Climate Change (Emissions Trading and Renewable Preference) Bill

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Explanatory note

General policy statement

Climate change, and how we deal with it, is one of the most important issues of our time. The introduction of this Bill is a critical step toward New Zealand playing its part to address climate change.

The Bill’s principal purpose is to amend the Climate Change Response Act 2002 to introduce a greenhouse gas Emissions Trading Scheme in New Zealand (NZ ETS). The Bill also amends the Electricity Act 1992 to create a preference for renewable electricity generation by implementing a moratorium on new fossil-fuelled thermal electricity generation, except to the extent necessary to ensure the security of New Zealand’s electricity supply.

Emissions trading schemes are increasingly being established in a number of countries and regions around the globe. Over time, the NZ ETS will cover all gases and all sectors, in order to minimise overall costs to the economy and operate with efficiency and equity. The scheme will apply an economy-wide price signal to activities that contribute to climate change.

Climate change is a global problem and New Zealand is reliant on international action to mitigate the risks associated with increased concentrations of greenhouse gases in the atmosphere. The design of the NZ ETS is compatible with the United Nations Framework Convention on Climate Change (the Convention) and the Kyoto Protocol (the Protocol), but is designed to endure under a range of possible future scenarios for international climate change agreements.

The objective that guided the design of the NZ ETS is:

That a New Zealand Emissions Trading Scheme support and encourage global efforts to reduce greenhouse gas emissions by:

  • reducing New Zealand’s net emissions below business-as-usual levels; and

  • complying with our international obligations, including our Kyoto Protocol obligations;

while maintaining economic flexibility, equity, and environmental integrity at least cost in the long term.

The NZ ETS is designed to operate as an integral part of the government’s broader climate change, sustainable development, and economic transformation agendas.

The preference for renewable electricity generation augments the NZ ETS goal of reducing New Zealand’s net greenhouse gas emissions below business-as-usual levels. It does this by implementing a moratorium on investment in new fossil-fuelled thermal generation, except to the extent required to ensure security of supply. This will reduce the potential for fossil-fuelled thermal electricity generation to increase the level of New Zealand’s greenhouse gas emissions.

The NZ ETS and the renewable generation preference are part of New Zealand’s wider effort to meet its international commitments under the Convention and Protocol to implement policies and measures to reduce greenhouse gas emissions.

Consultation and Engagement Process

This Bill was developed after an extensive process of consultation and engagement.

In December 2006, the government released five energy and climate change discussion documents, and embarked on a significant consultation process on a number of policy options. The high level of public engagement and feedback showed that New Zealanders take energy and land use sustainability seriously, and are keen to be part of the solution. Over 3 000 submissions were received and over 150 public meetings and hui with Māori held.

Following this consultation, the government established a cross-departmental Emissions Trading Group (ETG) to develop a proposal for an NZ ETS. The ETG includes representatives from the Treasury and the following agencies: Ministry for the Environment, Ministry of Economic Development, Ministry of Transport, and the Ministry of Agriculture and Forestry. The ETG also works closely with the Department of Prime Minister and Cabinet, Te Puni Kōkiri, the Ministry of Foreign Affairs and Trade, the Department of Conservation, the Ministry of Science, Research and Technology, and the Inland Revenue Department.

On 20 September 2007, the government released its proposal for an NZ ETS, and began an intensive period of engagement on the core design features, and with particular regard to Māori and to those sectors entering the scheme first (forestry and liquid fossil fuels).

The engagement also included the establishment of a Climate Change Leadership Forum, to facilitate communication between the government and the broader community on the proposed design of the NZ ETS. The Forum will continue until mid-2008 and its considerations will be taken into account through the legislative process. Issues that are likely to be discussed include the treatment of pre-1990 forests, the type of emission units allowed into the NZ ETS, phase-out of free allocation, and whether an intensity-based approach can be included within an absolute cap of free allocation.

Engagement process will continue throughout 2008, including on those aspects of the NZ ETS that are to be governed by regulations. A number of mechanisms are in place to achieve robust input, including technical advisory groups for energy and industry, and agriculture. A Peak Group for the agriculture component of the NZ ETS has been established. These groups will provide input on a range of matters.

In the longer term, the government will continue to engage with the broader community on the future evolution of the NZ ETS in light of changes to New Zealand’s obligations under international climate change agreements. The Bill provides a process for review of the NZ ETS, prior to the end of the Protocol’s first commitment period and each subsequent commitment period.

In October 2007, the government released the New Zealand Energy Strategy (NZES) and adopted a target for renewable electricity generation of 90% by 2025. Consistent with this, the NZES states a clear preference that all new electricity generation be renewable, except to the extent necessary to maintain security of supply. The NZES signalled consideration of regulatory options under the Electricity Act 1992 to support this objective.

The development of the NZES involved a large number of organisations, associations, interest groups and individuals offering comment on the ideas and options contained in the strategy.

Structure of the Bill

Part 1

Part 1 of the Bill contains amendments to the Climate Change Response Act 2002 to introduce the NZ ETS.

Clause 4 of the Bill sets out the dates from which certain provisions of the Climate Change Response Act 2002, once amended, will apply. Individuals and firms within different sectors will first assume NZ ETS obligations from the date when the relevant parts of Schedules 3 and 4 apply.

The entry of sectors into the NZ ETS is based on sectors’ preparedness for trading, administrative feasibility and consideration of price effects through the economy.

The table below reports when each sector first assumes obligations and first must comply with those obligations under the NZ ETS. Subsequent compliance periods for each sector extend from 1 January to 31 December in each calendar year.

Staged entry of sectors into the NZ ETS

SectorCommencement of obligationsEnd of initial compliance period
Forestry Date the Act comes into force (but first compliance period starts from 1 January 2008)31 December 2009
Liquid fossil fuels1 January 200931 December 2009
Stationary energy 1 January 201031 December 2010
Industrial processes1 January 201031 December 2010
Agriculture1 January 201331 December 2013
Waste1 January 201331 December 2013

By 2013, all sectors and all six major greenhouse gases will be covered by the NZ ETS, so that all major sectors of the New Zealand economy will be exposed to the international price of emissions, at the margin, for all operations.

The existing provisions in Part 2 of the Climate Change Response Act relating to the Crown’s trading in Kyoto units are amended to allow for the introduction of the NZ ETS. These amendments are mostly contained in clauses 6 to 28 of the Bill.

The core provisions that implement the NZ ETS are contained in a new Part 4 of the Climate Change Response Act 2002, inserted by clause 43. Part 4 covers participants, participants’ obligations, allocation of New Zealand units, compliance and enforcement, offences and penalties, review and appeals, future development and Ministerial review of the scheme.

The NZ ETS is based on the concept that participants incur obligations by doing activities.

The NZ ETS reduces compliance costs by ensuring that the activities giving rise to obligations are as high in the supply chain as possible. The activities that bring a participant into the NZ ETS are listed in new Schedules 3 and 4. Where possible, activity is defined with reference to other regulatory regimes to which participants might be subject.

Activities listed in Schedule 3 are those activities undertaken in New Zealand that will automatically give rise to obligations under the NZ ETS—a person who does one of these activities must register as a participant under the scheme and comply with their obligations in respect of that activity.

Although some sectors will not be brought into the NZ ETS for some years, the Bill contains the activities for all sectors. The dates are included now to give certainty to the all sectors, all gases principle that underlies the NZ ETS.

Persons can also elect to become participants if they do activities listed in Schedule 4. Schedule 4 covers:

  • owners of, or holders of forestry rights/leases over, forests planted after 1989:

  • producers who embed carbon in their products:

  • major users of jet fuel used for domestic aviation:

  • major users of coal and natural gas.

There are likely to be less than 200 participants in the NZ ETS not including those in the forestry sector. The number of forestry participants could range from 2 000 to 9 000, depending on the number of post-1989 forest owners or forestry right/lease holders who decide to become participants in the scheme.

The main obligation that participants will have under the NZ ETS is to surrender emission units to match the emissions from their activities in each annual compliance period. Participants are also obliged to:

  • calculate their level of emissions, using prescribed methodologies:

  • retain sufficient records to allow verification of emissions calculations:

  • report their level of emissions:

  • provide information, if required by the chief executive (NZ ETS administrator), to allow the chief executive to verify compliance.

