The Climate Change Commission's latest report recommends major changes to the Emissions Trading Scheme and highlights two big problems that need to be urgently addressed, Marc Daalder reports
Analysis: The supply of licences to pollute should be significantly curtailed over the next five years, the Climate Change Commission has told the Government.
All sectors of the economy except agriculture are covered by the Emissions Trading Scheme (ETS), which requires polluters to submit one unit (NZU) for each tonne of greenhouse gases they emit. The number of units available each year includes a set number auctioned by the Government, a few million given freely to big emitters whose international competitors don't face a carbon price and any generated by the planting of trees which sequester carbon dioxide to produce carbon credits.
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In advice released on Wednesday morning, the climate commission indicated that the way forestry is currently included within the ETS could mean gross emissions don't fall but are instead merely offset by sequestration by trees. This could lead to failure to meet specific targets the Government set for each sector of the economy in its Emissions Reduction Plan in May.
Auction limits and price controls
Under the Zero Carbon Act, the climate commission is tasked each year with advising the Government on how many units to auction over the next five years as well as the price control settings around those auctions. This is the first year it has done so and the Government will have to make decisions on those settings by the end of this year.
That advice recommends a surprising step change in the number of units available for auction and the pseudo price floor and ceiling for future auctions.
As it stands, the Government was planning to auction 68.1 million units between 2023 and 2026. Now, the commission says, it should reduce that to 58.1 million units. An extra reserve of units in the cost containment reserve, which opens up if auction prices rise too high, will also become less accessible.
The cost containment reserve will trigger next year if the auction price rises above $78.40, releasing up to seven million extra units into the market. The current secondary market price for an NZU was $72.60 on Wednesday morning, although it rose above $80 after the release of the commission's advice. The reserve was widely expected to be emptied in the first auction of 2023, after being triggered in three of the past four auctions and fully emptied both this year and last year.
The commission said the reserve should be split into two tiers, with a lower and higher trigger price. Even the lower tier trigger for 2023, $171, is nearly $100 above the current settings.
"We have heard that market participants may potentially see the CCR trigger prices as a ‘target’ or anchor for price expectations in the absence of clearer signals being available," the commission wrote.
"The CCR is intended to only be triggered in rare or exceptional circumstances, and our recommendations reflect this intent. We expect the increased trigger prices to add considerable headroom to allow for price discovery, rather than unduly influencing market price expectations."
The commission also recommended a steep adjustment to the price floor for auctions, below which the Government won't release any units. That was meant to be $32.10 next year, rising to $42.08 by 2026. If the commission's advice is implemented, the floor would jump to $60 next year and end up at $71 by 2026.
This wards off a collapse in the price of carbon if emissions reductions turn out to be easier than expected (in which case New Zealand should seek to overachieve its targets) or if emitters start to spend significant amounts of their unit stockpile.
Over the course of the last National government, the ETS was gutted to allow unlimited numbers of bunk international units and cheap domestic units into polluters' vaults. Now the private stockpile consists of around 150 million units or four years of emissions from ETS sectors.
The commission determined some of these units are being held for legitimate reasons - such as foresters who will need to surrender a portion when they harvest trees or polluters hedging against future price rises - but around 49 million constitute an unnecessary surplus that could see the ETS allow more emissions than permitted by the Government's emissions budgets.
In theory, the ETS is meant to cap emissions by limiting the number of units available for auction. The surplus enables companies to breach the cap by surrender more units than are auctioned in any given emissions budget period. Therefore, New Zealand could fail to reach its emissions budgets even while all rules within the ETS are followed.
Auction volumes for the next five years have therefore been severely curtailed in an effort to winnow this surplus down to zero units by 2030. A total of 35.2 million fewer units will be auctioned between 2023 and 2027 as part of the stockpile reduction effort (although they will be available in the cost containment reserve if prices rise to astronomical levels).
