In this Q&A we answer some questions about the scope and implications of consultation undertaken by the Government on the New Zealand Emissions Trading Scheme in May 2012.

  1. Why does New Zealand have an Emissions Trading Scheme (ETS)?

New Zealand signed up to the Kyoto Protocol in 1998. This international agreement places an obligation on New Zealand to reduce its greenhouse gas emissions to 1990 levels between 2008 to 2012, or pay for the difference by buying excess units representing emission reductions internationally. The Government considers the ETS to be the most cost-effective and efficient way New Zealand can fulfill its Kyoto obligations.

The ETS effectively imposes a cost on emissions across the economy. It does this by requiring mandatory participants (from across a range of sectors, such as forestry, transport fuels, stationary energy producers, and some industrial processes) to surrender units calculated by reference to carbon and carbon equivalent emissions (with the waste and synthetic gases sectors also to progress from having reporting obligations only to having surrender obligations from 2013). The ETS provides New Zealand Units (NZUs) for eligible forests that absorb emissions, and also grants NZUs to emission-intensive trade exposed industries. In this way the ETS creates a mechanism that puts a price on emissions and incentives for reducing them.

  1. What is the current consultation process?

The ETS legislation requires a statutory review during every commitment period under the ETS in order to refine the scheme. The first review was conducted by an independent panel in 2011 to consider how the scheme could continue to evolve. The review focused on policy issues and recommended changes to the existing ETS after a significant consultation process (with over 150 submissions received from the public, businesses and non-governmental organisations).

Following consideration of the review panel's recommendations, the Government is proposing a number of changes to the ETS. It is these changes that are the subject of the current consultation process.

In making changes, the Hon Tim Groser, Minister for Climate Change Issues, has indicated that the Government's intention is to find a balance between a number of interests, in particular balancing the need to do "our fair share" while not unreasonably impacting on any one sector in the economy, and at the same time "maintaining fiscal discipline" through the global recession - factors that are not always easily aligned. It is recognised that where individual submitters sit on the proposals will in many cases depend on how they are affected by the carbon price, and where they think this price is going.

  1. What are the key changes proposed by the Government?

Gradually phase out the "two for one" allowance

Participants with surrender obligations (apart from forestry) are currently required to surrender one unit for every two tonnes of carbon dioxide equivalent emitted, stepping up to a "one for one" obligation from the end of this year. The Government proposes a further gradual transition over three years, raising the surrender obligation in three equal steps from 2013 before reaching a "one for one" obligation by 2015. The Government believes that phasing out the "two for one" allowance should provide businesses with the ability to make clearer investment decisions, and recognises the fact that the economy is still in the process of recovery. The transition will also apply to the waste and synthetic gases sectors that enter the surrender obligation phase under the scheme from 1 January 2013.

Auction within a cap

In order to manage the purchase level of international units by ETS participants, the Government proposes a statutory power to auction NZUs subject to a cap linked to a target level of emissions. The new legislation would state matters that must be had regard to when setting the cap, such as the level of any domestic or international target to reduce emissions. The use of the power, level of the price cap and detailed auction settings will be up for further consultation before implementation.

In addition, there will also be the ability to place a restriction on the amount of international units an ETS participant can surrender to meet its obligations. This is to encourage the purchase of NZUs at an auction rather than international units. There will be further consultation on how this restriction would be used. The current consultation appears therefore to be focused on whether there should be the power to put such a restriction in place at all.

These measures will have an impact on costs for participants and on their flexibility to obtain units internationally. Given that New Zealand is looking to link with the Australian scheme, however, it comes as no surprise that the Government is planning to adjust features of the New Zealand ETS to align more closely with the Australian proposals. The Government has also stated as a reason its concern that unlimited access to international units creates an unnecessary flight of capital offshore, instead of units being purchased within New Zealand. No doubt the Government is also all too aware of the impact on the price of the NZU that the low price of international units has had.

Offsetting of deforestation on pre-1990 forest land

The review and the Government recognise that the deforestation liability placed on pre-1990 forest landowners for permanently removing trees from their land has meant that land use change is uneconomic in some cases. One of the key successes from New Zealand's point of view arising out of the Durban climate talks last year was to get agreement permitting "offsetting" under the Kyoto Protocol. Based on this agreement, from 1 January 2013, the Government proposes removing the requirement for pre-1990 forest landowners to surrender units when they deforest, provided they establish an equivalent new forest on eligible land elsewhere, essentially "offsetting" their deforestation.

