NEWS ON POLICY AND POLITICS
21 September, 2007

Watching Brief is a regular publication from Russell McVeagh on developments in public law and policy of interest to New Zealand business.

www.russellmcveagh.com

Welcome To The NZ ETS and NZU

In yesterday's long-awaited announcement, the Prime Minister confirmed the Government's plans to move New Zealand to a world-first carbon neutral energy position by 2040 with the introduction of a domestic emissions trading scheme (to be called the "NZ ETS"), beginning on 1 January 2008.  Legislation is to be introduced by the end of the year.

The Prime Minister, Treasurer Hon Michael Cullen, Hon David Parker (Minister for Climate Change Issues) and Hon Jim Anderton (Minister of Agriculture and Forestry) were all quick to point out that New Zealand is looked to by the world as an environmental leader and provider of solutions.  Over time, the Government sees yesterday's announcements and plans as providing New Zealand with a significant global competitive advantage.  The Prime Minister said these plans were necessary to pre-emptively protect our markets for the long-term.

In financial terms, the Government has decided to be "relatively generous" in terms of allocating (or 'gifting') free "New Zealand Units" (NZUs) - the currency of the new ETS - to certain emitters over the next few years, and especially to the agriculture sector when it joins the scheme in 2013.  The Government has confirmed at the same time that it will not provide any windfalls to firms whose profits will be largely unaffected by the introduction of the ETS (such as the fuel companies and renewable electricity generators). 

Due to the staged introduction of the various sectors up until 2013, the ETS will not fully distribute the cost of New Zealand's Kyoto Protocol obligations to emitters during the first commitment period (2008-2012).  It has signalled that some ongoing taxpayer support may continue beyond 2012.  The Government is confident, however, that the ETS will only affect GDP by 0.1% until 2010, with Michael Cullen confirming that these climate change initiatives are at the heart of the Government's economic transformation agenda.

It appears that the Government has a good level of cross-party support for the announced plans.  Although the Greens are not happy about the long phasing-in period and, in particular, the delayed introduction for the primary sector, overall they support the ETS design.  National has also come out in support of the package, but would like to see additional amendments to the Resource Management Act to assist new renewable projects in getting off the ground more easily (the documents released yesterday indicate that the Energy Strategy to be released in the next few weeks will "look at the role of the RMA" in this area).

Although the Prime Minister has signalled in recent days that low and fixed income New Zealanders would be entitled to compensation due to the likely increased costs, her announcement yesterday did not go into any further detail in this area.  She indicated that "additional measures" to reduce the possible financial impacts will be announced at a later date.

Summary
Overall, the Government's announcement has been met with wide support and cautious optimism at the proposed benefits and apparent minimal drawbacks for the economy as a whole. 

There are still some big questions to be answered in the upcoming months - and especially for forestry owners and fuel companies as they prepare for the introduction of the ETS next year.

The biggest obstacle now will be for New Zealand firms, and especially those who are emitters, to get up to speed on the complexities of the new regime.  There will be plenty of opportunities arising, both in terms of new products and technologies as well as marketing and branding initiatives, in addition to the new financial costs (including compliance costs) imposed under the new regime.

NZ ETS

The proposed ETS will be phased in for the major sectors as follows:

Why an ETS?
The ETS has a number of advantages over other mechanisms for emissions reductions:

• It provides the Government with relative certainty about the domestic volume of emissions given the registration, monitoring and reporting requirements for emitters (and is the best option available for ensuring actual reductions);
• It has linking capabilities with the international market which minimises the risk to taxpayers of overshooting or undershooting the Kyoto Protocol (and future international) commitments; and
• It provides businesses with flexibility by enabling them to reduce or offset their emissions by accessing emission reduction opportunities at the lowest cost.

It is predicted that only 200 participants will be directly involved.

