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Emissions Trading Bill – can it get passed and in what shape?

20 June 2008

It is being called the most significant economic reform since the economic deregulation of the 1980s. It will touch every sector of the New Zealand economy, increasing costs and adding to the burden of compliance. Perhaps not surprisingly then, with just a few short months until the election, the Labour-led Government is struggling to get its Emissions Trading Bill over the line.

The Bill was reported back this week by the Finance and Expenditure Select Committee, along with more than 1000 amendments and two minority reports expressing opposition. In fact the amendments are largely technical and the Bill remains mostly intact. The Select Committee has acknowledged the logic of many of the submitters opposing aspects of the scheme, and yet proceeded with the Bill as written. There will be changes though as a result of Labour's "long and constructive" talks with the minor parties. Labour needs a combination of New Zealand First and the Greens or New Zealand First and the Māori Party to support the legislation for it to pass.

At the time of writing it is not at all certain Labour will get the votes it needs. And if it does and the Bill becomes law there will still be a high degree of uncertainty since in its current state many of the harder questions are left unresolved. These are to be worked through later by regulation. Before then of course there will be an election. National, which opposes this Bill, is understood to be planning to pass its own amendments if it becomes government.

These factors combine to make it much harder for business to know what to expect. There will be an emissions trading scheme and it will proceed on an all sectors, all gases basis. But so much of how the scheme will work in practice remains open-ended.

Reaping what you sow

To some extent this is a consequence of Labour's initial gang-busters approach. It introduced this Bill with too much flourish and too many promises. It was going to be the 'world's first' all gases, and the 'world's most comprehensive' all sectors scheme. And Labour made sure the scheme became political by using its ownership of the ETS to showcase its green credentials.

Subsequent events have shown that devising a scheme as comprehensive as this one is too complicated to be done in a rush and without broad political agreement.

So what we have now is a commitment to a full ETS, with the mechanics still to be worked on. There is still political consensus around the need for a scheme, but there is now a wide divergence about what this model might require. A snap-shot example; Minister in charge of the scheme David Parker claims the costs of the scheme will be "inconsequential". He estimates less than $250 million by 2020. National claims the costs will be huge, as much as $23 billion by 2020. On the information currently on hand, it is simply not possible to judge which figure might be right.

In reality, and regardless of whom leads the next government, there will likely be a series of significant amendments between now and 2013 as each sector comes into the scheme and the practicalities of the existing scheme are ironed out. This means business will need to be engaged in this process for some years to come. And still it is uncertain how it might all work out.

Here and Now

Having noted that fluidity, and to assist you in keeping informed, we have prepared a precis of where the Bill now stands.

Entry into the ETS

The Select Committee endorsed the previously announced staged entry of sectors into the ETS, including the delayed inclusion of agriculture and the change to the phase-in of liquid fossil fuels.

However, the scheme now has an "early reporting" regime for liquid fossil fuels, agriculture, waste, and importers of sulphur hexafluoride and hydro fluorocarbons. For each of these sectors, there will be one year of voluntary reporting, and one year of mandatory reporting before the scheme fully kicks in for the sector.

This gives firms time to get used to measuring and reporting their emissions. Combined with a provision relieving firms from penalties for incorrect emissions returns in the first year of full participation (which was in the Bill as introduced), firms will have some time to come up the learning curve.

World leader, fast follower?

The Select Committee acknowledged the many submissions in favour of adopting a slower pace forward, in line with New Zealand's trading partners, but rejected the argument just the same. It claims the ETS all-sectors approach is consistent with initial indications as to the design of the Australian scheme and mirrors the obligations placed on countries signed up to the Kyoto Protocol. Countries whose emissions trading schemes are less comprehensive use other price measures such as higher fuel taxes to influence behaviour.

Forestry

Given the staged entry of each sector it is no surprise that while much of the detail is yet to be determined for agriculture (2013) and industry (2010), detailed amendments have been made for the forestry sector (2008).

The Select Committee has left unchanged the key design features of forestry within the ETS.

Forestry continues to be the first cab off the rank, coming into the ETS from 1 January 2008. And the key distinction between pre-1990 forest land and post-1989 forest land remains – that is, deforestation liability generally will arise for pre-1990 forest owners, with post-1989 forest owners being eligible to participate in the ETS if they so choose (i.e. earn credits from forestry growth but be correspondingly liable for any emissions from the clearing of forest).

A number of operational changes should provide greater clarity to forest owners about their forestry-related obligations under the ETS. Among these operational changes are:

  • new provisions relating to a "carbon accounting area" for post-1989 forest land will allow a landowner to flexibly add or remove parcels of land to the scope of the person's participation in the ETS, providing greater flexibility for forest owners wishing to actively engage in carbon farming in addition to other land use activities.
  • provisions confirming the three practical choices facing owners of pre-1990 forest land who wish to clear trees on their land: (i) replant the land and avoid a deforestation liability, (ii) pay a deforestation liability and change the land use or (iii) pay a deforestation liability and replant the land and 'opt in' as an owner of post-1989 forest land to earn carbon credits.

