Wednesday, February 21, 2024

ETS reforms come with costs and controversy

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Discussion document details tough choices ahead for New Zealand.
Forests are hugely significant to our economy, rural communities, and to Māori, both culturally and economically,’ Forestry Minister Peeni Henare said. ‘But encouraging afforestation should not replace or delay gross emissions reductions.’   File photo
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The government has released a discussion document on reforming the Emissions Trading Scheme, saying changes need to be made to drive greenhouse gas emission reductions.

Failing that, New Zealand could face a bill of up to $23.7 billion for not meeting its international commitments.

The discussion document outlines four broad options to reform the Emissions Trading Scheme (ETS), all of them with their share of benefits, costs and controversy.

Under the ETS, those creating emissions must surrender New Zealand Units, which are the equivalent of one tonne of carbon. They can buy these NZUs from the government at auction or on the secondary market. 

NZUs are also created by forest plantings equivalent to the carbon absorbed by trees.

The government is trying to achieve a stable carbon price that is high enough to get emissions reductions but without excessively driving up costs to households.

The problem for now is that it’s cheaper for emitters to plant trees or buy NZUs off foresters than it is to take steps like cutting coal, gas or petrol use. 

Compounding this problem is that the government currently has no control over how many trees are planted, so the supply of NZUs can’t be capped.

The first option: As existing

The first option suggests leaving the ETS largely alone and the government further tightening the supply of NZUs.

The Climate Change Commission advised tightening the supply last year, but ministers declined to do this because of the inflationary effect. 

After this, carbon prices collapsed from record levels above $80 to around $50 due to a lack of confidence in the market. 

Prices are now around the $60 mark and the first two auctions of the year failed to sell any units due to uncertainty about the future of the ETS.

The Ministry for the Environment (MfE) paper does not make any preferred recommendations, but says the first option could drive up prices and drive emissions reductions. However, it could also just drive more forestry planting. This could then create a glut of NZUs and drive down prices.

The second option: Increase demand

The second option would allow the government and overseas buyers to buy NZUs from removal activities, such as trees absorbing carbon at the end.

This could raise the NZU price if enough additional NZUs are purchased to increase demand, encouraging both emissions reductions and more removals.

The MfE said it would expect demand for NZUs created from pine plantations from overseas buyers to be limited. 

Also, the government would have to consider whether money is better spent to buy NZUs or provide funding directly to cut emissions as it recently did with NZ Steel.

The third option: Restrictions

The third option would be to reduce the type of NZUs that emitters can use to settle their ETS obligations.

For example, the government could restrict how many forestry-generated NZUs emitters can use to pay for their emissions. Or it could reduce the number of NZUs given out for forestry, relative to the amount of carbon removed from the atmosphere.

The problem with this is it could reduce tree planting, which means less carbon is absorbed.

The fourth option: Separate incentives 

The fourth option is to create two ETS markets with separate prices: one for emissions reductions and another for removals. 

Emitters would not be able to use forestry NZUs to pay for their emissions. Instead, forest NZUS would be sold directly to the government or on a separate market.

MfE said this would allow “the government to incentivise reductions and removals independently towards budgets and targets, and provides the most comprehensive change to the NZ ETS, relative to the other options. Because the government can now control the cost for businesses to pay for their emissions, it can encourage faster decarbonisation.”

Forestry issue

Alongside the ETS reform paper, the government is also working on other issues around the treatment of forestry.

“Forests are hugely significant to our economy, rural communities, and to Māori, both culturally and economically,” Forestry Minister Peeni Henare said. “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.”

Last year, ministers floated the idea of pulling permanent pine or “carbon forests” out of the ETS.

This caused a backlash from foresters and, in particular, iwi who are against a change in the rules that would reduce the ability to make money off highly marginal land.

One group even went to court to delay the release of the discussion document, saying it had not been properly consulted. The court denied the application.

Henare and Climate Change Minister James Shaw said in a statement: “Last year, the government consulted on proposals to restrict permanent exotic forests in the NZ ETS in response to concerns about the impacts on the environment and rural communities from these forests. 

“The proposals generated wide interest, prompting the government to look further into the permanent forest category.”

The permanent forestry category defines what sort of planting qualifies for NZUs and how they are allocated.

Forestry is estimated to contribute up to 95 million tonnes of carbon dioxide removals between 2021 and 2030 towards NZ’s first Nationally Determined Contribution target under the Paris Agreement. 

Under current policy settings, between 0.97 and 1.44 million hectares of extra afforestation out to 2050 are needed to meet NZ’s climate-change targets.

The three key design choices that guide the redesign of the ETS permanent forest category are:

• What forests should be allowed in the permanent forest category?

• How transition forests should be managed.

• What rules will best maximise the benefits of permanent forests in the category?

 Henare said: “The proposals complement the recently announced changes to the National Environment Standards for Plantation Forestry that will give local councils more control over deciding which land can be used for plantation and carbon forests. The proposals being consulted on consider the overall incentives driving afforestation and aim to help ensure the right types of forests are in the right locations.”

The MfE paper underlines the importance of getting emissions down quickly, highlighting recent work by the ministry and Treasury, which estimated the government is expected to need spending between $3.3bn and $23.7bn in offshore carbon credits to meet the 2030 commitment.

This would have obvious fiscal and political implications.

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