"Doing New Zealand’s Fair Share" is the title and focus of the New Zealand Emissions Trading Scheme Review Panel Final Report, released last month. In this FYI Elisabeth Welson and Craig Nelson comment on what the Panel’s recommendations might mean for the agriculture and forestry sectors. For a more general overview of the Panel’s recommendations.

Agriculture

Agriculture has long held concerns about entering the ETS in 2015 and has been lobbying for exclusion ever since the ETS was introduced. The agriculture sector argues that New Zealand would be the only country to treat agriculture in this way and its inclusion would have a huge negative economic impact on the competitiveness of agriculture internationally, with little ability for agriculture to mitigate its emissions.

Entry to ETS: The Panel recommends that agriculture remains within the ETS on the timetable currently legislated for, but with a range of transitional measures aimed at providing the sector a reasonable time to adjust to a carbon price on biological emissions. Climate Change Minister Nick Smith, consistent with previous statements, has however recently commented that agricultural emissions will only be included in the scheme if technologies are available to allow farmers to reduce their emissions and more progress is made by New Zealand’s trading partners on measures to reduce emissions.

The Panel’s recommended transitional phasing in of the ETS for agriculture is as follows:

Click here to view the table.

Point of Obligation: The Panel recommends that the point of obligation be shifted from processor to the farm gate. The purpose of this shift is to provide stronger (and more direct) incentives on farmers. The Panel, nonetheless, recognises that this creates certain practical challenges around administration, monitoring and verification, and suggests further investigation. The Agriculture ETS Advisory Committee is working on a report on how the point of obligation could be shifted to farmers, which is due to the Minister of Agriculture by 31 December 2012.

The Agriculture ETS Advisory Committee’s Report to Ministers dated 30 June 2011 was also recently publicly released. The committee has recommended specific changes relating solely to the agriculture sector, including that the emissions factor methodologies be reviewed each year. As with the final report, the success of this committee’s recommendations are also likely to be subject to the make-up of the next Parliament.

Forestry

Forestry was the first sector to come into the ETS in 2008. The forestry sector is divided in two for the purposes of the ETS. Pre-1990 and post-1989 forests are treated entirely differently under the ETS (reflecting the current Kyoto Protocol rules).

One of the Panel’s key concerns in the forestry sector is the emphasis that is currently placed on the Kyoto Protocol in framing New Zealand’s commitments, especially given that a new and different international climate framework may emerge in time. Bearing in mind the constraints of the international rules, the panel calls upon the Government to make a “hard-headed national interest assessment” to ensure the scheme appropriately accommodates New Zealand’s unique position.

We comment below on a sample of the 16 recommendations made specifically in relation to the forestry sector.

Pre-1990 Forests

Pre-1990 forest owners of a certain size are compulsory participants in the ETS and as such are liable for deforestation. In return for assuming this potential liability, they are eligible to receive an allocation of units (in two tranches) from the Government. The liability for deforestation imposes a significant cost on land use change (and so on property values) which is not fully compensated by the pre-1990 forest allocation of units. Pre-1990 foresters’ concerns with the ETS have tended to focus on seeking flexibility to change land use without incurring significant costs. They have also been concerned to obtain maximum benefit via the pre-1990 forest allocation of units.

Offset Planting: The Panel recommends that from 2012 pre-1990 forestry offset planting should be introduced effectively allowing deforestation, provided a new forest is planted elsewhere. The ETS already provides for offset planting to be permitted if the international rules change to allow it. The Panel is recommending the Government should take a hard headed assessment of the Panel’s recommended changes and if necessary, make unilateral changes to the ETS, even if those changes depart from international rules.

Allocation Claw Back: The Panel recommends that if offset planting is permitted, the Government should claw back some of the second tranche of the pre-1990 forestry allocation. The rationale behind this claw back is that the allocation is designed to partially compensate pre-1990 foresters for costs imposed under the ETS if land use is changed. The introduction of an offsetting regime is intended to reduce those costs.

Timeframes for Allocations and Exemptions: The Panel recommends that the Government should consider whether there is a need to extend the current application timeframes for allocations and exemptions. This recommendation is based on submissions from some foresters that they need more time to apply for their allocation or for exemptions. A significant proportion of those eligible for the pre-1990 forestry allocation have not applied for their allocation and the deadline for doing so is 30 November 2011. Many of the large foresters have applied for their allocation, but indications are that a large number of smaller forest holders have not done so. This suggests a lack of understanding of the fundamental rule in the ETS that if you have more than 50 ha of pre-1990 forests, whether you apply for your allocation or not, you will still be liable under the ETS for any deforestation liability.

Post-1989 Forests

Post-1989 foresters are voluntary participants in the ETS who earn units for carbon stored in their forests and are liable for carbon stock decreases. Post-1989 foresters have a fundamental opposition to the arbitrary nature of the rules which deem emissions to occur on harvesting, when in reality carbon continues to be stored in wood products for many years. The sector has also been grappling with how to benefit from the ETS while also managing its liability to surrender units on harvest, or when catastrophic events occur (e.g. fire). Other key issues (not explored in this FYI) include how to account for the ETS and how to measure changes in carbon.

Emissions to Atmosphere: The Panel recommends that ETS rules in relation to post-1989 forests should not deem emissions to occur on harvest, but reflect an “emissions to atmosphere” approach if international agreement is reached on this issue. This recommendation is consistent with New Zealand’s approach in international negotiations. The legal fiction that emissions arise on harvest reflects the Kyoto Protocol rules. If this recommendation is progressed, more detailed rules will need to be developed to specify exactly when emissions occur with respect to the end of a wood products life. For example, when would emissions occur if trees are felled and used for structural timber in buildings, compared to wood used for paper?

Averaging: The Panel recommends that the concept of averaging should be available from 2012 to help manage harvest liabilities. The Panel’s recommendation that “averaging” should be available is designed to alleviate the open-ended harvest risks faced by post-1989 forest owners. In essence, averaging involves issuing units in respect of post-1989 forests up to the long-term average forest carbon stock level for carbon earned for post-1989 forests from 1 January 2008. On harvest, instead of requiring units to be surrendered, there will be no obligation to surrender units provided the forest is replanted.

Carbon Market: A number of the Panel’s recommendations have the combined potential to alter the supply and demand balance for units in New Zealand. For example, extending transitional measures will reduce demand for the number of units required for surrender under the ETS for the period 2012 – 2015. See the general overview of the Panel’s recommendations in our companion FYI Crystal Ball Gazing the Future of the NZ ETS. All of this is likely to impact on the carbon price that can be achieved, notwithstanding the increasing price cap recommended by the Panel. It will also be highly relevant to any modelling undertaken for future investment decisions in the forestry sector.

Crystal Ball Gazing the Future

The ETS has always suffered from uncertainty due to the politics that surround climate change. The report from the Panel provides some useful guidance on where the ETS is going. Perhaps the strongest message to be drawn is that fundamentally, the ETS is here to stay, although we will not see any changes pre-election. Undoubtedly there will be some fine-tuning to come but exactly what will depend on the post-election make-up of Parliament.

With more than 20 different recommendations made directly in relation to the agriculture and forestry sectors and many of the Panel’s other recommendations also having the potential to impact these sectors, participants will be carefully scrutinising the detail of the Panel’s recommendations and monitoring the next steps. Pending more certainty on how the ETS might look going forward, the prudent approach will be a cautious one for decisions beyond 2012.