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Brief Counsel

Panel to Government on ETS – stay the course, but let's not rush

21 September 2011

​The Government is not expected to respond formally to the Caygill Review Panel’s report into the Emissions Trading Scheme (ETS) until next year.  But initial indications are that many – if not most – of the Review’s ideas will be taken on board.

This Brief Counsel takes a practical, sector-based look at the Panel’s principal recommendations.

Overview

The Panel takes as its starting point the need to strike a balance between steadily increasing the incentives for emissions reductions and managing the short-term economic costs. 

Most of the key recommendations were well-telegraphed in advance, especially those relating to the extension of the transitional phase and the “scaling-up” of ETS obligations.

The report is finely nuanced and pragmatic, arguing simultaneously that:

  • the strongest incentive to behavioural change is through a clear long-term cost signal
  • the ETS should be slowed from its current settings, given the uncertainty over any new international agreement on climate change and the challenging state of the economy
  • a softening of the ETS now will lead to a more durable ETS in the longer term (especially if the phase out of the transitional measures avoids the “double-whammy” which would be created if they were removed at a time of increasing carbon prices), and
  • where the ETS does bite, the rules should be changed to better incentivise behaviour that results in environmental benefits in a least cost way (e.g. allowing forestry off-setting and locating the agriculture point of obligation with farmers rather than processors).

The Panel notes it is unlikely that a successor to the Kyoto Protocol will be in place by the end of 2012 but says that New Zealand will still face “a range of strong international drivers to take responsibility for its emissions” which will only increase over time.  These include prospects for new international agreements and the fact that other countries are taking abatement action, including Australia, the EU, China and the US.

Many of the changes the Review is recommending will require legislative amendment.  Once the amending legislation is introduced, after the Government has made its policy decisions in response to the report next year, there will be the opportunity to make submissions during the select committee stages.

Principal recommendations

Transitional measures

  • That the 50% surrender obligation, which was to expire on 31 December 2012, be phased out in three equal instalments from 2013 to 2015 – that is, to 67% in 2013, 83% in 2014 and 100% in 2015.
  • That the price cap of $25 per NZU be increased by $5 a year from 2013 to 2017.

Ultimately, the transitional measures have been extended for a (relatively modest) period of two years. The Panel’s recommendations seek to strike a balance between the desirability of softening the short-term impact of the ETS (to address concerns about international competitiveness and uncertainty as to the emergence of new international agreements) and the desirability of establishing a clear and certain pathway towards full ETS obligations and a transition that avoids cost shocks. 

Industrial allocation

  • That the existing allocation thresholds (90% for highly emissions-intensive activities and 60% for moderately emissions-intensive activities) be maintained.
  • That the free allocations to trade exposed industries be phased out in a straight line of 1.3% a year, rather than on the current basis which could theoretically have resulted in some free allocation continuing forever.

The Panel kicked for touch on whether New Zealand should adopt an overall allocation cap, saying that more progress was needed toward a new international agreement before any decisions could be made in this area. 

This remains a key issue for future ETS design.  Such a cap might make it easier in the longer term to link to other domestic emissions trading schemes but would likely result in a faster phase out of free allocation. 

Agriculture

The Panel recommended that the entry date for agriculture remain at 2015 but that the sector have a 50% surrender obligation for the first two years, then the same phase-out as for other sectors but conducted over the years 2017 to 2019. 

The recommendation was driven by the Panel’s view that, as agriculture accounts for 47% of New Zealand’s emissions, bringing agriculture into the ETS is integral to achieving the Government’s 50% by 2050 reduction target.

The Panel noted concerns at the lack of abatement options but also noted that the ETS was now essentially an intensity-based regime and that the sector had already demonstrated an ability to reduce emissions per unit of production year on year. 

However, Nick Smith has hinted at further delay, saying that agriculture will be included only if “practical technologies are available to enable farmers to reduce their emissions and [if] more progress is made by our trading partners on measures to reduce emissions”. 

Given the need for a cost incentive to act as a key driver of scientific R&D, there is a “chicken and egg” element here that needs to be carefully managed.  

A further – and important – recommended refinement is that the point of obligation should be the farmer rather than the processor as “this will ensure that those who are best able to reduce their emissions are motivated to do so”.  While this would increase the number of ETS participants by many thousands, it does reflect a strong underlying philosophy throughout the Caygill report that the ETS rules should provide the best possible incentives to reduce emissions. 

Forestry

Key recommendations are that:

  • the ETS rules should allow offset planting for pre-1990 forests so that the land can be converted to its most economic use - without deforestation liabilities being incurred – if a comparable forest is replanted elsewhere
  • the rules in relation to post-1989 forests should recognise that not all carbon is actually oxidised and released into the air upon the trees being felled (i.e. carbon is retained in the form of wood products)
  • “averaging” (whereby units would be issued only up to a long-term average forest carbon stock level, with the Crown taking the benefit of any carbon sequestered above the average and the ETS participant having no obligation to surrender units on harvest if the forest is replanted) should be available as an option from 2012 for post-1989 forests, and
  • the Government should consider a self-insurance pool of units for post-1989 forests.

The Panel went so far as to suggest that the New Zealand Government should be prepared to adopt changes to the ETS rules ahead of any international agreement to change the international carbon accounting rules.  This indicates a view that:

  • the Kyoto rules on carbon forestry are flawed, and do not provide the right incentives for efficient land use decisions
  • New Zealand is confident it is on the right side of the debate, and that it will succeed in changing the international rules, and
  • forestry is critical to New Zealand’s long term emission reduction plan so getting the rules right is important to maximising the ETS benefits to be derived from forestry activities.

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