ Full obligations​

Forestry

-​ -​ 1 January 2008​
Transport fuels​ -​ ​1 January 2010 1 July 2010​
Electricity production​ -​ 1 January 2010​ 1 July 2010​
Industrial activities​ -​ 1 January 2010​ ​1 July 2010
Synthetic gases​ 1 January 2011​ ​1 January 2012 ​1 January 2013
Waste​ 1 January 2011​ 1 January 2012​ 1 January 2013​
Agriculture​ 1 January 2011​ 1 January 2012​ 1 January 2015​

Compliance with the reporting requirements will require:

  • registering as a mandatory or voluntary ETS participant

  • opening a holding account, and

  • monitoring yearly emissions.

Transition phase

During the transition phase between 1 July 2010 and 31 December 2012, only forestry-related New Zealand Units (NZUs) can be traded outside of New Zealand.  The transitional obligations will include:

  • submitting an annual emissions return reporting on ETS activities, emissions, and surrender obligations for the previous year

  • applying for allocations (where applicable), which will be provided at half the normal rate, and

  • by 31 May in each year, either

    • surrendering one NZU for every two tonnes of CO2 emissions (a 50% surrender obligation) or

    • paying NZD $25 per unit obligation (the fixed-price purchase option).

The 50% surrender obligation applies to the stationary energy, industrial processes and liquid fossil fuels sectors.  These sectors plus the forestry sector have access to the fixed-price purchase option.

ETS review

The key features of the ETS are discussed briefly below, as applicable to each sector.  Although now “final”, the scheme will be reviewed at least once every 5 years, with the first review scheduled for 2011.  While wholesale changes are unlikely in the foreseeable future, the five yearly reviews open the prospect for on-going adjustments to the ETS.

Key issues to watch for the 2011 review include:

  • any amendments to take into account outcomes from Copenhagen

  • responses to the ultimate form of the Australian legislation

  • alterations to the phase-out rates for free allocation (most likely to accelerate the phase-out rate)

  • revisions of the point of obligation for each sector, particularly agriculture (who has to surrender units and when), and

  • mechanisms to address practical and legal limitations on passing on the cost of carbon.

Sector by sector analysis

Industrial activities

Businesses that conduct certain industrial process activities are required to register and participate in the ETS.  The industrial sector covers emissions from industrial processes in major metal, mineral and chemical industries, such as the production of iron, steel, aluminium and glass.

Reporting obligations start on 1 January 2010.  The transition period obligations begin on 1 July 2010.   

Full obligations come into effect from 1 January 2013.  These will include:

  • the implementation of a 100% surrender obligation

  • the removal of the fixed-price purchase option, and

  • the full proportion of allocation entitlement (if eligible for a free allocation.  This is discussed below).

Reporting regulations have already been passed and details on compliance are available from the Ministry for the Environment.  Activity-specific guidance manuals will be released separately at a later date.

The total level of free allocation to emissions intensive trade-exposed industry is uncapped and based on output intensity (i.e. will vary with output).  The allocation process involves industry applying for an initial “provisional allocation” each year (based on output data from the previous year), which is then subject to a final allocation adjustment at the end of the year.

The Government SOP has included more guidance for the Minister to make regulations regarding free allocations.  The regulation making process will include:

  • developing specific descriptions of potential “eligible industrial activities” 

  • collecting emissions and revenue data from firms carrying out those activities to determine whether they are “highly emissions intensive” or “moderately emissions intensive”, and 

  • calculating allocative baselines on the basis of that data.

Highly emissions-intensive activities are those that emit at least 1600 tonnes of CO2 per million dollars of revenue.  They are eligible for an allocation baseline of 0.9 (90% of total emissions are covered by a free allocation).

Moderately emissions-intensive activities are those that emit at least 800 tonnes of CO2 per million dollars of revenue.  They are eligible for an allocation baseline of 0.6 (60% of total emissions are covered by a free allocation).

The regulatory process also provides for adoption of the Australian CPRS definition of activities (and emissions intensity level, products and allocation baselines) for New Zealand ETS purposes.

The allocation levels are phased out at a rate of 1.3% per year from 2013.  As noted above, expect to see this phase-out rate adjusted when the scheme is reviewed. 

An activity can only be eligible for allocation if it is “trade exposed”.  It is presumed that activities are “trade exposed” unless the Minister considers that:

  • there is no international trade of the output of the activity across oceans, or

  • it is not economically viable to export or import the output of the activity.

A consultation paper on the treatment of eligible industrial activities is expected to be published this month.

Stationary energy

The stationary energy (SE) sector will enter the ETS on 1 January 2010.  Monitoring and reporting obligations will begin on 1 January and unit-surrender obligations will commence on 1 July 2010. Participation in the ETS is mandatory for activities which:

  • mine or import coal or natural gases

  • generate electricity or industrial heat from waste, geothermal fluid, solid biofuel, used tyres and used or waste oil, and/or

  • refine petroleum using intermediate crude oil products for energy or feedstock purposes.

