Motu Economic and Public Policy Research

The six papers on this page are designed to introduce the issues surrounding emissions trading for a non-technical audience. Each paper can be downloaded either in summary form by clicking on the link at the end of each introductory paragraph, or in full. The full-length articles are 5-6 pages long.

1. Cap and Trade System

In a cap and trade system, the ‘cap’ restricts how many GHGs can be released in a specified time period. This forces people to significantly reduce their GHG emissions. The cap is broken into a number of ‘emission units’. In a comprehensive cap and trade system, the total emissions in the economy can’t be greater than the total number of emission units.

The cap determines the environmental impact of the system. Trading creates flexibility in terms of where, how and by whom emissions are reduced. Emission units can be bought and sold. As long as the cap is not exceeded, it doesn’t matter where emissions are reduced.  Flexibility is essential if we are to reduce our emissions at the lowest economic and social cost.

One page summary: How a Cap and Trade System Functions

Kerr, Suzi and Murray Ward. 2007. “Emissions Trading in New Zealand: Introduction and Context,” paper prepared for New Zealand Climate Change Policy Dialogue, 20 September.

2. The Risk of Emissions Leakage

In a world where not every country has the same climate change policy,  there is a risk of emissions leakage occurring. When New Zealand implements an ETS, the resulting increase in production costs could mean that some exported products are no longer competitive, or products imported from other countries with less stringent climate policies are substituted for domestic products. This could cause some production activities to head off-shore, leading to job losses and no ‘real’  decrease in GHG emissions.

These problems could be reduced if they are effectively addressed in the design of the ETS. There are two potential solutions: we could allocate emissions units (New Zealand Units) each year to GHG-intensive firms or we could introduce a ‘border tax adjustment’.

One page summary: The Risk of Emissions Leakage

Greenhalgh, Suzie, Jim Sinner and Suzi Kerr. 2007. “Emissions Trading in New Zealand: Options for Addressing Trade Exposure and Emissions Leakage,” paper prepared for New Zealand Climate Change Policy Dialogue, 21 September.

3. Points of Obligation

In any industry, there is a vertical chain of production and consumption,  with several ‘layers’ from initial production to final consumption.  For example, in the electricity sector fuel is imported and sold to generators; generators use fuel to create electricity which is sold to retailers; retailers sell the electricity to businesses who use it to create products that they sell, and to households who use the electricity directly.

The ‘points of obligation’ in an emissions trading system are the entities in each industry that are required to report a defined set of information.  This information is used to model the GHG emissions relating to each chain of production and consumption.  The points of obligation must then surrender sufficient emission units to match those GHG emissions.

One page summary: Choosing a ‘Point of Obligation’

Small, John and Suzi Kerr. 2007. “Emissions Trading in New Zealand: Points of Obligation,” paper prepared for New Zealand Climate Change Policy Dialogue, 24 September.

4. Managing Economic Risk

An Emissions Trading System helps reduce global climate change, lowers the risk of New Zealand non-compliance with Kyoto, and reduces the risk that controlling New Zealand’s emissions will be extremely expensive to the economy.  It also introduces the risk that the price of emission units may be very high and volatile.  This is a particular risk in the short run when international trade in emission units is new and trading rules are still being established in all countries; it is unclear how New Zealanders will be able to buy and sell in international markets and prices are likely to be very volatile.

One page summary: Managing Economic Risk

Kerr, Suzi. 2007. “Emissions Trading in New Zealand: Managing Economic Risk,” paper prepared for New Zealand Climate Change Policy Dialogue, 25 September.

5. Transition Into and Evolution of an Emissions Trading System

An Emissions Trading System is not a static institution.  It needs to evolve in response to changes in international climate agreements, new science, and domestic learning and adaptation.  It is helpful to think of three periods across which the system must evolve.

One page summary: Transition Into and Evolution of an Emissions Trading System

Kerr, Suzi and Ralph Chapman. 2007. “Emissions Trading in New Zealand: Transition and Evolution,” paper prepared for New Zealand Climate Change Policy Dialogue, 25 September.

6. Allocating Emissions Units

New Zealand firms will be better off overall if we meet our international obligations with an emissions trading system than without. Some groups will however win while others lose. With no free allocation of emission units,  the distribution of costs across the economy is equivalent to under a carbon tax.  There will be one-off costs/gains to ‘stranded assets’ when the system is introduced. Stranded assets are capital assets (including land, forests and human skills specific to a particular industry) that are suddenly worth a different amount once the system is introduced.

One page summary: Allocating Emissions Units

Full paper not available.