Re-activating the NZ ETS

May 12, 2016

While New Zealand’s Emissions Trading Scheme (NZ ETS) was a world first in many respects, it was calibrated to operate in a world which no longer exists.

“Fundamentally, the NZ ETS offers a sound foundation for supporting New Zealand’s contribution to global mitigation effort. For most sectors it is simple and administratively it works well,” said Suzi Kerr, Senior Fellow at Motu Economic and Public Policy Research.

Dr Kerr was heavily involved in the initial design of the NZ ETS and was recently employed by the World Bank and International Carbon Action Partnership to lead development of a handbook for jurisdictions wanting to set up their own trading system for emissions.

New Zealand’s emissions – both gross and net (including forestry) – have increased since 1990. Projected emission trends through 2030 suggest the New Zealand government will need either more effective domestic policies or international mitigation credits to achieve its promised 11 percent reduction below 1990 levels. Currently New Zealand doesn’t have access to mechanisms for purchasing such credits.

As of 30 June 2015, there were 329 mandatory participants and 2,207 voluntary (mostly forestry) participants using the NZ ETS. The annual cost to the government of implementation and administration in the 2014–15 financial year was $6.4 million. The system covers roughly half of New Zealand’s emissions.

Kerr and her colleague at Motu, Catherine Leining, have a plan for how to re-activate the NZ ETS as an effective tool to support New Zealand’s transition to a low-emission economy.

“A market cannot function when no one can predict supply. The first thing the NZ ETS needs is greater certainty over the domestic supply of units by fixing a cap on units issued into the ETS other than for removal activities. This option was legislated but has never been implemented,” said Dr Kerr. “Greater certainty over the future supply of international credits could be provided by clearly signalling that once market access resumes – which may not happen for an extended period – it will be limited and strictly controlled. These changes would help focus domestic attention on domestic mitigation.”

“In addition to fixing a cap in the short term, there is merit in setting a longer-term trajectory for both emissions and emission prices. This would signal to investors how quickly we aim to reduce our domestic emissions and how much effort we expect to make,” said Dr Kerr. It would also guide policy makers in setting future caps and rules on the use of international credits and price protection measures. Confidence in low-emission investment is really important for New Zealand’s cost-effective transition. Providing clarity around policy intentions is a key step.”

“The NZ ETS is the only ETS in the world that has operated without any constraint on domestic emissions or longer-term mitigation pathway. Ultimately New Zealand needs to transition to net-zero domestic emissions of long-lived greenhouse gases and to substantially reduce emissions of methane, which is shorter-lived,” said Ms Leining. “The cap trajectory should reflect New Zealand’s international targets, the desired rate of domestic decarbonisation, the relative contribution toward target achievement from capped and uncapped sectors, and the operation of other mitigation policies.”

A particularly contentious issue has been the system’s past acceptance of international credits in unlimited quantities and with questionable environmental integrity. The system delinked from the international market on 1 June 2015.

“At the moment there is no mechanism for New Zealand to fund and take credit for emissions reductions abroad so the NZ ETS price will be determined by the cap we choose and the reductions we can do within New Zealand,” said Dr Kerr. “If future access to international credits becomes feasible again, then we’ll need limits on international credits to safeguard environmental integrity and manage domestic prices. One option would be for the government to assume responsibility for purchasing international credits and managing the corresponding supply of units in the NZ ETS.”

Another contentious issue is how to manage the substantial ‘bank’ of NZUs held by NZ ETS participants as well as the government’s target surplus from the 2008-2012 Kyoto commitment period.

According to Ms Leining, “Banking provides flexibility and liquidity while reducing price volatility. As long as mitigation ambition is increasing and banking incentives are retained, then the domestic price will be set by longer-term expectations of unit supply and the price will rise. Protecting units that have been banked is critical for market confidence in the ETS.”

Both Dr Kerr and Ms Leining emphasise the vital importance of policy stability.

“The history of the NZ ETS means that it’s been a bit of a political football. That sort of volatility makes it very difficult for everyone involved in a trading scheme, so government has to reach cross-party consensus on how to move forward,” said Dr Kerr.

“Once we have a cap that is clearly linked to our international targets and other domestic mitigation policies, a longer-term vision for New Zealand’s emissions and predictable ways to make adjustments as conditions change and we learn, we could have a system that drives an effective transition to a successful low-emission economy,” said Dr Kerr.

A recent academic paper by Ms Leining and Dr Kerr outlines how the NZ ETS has worked over the last eight years with the aim of identifying how it could be improved.

Dr Kerr and Ms Leining have just released their submission to the Government’s review of the emissions trading scheme that examines these issues in more detail.