NZ ETS review under way

Barry Brill, OBE, chairman of the NZ Climate Science Coalition, former Minister of Science and Technology and former Minister of Energy, thoughtfully offered the ETS Review Panel some assistance in sorting out the issues. He sent the following letter on 28 February to David Caygill, chairman of the ETS Review Panel. Seeing the sharp Brill intellect delineate the economic and political issues with his usual surgical accuracy we await the panel’s Issues Statement with keen interest. Let’s hope the panel approaches its duties with the larger portion of at least one mind still open.

almost — they just want to decide describe the issues

Dear David

I understand that the Review Panel intends to publish an “Issues Statement” prior to undertaking its proposed consultation process on the ETS Review 2011. This will presumably provide a summary of the key issues seen to be raised by the Review’s terms of reference – and might also present the Panel’s preliminary views on some or all of those key issues.

I would like to put forward some suggestions regarding 10 matters the Panel might consider appropriate for inclusion in the Issues Statement.

HELPING NEW ZEALAND TO DELIVER ITS ‘FAIR SHARE’ OF INTERNATIONAL ACTION TO REDUCE EMISSIONS, INCLUDING MEETING ANY INTERNATIONAL OBLIGATIONS

Expectations of international negotiations have changed enormously since the ETS legislation was before Parliament in November 2009. In particular:

• USA, Canada, Japan and Australia have all rejected their proposed ETS mechanisms.
• No other country has enacted any form of ETS since the EU in 2004.
• No other country has sought to suppress emissions by ‘putting a price on’ motor spirits; or on any greenhouse gases other than carbon dioxide.
• There is now little prospect of any ‘second commitment period’ under the Kyoto Protocol.
• No legally binding international treaty is likely to be agreed within the next few years.

During 2009, Ministers frequently explained that New Zealand ought not to be seen as “lagging” international efforts to combat climate change, lest its exports attract formal or informal barriers. This perceived threat has now dissipated, as have most concerns regarding potential reputational costs.

As New Zealand’s aggregate emissions remain less than 0.1% of world totals, our actions cannot have any material effect on the future global climate.

Issue 1: What is the current level of “international action to reduce emissions”, and how should it be quantified?

Under this heading, it is especially important to separate achievement from rhetoric, and current efforts from historic (eg 1990s) events.

It is submitted that international comparisons should focus on trading partners – and quantification should perhaps be trade-weighted. The Commonwealth, or English-speaking countries, might comprise another comparison group. If “rich countries” are to be a comparator, they should be ranked by GDP-per-capita and include non-members of the OECD.

Issue 2: How should New Zealand’s ‘fair share’ be quantified?

This question was addressed in the paper prepared for the cabinet meeting of 10 August 2009, in the context of the 2020 Emission ReductionTargets.

MfE explained the concept of “Equal Cost” at para 37, which was supported at para 80 as follows:

“Treasury agrees that New Zealand should do its fair share as part of the global climate change response and considers that this should mainly be assessed by comparing the relative costs incurred by countries in meeting their announced targets.”

“Equal cost” should be assessed as a GDP percentage, and take into account a range of national circumstances including population growth, relative wealth, and mitigation potential. The cabinet paper mentions two consultancy reports (IIASA and Greenland dialogue) which discuss the outcomes of appropriate methodologies.

The Australian Productivity Commission is to report by May 31 on the “effective carbon price” brought about by emission reduction policies in a range of relevant countries. www.pc.gov.au/projects/study/carbon-prices. No doubt the Panel will consult with the Commission in the course of preparing its Issues Paper.

Issue 3: What are New Zealand’s current international obligations?

The quantified obligations under the Kyoto Protocol will likely expire at the end of next year, and observance through 2012 will not be much affected by the recommendations of the Review Panel.

The responsibility target for 2020 will not come into effect unless and until its several conditions are satisfied, which is unlikely to occur in the period affected by the Review. The 2050 target is no more than an aspirational slogan.

No doubt New Zealand bears an inchoate obligation to contribute our “fair share” to the achievement of the international objective to see global average temperature increases limited to 2°C. How that relates to 2011 ETS operational issues is arguable to an endless degree. At this time, the manner of interpreting and discharging that obligation is a domestic political matter for the New Zealand Government alone.



Issue 4: Is ‘scaling up to a full obligation’ necessary to ensure New Zealand undertakes its ‘fair share’ of international action?

The answer to this issue is obviously dependent on the outcome of Issues 1-3 above. But New Zealand has already taken carbon pricing further than any country outside Europe, and has broader coverage than the EU scheme. Scaling up seems very likely to position this country as a ‘world leader’ – a status clearly eschewed by the present Government.

DELIVERING EMISSION REDUCTIONS IN THE MOST COST EFFECTIVE MANNER

The Government has taken the decision that “pricing emissions is the most efficient way of addressing climate change.” This is because price penalties for high-emission activities (a) reduce demand and (b) encourage the use of substitutes. But energy is notoriously price-inelastic in most applications, so almost all of the practical effect must be achieved through re-directing economic actors into low-carbon alternatives (including efficiencies).

If no ‘low-carbon alternative’ is available (or reasonably in prospect) in respect of any activity or sector, then a price increase by application of the ETS will not be cost effective.

Issue 5: Will it be cost effective to extend ETS coverage to methane and nitrous oxide?

It is not cost effective to force a reduction in the carrying capacity of New Zealand farms. No other countries price these emissions by their agricultural sectors, and we must compete with those countries.

Issue 6: Should the ETS be removed from motor spirits?

If the Panel concludes that New Zealand is currently exceeding its ‘fair share of international action’ (above), a sensible balancing could be achieved by suspending the application of the Act to liquid fuels. Suspension would allow simple re-application if and when justified by the activities of our trading partners.