In the context of this proposed change the Government is reviewing the number of NZUs that will be provided to pre-1990 forest landowners in the second tranche of compensation for the restriction on land use change under the current rules that do not allow offsetting. Three options are being consulted on:

  1. A full removal of the second tranche - this option may not be attractive to pre-1990 forest landowners who are not sure that they would be in a position to offset.
  2. A reduction of the second tranche - this may be either as an across board reduction to a specified number of NZUs per hectare, or may be on a pro-rata basis based on the categories that currently differentiate this compensation.
  3. Only remove the second tranche for landowners taking up offsetting - the consultation paper hints that this option may not be preferred as it "does not recognise the original reason for the compensation", ie the effective lack of the ability to offset.

If one of these options is implemented, the Government will give small landowners a chance to reconsider applying for the less than 50 hectare exemption from compliance with the surrender obligations for pre-1990 forest land.

Owners of pre-1990 forest land may wish to consider the best option and make submissions on this point.

  1. What did the Government choose not to change and why?

Keep NZ$25 fixed price

Due to the potential for continued volatility in international carbon markets, the Government proposes to maintain the fixed price at which participants can buy NZUs for surrender at NZ$25 per unit until at least 2015. It will not raise the fixed price by NZ$5 per year, as suggested in the review. The fixed price option may also be extended beyond 2015 if necessary, to align with Australia's price ceiling and smooth the integration of the New Zealand and Australian schemes.

Clearly, the relevance of the fixed price option is determined by the price of units. At the moment, the price is low, due in part to the low price of international units which can presently be used in the ETS for compliance purposes with no major restrictions. If auctioning of NZUs is implemented together with restrictions on usage of international units, the relevance of the fixed price option may become more important in practical terms with market commentators expecting NZU prices to rise as a result of this policy. A fixed price option gives the economy a clear price signal on the "maximum" cost of carbon in the medium term.

The consultation paper makes no suggestion of bringing in a price floor, as there will be in the Australian scheme.

Delay entry of emissions from agriculture

Despite the recommendation of the review to continue to bring the agriculture sector into the ETS from 2015, the Government has confirmed its well-signaled intention to delay the entry of emissions from animal livestock and fertilizer use for up to three years, following a review in 2014 (noting though that reporting obligations have already started for agriculture). Before agricultural emissions are required to be accounted for in the ETS, the Government wants to ensure that there are appropriate technologies available in NZ to reduce agricultural emissions, and that other countries are also taking sufficient action to reduce their emissions in general. The consultation paper indicates that the power to defer the sector may be for some or all agricultural activities.

  1. What will we be able to do with NZUs from 2013?

Under the proposals, NZUs will no longer be backed by international units, and therefore will not be able to be exported (except as specifically agreed, for example if the ETS is linked with Australia). At present forestry NZUs can be converted into internationally accepted assigned amount units (AAUs). NZUs issued to non-forestry sectors are not presently permitted for export and this is expressly to remain the case while the fixed price option remains in place and the ETS is not linked to another country's emissions trading scheme. It is not clear whether the Government would lift this restriction if the ETS links to Australia's scheme. Emissions intensive trade exposed industry recipients of affected NZUs may wish to seek clarification on this point.

  1. What else might change in the future?

There will be further consultation on the detail of a number of proposals in the current consultation paper, if they are adopted. There will also be future consultation on recommendations from the review relating to synthetic greenhouse gases. The review also made recommendations about the waste sector and other forestry changes that are yet to be considered by Cabinet, along with the electricity industry allocation factor for NZUs and various "technical" amendments. Some of these review recommendations are summarised in our recent FYIs: NZETS Update 2012, Crystal Ball Gazing the Future of the NZ ETS and Crystal Ball Gazing the Future of the NZ ETS – a Focus on Agriculture and Forestry.

The question is still open as to whether New Zealand will sign up to the next commitment period under the Kyoto Protocol, or whether this will now continue with Europe alone. We may well be influenced by whether Australia signs up. Although not flagged as a topic for consultation, some submitters may wish to take the opportunity to comment on their preferred position.

  1. When will the changes be implemented?

The changes to transitional measures need to be legislated this year, as otherwise transitional positions end at 31 December 2012. Other changes may be able to be legislated at a later date, but logically we can expect a parcel of changes this year, perhaps with the power to implement the detail by regulation.

Auctioning of NZUs (and logically the related limit on the use of international units) is likely to commence in 2014 or 2015, with a pilot auction to be held in advance.

  1. How and when can we make a submission?

Submissions can be emailed to etsconsultation@climatechange.govt.nzor posted to ETS Review Consultation, Ministry for the Environment, PO Box 10362, Wellington, 6143. All submissions must be received by 5pm Friday 11 May 2012. We would be happy to assist with preparing submissions or discussing issues raised in this consultation process.