The methodologies prescribed in regulations will include formulas to calculate emissions, such as scientifically-determined factors that relate activities to emissions (eg, the quantity of carbon dioxide emitted when a litre of fuel is burned). They will also include methods for measuring activities directly or indirectly resulting in emissions.

Participants undertaking removal activities will also be able to earn emission units. Post-1989 forest land participants, and participants who embed carbon in their products, may elect to account for both their emissions (if any) and removals, and receive one New Zealand unit for each tonne of carbon dioxide stored in their trees or products.

The primary unit of trade in the NZ ETS is a New Zealand unit (NZU), issued by the government. For the first commitment period of the Protocol (2008–2012), each NZU issued by the government will be backed by a Kyoto unit held in a Crown holding account in the Registry.

Participants may surrender Kyoto units to meet their NZ ETS obligations (subject to some restrictions). Kyoto units can be acquired overseas or domestically. The Bill itself does not contain a provision to limit the volume of Kyoto units that can enter the NZ ETS, but gives the responsible Minister the ability to place restrictions on which classes or subclasses of Kyoto units may enter the NZ ETS and what transactions may or may not be registered in respect of those units.

The government has already decided to exclude certain units (eg, Certified Emission Reduction units from nuclear projects). The government is still seeking feedback on the need for other restrictions. The Bill places no restriction on the entry of AAUs into the NZ ETS; this has been welcomed by some and criticised by other domestic stakeholders, who have expressed concerns about potentially damaging the integrity of the NZ ETS, and reducing New Zealand’s prospects of linking with other countries’ schemes. Consideration of these views needs to be weighed against the costs of compliance without AAUs entering the NZ ETS and recognition of the fact that all Parties have agreed to the provisions of the Protocol. Maintaining the spirit of the Protocol is critical to negotiating future inclusive agreements.

The amendments to Part 2 of the principal Act are designed to permit bilateral linkages with other countries’ domestic trading schemes in the future.

In terms of trading, the NZ ETS is designed to allow flexibility in how participants trade units in the market, whether trading occurs via trading platforms, or via direct exchange. Any person eligible to open a holding account in the Registry (not just participants) will be able to hold and trade emission units).

Subpart 2 of new Part 4 contains provisions for the free allocation of emission units to the forestry, and to trade-exposed industry and agriculture sectors.

New section 69 establishes the level of allocation to pre-1990 forest land owners at 55 million New Zealand units. The treatment of pre-1990 forests relative to post-1989 forests (particularly the free allocation of emission units equivalent to 55 million tonnes of emissions to owners of pre-1990 forests) has been criticised by elements of the forestry industry. Further advice is being prepared for Ministers on options for targeting of free allocation for pre-1990 exotic forests, such as on the basis of restrictions on land-use change since 2002 (when the government first signalled there would obligations associated with deforestation).

Electricity generators and liquid fossil fuel providers are not likely to suffer major (negative) impacts on their profitability through the introduction of the NZ ETS, as they are likely to pass on any extra costs imposed by an ETS to consumers down the supply chain. Consequently, they will not receive transitional assistance.

The approach to assistance to industry and agriculture (sections 70 and 71) is to limit the total level of assistance to be provided by firstly identifying the initial level of assistance to be provided, and secondly, by defining the way forward (including phase-out of assistance by 2025):

  • The initial level of assistance to eligible trade-exposed industrial firms is 90% of their 2005 emissions from direct use of coal, natural gas or geothermal stream; direct consumption of electricity; and non-energy industrial processes.

  • The initial level of assistance to agricultural firms is 90% of their 2005 emissions of methane and nitrous oxide from eligible activities.

The government is continuing to engage with sectors on allocation plans and the emission abatement paths. This will occur via the Climate Change Leadership Forum, the Māori Leadership and Reference Groups, the Peak Group, and the Technical Advisory Groups.

New section 68 provides for the making of allocation plans by Order in Council. The plans will set out a maximum free allocation for each sector over 2008–2012 and 2013–2025 and specify who is eligible for a free allocation of NZUs.

Sections 72 and 73 contain the process to govern the making of allocation plans. Before recommending that an Order be made to issue an allocation plan, the Minister must notify his or her intention to make the allocation plan, gather information from people who may be eligible for an allocation of NZUs, and seek public submissions on the draft plan.

Provisions dealing with compliance and enforcement are in Subparts 3 to 5 of new Part 4.

The NZ ETS follows a self-assessment model. Under this approach, all the obligations placed on participants are clearly set out in legislation. Participants are required to submit annual emissions returns. Since this information will be of a commercial nature it will not be publicly available; nonetheless, certain information will be disclosed in aggregated form. The government is engaging on whether firms would be willing to report more frequently.

The chief executive will have the ability to audit the compliance of emissions returns submitted by participants. If participants fail to meet their obligations, or are shown to have failed to comply following an audit, financial and make-good penalties will apply, and will increase with the degree of culpability. To aid compliance, the chief executive will be able to issue advance rulings (called emission rulings), which will bind the chief executive to a particular interpretation of the legislation.

Ministers and departmental chief executives are the principal decision-makers under the NZ ETS. The Bill creates the right to seek District Court review of decisions. Appeals on questions of law will lie with the High Court.

New Part 5 of the Climate Change Response Act 2002 contains the provisions specific to the forestry, transport and stationary energy sectors.

The forestry-specific provisions in Subpart 1 of Part 5 cover:

  • The designation of forest land as either pre-1990 forest land or post-1989 forest land.

  • Changing the land use of pre-1990 forest land gives rise to mandatory obligations under the NZ ETS. Exemptions are available for deforestation on land-holdings of less than 50 hectares and of land containing tree weeds.

  • Owners of post-1989 forest land, or the holders of forestry rights/leases over post-1989 forest land, may elect to join the scheme (Schedule 4) to receive New Zealand units when their forest grows and surrender units when carbon mass decreases.

  • Registration as a participant in respect of post-1989 forest land, possible deregistration, and the associated entitlements and liabilities.

The transport-specific provisions (Subpart 2 of Part 5) cover the ability of major jet fuel users to assume obligations under the NZ ETS if they wish. The stationary energy-specific provisions (Subpart 3 of Part 5) mirror these provisions in respect of major coal and gas users.

Part 1 of the Bill also provides for the consequential amendments that are required to ensure other statutes are consistent with, and support, the introduction of the NZ ETS.

The Income Tax Act 2004 and the Income Tax Act 2007 are amended to provide for the taxation treatment of the forestry sector of the NZ ETS. Provisions relating to the tax treatment of the NZ ETS for other sectors will be included in a tax bill scheduled to be introduced in early 2008.

The Forests Act 1949 is amended to provide for the potential use under that Act of verifiers recognised under the Climate Change Response Act 2002 and methodologies prescribed under the Climate Change Response Act 2002 (as provided for in this Bill).

The Forestry Rights Registration Act 1983 is amended to remove certain definitions that are superseded by definitions in this Bill.

The Personal Property Securities Act 1999 is also amended to allow security interests over emission units to be registered in the Personal Property Securities Register.

Regulations

The principal features of the NZ ETS, including obligations on participants, are provided for in primary legislation. Regulations (as provided for in new section 148) will supply further technical details. The areas that will be covered by regulations include:

  • certain definitions where the definition may need updating on a regular basis (such as obligation fuel):

  • specification of the methodologies to be used to calculate emissions and removals:

  • exemptions from the NZ ETS:

  • the manner and form in which information is to be provided to the chief executive:

  • fees.

Part 2

Part 2 of the Bill amends the Electricity Act 1992 to create a preference for renewable electricity generation by implementing a moratorium on new fossil-fuelled electricity generation, except to the extent necessary to ensure the security of New Zealand’s electricity supply.

To help meet the government’s climate change objectives, the New Zealand Energy Strategy (NZES) contains a target for 90% renewable electricity generation by 2025, and states a clear preference that all new electricity generation be renewable, except to the extent necessary to maintain security of supply.

Modelling undertaken to support the NZES indicates that renewable generation is expected to be cost competitive with fossil-fuelled thermal generation, particularly under the range of potential carbon prices envisioned under the NZ ETS. It is feasible, however, that a combination of factors, such as a high exchange rate and low gas price (as could arise from a major gas discovery) could mean that, even with emissions pricing, fossil-fuelled thermal generation may become more economic. Unexpected high costs or other barriers to new renewables could also make fossil-fuelled thermal generation more economic.