No other country applies carbon pricing to petrol, diesel and aviation fuel. Australia exempted these fuels from its CPRS, and will probably do likewise for its recently-announced carbon tax. The EU ETS picks up diesel used for electricity generation, but all vehicle fuels are exempt. The Cap-and-Trade Bill debated extensively in USA would also have exempted liquid fuels, as would mooted legislation in Canada and Japan.

Is it reasonable to assume that New Zealand policymakers have insights denied to those in every other country?

When oil prices soared in 2008, we learned (again) that fuel demand is supremely inelastic. No substitutes are in short-term prospect, except in trivial volumes. The impost on motor fuel is simply an inefficient and regressive tax (which was partly responsible for the country’s negative GDP in Q3 last year) which delivers no measurable emission reductions.

Originally, the fuel impost might have been expedient to deliver sufficient funding for the Government to pay its $1.7 billion debt to the forestry sector. But that ‘earmark’ will expire when the debt is satisfied – by July 2012.

At a time when oil prices are rising rapidly, a reduction in fuel costs will handily offset cost inflation and delay the time when the Reserve Bank feels obliged to raise the OCR.

Issue 7: What is the ‘Regulatory Impact’ of the ETS?

To judge the cost-effectiveness of delivering emission reductions, one needs to know something of the costs being incurred. This has long been elusive, leading to strong Treasury criticism of the RIS which accompanied the Amendment Bill in 2009.

Earlier attempts to quantify the costs and benefits of the ETS were abandoned by the Select Committee set up following the 2008 election.

In lieu of assessing cost-effectiveness, policy was based on the modelling exercise reported by NZIER/Infometrics in July 2009. But it was a key assumption of that project that a liquid international market in ‘carbon credits’ would be rapidly established. That assumption was based on various expectations which have not been fulfilled.

The Review Panel should enquire into the ramifications of the ETS ceasing to be a true trading scheme, and the impact of removing the $25 fixed price option. In particular, it should commision further modelling to be undertaken, based on 2011 conditions.

SUPPORTING EFFORTS TO MAXIMISE THE LONG TERM ECONOMIC RESILIENCE OF THE NEW ZEALAND ECONOMY AT LEAST COST

Insofar as the ETS brings about a simple transfer from the private sector to the Government, then it is no more inefficient than any other tariff. But when it imposes irrecoverable costs on the tradeable sector, its costs will inevitably exceed its benefits. Economic cost would be minimised by targetting the impost solely at the non-tradeable sector – allowing the full cost burden to be passed through to ultimate consumers.
Apart from consumers, the major burden of the ETS has already been borne by farmers and non-energy-intensive manufacturers. The foreign exchange earned or saved by these sectors are key to the country’s long term economic resilience.

Issue 8: Should the ETS be removed from diesel fuel?

This is obviously a sub-set of Issue 6 dealing with all motor spirits. But its case is much stronger, because a tax on diesel is virtually a tax on exports. All New Zealand’s key export industries – pastoral farming, horticulture, fisheries, forestry, tourism – are powered by diesel. All of these enterprises are “price takers” and ETS costs (both direct and indirect) go straight to the bottom line.

As profitability of the tradeable sector declines, so investment and effort flows into the ‘cost plus’ areas of the economy, defeating the Government’s announced intention to achieve an overdue rebalancing.

A diesel impost meets the Australian description of “a great big new tax on everything”. Most of the freight transport system is dependent on diesel, and New Zealand’s geography ensures transport is a significant cost component in almost all consumer goods.

Issue 9: Should the wholesale electricity market be amended to exclude windfall profits being awarded to non-fossil-fuel generators?

As the costs of fossil-fuel power stations determine the New Zealand-wide half-hour spot price for about 90% of the time, their carbon charge becomes additional unearned profit for all of the stations using non-carbon fuels. While this may be justified for new technologies (wind, solar) it offers no useful incentives for the long-established hydro stations which comprise over 70% of New Zealand’s power supply. It simply imposes a wholly unnecessary cost.

Electricity is similar to diesel in that a systemic price increase raises production costs throughout the entire economy, and renders the country less competitive. Unlike GST, energy imposts cannot be drawn back at the frontier.

Most of the windfall profit flows to the Government, which has recently expressed embarassment at the swollen dividends it receives from SOE generators. Whether a policy change might trigger any claim for compensation by private generators (Contact, Trustpower) should be explored by the Panel. Any adjustment to the rules of the wholesale market will need to be undertaken before the mooted part-privatisation of energy SOEs.

Issue 10: Should forest production subsidies be permanent?

A major driver of the ETS was the Government’s need for carbon credits to compensate forest-owners for ‘nationalised AAUs’ being applied in satisfaction of the Government’s 2008-12 obligations under the Kyoto Protocol. Those credits, having a value of approximately $1,700 million, will have been received and disbursed by 30 June 2012.

In the absence of any post-2012 legal obligation, can ongoing Government support for commercial tree-planting be justified?

This question needs to be addressed on several levels. Do production subsidies breach our WTO obligations? Is ‘corporate welfare’ and ‘picking winners’ consistent with the Government’s economic objectives? Do artificial farming/forestry distortions produce net economic benefit? Does long-term preservation of plantation forests produce environmental benefits?

Insofar as the world values the CO2 absorption of new trees, New Zealand forest owners should be encouraged to sell their certified carbon credits into the world market (just as they sell the eventual lumber). But it is far from obvious that the New Zealand Government should stand as permanent guarantor of that market’s prices – or any other price level.

I hope the foregoing may be of some interest to Panel members during the process of formulating their Issues Statement. I will look forward to offering additional comments during the formal consultation period.

Barry Brill OBE

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