19 Jun 2023

New additional ETS scheme floated in review of carbon market

12:24 pm on 19 June 2023

The government has floated a series of options to reform the Emissions Trading Scheme (ETS), with the highest ranked option one which sets up a whole new additional ETS scheme.

The ETS scheme is a government-run market where polluters buy credits to emit. The idea is for prices to rise over time, incentivising firms to innovate more, and pollute less.

The Climate Change Commission said the ETS was not currently incentivising emissions reductions, as it was cheaper to buy units than invest in cutting pollution.

Climate Change Minister James Shaw and Forestry Minister Peeni Henare launched consultation on changes to the scheme on Monday morning.

Shaw said the problem was New Zealand's scheme was unique in allowing unlimited forestry as an offset to companies' emissions, which could tank the price of credits - affecting forestry owners and potentially making the scheme unworkable.

"The commission have become increasingly alarmed that it will stop working sometime in the early to mid 2030s under the current settings," he said.

"In our view, new forests cannot be at the expense of gross emissions reductions, it is not an either-or situation - we need both - and this review will help us get there."

Options include making changes to the existing ETS such as restricting the amount of units available; allowing the government or foreigners to buy credits; creating two prices - one for reducing emissions and one for removals like tree planting.

The biggest change, and the one ranked as most effective by officials, would be to establish a whole new ETS market for "removals" - for example, from tree planting - so the current one can be focused on reductions.

All the options have tradeoffs, all impose economic and household costs, and some polluting firms could go out of business. Components within each option could be combined into a package after this consultation.

Shaw said the ETS had been New Zealand's main tool for tackling climate change for the past 14 years, accounting for about a third of the emissions reductions expected to be needed to meet targets.

However, any recommendations resulting from the consultation launched on Monday would not be ready to enact before October's election, Shaw said.

"The execution of any changes will be a matter for an incoming government."

The four options

The government has come with four "high level options" it wants input on.

Option 1: Use existing levers to strengthen incentives for net emissions reductions e.g. reducing the number of NZUs sold through auction.

It could adjust the existing regulation for the ETS.

Fewer units mean prices would rise - incentivising polluters to reduce emissions faster.

While it may boost prices in the short term, it may be less effective in the long run.

If it leads to greater tree planting, more units then could flood into the ETS which then drops the price again - discouraging investment in gross emissions reductions.

Option 2: Increase the demand for emissions units by allowing the government and/or overseas buyers to purchase them.

More buyers could mean increased demand so the price would rise.

But the report said it might have a limited effect. Overseas demand is unknown, likely minimal.

The government would need to weigh up whether to buy credits versus spend on other means of reducing emissions.

New Zealand units may also not meet international standards for carbon credits.

The report said this option was only expected to be marginally more effective than the status quo. The Climate Commission also does not consider this plan a viable option to encourage gross emissions reductions, or support afforestation.

There was currently no process for managing the sale of units offshore.

Option 3: Strengthen the incentives for gross emission reductions by changing the incentives for removals.

It would create two prices: one for emissions reduction activities and another for removal activities.

A lower price will apply to removal activities, making them less financially attractive.

For example, the government could restrict how many forestry units can be used to 'pay' for emissions, or could give fewer units to forestry for planting in the first place.

This would make units from tree planting less attractive, and increase demand for units at a price that encourages businesses to make cuts to gross emissions.

But it would disincentivise tree planting, which was still needed for the country's overall reduction plans.

The government might have to provide other incentives outside the ETS for forestry.

Option 4: Create separate incentives for gross emission reductions and removals by setting up a whole new additional ETS.

Separate out prices for emissions reductions from removals such as tree planting.

This is similar to how the European Union ETS and United Kingdom ETS operate: emitters cannot access removals to offset their emissions, and removals are incentivised through complementary policy interventions.

Removals from forestry could be sold on this separate market, or directly to the government.

Because the government would now control the cost for businesses for their emissions, it would encourage faster decarbonisation.

This option was ranked highest by officials overall in terms of the impact and likelihood of achieving the objective.

James Shaw and Peeni Henare speak to media about the ETS review

Climate Change Minister James Shaw speaking at the conference on Monday morning. Photo: RNZ / Angus Dreaver

NZ ETS an outlier

New Zealand's Emissions Trading Scheme is an outlier in that it does not differentiate between reducing emissions, i.e. not emitting the gas in the first place, and reductions from trees absorbing and storing carbon.

It also allows unlimited amounts of units generated from forestry into the scheme.

The review said focusing on reducing emissions now through the NZ ETS rather than removing them through forestry could be more expensive, at least in the short term.

These costs were likely to get passed on to households through higher fuel and electricity prices.

In the long term, New Zealanders will benefit from a low-carbon economy built on efficient, low-carbon technologies.

There was some uncertainty whether reducing emissions now or waiting would be more expensive in the long run.

The Climate Change Commission considers that prioritising emissions reductions would put Aotearoa in a stronger position to meet and sustain net zero, at lower overall costs to New Zealanders.

Before the government makes final decisions, detailed modelling and analysis will be done.

The government has also released its redesign of the permanent forestry category.

It was supposed to be released under embargo with the ETS review material, but was only sent to reporters hours later.

RNZ will have coverage of the redesign shortly.

Can the ETS work better? - government

Climate Change Minister James Shaw said the ETS was the main tool for meeting New Zealand's domestic and international targets.

"Can the NZ ETS work any better? And if so, how?" he asked.

Forestry Minister Peeni Henare said forests were hugely significant to the economy, rural communities, and to Māori, both culturally and economically.

"But encouraging afforestation should not replace or delay gross emissions reductions.

"We need to consider how the NZ ETS can provide the necessary price for both gross emissions reductions while continuing to incentivise the planting of trees."

Environment Minister David Parker said there was potential for the NZ ETS to lead to wider environmental and health benefits, through encouraging alternative transport, such as cycling and public transport.

"The NZ ETS affects everyone in different ways so it's important that as many people as possible have a say on how it works and give their views on the right balance to strike," Parker said.

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