Due to the economies of scale involved in electricity generation investment, any significant investment in fossil-fuelled generation could crowd-out renewable investment for a number of years. This would jeopardise the government’s climate change and NZES objectives and undermine public confidence in the climate change policy.

To minimise these risks, this Bill implements a 10-year legislative moratorium on new fossil-fuelled thermal baseload generation. This moratorium applies equally to all generators, whether state-owned or private, thereby ensuring competitive neutrality between generators with regard to the type of investments they can undertake. It is designed to influence generators’ investment decisions towards renewables in the short-term, allowing time for the full introduction of an emissions price via the NZ ETS, which will influence investment decisions over the longer term.

Part 2 of the Bill inserts a new Part 6A into the Electricity Act 1992 providing for a 10-year moratorium on new fossil-fuelled thermal generation. The moratorium will apply to all fossil-fuelled generation greater than 10MW in capacity. Nevertheless, because a moratorium on new baseload fossil-fuelled generation has the potential to adversely affect security of supply, the Bill provides for exemptions for specific fossil-fuelled generation proposals that address concerns over security of supply.

Applications for exemptions from the moratorium will be judged against a set of criteria aimed at addressing concerns over security of supply. Exemptions will be granted by the Minister of Energy on the recommendation of the Electricity Commission.

Clause by clause analysis

Clause 1 relates to the Title.

Clause 2 relates to commencement.

Part 1
Amendments to Climate Change Response Act 2002

Clause 3 provides that the principal Act amended is the Climate Change Response Act 2002.

Clause 4 inserts new section 2A, which concerns the application of various Parts of new Schedules 3 and 4.

Clause 5 amends section 3, which concerns the purpose of the principal Act. The amendment augments the principal Act’s purpose, providing that it includes implementing a greenhouse gas emissions trading scheme.

Clause 6 amends section 4, which concerns interpretation. The amendments account for the use of new defined terms.

Clause 7 amends section 7, which concerns the Minister of Finance giving directions to the Registrar regarding accounts and units. The amendments add surrender accounts and conversion accounts to the accounts for which the Minister of Finance may give directions.

Clause 8 amends section 10, which concerns the purpose of the Registry. The amendments specify the purpose of the Registry in relation to various units and the recording of certain information.

Clause 9 amends section 11, which concerns the appointment of the Registrar. The amendment omits the phrase of the Ministry responsible for the Registry.

Clause 10 amends section 14, which requires the Registrar to give effect to directions. The amendments provide that the chief executive may not give certain directions relating to certain operations in the Registry unless certain conditions are met.

Clause 11 amends section 15, which requires the Registrar to allocate unique numbers. The amendments account for New Zealand units and approved overseas units.

Clause 12 amends the heading to section 16, which concerns the carry-over of units. The amendment changes units to certain Kyoto units.

Clause 13 amends section 17, which concerns the commitment period reserve. The amendments account for the use of new defined terms.

Clause 14 amends section 18, which concerns the form and content of the unit register. The amendments account for the surrender and conversion of units.

Clause 15 amends section 18B, which concerns the closing of holding accounts. The amendments clarify the matters that are relevant to the chief executive when giving a direction to close a holding account, and replace the definition of reasonable notice.

Clause 16 amends section 18C, which concerns the transfer of units. The amendment clarifies that section 18C(3) applies to Kyoto units.

Clause 17 inserts new sections 18CA and 18CB. New section 18CA sets out the effect of surrendering, retiring, converting, and cancelling units except in accordance with section 30E(4)(c). New section 18CB provides that certain Kyoto units may not be surrendered.

Clause 18 repeals section 19 and substitutes new section 19, which provides for the retirement of Kyoto units by the Crown.

Clause 19 amends section 20, which provides that transactions must be registered. The amendments account for the use of new defined terms.

Clause 20 amends section 21, which concerns the registration procedure. The amendments account for the use of new defined terms, and clarify aspects of the registration procedure for Kyoto units in relation to the international transaction log.

Clause 21 inserts new section 21AA, which sets out the registration procedure for New Zealand units and approved overseas units.

Clause 22 amends section 23, which concerns receiving units from overseas registries. The amendments account for the use of new defined terms, and clarify that the section concerns Kyoto units.

Clause 23 inserts new section 23A, which concerns receiving New Zealand units and approved overseas units from overseas registries.

Clause 24 amends section 25, which concerns correction of the unit register. The amendments account for the international transaction log and overseas registries.

Clause 25 amends section 27, which requires certain information to be accessible by search. The amendments augment the categories of information that must be accessible by search.

Clause 26 amends section 30, which concerns the recovery of fees. The amendments omit the phrase of the Ministry responsible for the Registry.

Clause 27 amends section 30A, which provides that the Crown or Registrar are not liable in relation to searches in certain cases. The amendments take account of the use of new defined terms, and extend the application of section 30A(b) to include errors in the unit register resulting from reasonable reliance on information received from overseas registries or third parties.

Clause 28 inserts new sections 30E to 30J. New section 30E provides for the conversion of New Zealand units into assigned amount units for sale overseas. New section 30F sets out restrictions on the surrender and conversion of certain New Zealand units allocated in respect of pre-1990 forest land. New section 30G sets out a regulation making power with respect to various matters. New section 30H provides for the incorporation by reference in regulations made under new section 30G. New section 30I creates an offence for signing false declarations with respect to regulations made under new section 30G (a fine not exceeding $5,000). New section 30J creates an offence for providing false or misleading information to the Registrar with respect to regulations made under new section 30G (a fine not exceeding $50,000 for an individual and $200,000 for body corporate $200,000).

Clause 29 inserts a new Part 3 heading above section 31.

Clause 30 amends section 33, which provides that the inventory agency is under the direction of the relevant Minister. The amendments omit the phrase responsible for the inventory agency.

Clause 31 replaces the Part 3 heading and cross heading above section 36 with a new cross-heading.

Clause 32 amends section 36, which concerns the authorisation of inspectors. The amendment clarifies that powers are exercised and duties are carried out.

Clause 33 amends section 37, which concerns the power to enter land or premises to collect information to estimate emissions or removals of greenhouse gases. The amendments omit the phrase responsible for the inventory agency.

Clause 34 amends section 38, which concerns limitations on the power of entry under section 37. The amendment omits the phrase responsible for the inventory agency.

Clause 35 inserts new section 45A, which provides protection for persons acting under the authority of the Act.

Clause 36 amends section 47, which concerns an offence for obstructing, hindering, resisting, or deceiving a person exercising a power. The amendments change Act to Part wherever it appears.

Clause 37 amends section 48, which concerns an offence for signing false declarations. The amendment changes the title of the section to indicate that the offence is in respect of regulations made under section 50.

Clause 38 repeals section 48A.

Clause 39 amends section 49, which concerns reporting. The amendment inserts the phrase responsible for the administration of this Act after Minister in the first place where it appears.

Clause 40 amends section 50, which concerns regulations. The amendments delete matters for which regulations may be made under the Act that have been moved into Part 2 (section 30G).

Clause 41 repeals section 51 and substitutes new section 51, which provides for the incorporation of material by reference in regulations made under section 50.

Clause 42 amends section 52, which concerns reporting by the inventory agency on certain matters to the relevant Minister. The amendments omit the phrase responsible for the inventory agency.

Clause 43 inserts new Parts 4 and 5. New Part 4, which consists of 6 subparts, sets out the provisions that establish the New Zealand greenhouse gas emissions trading scheme. New subpart 1 establishes who must or may be a participant. New subpart 2 concerns the allocation of New Zealand units. New subpart 3 sets out the principal powers, duties, and functions of the chief executive. New subpart 4 sets out the relevant offences and penalties. New subpart 5 sets out the review and appeal provisions. New subpart 6 sets out a number of miscellaneous provisions.

New Part 5, which consists of 3 subparts, sets out the sector specific provisions. New subpart 1 concerns the forestry sector. New subpart 2 concerns the liquid fossil fuels sector. New subpart 3 concerns the stationary energy sector.

Clause 44 adds new Schedules 3 and 4, which are set out in the Schedule of this Bill. New Schedule 3 sets out the emissions trading scheme activities relevant to persons who must be participants. New Schedule 4 sets out the emissions trading scheme activities relevant to persons who may elect to be participants.

