Where to for the Emissions Trading Scheme? A first principles discussion or tinkering around the edges?

A new political environment for environmental issues

The election of a National-led government has thrown the newly enacted Emissions Trading Scheme (ETS) back onto the political playing field. Many in the business community will welcome this.

The global political backdrop is also substantially different from when the ETS was first announced just over a year ago. 

US President-Elect Barack Obama has signalled an increased willingness of the US to become a global leader on climate change, to re-engage with the UN Framework Convention on Climate Change and to implement an economy-wide cap and trade scheme.

However, at the same time the global economic crisis has relegated the issue of climate change from a top of mind issue to, at best, a lower priority in the short-medium term.

Further, increased distrust of market instruments due to the financial market meltdown, increased volatility of carbon prices on European markets and the potential for increased direct subsidisation of clean technology (including as a short-medium term economic stimulus measure), could add weight to calls for a re-think of whether an ETS is the correct policy response to incentivise long-term behavioural change.  

So where to for the ETS?

ACT leader Rodney Hide has put the future of the entire ETS itself, and New Zealand's continued participation in the Kyoto Protocol, firmly on the table for discussion.

However Mr Hide's pledge of support for the National-led government before any policy agreement has been finalised means that, practically, the future of the ETS is not a bottom line for ACT. 

In addition few business leaders are calling for New Zealand to walk away completely from its share of international climate change responsibilities, noting risks to New Zealand's reputation and access to export markets.

A direct or indirect cost on emissions will therefore almost certainly continue to be part of the fabric of the business environment in New Zealand.

National's take on the ETS

National campaigned on changing (rather than dumping) the ETS, and has stated that it will introduce amending legislation before the end of the year. This means that select committee submissions on the new Bill will likely need to be finalised by early next year.

National has (so far) avoided outlining the specific changes it will make to the ETS but the key issues are likely to be as follows.

Timetable for exposure to the price of emissions

It's clear from National's comments that there will likely be changes to delay exposing trade-exposed sectors of the New Zealand economy to a cost on emissions. In the context of a global financial crisis, this has political appeal, at least in the short term.

However, Nick Smith (Environment Spokesperson when National was in opposition, and likely to be Minister Responsible for Climate Change in the new Government) has already indicated during the election campaign that the current timetable for staged entry by sectors into the ETS would not change (the electricity and industrial processes sectors are scheduled to join the ETS by 1 January 2010 and the agriculture sector by 1 January 2013).

This suggests that any reforms to the ETS to avoid a competitive disadvantage to trade-exposed sectors are likely to take the form of either or both of:

  • delaying the commencement of the obligation to surrender credits for emissions; that is, initial obligations are likely to be no more than reporting obligations,
  • more generous free allocation of credits to off-set the costs of participation in the ETS.

Intensity-based allocation

National proposes amending the ETS to reward investment that, while increasing emissions, reduces emissions per unit of output. National argues this better balances economic growth with the objective of reducing emissions from industrial activities. How this will be achieved is, again, unclear, although it will likely involve an increased free allocation of additional credits.

Cap on the price of emissions

National has also argued for a cap on the price of carbon credits within the ETS. A cap on the price of emissions would align the ETS with Australia's proposed Carbon Pollution Reduction Scheme. 

Some may question whether a price cap is necessary. Prices in the ETS will be set by global prices for carbon credits, which are currently trending downwards (although over the long term are expected to increase and be relatively stable) and the ETS legislation already provides for additional credits to be auctioned into the scheme by the Government, a form of price "safety valve".

None of the above changes would represent a fundamental shift in the framework of the ETS. Rather National will argue that these are pragmatic changes to avoid risks to New Zealand's export competitiveness while playing our part in the global response to climate change.

National's criticism of the ETS has focused on six principles, first outlined in National's extensive minority view in the select committee report on the Climate Change (Emissions Trading and Renewable Preference) Bill. 

  • The ETS must strike a balance between New Zealand's environmental and economic interests. It should not attempt to make New Zealand a world leader on climate change.
  • The ETS should be fiscally neutral rather than providing billions of dollars in windfall gains to the government accounts at the expense of business and consumers.
  • The ETS should be as closely aligned as possible to the Australian Carbon Pollution Reduction Scheme, with, where possible common compliance regimes and tradability. National wants to closely co-operate with Australia as the respective schemes are developed.
  • The ETS should encourage the use of technologies that improve efficiency and reduce emissions intensity, rather than encourage exodus of industries and their skilled staff off-shore.
  • The ETS needs to recognise the importance of small and medium enterprise to New Zealand and not discriminate against them in allocating permits.
  • The ETS should have the flexibility to respond to progress in international negotiations rather than setting a rigid schedule.  This way, industry obligations can be kept in line with foreign competitors.

The moratorium on new thermal generation

Finally, the previous government's 10-year moratorium on new base-load thermal electricity generation will almost certainly be scrapped, in line with National Party policy. The fact that this will likely have very little impact on generation investment decisions by electricity companies suggests the policy was ill-conceived in the first place. The biggest winner here will be the oil and gas exploration industry.  Investment in renewable generation was already increasing for reasons unrelated to the moratorium.  Long-term prices of fossil fuels are likely to continue to increase steadily (despite the temporary collapse in oil prices over recent months in response to the global financial crisis) and uncertainty remains over future supplies of gas.  The ETS itself will also incentivise a move away from thermal generation.   Proposed reform of the Resource Management Act by the new government will likely accelerate this shift towards renewable generation.  Legislation to amend the RMA is expected to also be introduced before Christmas.

Chapman Tripp will continue to monitor developments in the climate change policy area and publish further alerts as specifics of the new Government's changes to the ETS are announced.

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