And voluntary for businesses which purchase:

  • more than 250 000 tonnes of coal a year, and/or

  • more than 2 petajoules of natural gas a year.

Because the SE sector is expected to pass on its carbon costs to the consumer, there is no provision in the ETS for free credits to SE businesses on their SE activities.  Industry may, however, be entitled to compensation for increased energy costs passed on to them by “upstream” SE suppliers as part of the process of free allocation to industry (see Industry Sector). 

Estimates are that electricity prices to end consumers will rise by 3.6% during the transition period.

Liquid fossil fuels

The liquid fossil fuels sector will enter the ETS at the same time as the industrial and stationary energy sectors – 1 January 2010 for monitoring and reporting emissions, and 1 July 2010 for the start of unit-surrender obligations. 

Liquid fossil fuel participants are those who take fuel (such as petrol, diesel and fuel oil) from the refineries or import it – currently including BP, Caltex, Gull, Mobil and Shell.  No free allocation will be provided to this sector.

Consumers of liquid fossil fuels do not participate directly in the ETS, but will face increased fuel costs (as a result of ETS cost pass-through).  The Government is estimating a 3.5 cent per litre rise in fuel prices during the transition phase.

Agriculture

Agriculture is scheduled to become a full scheme participant at 1 January 2015.  Voluntary reporting begins at 1 January 2011 and mandatory reporting at 1 January 2012.

The point of obligation will start at processor level with the option to move to farm gate.  Free allocation will be on an intensity basis. 

Fisheries

The fishing sector is not a direct participant in the ETS but is exposed to carbon costs through its use of fuel.  The support to the industry has been raised from 50% to 90% of fuel costs in the ETS Mark II.  This will apply during the transition period (to 31 December 2012) with provision for 700,000 free units to be allocated.  Free allocations are through the fishing allocation plan and will be paid to quota owners (not fishing vessel operators).   Quota owners will be eligible for a free allocation in proportion to their share of the quota weight equivalent of stocks owned as at 24 September 2009.

Publication of a draft fishing allocation plan is expected in the first half of 2010.

Forestry

The forestry sector rules remain largely unchanged under the ETS Mark II (any changes were generally technical changes for clarity).  The key distinction between pre-1990 forests and post-1990 forests remains. 

Pre-1990 forests are on land that was forested as at 31 December 1989 and was still in forest at 31 December 2007.

Owners of exotic pre-1990 forest land face a liability under the scheme to surrender units if they ‘deforest’ and do not either replant the land or leave it to regenerate into forest (in short, convert the land to an alternative land use).  These liabilities can be avoided by replanting; provided the replanting is on the same land.  The Government has acknowledged that there should be the flexibility to plant equivalent forests in alternative locations (known as offsetting), but this is currently not permitted under the international Kyoto rules.  The Government is pushing for a change in the international rules, although any change would be unlikely to come into force until after 2012.

Exemptions from this liability are available:   

  • to landowners whose total forest holding as at 1 September 2007 was less than 50 hectares (people in this position will need to apply for an exemption)

  • to areas of deforestation of less than two hectares during 2008–2012, and

  • subject to public notice, where forest land contains specified tree weeds.

Owners of pre-1990 exotic forest land will be allocated NZUs on the basis of the forest area and purchase date of their forest holding.  The allocations will be made in two parts (commencing in 2010), as per the table below.

 

Allocation before 31 December 2012

Allocation after 31 December 2012

Owners of forest bought before 1 November 2002

23 units per hectare

37 units per hectare

Owners of forest bought on or after 1 November 2002

15 units per hectare

24 units per hectare

Future Treaty claimants who receive Crown Forest License land

7 units per hectare

11 units per hectare

During the transition phase to 31 December 2012, pre-1990 forest owners may buy NZUs at the fixed price of $25 to meet their obligations for deforestation under the scheme.

Post-1989 forests are on land that either was not forested at 31 December 1989 or was deforested between 1 January 1990 and 31 December 2007.

The owners of eligible post-1989 forests can elect voluntarily to enter the ETS.  Those who choose to enter will receive NZUs for tree growth from 1 January 2008, but will be required to surrender units to the Government if carbon stocks fall, such as when the forest is harvested or if it burns down.

The Government retains responsibility for the credits and liabilities of post-1989 forests where owners elect to remain outside the ETS.

Waste

ETS Mark II leaves the treatment of the waste sector largely unchanged from ETS Mark I.  The waste sector will receive no free allocation and is expected to pass ETS costs on to consumers.

Operators of landfills that accept some household waste will have full ETS obligations from 1 January 2013, with mandatory reporting requirements from 1 January 2012.  Incinerating waste for the purpose of generating electricity or industrial heat is also caught, but forms part of the stationary energy sector.

Key waste sector issues are yet to be resolved.  Regulations will need to grapple with matters such as methodologies for measuring landfill emissions and treatment of “legacy” emissions (emissions arising from ‘historic’ waste that was deposited before the ETS).  There are also questions around the operation of both the ETS and the waste levy (currently $10/tonne) as pricing mechanisms for the waste sector.

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