Possibly the most substantial change to the forestry provisions of the NZETS is the signalled (though not yet effective) introduction of a forestry offsetting scheme. Under this scheme landowners who deforest pre-1990 land can avoid a deforestation liability if they replant elsewhere, on a hectare for hectare of equivalent carbon absorption capacity.

The Select Committee has recognised that such forestry offsetting is currently not provided for under the Kyoto Protocol, while signalling a willingness to permit such forestry offsetting, should future international rules permit. This potentially provides a further land management choice for pre-1990 forest owners.

Permitting forestry offsetting was also seen as justifying the retention of the much criticised "8-year rule", under which pre-1990 forest land that comprises trees less than nine years old and which is deforested will be treated as if the trees cleared were the age and species of the trees previously harvested (rather than the age of the juvenile trees).

The level of free allocation has been increased for pre-1990 forest land purchased prior to a (yet to be determined) date in late 2002, and iwi claimants receiving Crown forest licence land under a Treaty of Waitangi settlement after 31 December 2007.

The Bill now clarifies that a transferee of post-1989 forest land which has entered the ETS, automatically becomes a participant in the NZ ETS in respect of that land. While this seems a logical outcome when ownership of a forest is transferred, the new owner will in effect assume a contingent liability to repay to the government all net carbon credit gains received in respect of that particular area of land during the entire period of the land's participation in the ETS, if the new owner of the forest elects to exit the ETS. The financial impact of this will place considerable restraint on future land use by any purchaser of forest land that is already within the ETS – affecting the resale value of the land.

From the forestry sector's perspective the most practical form of compensation for early inclusion in the scheme would have been earlier staged entry into the ETS of liquid fossil fuels (who will be big purchasers of credits) and ensuring agriculture also came into the ETS sooner than 2013, since it would have seen carbon costs imposed on all forms of land use. The former lost out to the political implications of high oil prices, and the latter was ruled out by Cabinet while the Select Committee was still hearing submissions.

Allocation plans for industry and agriculture

The Select Committee has streamlined the process for preparing and implementing allocation plans; following the issue of an allocation plan, the minister will now make 'determinations' of individual entities' entitlement to allocations.

The changes appear to provide increased flexibility for allocations to change over time; under the changes, there can be separate allocation plans for each commitment period, and there is also a power for the minister to "remake" determinations (in accordance with an allocation plan).

The Select Committee sees these changes as balancing certainty with flexibility. In the absence of any criteria or methodologies in the Bill it is difficult to know how the provisions for flexibility will play out in practice. What has not changed is the allocation cap; if changes to allocations mean one person's entitlement increases, there will be a corresponding decrease in someone else's entitlement.

The Select Committee has also spelt out principles to guide the formation of allocation plans. These include that allocation should avoid economic regrets, significant concentrated job losses and perverse behavioural incentives, and that new entrants and growing incumbents within a sector should be treated similarly (although there is no guidance on just how they should be treated). The principles also refer to certainty and minimising administrative and compliance costs. But the principles aren't binding – the minister is to "have regard" to them.

Agriculture point of obligation

The Select Committee has not reached a position on the point of obligation for agriculture (that is, whether it should be at farmer level or processor level), on the basis that there is too much technical detail to work through about the mechanics of farm level measuring and reporting before a decision can be made.

Instead the Select Committee has added a third option – for farmers to opt in if the point of obligation is set at the processor level. This option may or may not ever be brought into force – it can be brought into force any time between January 2011 and December 2012, but will expire if it is not brought into force by then.

Point of obligation for stationary energy

The Select Committee has responded to concerns that the ability to opt in as a purchaser of natural gas was undermined by the fact that it was only available to entities that purchase directly from the miner. The Bill now allows entities to opt in if they purchase gas from a wholly owned subsidiary of the miner.

This doesn't quite fix the problem; the wholesalers that sell gas to most major users are not wholly owned subsidiaries of the miners. As a result, most major users of gas will still not be able to opt in.

It is also noteworthy that the Select Committee ignored calls from the gas industry that greater attention be given to how the price signals are given to end consumers, given that most gas is tied up in existing contracts that will not allow pass-through of the ETS cost.

Fishing and shipping

The fishing industry failed to convince the Select Committee that it should be allocated credits.

In response to concerns about the competitiveness of the industry and of domestic shipping, the Select Committee has introduced a power to add to the ETS two new activities: (i) fishing inside the New Zealand exclusive economic zone and consuming fuel purchased outside New Zealand, and (ii) domestic shipping in New Zealand and consuming fuel purchased outside New Zealand (or fuel purchased in New Zealand but not already subject to the ETS).

One of the prerequisites for adding these new activities is that it is necessary to ensure that ships that carry out an activity and consume fuel purchased inside New Zealand do not face significantly higher costs that ships that carry out the same activity but consume fuel purchased outside New Zealand. This is hardly a hard threshold to meet – it should be met as soon as liquid fossil fuels enter the scheme.