Clause 45 amends section 67Y(1) of the Forests Act 1949, which concerns the making of regulations with respect to forest sinks. The amendments clarify that the methodologies or mechanisms prescribed under section 67Y(1)(b) of the Forests Act 1949 may be those methodologies or mechanisms prescribed under section 148(1) of the Climate Change Response Act 2002. The amendment also provides for the making of regulations that prescribe the persons or organisations that may carry may carry out verification functions in relation to a forest sink or forest sink covenant.

Clause 46 amends section 2 of the Forestry Rights Registration Act 1983 by repealing the definitions of carbon sequestration, forest sink, and greenhouse gas. It also amends section 2A(2)(b) by replacing the phrase units based on carbon sequestration that are received in accordance with a forest sink covenant with the phrase the right to receive and the obligation to surrender units.

Clause 47 states that clauses 48 to 55 amend the Income Tax Act 2004.

Clause 48 inserts a new clause CB 29 into that Act, providing for the extent to which the disposal of a unit gives rise to an amount of income, including disposal by way of surrender or conversion. Generally, a disposal of a unit to a third party (other than on surrender) gives rise to an amount of income for income tax purposes.

Clause 49 inserts a new clause CW 3B into that Act that provides that any income arising on acquisition or disposal of a unit issued by the Crown free of charge in respect of pre-1990 forest land is exempt income.

Clause 50 inserts a new section CX 44F into that Act that provides that any income arising on issue by the Crown of a unit without charge in respect of post-1989 forest land is excluded income.

Clause 51 inserts new sections DB 46 and 47 into that Act. New clause DB 46 deals with the treatment of the cost (if any) of acquisition of a unit, including issue of forest land units the Crown without charge and an acquisition of a Kyoto unit on conversion. Generally, a deduction is allowed for the cost of acquisition if a unit is acquired from another person and it is not a forest land unit issued by the Crown without charge. New clause DB 47 treats a person that has surrendered a pre-1990 forest land unit in respect of post-1989 forest land as having acquired the unit from a third party for its market value at the time, in order to allow the person a deduction for that value.

Clause 52 inserts a new section EA 2B into that Act and generally requires a first in first out cost flow method to be used to identify which units are held by a person at any time and specifically requires that approach in relation to forest land units issued by the Crown without charge.

Clause 53 amends section EB 2(3)(g) of that Act to provide that units are not subject to the trading stock valuation rules in that Act.

Clause 54 inserts new section GD 16 into that Act, which provides that, if a unit is disposed of to another person for less than market value and the disposal is not a surrender or conversion, the disposal is treated as having been for market value.

Clause 55 inserts new defined terms into that Act that are used in the other inserted provisions of that Act and generally refer to new defined terms in the principal Act. The clause also amends the definition of revenue account property and inserts a new definition of replacement ETS unit. Those latter amendments provide that the deduction for the cost of a unit (other than a unit that merely replaces a forest land unit that was issued without charge by the Crown and then sold) is deferred until the unit is disposed of.

Clause 56 states that clauses 57 to 64 amend the Income Tax Act 2007.

Clause 57 inserts a new clause CB 36 into that Act, providing for the extent to which the disposal of a unit gives rise to an amount of income, including disposal by way of surrender or conversion. Generally, a disposal of a unit to a third party (other than on surrender) gives rise to an amount of income for income tax purposes.

Clause 58 inserts a new clause CW 3B into that Act that provides that any income arising on acquisition or disposal of a unit issued by the Crown free of charge in respect of pre-1990 forest land is exempt income.

Clause 59 inserts a new section CX 48B into that Act that provides that any income arising on issue by the Crown of a unit without charge in respect of post-1989 forest land is excluded income.

Clause 60 inserts new sections DB 60 and 61 into that Act. New clause DB 60 deals with the treatment of the cost (if any) of acquisition of a unit, including issue of forest land units by the Crown without charge and an acquisition of a Kyoto unit on conversion. Generally, a deduction is allowed for the cost of acquisition if a unit is acquired from another person and it is not a forest land unit issued by the Crown without charge. New clause DB 61 treats a person that has surrendered a pre-1990 forest land unit in respect of post-1989 forest land as having acquired the unit from a third party for its market value at the time, in order to allow the person a deduction for that value.

Clause 61 inserts a new section EA 2B into that Act and generally requires a first in first out cost flow method to be used to identify which units are held by a person at any time and specifically requires that approach in relation to forest land units issued by the Crown without charge.

Clause 62 amends section EB 2(3)(g) of that Act to provide that units are not subject to the trading stock valuation rules in that Act.

Clause 63 inserts new section GC 4B into that Act, which provides that, if a unit is disposed of to another person for less than market value and the disposal is not a surrender or conversion, the disposal is treated as having been for market value.

Clause 64 inserts new defined terms into that Act that are used in the other inserted provisions of that Act and generally refer to new defined terms in the principal Act. The clause also amends the definition of revenue account property and inserts a new definition of replacement ETS unit. Those latter amendments provide that the deduction for the cost of a unit (other than a unit that merely replaces a forest land unit that was issued without charge by the Crown and then sold) is deferred until the unit is disposed of.

Clause 65 consequentially amends the Personal Property Securities Act 1999.

Part 2
Amendments to Electricity Act 1992

Clause 66 provides that the principal Act amended is the Electricity Act 1992.

Clause 67 inserts new Part 6A. The purpose of this Part is to reduce the impact of fossil-fuelled thermal electricity generation on climate change by creating a preference for renewable electricity generation through the implementation of a 10-year moratorium on new fossil-fuelled thermal electricity generation capacity, except where an exemption is appropriate (for example, to ensure security of supply).

Under new Part 6A

  • no person may connect a new fossil-fuelled thermal electricity generation plant (a specified generation plant) to the national grid or a distribution network, or operate a specified generation plant, unless—

    • the person has an exemption granted under the Part; and

    • the plant is connected and operated in accordance with the exemption:

  • every person who breaches this prohibition commits an offence and is liable on summary conviction to a fine not exceeding $500,000. In addition, a penalty of up to 3 times the value of any commercial gain resulting from the breach may be imposed:

  • the Minister of Energy on the recommendation of the Electricity Commission (the Commission) may, by notice in the Gazette, exempt a person from the prohibition.

An exemption may be granted if the Minister of Energy is satisfied that the specified generation plant—

  • is a non-baseload plant that has a load factor or emissions level below or less than prescribed limits; or

  • is necessary or desirable for 1 or more of the following purposes:

    • for the purpose of mitigating the effects of an emergency:

    • for the purpose of providing reserve energy:

    • for the purpose of providing electricity to a small isolated community that does not have a reasonable non-fossil fuel based alternative:

    • for the purpose of forming part of a co-generation process to improve the overall energy efficiency of the process above a prescribed level; or

  • uses an acceptable combination of renewable energy sources and fossil fuels as prescribed in regulations; or

  • is based on waste material; or

  • will be connected and operated in circumstances where an existing thermal electricity generation plant will be retired in whole or in part and the specified generation plant together with any part of the existing thermal electricity generation plant that is not retired—

    • will significantly decrease emissions of greenhouse gases; and

    • will not reduce security of supply margins.

An exemption must be granted on the terms and conditions that the Minister of Energy considers are reasonably necessary to ensure that the specified generation plant is operated in accordance with any purpose for which the exemption was granted and for no other purpose. The public must be consulted in relation to draft exemptions. Exemptions may be suspended or revoked.

New Part 6A also provides for the Commission to monitor compliance with the Part.

Clause 68 consequentially amends section 169(1)(30) (which relates to regulations that authorise the waiver, refund, or remission of fees).

Clause 69 consequentially amends section 172KB (which requires industry participants to co-operate with Commission investigations). The amendment extends the provision to apply to investigations carried out for the purposes of monitoring or enforcing new Part 6A.

Clause 70 consequentially amends section 172O (which relates to the functions of the Commission).

Regulatory impact statement

A proposed New Zealand emissions trading scheme

Executive summary

Human induced climate change is a real and serious phenomenon that the world must take action to address. New Zealand has ratified the Kyoto Protocol and consequently is liable for New Zealand’s greenhouse gas emissions above 1990 levels over the period 2008–2012.

Action to address climate change and to meet ongoing international obligations will incur economic costs and benefits. The government has a range of tools available to meet these challenges—some mechanisms will be significantly less costly and disruptive to the New Zealand economy than others. The government wants New Zealand’s future net emissions to be below business as usual levels and to meet international obligations in a least-cost manner over the long term.