Design details

• A limited number of NZUs will be issued each year, and the scheme will operate within the global cap on emissions set by the Kyoto Protocol.  This means that there will be no specific cap on domestic emissions - ETS participants will help New Zealand contribute to its Kyoto Protocol obligations which the Government needs to account for after 2012;
• The currency for the new ETS will be the NZU.  One NZU will equal one tonne of Greenhouse gas emissions (as specified under the Kyoto Protocol);
• All sectors will be phased in to the new regime between 2008-2013;
• The Government will devolve carbon credits to landowners for forestry activities that lead to the removal of CO2 from the atmosphere (ie planting new trees post-1990); and associated forestry liabilities will be imposed for the release of CO2 into the atmosphere (ie harvesting or deforesting);
• The scheme will allow full international linking with other global emissions trading schemes - allowing the purchase and sale to/from overseas buyers and sellers - this will assist in the market's liquidity; and
• There will be 3 types of participants: those with obligations to surrender NZUs to cover their emissions; those that receive freely allocated NZUs, or hold NZUs which can be traded to other parties; and those that engage in trading activities for commercial purposes.

There are still a number of design decisions to be made, especially in relation to how the forestry and liquid fossil fuels sectors will be brought into the scheme initially.  The Government has identified a series of preferred options in order to further engage with stakeholders over the next month.  These decisions will be made prior to the introduction of the legislation before Christmas.

Impacts of the NZ ETS
The desired impact of the NZ ETS will be to change investment and consumption behaviours by integrating a price for emissions into decision-making by producers and consumers.

Introducing an emissions price will increase the cost of transport fuels and other non-renewable energy (eg coal and natural gas), and will cause relative price increases in other sectors that involve emissions (eg industrial processing and agriculture).

Aspirational Targets

The following long-term targets have been set to help NZ achieve our ultimate goal of 100% carbon neutrality:

• 2020: net increase in forest area of 250,000 hectares (2007 baseline)
• 2025: 90% renewable electricity generation
• 2040: per capita transport emission reduced to half of 2007 levels
• One of the first countries (if not the first) in the world to widely deploy electric cars

Forestry

There will be a significant element of satisfaction felt by owners of post-1990 forests with the announcement that the Government has finally agreed to devolve 100% of the carbon credits (and liabilities) to the owners of Kyoto forests planted after 1 January 1990.  For those Kyoto forestry owners who do not wish to take up this opportunity, they can choose instead to receive cash payments under the new Afforestation  Grants Scheme (AGS) which will comprise $50 million in funding for new forests planted after 1 January 1990.

The bad news in the forestry sector comes for those owners of exotic non-Kyoto forests (planted before 31 December 1989) who will be penalised if they choose not to replant their trees following harvest (exemptions will apply for small holdings less than 50 hectares).  The rationale behind this is that New Zealand can't afford to lose any more trees (which are used to offset our total emissions under the Kyoto Protocol) to alternative and more profitable land uses such as dairy farming.  Deforestation rates have been increasing at an unprecedented rate over the past few years, and are set to continue over the first Commitment Period.  For each hectare of non-Kyoto forest that we lose, New Zealand must account for the increased emissions result (because the deforested trees are not offsetting emissions anymore).

Under the new ETS, the forest owners will be 'gifted' partially free credits on the basis of their forest landholdings.  Due to Kyoto Protocol accounting, however, this is estimated to equate to only $585 per hectare - which leaves the remaining $11,500 cost for the landowner to meet.  This will have a drastic impact on proposed land conversion plans, and new dairy conversions are likely to be halted.

The first reporting period for forestry owners under the ETS will be 2 years (compared to the one year period for all other sectors).  This means that they will initially be able to trade units with the transport sector.

No decisions have been made yet on indigenous forests (mostly owned by Maori and the Government).  These decisions will be the subject of further consultation and engagement in the near future.

Transport

The ETS will cover liquid fossil fuels including petrol, diesel, aviation gasoline, jet kerosene, light fuel oil, and heavy fuel oil.