Trees and reductions overseas
In addition to advising on auction volumes and price controls, the commission also briefly weighed in on two "key areas where the Government is yet to make clear decisions about the overall transition strategy for Aotearoa New Zealand and has not yet clarified its goals for the NZ ETS".
The first of these is the relationship between forestry and the ETS. Currently, forestry can generate unlimited units that feed into the ETS market, often at much lower prices than the current NZU market price.
In fact, it is now "economically more attractive" not to harvest plantation forests in the ETS because they can earn more for sequestering carbon. The commission's advice on the country's path to a zero carbon economy, released last year, assumed declining rates of pine planting and a high but flat rate of native tree planting out to 2050.
Instead, current carbon prices are driving a boom in exotic afforestation, even while native planting intentions fade - native trees earn less in the ETS than species like Radiata pine.
Over first 15 years of New Zealand's low-carbon transition, the ETS could see more than one in every 18 non-forested hectares of the country planted in exotic pine, double the amount planted under the commission's recommended pathway.
The commission was blunt in its comments on this path, in which we continue to pollute in transport, industry and agriculture but just offset it all with tree planting.
"The current structure of the NZ ETS steers toward a pathway that would achieve the 2050 target primarily through exotic afforestation, with little reduction in gross emissions beyond business as usual. Such a pathway would require high ongoing levels of new planting to maintain net zero emissions, and push the work of decarbonising onto future generations. It would also leave us out of step with much of the world."
The Government's Emissions Reduction Plan from May set out specific emissions targets for each sector of the economy. If the ETS isn't fixed, the commission warned, these targets won't be met through reductions.
There is also a scientific question here about the fungibility of emitted-and-sequestered carbon dioxide versus avoided carbon dioxide emissions.
"It raises a bunch of questions and this wanders beyond what the commission has done the work on, but at the heart of the ETS is the assumption that one tonne of carbon dioxide equivalent emitted can be offset by one tonne of carbon dioxide equivalent sequestered," the commission's chair, Rod Carr, told Newsroom.
"I would just pose the question whether, if the tonne of emissions is indeed carbon dioxide and it lingers in the atmosphere for as long as a thousand years, whether it is equivalent to offset that with one tonne of carbon dioxide sequestered in a forest that needs to be maintained as forest cover for a comparable length of time. And of course the risk of that carbon being released because the trees die or are blown down or become diseased or a fire rages through isn't reflected in the one-for-one equivalency."
David Hall, a senior lecturer on climate policy at AUT, said recent research has shown there isn't a perfect one-to-one equivalency between emissions reductions and emissions removals, even if they're roughly equal on a small scale.
"There has been earth system modelling undertaken and it finds that there's an asymmetry in the signals from a reduction and a removal. That removals don't have a full inverse signal to an emissions," he said.
"The way forward is just to recognise that removals can play different roles. I think we need to transition the current system into a more discerning use of removals."
While the commission didn't provide examples of how to differentiate between reductions and removals, the Government is currently consulting on a change to make exotic forests ineligible to receive carbon credits if they're converted to permanent carbon forests. It's unclear whether this would fully address the problem.
The other key area which needs attention is the role of the ETS in meeting our international obligations under the Paris Agreement. New Zealand's Paris target (or NDC) for cutting emissions by 2030 is significantly more stringent than the reductions promised in our domestic emissions budgets.
Around 100 million tonnes of reductions will need to be sourced from overseas over the next eight years, either from other countries' carbon markets or by paying for offshore reductions or removals directly.
If the ETS is to play a role in this, the commission said, changes will need to be made quickly. The Government can't leave procuring a hundred megatonnes of emissions cuts to the last minute.
"The Government is going to have to step into the bright light about this offshore mitigation question," Carr said.
"We're now in 2022, soon to be 2023, and there's some tough questions to be asked. What are we doing now to get our head around offshore mitigation? Who are we going to buy it from? How much is it going to cost? We need to be transparent about incurring the liability rather than just dumping it on taxpayers in 2030."