On 20 September, the government released the document A Framework for a New Zealand Emissions Trading Scheme. This document noted that, subject to engagement with stakeholders and Maori, the government had decided in principle to introduce a New Zealand Emissions Trading Scheme (NZ ETS). The proposed transition period of the NZ ETS differs for each sector depending on their readiness and other factors. The main impact of the NZ ETS will be that the price of emissions will be reflected in prices throughout the economy. The government is working on an assistance package for firms and households to help manage some of these potential impacts.

The Cabinet paper recommending the NZ ETS, attached a Regulatory Impact Statement (RIS), which was publicly released. This current RIS updates the analysis of the original RIS and is to be read alongside the Cabinet paper A New Zealand Emissions Trading Scheme: 2007 Decisions.

Adequacy statement

The Regulatory Impact Analysis Unit has reviewed the RIS and considers the RIS is adequate according to the adequacy criteria.

Status quo and problem statement

Human induced climate change is a real and serious phenomenon that the world must take action to address. New Zealand greenhouse gas (GHG) emissions comprise a very small proportion of the global total and we are reliant on effective international action to reduce total GHG emissions, and thereby reduce the extent of future climate change. Our biologically-based economy relies on a benign and stable climate for production, and therefore effective international action on climate change where all nations play their part is crucial for New Zealand’s long-term economic, social and environmental wellbeing. Moreover, New Zealand’s clean green image is part of the international brand, which underpins important sectors of the economy, such as tourism, as well as the premium prices New Zealand exporters seek for the country’s products and services in overseas markets. A failure to act sustainably and responsibly could reduce New Zealand’s international credibility and influence in international forums. A failure to act now would see costs for New Zealand rise over the long term.

Status quo

New Zealand is party to the United Nations Framework Convention on Climate Change (UNFCCC) and its Kyoto Protocol. The major feature of the Kyoto Protocol is that it sets mandatory targets on GHG emissions for developed countries and economies in transition listed in Annex 1 to the UNFCCC. In New Zealand’s case, our commitment is to take responsibility for emissions above 1990 levels during the period 2008–2012.

New Zealand GHG emissions (excluding emissions from deforestation) are projected to grow to around 30 percent above 1990 levels by 2010.

The government has yet to implement an economy-wide mechanism to reduce GHG emissions. However, the government has undertaken and will undertake more specific policy interventions for selected sectors. These have been funded either directly from government via tax revenue (eg, solar water heating) or through compliance costs of legislation and regulations (eg, building standards). The emissions reduction expected from these measures is relatively small, and based on current projections, business as usual emissions levels in New Zealand are expected to continue to grow strongly.

New Zealand’s emissions profile has two major elements. Firstly, there is an underlying emissions path that rises steadily at approximately 1 percent per year in the period through to 2045. Secondly, it has a forest sink trend running through it. As the forests planted in the 1990s are due to be harvested (through the mid to late 2020s to mid 2030s), New Zealand’s overall emissions (including forest sinks) spike significantly.

It is estimated that under the business as usual model, New Zealand’s net emissions in 2023–2027 will be over 60 percent higher than in commitment period one (CP1) of the Kyoto Protocol (2008–2012).

The status quo (business as usual) is not a sensible option. It would leave the government to fund emissions above 1990 levels by purchasing units on the international market through general taxation. Firms would have little incentive to reduce emissions as they would not be directly incurring the costs of their emissions. Thus, emissions would continue to rise and thus become increasingly costly for government (ie, taxpayers), especially as the international agreements are expected to become more stringent.

Costs and benefits of climate change mitigation

There is a significant body of international work describing the range of costs and benefits of climate change mitigation and the cost of global action.

Action to address climate change is likely to incur real economic costs. Working Group III of the Intergovernmental Panel on Climate Change (IPCC) has concluded that in 2030, the macroeconomic costs for multi-gas mitigation, consistent with emissions trajectories towards stabilisation between 445 and 710 ppm CO2-eq, are estimated at between a 3 percent decrease of global GDP and a small increase, compared with emissions with the level of GDP that would have occurred under a business as usual scenario (note, with projected rates of GDP growth, levels of GDP per head will be significantly greater than they are today, even with these estimated reductions).

The question, therefore, is whether the costs of action are justified by the benefits.

In deciding whether to reduce GHG emissions in New Zealand, the appropriate question is not whether it can be demonstrated that climate change will harm New Zealand and whether the damage to New Zealand averted by the reduction exceeds the costs it would impose. This question does not recognise that New Zealand is a participant in the international climate change policy process and has ratified the Kyoto Protocol. New Zealand has assumed specific obligations under that Protocol and has consistently stated that it is prepared to undertake commitments beyond 2012 in the context of the broadest international agreement to do so. Under international agreements, harm is not directly defined in environmental terms, but in terms of the cost to New Zealand of meeting these international commitments.

International studies have estimated the global potential for climate change mitigation. These studies suggest that there is a significant potential for mitigation, some of which have negative cost (ie, the savings in energy costs outweigh the costs of the investment). Even though some of these studies are not directly relevant to New Zealand, they show that there are abatement activities available around the globe which, through linking to the international market, will help to limit the cost of emissions in New Zealand.

Objectives

Specific climate change initiatives sit within New Zealand’s broader sustainability and climate change goals and objectives. These are outlined in the report New Zealand’s climate change solutions: An overview. The government’s guiding principles for its climate change policies are that they:

  • (a) are long term and strategic:

  • (b) balance durable efforts to reduce emissions with preparations for the impacts of a more variable climate:

  • (c) engage with the wider public, industry and business to inspire their willing, effective and long-term involvement:

  • (d) focus on international engagement that advances New Zealand’s national interests.

The government’s current policy development process is underpinned by some key assumptions that are consistent with the approach it has taken to climate change over the past few years. These include:

  • (a) Faced with sufficient consensus on climate change science, responsible government must act to address the risks for New Zealand’s vulnerable environment, economy and way of life. While action to reduce greenhouse gas emissions over the long term will have a cost, the predicted costs and risks of inaction are expected to be unacceptably high.

  • (b) Effective international action is needed to reduce global greenhouse gas emissions. To support and encourage international action, New Zealand needs to play its part in reducing emissions, as well as encouraging other countries, especially the major emitters, to act.

  • (c) New Zealand’s response should maximise the economic advantages of using energy and resources more efficiently and facilitate our involvement in the development or adaptation of low emission technologies relevant to our needs.

  • (d) Our policy response should start with the most achievable options and seek least-cost solutions.

  • (e) All sectors of the economy should play a fair and equitable part in the national response to climate change, reflecting the fact that some sectors will be able to achieve emissions reductions more easily than others.

Key in a decision to implement specific climate change initiatives is an assessment that New Zealand will continue to operate in a carbon-constrained world.

These principles and assumptions (outlined above) have been synthesised to provide a more detailed NZ ETS objective to frame policy development in this area as follows:

  • to develop climate change initiatives that support and encourage global efforts to reduce greenhouse gas emissions by:while maintaining economic flexibility, equity, and environmental integrity at least cost in the long term.

    • reducing New Zealand’s net emissions below business-as-usual levels;

    • complying with our international obligations, including our Kyoto Protocol obligations;

Alternative options

There are a number of possible policy approaches to reducing emissions including:

  • (a) Direct regulation: this could include requiring a certain proportion of liquid fuels to be biofuels; prohibiting certain activities (eg, certain fuels in certain circumstances); imposing restrictions on certain activities (eg, requiring all new electricity generation to be from renewable sources). Some of these have already been implemented; others have been discounted or are still being considered. Overall, the regulatory options alone will not optimise New Zealand’s climate change response.

  • (b) Information and promotion: initiatives that give consumers and businesses better information about the GHG emissions that their actions lead to, and encourage them to change their behaviour, can be effective in some areas. New Zealand already has a number of such initiatives in place (eg, energy efficiency labelling and promotional activities undertaken by the Energy Efficiency and Conservation Authority (EECA)).

  • (c) Emission reduction incentives: the incentive option is problematic as in order to calculate the level of incentive to pay a particular firm, it is necessary for the government to estimate the level of emissions a firm would have emitted in the absence of the incentive. Due to the practical difficulties in establishing this emissions baseline, widespread use of an incentive approach is not likely to be effective. However, incentives can still be effective in certain key areas (eg, provision of subsidies for household insulation and solar heating).