Moreover, at least as regards fishing, this new provision seems to us to miss the point. Imposing costs on foreign vessels fishing in New Zealand with fuel purchased offshore will reduce the incentive to use foreign fishing vessels. But it does not reduce the New Zealand fishing industry's trade exposure. The New Zealand fishing industry competes (i.e. is trade exposed) globally, not just in relation to fishing in New Zealand waters.

The thermal moratorium

Given the strength of submissions opposed to the moratorium and in the context of the current anxiety about security of electricity supply in a dry year we had expected the moratorium to be abandoned. In fact the Select Committee has stuck with it, though it has changed the wording so the moratorium is now a "restriction", since the Committee insists the Bill does "not purport to impose a blanket suspension of baseload fossil fuel operation or investment".

But the impact of this part of the Bill remains unchanged. This is a blunt instrument which should cause concern.

Other changes

The Select Committee has made a large number of technical and "machinery" changes to the Bill. For example – introducing consultation requirements for regulations relating to units and the operation of the registry, streamlining the consolidated group provisions, clarifying how thresholds for opt-in provisions will be applied, and giving the chief executive discretion to reduce penalties by 100%, instead of the original 75%.

The Select Committee has also "beefed up" the review provision – spelling out mandatory considerations in more detail, including explicit reference to the climate change obligations and emissions policies of New Zealand's trading competitors, and any significant changes in emissions mitigation technology. The Bill also spells out requirements for the review panel – including that a majority must not be employees of a government department.

The political reality

As noted at the outset Labour is struggling to get the numbers to pass this Bill. With 49 votes of its own and one from Jim Anderton, it requires a combination of either New Zealand First (seven votes) and the Greens (six votes) or New Zealand First and the Māori Party (four votes) to push the Bill through.

This puts New Zealand First leader Winston Peters in the driving seat. Peters, as Foreign Minister, has spoken about the damage New Zealand's international reputation would suffer if legislation aimed at honouring our obligations under the Kyoto Protocol were not passed. However in negotiations with Labour it is understood his focus is much more domestic. Peters is seeking a significant compensation package for superannuitants who will have to cope with rising fuel and electricity prices under the scheme. New Zealand First's bedrock supporters are in this age cohort and with the party averaging just below 4% in opinion polls a "win" here will provide Peters with a useful platform.

At the time of writing Labour believes Peters will vote for the Bill, while National believes he will vote against. This probably says more about Peters' skill as a negotiator than anything else. But if he is looking for an issue on which he can differentiate, on the eve of the election campaign, this would be ideal.

Without New Zealand First the Bill cannot proceed. This may weigh heavily on Peters, since during this term he has put great store in being a stable and reliable support partner. If he can ratchet out of Labour a significantly big compensation package (and he probably can) then he may calculate New Zealand First has enough to campaign on.

But even if Labour wins over Peters the Greens could still vote the Bill down. The Greens issued a minority report from the Select Committee. They oppose the Government's decision to delay the inclusion of transport and agriculture into the scheme but also want some kind of 'citizen's dividend', a broader compensation package to soften the impact of higher prices. Co-Leader Jeanette Fitzsimmons has said the scheme is only worth having if it is going to "really reduce" greenhouse gases. "If it is not going to do that we would actually be better off without it."

It is understood talks between Labour and the Greens are "sticky". Labour is convinced the Greens will not be able to vote down an emissions trading scheme, without hurting their own brand. However the Greens have surprised before. One option could be to abstain.

In that event Labour needs the support of the Māori Party. The Māori Party did not have representation on the Select Committee and so come to this stage of the debate less prepared. Interestingly, to date Labour has not initiated talks with the Māori Party on this Bill. Like the Greens, the Māori Party has concerns over affordability and compensation. Co-leader Tariana Turia has called the Bill "unfair" and "fundamentally flawed". The Party is under pressure from Māori fishing and forestry interests to oppose the Bill, and is likely to vote against it.

The continuing poor relations and personality conflicts between Labour and the Māori Party also mean that were Labour to initiate talks at this late stage Mrs Turia is likely to take offence.

If New Zealand First votes for the Bill, but the Māori Party votes against it and the Greens abstain the vote would be 57-57, with former Labour MP Taito Philip Field the decider. To date, Field has not expressed a view on this Bill.

One last scenario is that a combination of parties led by National will vote to have the Bill and some specified changes reported back to the Select Committee for further consideration. This would naturally open the way for another round of consultation.

Planning for the future

Labour is hugely motivated to do whatever it takes to get this Bill enacted. National is equally motivated to reconfigure whatever legislation it may inherit. Under either scenario a prudent course would be to consider this Bill just an opening chapter.

The next phases will be determined, either by regulation but also by amendment, post-election when the balance of power in the House could be very different. Only once that configuration is known will much of the detail so necessary for the implementation of an effective ETS be able to be negotiated with any degree of certainty.

In retrospect an easier, cleaner way of introducing an ETS would have been to design and introduce each sector one at a time. It would have been a less ambitious approach, but also more pragmatic. A smaller field of focus could have allowed for a greater political consensus. As it stands there is just the thinnest consensus, and still a great deal of uncertainty and discomfort.

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