Because the ETS takes its overall guidance from the Kyoto Protocol system, international aviation and marine transport emissions will be exempted from the scheme.

The point of obligation under the ETS will be the top of the supply chain - focusing predominantly on the oil refineries and importers of refined oil products (ie BP, Caltex, Gull, Mobil and Shell).  Although the costs will be imposed on the fuel companies, it is expected that the costs will be passed on directly to consumers at predicted higher costs of 4-9c per litre.

A Transport Strategy Plan of Action is due to be released around the same time as the Energy Strategy in early October.

Stationary Energy

Stationary energy includes all fuels used in electricity generation and in the direct production of heat in the industrial, commercial and residential sectors.  It does not include energy used for transport, or emissions from industrial processes.

It is expected that emissions trading within the stationary sector will increase electricity and other energy prices for consumers, placing more importance on energy efficiency and conservation.  This is because the electricity generators are expected to increase wholesale electricity prices (which will be paid for by consumers).  Given the design of the wholesale electricity market, electricity prices for all types of electricity, including renewable such as hydro and wind, will also increase.

More information on plans for this sector will be released in early October in the new Energy Strategy.

Industrial processes

The metal, mineral and chemical industries in New Zealand emit significant quantities of CO2, in addition to the other range of Greenhouse gases.  The products made by these industries include steel, aluminium, cement, burnt lime and glass, plus ammonia and urea.

Industrial producers are likely to face increased costs twice over via direct process emissions obligations as well as their high electricity consumption levels.  The Government will assist these producers by either reducing their emissions obligations, or through an allocation of free NZUs.

Agriculture

The primary sector, and specifically NZ's 40,000 farmers, will be breathing a sigh of relief given that the Government has listened to their concerns and has agreed to give them (and their cows) some breathing space until, for the most part, 2013.  The rationale for excluding the sector in the short-term is to protect against the possible loss of international competitiveness whilst science catches up in terms of reducing methane emissions.

The Government has acknowledged that this sector has significant adaptation issues in respect of emissions pricing.  It has agreed to stand by its promise in 2003 to meet the costs of non-CO2 emissions until the end of 2012 (in return for the industry agreeing to invest in research and development in this area).

The baseline for agricultural emissions will be set as at 2005, rather than 1990.  When the ETS applies in 2013, the Government will be prepared to 'gift' up to 90% of the 2005 emissions to the sector.  There are 3 options in respect of who will receive the free NZUs: individual farmers; companies and processors dealing with farm produce; or farming industry organisations (who would manage NZUs on behalf of farmers).

The sector will need to meet monitoring and reporting obligations from 2011, and will also be expected to take up new technologies as they are introduced for emissions reductions - such as the nitrogen inhibitors being encouraged currently.

Hon Jim Anderton noted that a key aim for this sector over the next 5 years will be living up to the "environmentally responsible" brand.

A further $175 million is to be invested in the agriculture sector in the next 5-8 years (mostly tagged to R&D).  One newly announced initiative is an investment in "Biochar" - a new form of carbon sink which is able to remove carbon from the atmosphere through plant growth, storing it as inert carbon in soils.  Biochar can then be used to make a bioenergy co-product that can be used to produce heating, electricity generation and other applications.

Waste

Methane and nitrous oxide are emitted via waste treatment and disposal (eg solid waste, wastewater facilities and incineration).

It is proposed that the ETS will apply from 2013 to methane emissions from solid waste disposal via landfills.

The Government is also set to introduce a national waste levy via the re-modelled Waste Minimisation (Solids) Bill which is to be reported back from the Local Government and Environment select committee within the next month.  The Government has developed a comprehensive Supplementary Order Paper which significantly amends the original Bill introduced by Green MP, Nandor Tanczos (with his agreement).

Offsetting

The Government is still considering introducing a domestic offsetting mechanism that could award NZUs for emission reduction activities not covered by the ETS.  This option could be needed for those emitters hit the hardest by the introduction of the ETS.

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