  • (d) Broad price-based carbon tax: a broad price-based mechanism, such as a carbon tax, results in the price of emissions being reflected throughout the economy. Although the government can control the overall stringency, decisions on which abatement activities occur are made at the firm and consumer level. In general, firms and consumers are better placed to make these decisions than central government. The effectiveness of taxes in reducing emissions is dependent on the sensitivity of consumers and firms to prices. If consumers and firms are not very sensitive to prices (in economic jargon, if demand is inelastic), then a large increase in price is required to induce even a small reduction in emissions.

Preferred option

A cap and trade ETS with a transitional introductory phase is the preferred option for meeting the detailed objectives set out above. The ETS, while an important element of New Zealand’s proposed climate change response sits within a suite of policies including direct regulatory measures, improved information and specific initiatives (eg, increased funding for relevant agricultural research).

The key difference between a carbon tax and an ETS is that with a tax, the government sets the price of emissions, while with an ETS they set the quantity of emissions. Under a tax, there would be an inevitable degree of uncertainty around the level of emissions that would result, and that the government would be responsible for, in any one year or commitment period. A tax would provide greater emissions price certainty to emitters. However, it would subject the government and taxpayers to potentially very large fiscal costs if the tax was set too low. Adjusting taxes to changing circumstances and to improve efficiency and effectiveness can also be problematic; as decisions by governments can be influenced by wider considerations than simply the narrow purpose for which the tax was designed.

An ETS allows greater flexibility in terms of price adjustments. Prices adjust automatically in an ETS as international carbon prices adjust, whereas tax-based systems tend to be sticky as they can only be increased by an explicit government decisions. Inevitability, under a tax-based system that the price of emissions in New Zealand would not reflect the international price of emissions. This would increase the cost New Zealand incurs to meet its international obligations. Having said this, it is important to note that price volatility as implied by an ETS is not costless. A permit system has considerable advantages when it comes to small open economies like New Zealand if there is a well-functioning international market for carbon, especially if the international price is subject to shocks. This is because under a tax, unless the government continually adjusted the tax in response to these shocks, government would face fiscal risk and New Zealand would either over or under invest in emission reducing activities.

It is proposed the NZ ETS be internationally linked. The NZ ETS will operate within the international cap on emissions that is agreed through international negotiations (currently Kyoto).

One of the key advantages of an ETS is that it is consistent with the nature of our international obligations (the Kyoto Protocol is a global cap and trade system). More generally, there is considerable strategic and economic benefit in taking the same broad approach to reducing emissions as some of our key trading partners.

The proposed NZ ETS would work by placing an obligation on participants to surrender emissions units to cover their emissions. Firms would have the flexibility to choose their best response to this obligation. Participating firms who value their emissions producing activities more than the cost of reducing them have the option to purchase units, while firms who value their emission less than the cost of purchasing units may choose to reduce their emission output. In this way, trading would result in emission reductions being made by firms who can do so most cheaply and encourages innovation.

By internationally linking the scheme, trading can occur in the much larger and more liquid international market. This effectively allows NZ firms to take advantage of low cost abatement opportunities offshore. The market would determine the level of domestic versus international abatement that would occur.

A key element of the preferred option is a transitional period that will allow affected parties time to adjust and help address equity issues. These are different, recognising varying levels of readiness. The dates of entry are set out in the table below.

The core obligation placed on participating firms will be defined in absolute terms, (tonnes of CO2-e per year), rather then an intensity based measure (tonnes of CO2-e per unit of activity). This will mean that participants must surrender one emission unit for every metric tonne of CO2-e emitted each year. Adopting an absolute approach provides certainty over the (global) environmental outcome and is relatively simple to implement.

Staged entry of sectors into the NZ ETS
Sector Commencement of obligationsEnd of initial compliance period
Forestry (includes deforestation of pre-1990 land and afforestation post-1989 1 January 200831 December 2009 (first compliance period is 2 years)
Liquid fossil fuels 1 January 200931 December 2009
Stationary energy (includes coal, natural gas, and geothermal) 1 January 201031 December 2010
Industrial process (non-energy) emissions 1 January 201031 December 2010
Agriculture (includes pastoral and arable farming and horticulture) 1 January 201331 December 2013
Waste 1 January 201331 December 2013
All other emissions 1 January 201331 December 2013

In each sector, there are a range of options for where to place the point of obligation. Points of obligations are designed to:

  • (a) Keep compliance and administration costs low.

  • (b) Capture as many of sectors’ emissions as practicable.

  • (c) Reflect the feasibility of monitoring and verifying emissions at each point.

  • (d) Create appropriate incentives to reduce emissions while not unduly deterring worthwhile economic activity and investment.

Impacts and Sector Specifics

The fundamental impact of an ETS is that it changes prices in the economy to reflect the cost of emissions. Price changes will incentivise abatement activity, which should see net emissions reducing from business as usual. Given the stringency of the Kyoto agreement, the overall macro impacts on the economy will be small over 2008–2012 . However the impacts on particular sectors of the economy (ie, the microeconomic effects) could be more significant due to emissions being concentrated around certain activities and sectors. To give a sense of magnitude, some indicative price changes are shown in the table below. These assume no assistance or compensation has been provided. These changes would be the same under a carbon tax set at the corresponding emission price.

Price changes due to an ETS assuming no assistance or compensation Emission price scenarios
  $15/t CO2–e$25/t CO2–e$50/t CO2–e
Households    
Increase in household expenditure (per annum) $100–$200 pa$170–$330 pa$330–$660 pa
Approximate % of total household expenditure 0.3–0.5%0.5–0.8%1–1.6%
Liquid fuels (transport)
Petrol c/litre GST incl. (% increase over current price) 3.7 c (2.5%)6.1 c (4%)12.2 c (8%)
Diesel c/litre GST incl. (% increase over current price) 4 c (4%)6.7 c (7%)13.3 c (14%)
Transport sector emission reductions in the medium-term (relative to business-as-usual) 0.3%0.6%1.1%
Electricity
Wholesale c/kwh (% increase over business-as-usual) 0.7 c (9%)1.4 c (19%)2.9 c (37%)
     
Retail c/kwh GST incl. (% increase over business-as-usual) 1 c (5%)2 c (10%)4 c (20%)
Long-term (2020 and beyond) Electricity Generation Emission levels Emissions at about current levels—improvement over business-as-usual (around 6.5 million tons pa)1990 levels (around 3.5 million tons pa)
Other fossil fuels
Wholesale gas $/GJ $0.8 (11%)$1.4 (18%)$2.6 (35%)
Retail gas $/GJ (GST incl.) $0.8 (11%)$1.7 (4%)$2.8 (6.5%)
Wholesale coal $/GJ $1.5 (40%)$2.5 (67%)$4.9 (134%)
Agriculture (methane and nitrous oxide emissions only)
Dairy: reduction in payout if facing full cost (relative to payout of $4.56 kg/ms) -3.5%-5.9%-11.8%
Beef: reduction in payout if facing full cost (relative to current payout) -6.3%-10.4%-20.9%
Sheepmeat: reduction in payout if facing full cost (relative to current payout) -10.1%-16.9%-33.8%
Venison: reduction in payout if facing full cost (relative to current payout) -12.8%-21.4%-42.8%
Macroeconomic modelling

The Emissions Trading Group (ETG) commissioned economic consultants Infometrics to update their previous analysis of the effect of various policy instruments on the New Zealand economy.

Impact over Kyoto period

The macroeconomic impact, as represented by a variety of indicators is very small. This is consistent with the previous message that the impact under Kyoto would be around 0.1 percent of GDP. It should be noted that New Zealand faces an impact, regardless of having an ETS as we have already signed up to Kyoto. In fact, under an ETS New Zealand’s net emissions should reduce; this will work to further reduce the macroeconomic impacts over the status quo.

Infometrics has pointed out that GDP is not a particularly good indicator of welfare or living standards. In fact, its modelling of the ETS indicates the impact on GDP would be zero, however, this would be a misleading figure to use, because there will be a real reduction (albeit small) in living standards as measured by the level of private consumption.

The macroeconomic impact over the Kyoto period is small because:

  • (a) The shock to the economy of introducing an emission price into the economy is small compared to the size of the economy. In any case, this shock involves a transfer of resources within the economy from taxpayers to sectors that produce emissions. This transfer of resources does not represent a loss to the economy as a whole.

