Emissions Trading Scheme: What you need to know

5:16 pm on 20 July 2022

The Emissions Trading Scheme is one of the most important drivers of the changes needed to have any hope of avoiding the catastrophic impacts of climate change.


Since it was launched nearly 15 years ago it has been under constant reform - and the government is working on yet more changes right now.

The recent forestry-related proposals to restrict some carbon farming have incensed Māori, and could end up in the courts, while sheep and beef farmers argue that rural communities could be destroyed without the moves.

Meanwhile the Climate Change Commission is expected to release its ETS advice to the government shortly.

Here is what you need to know about the ETS.

What is the Emissions Trading Scheme (ETS)?

It is a market managed by the government, and a key force to get long-lived climate gases to net zero by 2050.

Businesses that generate damaging gases have to buy units off the ETS.

The number of units available shrinks over time which causes their price to go up incentivising businesses to find ways to emit less.

The costs can be passed on to consumers, like they are with petrol prices, making lower emissions options more attractive.

Trees absorb carbon, so eligible forest owners can sell units to polluters at a price set by the ETS market.

The ETS covers about half of all emissions in Aotearoa including almost all from fossil fuels, industrial processes and waste.

The scheme is very effective because of that reach - although agriculture, which is a major emitter, is not covered and has been allowed instead to work with government officials to come up with a plan to price emissions by 2025 as an alternative to the ETS.

Revenue gathered from the scheme is used to fund efforts to reduce emissions - with nearly $3 billion in spending in the next four years announced during Budget week this year.

Some businesses and economists claim the ETS alone will get us to our reduction targets, but the Climate Change Commission, the IPCC and most experts say additional government policy is needed.

How does it work?

The basic idea is it makes businesses pay for the invisible but real effect of releasing damaging climate gases.

Its strength is that it lets firms weigh up their options and make fine-grained decisions about how to most cost effectively cut their own emissions (rather than, for example, have the government decide) or whether to pay others to reduce emissions.

They can buy units at government auction or from other market participants, but some businesses also get given a bunch of free units.

These are firms that produce large amounts of emissions and which need to compete with offshore producers.

The freebies are to stop emissions from industrial production from simply shifting to other countries.

The Climate Change Commission estimates that in 2019 (barring forestry) free units made up about a fifth of gross emissions from ETS sectors.

The ETS was launched in NZ in 2008 and essentially did not work very well.

Businesses bought a bunch of cheap units overseas from places like Russia and Ukraine which undermined the incentive to reduce gross emissions in New Zealand.

Our ETS has been domestic only since mid-2015 and serious reform began in 2016.

It was not until last year that the first government auctions were held.

What's happened since 2021?

The price of a unit of carbon has gone up big time - from about $30 a unit to more than $70.

There is a stability mechanism that either limits or releases units to try and slow price changes to stop sectors from getting absolutely whacked by hikes.

Despite the fact the price is going up there is actually an oversupply of units which have accumulated over time - but more on that later.

The large increase in unit prices is driving higher rates of planting of fast growing exotic forests (to be left alone rather than harvested, something called carbon farming).

Increased exotic afforestation has caused an outcry as it is gobbling up land that could be used to farm or grow food, and is displacing options to plant in indigenous species.

Again, more to come further down.

But the emissions price is expected to keep increasing - and the government is now reviewing the rules.

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Photo: Supplied

Striking a balance

Relying too heavily on exotic forestry long term has challenges because eventually you do need to cut the trees down - that's why having a mix of natives is important, and why the country needs to actually cut emissions not just rely on planting huge numbers of trees.

Some other countries, and some climate activists here, argue that while forestry has an important role to play in reducing climate change, we have to stop putting the emissions into the atmosphere in the first place.

They say the only thing that is going to actually help tackle climate change is to stop putting the emissions into the atmosphere in the first place.

The OECD has also warned New Zealand that relying on tree planting rather than making actual cuts may not hold water international much longer.

But it will take time for the country to make the large cuts needed in transport and agriculture, and to electrify factory processes, and tree planting will always be part of the mix to offset unavoidable emissions.

Currently forests offset, or capture, about a third of our gross emissions. Under government rules, not all of this counts toward our international and domestic targets.

It's a little complicated but basically if you own a forest established after 31 December 1989 you can choose to join the ETS and earn units as the trees grow.

You can sell units to other market participants. Forest owners have to pay back the units they have earned if they deforest. For post-1989 forests registered through 2019, forest owners also have to pay back units when they harvest. And there are new rules coming in 2023.

As of early 2022, 50 percent of post-1989 forest had joined the scheme.

There are changes coming at the start of next year designed to incentivise foresters to join the ETS and establish a larger number of permanent forests.

ETS changes demanded by farmers, but Māori promise to fight them

The government is looking at changing the ETS to discourage the planting of new permanent exotic forest by excluding them from the ETS (though not trees destined to be logged).

The large price increase since ETS auctions started last year has seen a ramping up in planting of these species.

It has prompted outrage from sheep and beef farmers and rural communities that productive land will be swallowed up.

They say farms employ people who spend money in the community and put their children into local schools.

They say carbon farming means large empty plots of land quietly sequestering but also only making money for the owners, with little benefit for the community.

Poorly managed exotic forests can also harbour pests and be a fire danger - which can be a threat to our national stores of carbon held in our forests.

But the government's proposed changes have been labelled disastrous for Māori, and there are moves to take legal action.

Māori are major forest owners (about a third of plantation forestry, and it will tip over 40 percent as more Treaty settlements are completed), and make up about 40 percent of the forestry workforce.

Much of these forests existed before 1990 meaning they are not eligible for units under the ETS.

Their holdings are often all that was left after more desirable land was confiscated, or what was returned to them as part of the Treaty process.

It is often marginal, scattered and difficult to monetise, and Māori see the opportunity to finally make some money from them by selling units on the ETS potentially being yanked away from them.

Meanwhile, there are fears that long-term overplanting exotics could also lead to lower ETS prices, disincentivising investment and innovation in low-carbon technology and suppressing moves to make actual reductions in emissions.

The stockpile problem

At three of the six auctions since 2021 the price has got high enough to hit a trigger point releasing more units.

There is already a large stockpile of units left over from previous iterations of the ETS and, coupled with the extra units from recent auctions, means that's a lot floating around out there that can be surrendered instead of real cuts to emissions being made.

This could undermine the government's ability to hit its reduction targets, and the government is currently investigating.

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