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Emissions Trading Scheme facing significant challenges

Geoff Thompson, New Zealand Tree Grower February 2012.

The Cabinet is expected to make decisions very soon about the recommendations of the ETS Review panel’s report. It will be dealing with them in the context of the latest moves in the international climate change dance of two steps forward and at least one step backward which came out of the Durban conference.

The ETS is giving a boost to forestry by introducing another income stream from growing trees. Climate Change Minister Dr Nick Smith regularly talks about the benefit to New Zealand’s carbon emissions position from planting more trees. It now looks as if about 12,000 hectares of new planting in 2012 on Kyoto compliant land can be expected. But the current picture is becoming murky and the government has within its power the opportunity to improve clarity in the scheme.

Free market failure

The ETS Review was undertaken in 2011 as a legislative requirement. At a high level it was determined that the scheme was fit for purpose and represented a fair response to New Zealand’s international greenhouse gas obligations. The result was to recommend extending the transactional measures for major emitters, add several sectors to the scheme and introduce a number of provisions to improve the position of forestry.

However the financial meltdown in Europe in late 2011 undermined a key feature of our ETS design. This was relying on a free market to set the price of carbon units. Before Christmas the New Zealand unit (NZU) spot price had dropped to below $8 from over $20 in the middle of 2011. This is because New Zealand emitters can satisfy their surrender requirements with cheap units bought from the European market. In Europe, demand has plummeted as industrial activity has reduced and governments cash up their units in search of funds.

The ETS Review

The Review recommended urgent consideration be given to banning cheap and dubious industrial hot air units. The government has acted on this after a consultation about when the ban should be applied. In an announcement on Christmas Eve, these HFC 23 and N2O units can no longer be surrendered by New Zealand emitters and any bought in advance will lose their currency on 1 June 2013.

The government should be bolder, and take the next step, by signalling that a form of quota on the percentage of imported units that can be surrendered by emitters will be introduced. This is common internationally, notably in Australia which is drawing more closely to alignment with New Zealand as it works toward an ETS of its own in 2015. Foresters need a stable and realistically priced market to provide the encouragement for participation and planting.A low NZU value undermines the purpose of the scheme.

The purpose of the ETS

The ETS is New Zealand’s principal response to international obligations made for the Kyoto Protocol. New Zealand pledged to reduce its greenhouse gas emissions in 2012 at the end of the Kyoto period to the levels of 1990. Its emissions commitment was helped by having existing pre-1990 forestry carbon credited against greenhouse gas emissions. Along with the credits from subsequent forestry this suggests that New Zealand will meet its 2012 Kyoto target without a penalty. This is unlike Canada which faces an $18 billion cost and announced a rejection of its commitment at Durban and withdrawal from Kyoto.

It is all very well to apply netting-off figures but it masks the real purpose of a climate change response policy. The aim was to change people’s behaviour by applying a charge for carbon emissions, and from this cost persuade people and industry to emit less carbon. It is a long game and the ETS design and use of forestry as a netting-off mechanism has to apply a long horizon, at this stage looking out to 2050.

However with the ETS costs determined by a free market and that market dropping to unrealistic levels, the cost of emissions built into fuel and electricity prices is very modest. It is probably not enough to influence greenhouse gas reduction activity. So the Review’s conclusion that the scheme is fit for purpose is heavily conditional on realistic price cost signals getting through to the consumer and industrial emitters. The push for green-tech solutions slows down if the price signals are muted.

The signal for forestry

The ability to sequester carbon in new forest plantings is a natural advantage available to New Zealand as a successful plantation forest grower. Currently the outlook for New Zealand’s emission profile is grim. Harvesting of the large plantings from the 1990s spikes in the mid 2020s. The Review panel proposed a number of ideas to encourage new planting to build up carbon stocks and smooth the emission profile.

The panel listened carefully to submissions from forestry leaders, including the NZFFA, about ways to encourage new planting. MAF and MfE have been working through details of how these proposals will work, to back up the Cabinet papers proposed for February. The most consistent call was for certainty in the scheme, because forestry is a long term proposition, and for ways of moderating the harvesting liability for foresters who have claimed carbon credits during the growing cycle as cash flow benefits.

The recommendations cover a number of points. The main ones are −

  • An averaging regime to remove harvesting liability
  • A self-insurance pool to cover catastrophic events
  • Review legal barriers to the amalgamation of forest blocks
  • More flexible options for measurement of forest carbon
  • Continued advocacy for credit to be available for retained carbon in harvested wood products.

The Durban effect

Government Ministers applied a positive spin to the result of the UN Durban conference in December. It was an agreement to agree in the future and now involves countries previously resistant to inclusion in international carbon reduction commitments.

It has given Kyoto countries the opportunity to review their individual rules beyond 2012. This was anticipated in the Review where it was recognised that New Zealand could change some rules to better suit forestry, as long as the NZUs from forestry were tradable internationally. The panel anticipated that bi-lateral trading arrangements would be possible, for example with California.

The Durban outcome does confirm the slow, reluctant acceptance of commitments to reducing greenhouse gas and the validity of New Zealand’s scheme. It is seen as a model for countries looking to provide their own response – such as Chile. This country sent a delegation of forestry officials to New Zealand late last year to get experience and advice on a scheme.

Pre 1990 forestry

As mentioned our pre 1990 exotic forestry stocks were used by the government to gain a favourable measurement on the introduction of the Kyoto Protocol. Having gained the credit the government requires all pre 1990 forestry land to stay locked into forestry in perpetuity.

In a modest concession to an outcry from foresters about this restriction on land use and the likely loss of value, an allocation of NZUs was made in July 2010, issued in two parts. Deforestation − a change of land use − involves heavy penalties calculated on the value of the carbon locked up in the block. However it has long been recognised that forestry is not necessarily the highest and best use of the land. A regime has now been accepted internationally to allow a switch to replanting a harvested pre 1990 forest on other Kyoto compliant land to produce equivalent carbon value. It is called off-setting.

However the government has proposed that with this option being available, the second tranche of compensation will not be available on the grounds that the loss of land value does not occur. At the time of writing this article the government position on compensation is being challenged.

Carbon farming and the new income stream

The market for poorer grade hill country farms is now finding a new market with a number of local and Australian carbon farming operations competing for offerings. This is keeping prices relatively high at over $3,000 a hectare for plantable areas. That requires a robust carbon price to provide the return, but this is also a long game and like forestry generally, there will be highs and lows.

The ETS offers foresters, and farmers with plantable land, a new business opportunity. It has been rare to plant trees and receive any sort of income before maturity. At the very least, plans can now be made to secure a harvesting payment in advance and cash in carbon credits earned during the growing cycle. This can start at year five and can be regularly claimed. The easiest approach is to use MAF’s conservative look-up tables for carbon values, but if the plantation is big enough field measurement costs can be justified to seek higher readings. The expectation is that actual harvest values can ultimately cover the NZU surrender liability. However this needs to be monitored like any land based product and adjustments made if necessary.

Registration and mapping for participation is simple with MAF online tools now well developed. From early 2012 the Environmental Protection Agency will take over administration of the ETS and hopefully continue to support work on a number of technical issues that are being identified about the ETS forestry rules.

This new business sector is a work in progress. The international development of carbon trading systems will continue slowly but surely. The benefits and technicalities of participation will improve as carbon liability is moderated. I am also sure that the prime point of the scheme will be more readily recognised by having a trading market that sends signals which really will change behaviours. Watch this space.


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