  • (b) The resources that are required to pay for the emission units that must be purchased offshore (as a result of the country having a net emissions deficit) do represent a loss to the economy. However, under Kyoto the country’s net position is small compared to the size of the economy. Given the assumptions behind the model, this loss does not actually cause a reduction in GDP (in world prices), as the volume of goods and services produced by NZ does not change. It is simply that more resources need to go into exporting, leaving less for private consumption. The reduction in private consumption does represent a reduction in living standards relative to business as usual.

Potential impact over longer term

The longer term impacts of an ETS will be driven by the stringency of international agreements going forward. As international agreements become more stringent , the impacts will increase. However, these could be moderated by technology improvements and by the degree to which international agreements become more comprehensive (ie, the degree to which imbalances in global competitiveness between firms can be reduced).

Modelling in 2025 under a range of different scenarios was carried out by Infometrics to give insights into the potential impacts over the longer term. The modelling shows that the impact on the NZ economy would increase if international agreements become more stringent and the price of emissions rises. Given a range of speculative but plausible scenarios, the impact is still not large when compared to the underlying growth in living standards expected over time (eg, we might have living standards in 2030 that we would otherwise have expected in 2028 or 2029). The modelling has also shown how:

  • (a) An ETS reduces the impact of meeting our international obligations over the case where the government remains responsible for all emissions. For example private consumption fell by 1.0 percent in a scenario where the government is responsible but only 0.7 percent under an ETS.

  • (b) Stringency of international agreements (ie, how many emission units NZ gets allocated for free) is a key driver to the size of the impact.

  • (c) The coverage and nature of international agreements is very important. For example a scenario with key international trade prices reflecting the price of emissions (ie, if our international competitors also faced a price of emission) reduces the impacts.

Independent analysis of carbon markets

ETG commissioned two reports from Point Carbon, a world-leading provider of independent analysis on carbon markets based in Norway:

  • (a) Issues in the International Carbon Market 2008–2012 and Beyond

  • (b) Functionality in the International Carbon Reduction Project.

Issues in the International Carbon Market 2008–2012 and Beyond covers price ranges in the international emissions trading market price risk management tools and the relationship between transaction costs and size of participants. The key points that arise from this report are:

  • (a) There is a range of prices in the international carbon market. These vary by risk of project and type of unit—Kyoto credits range between NZ $10 and $33.

  • (b) Uncertainties exist in the carbon market going forward. A major source of that uncertainty surrounds the prospect of assigned amount units (AAUs) entering the market.

  • (c) It is not yet clear how the AAU market will evolve but it is possible this will involve occasional, large volume intergovernmental transactions rather than a more liquid market with many private sector participants. The first intergovernmental transaction is expected in 2008.

  • (d) Prices in the secondary Certified Emission Reduction (CER) market (units with guaranteed delivery from the Clean Development Mechanism) are influenced by prices in the EU ETS. Yet, short-term volatility in the EU market does not affect the primary CER market.

  • (e) The international carbon market is evolving rapidly but is not yet as developed as other more established commodity markets. The emerging financial products and routes to the market are likely to increase the ability of participants to manage their exposure to price fluctuations in the carbon market.

  • (f) Although the growth of the financial services sector within the carbon market presents opportunities for smaller players to enter the carbon market, smaller players may be disadvantaged in terms of their ability to invest in the primary CER market, and in terms of brokerage and exchange fees.

Functionality in the International Carbon Reduction Project Market report covers issues related to the carbon market offset project market such as additionality, incentives to own high quality units, and validation processes. Key points arising from this report are:

  • (a) It is impossible to be definitive about the environmental veracity of processes such as the Clean Development Mechanism. The nature of the mechanism, especially the need for an additionality criterion, is such that environmental integrity cannot always be guaranteed.

  • (b) The tendency is for increasingly stringent rules and probity checks and it is expected that processes will continue to improve.

  • (c) There is evidence that buyers are exerting some control over the quality of the credits that they own.

  • (d) In the secondary CER market, it is not possible to identify the type of project that the credit originated from (eg, it is possible that credits associated with HFC-23 credits may be resold without being identified as such).

Firms

Most New Zealand firms will face costs and benefits under the ETS. Increased costs will occur under an ETS as a result of firms being required to surrender New Zealand Units (NZUs) to cover their emissions, or due to them facing higher energy and fuel prices. Many firms will be able to pass a portion of these costs down the supply chain, reducing the impact on their profitability. However, some firms will not be able to pass costs on, resulting in greater profit impact and a loss of competitiveness. The loss of competitiveness would be exacerbated if these firms competed with overseas firms that were not subject to the same price for emissions.

These impacts could be significant for some firms. In particular this disproportionate impact raises equity concerns. But most importantly it may also lead to long term regrets if the ETS resulted in reduced output, or closure of a firm, that would have been competitive if its competitors faced similar greenhouse gas measures and there were a good chance that these competitors will face such a charge in the foreseeable future. There would also be a concern if particularly large or concentrated job losses resulted or New Zealand’s reputation as a good place to do business relative to its neighbours and trading was damaged.

For these reasons, the government is proposing an industry assistance package. The exact shape and nature of this package is the subject of engagement between industry and government. This assistance could be in the form of free allocation (where the government gives free units to firms) and/or some form of progressive obligation where the obligation to surrender units gradually increases through time.

Direct emission reductions from New Zealand industry over the next 10–15 years under an ETS will be somewhat constrained by the nature of the existing facilities, although there are still promising opportunities to reduce emissions. These include:

  • (a) Switching from using coal to using gas or biomass for industrial heat wherever possible.

  • (b) Increasing the use of cogeneration in conjunction with industrial heat production (cogeneration technology allows heat that is generated for industrial processes to be used to produce electricity as well).

Over the longer term, there are many new technologies that could allow for dramatic improvements in industrial energy efficiency and emission reductions. The actual level of emission reductions will be determined by the price of emissions relative to the cost of the abatement activities.

Households

Households will face higher energy prices (eg, petrol and electricity). The government is particularly concerned about impacts of electricity price increases on consumers and is considering compensation outside of the ETS.

Transport

There will be relatively small emission reductions, relative to business as usual, in the transport sector as consumption does not change much when the price rises. In fact, transport emissions are still expected to rise significantly over the long term (with key drivers being GDP and population growth). Pricing emissions will improve the cost effectiveness of new technologies for emission reduction to make them more widely available (and thus make them economic sooner than would have been the case).

Electricity

Emissions from the electricity sector will not decrease in the short term, but in the medium to longer term there should be significant emission reductions relative to business as usual. This occurs as old thermal plant is replaced by plant with lower emissions (in particular new renewable generation capacity). Emission reductions would not be materially effected by compensation offered to consumers outside of the ETS, as generators will still face the correct price signals when building new plant.

Forestry

This sector is a priority for the government as the sector can be a significant driver behind NZ net total emissions (both in a positive and negative sense). There are both benefits and costs for participants to be in the NZ ETS. Significant emissions could occur if this sector does not face the correct price signals for their deforestation of pre-1990 forests. On the other hand, the reduction of deforestation is likely to be one of the lower cost abatement options in the domestic economy in CP1.

It is currently estimated that for every 12 months that deforestation remains outside the ETS after 1 January 2008, increased emissions of 12-24Mt CO2-e are likely to occur, resulting in increased costs to the Crown of $180–$600 m. This reflects an assumption that owners would bring forward deforestation to avoid likely future controls. Current analysis suggests that deforestation would reduce substantially, and in many cases stop entirely, if the parties faced the full cost of the emissions involved.

Thus there will be compulsory entry for pre-1990 forests, but with a threshold to avoid high transaction costs. Yet the ETS will be voluntary for post 1990 forest. That is, the owners of these forests will be given the choice to enter the ETS and receive all of the relevant sink credits and future liabilities. This is expected to be more attractive for most investors than the existing (and ongoing) Permanent Forest Sinks Initiative (PFSI), because of restrictions under that initiative (although officials understand that these restrictions are seen by some investors as adding value).

Agriculture

Agricultural sector emissions represent almost half of New Zealand’s total GHG emissions and are currently a significant source of emissions growth. Any ETS that did not include agriculture emissions would be inconsistent with a least-cost approach to emissions reduction, as the cost of these emissions would need to be absorbed elsewhere in the economy. This makes agriculture a priority for inclusion in the ETS. It is also important that the sector faces the full marginal price of emissions as the current growth in emissions is largely driven by conversion and intensification. These decisions would be influenced by facing the full marginal price of emissions.

The effects of the ETS on the agriculture sector are difficult to accurately predict for a number of reasons. Firstly, the government is signalling a preference for a processor/company level point of obligation, in which case the price signals reaching farmers will likely be weak or distorted in some cases. Secondly, the agriculture sector is highly dynamic due to the ability for some farmers to readily change land use, the cyclical nature of commodity prices, and the apparent resilience of farm businesses and their ability to adapt to new conditions.

In the short term, it is unlikely to expect strong emission reductions from the agricultural sector as current opportunities for abatement are limited, particularly around methane, which represents about two-thirds of agriculture’s emissions. However, some opportunities exist around nitrogen inhibitors. In fact, it appears likely that aggregate emissions from agriculture (and from the dairy sector in particular) will rise in the near term at least. The dairy industry would be taking into account the price of emissions when decisions are made that result in increases in emissions.

The farming sector is characterised by a large number of sellers producing relatively homogenous and perishable product, meaning that farmers are also price takers. All costs introduced into the agriculture value chain (eg, CO2 related costs introduced at the processor level) are generally absorbed at the farm level. Introducing emissions trading in this sector may, therefore, have significant impacts on farm profitability and raise equity concerns at the farm level. In recognition of equity concerns, the government is proposing to use allocation policy to partially compensate farmers for lost profits.

There are over 30 000 pastoral farmers in NZ and many potential difficulties in bringing them into an ETS. Further engagement with the sector is required before the details of the scheme are finalised, and various mechanisms have been put in place for this (eg, Peak Group on Agriculture and the ETS).

Impact on the stock of regulation

While the ETS will operate as a new set of regulations that apply to GHG emissions, officials have designed a scheme that, to the greatest extent possible, utilises existing legislation and regulations.

The existence of an ETS will mean that some interventions that have been discussed in consultation documents to reduce emissions will no longer be required (eg, RMA standards on land use/deforestation, and nitrogen tax).

Risk assessment

Risk

High levels of volatility in the price of emissions result in increased uncertainty (and thus cost) for business.

Mitigation

The NZ government will play an active role in international agreements to help ensure that the global carbon market develops in an orderly manner.

Enable the development of financial instruments to allow firms to reduce their exposure to the volatility in the price of emissions.

Consider measures to reduce the initial volatility that may be present during the establishment of a new market.

Ensure as much liquidity as possible by linking to international markets.

Consider the effects of government allocation decisions on market volatility.

Risk

There is a gap in international agreements after 2012.

Mitigation

The NZ government will actively participant in international negotiations with a view to reaching international agreement on arrangements post-2012.

Ensure flexibility in the design so that the operation of the scheme is not directly linked to any particular international agreement and can operate as a stand alone scheme if needed.

Need to ensure adequate liquidity in the case of a stand alone scheme or maybe look at a price cap or floor.

Risk

Potential for market failure in certain sectors resulting in less emission reduction occurring then should given the price.

Mitigation

Complementary measures (eg, energy efficient homes) can be targeted at areas where the price signal does not achieve the desired level of emission reduction.

Risk

Businesses have difficulty accessing the market.

Mitigation

Ensure that the registry is business friendly including low transaction fees.

Enable competition between a range of emission markets both within NZ and overseas (as a result of the scheme being internationally linked).

Consider the nature of the firm when setting points of obligation (eg, large firms, who have established trading desks should find it easier to participate in the market then a Small to Medium Business).

Risk

The international price of emissions rises to very high levels causing significant harm to NZ economy.

Mitigation

Governments will need to make ongoing decisions about what further international commitments NZ is prepared to sign up to post-2012, including the stringency of emission reductions. New Zealand’s position on this could consider factors such as the extent and nature of participation by other countries.

Risk

Transitioning to the new regime will be difficult and/or expensive.

Mitigation

Have a transitional period and different dates of entry to recognise different levels of readiness.

Risk

Increased uncertainty and market volatility during the start up phase of the scheme.

Mitigation

Signal policies in advance as much as practical.

Education and training for participants.

Link to international markets to increase market liquidity.

Risk

Loss of firms with long term regrets.

Mitigation

Government will look to provide an industry assistance package to reduce risk of firms shifting operations offshore as a result of the ETS.

Risk

Future international agreements are based around a carbon tax.

Mitigation

Ensure the ETS is easily modified to act as a tax (this would simply require the govt to provide unlimited units at a particular price—points of obligation, reporting and monitoring etc, could remain unchanged) if this becomes necessary given global developments.

Establish a regular review process for the scheme to take into account international developments.

Risk

Future international agreements move towards an intensity base approach.

Mitigation

Ensure the ETS can easily be modified to adopt an intensity based approach.

Establish a regular review process for the scheme to take into account international developments.

Risk

Breach of commitment period reserve (a requirement under the Kyoto Protocol that all party nations retain at least 90% of their initial assigned amount of AAUs within their emissions unit register).

Mitigation

Breach is unlikely due to the expected net inflow of Kyoto units over CP1 and can be managed by allocation decisions and staggered sectoral entry into the NZ ETS.

Risk

Required systems, processes or the administering agency are not fully functioning by the commencement of the scheme.

Mitigation

Implementation is discussed in the section below.

Implementation and review

The compliance and enforcement system for the NZ ETS is based on a self-assessment methodology like that used in the New Zealand tax system. Under this system, ETS participants will be responsible for complying with their obligations under the ETS and assumed to be in compliance unless subsequently challenged by the chief executive of the department with responsibility for administration of the NZ ETS (Chief Executive). This system should result in far lower compliance costs for both participants and for the Chief Executive than a full-regulation model and is consistent with the nature of the regulatory regime being imposed. In order to meet all the requirements of the compliance system, participants will need to undertake a number of activities including:

  • (a) surrender one emissions unit for each tonne of CO2-e emitted in each compliance period

  • (b) calculate their level of emissions using approved methodologies

  • (c) retain sufficient records to allow verification of emission calculations

  • (d) report their level of emissions, and emission units surrendered at the end of each compliance period, to the Chief Executive

  • (e) comply with any directions of the Chief Executive.

Participants’ emission levels will be determined by multiplying the volume of an emitting activity by an emissions factor in a particular time period. Emissions factors will be provided, or approved, by the Chief Executive. The Chief Executive will be given adequate rights to check the validity of information provided to it. Any failure to meet the core obligation will result in:

  • (a) a requirement to make up the surrender shortfall within 90 days of a determination by the Chief Executive that a participant is in breach and at a ration of 1:1

  • (b) a financial penalty of NZ $30 per tonne of CO2-e emitted for which emission units have not been surrendered

  • (c) the publication of the participant’s identity and nature of the compliance failure.

Where a participant knowingly fails to meet the core obligation, the make-up requirement will increase to a ratio of 1:2. Also, the financial penalty will rise to NZ$60 per tonne of CO2-e emitted and participants will face the possibility of criminal conviction. Failure to meet other obligations (eg, the requirement to monitor and report emissions) will result in a financial penalty of up to $4,000 for the third infringement, $8,000 for the second, and $12,000 for the third. Where a participant fails to meet these obligations knowingly, it will be subject to larger fines and possibly criminal conviction. This penalty structure is similar to that imposed under the self-assessment approach in the Tax Administration Act 1994.

Generally, feedback on the compliance and enforcement provisions has been accepting of the self-assessment compliance system. It is expected that detailed submissions will be received during the Select Committee process. However, some changes are proposed now in order to assist the development of the New Zealand carbon market. The accompanying paper asks Cabinet to consider a revised approach for the requirements around the surrendering of units when sectors first enter the ETS, variants of which have arisen during the engagement process. The revised approach is (note, forestry and transport enter at point b):

  • (a) for firms to monitor and report their emissions for the year (two years for agriculture) prior to entry to the NZ ETS on a voluntary basis (penalties for errors in reporting in that year would not apply):

  • (b) for firms to monitor and report for their year of entry into the ETS (with reporting penalties applying) and to surrender units for that year (without applying penalties other than a make good provision for under-surrender of units):

  • (c) for firms to monitor, report and surrender units for subsequent years with the full penalty regime applying.

In addition, the government will make it clear that any changes to the rules on what units can be used for compliance purposes will not apply retrospectively.

It is proposed the legislation for the NZ ETS proceed as a new part of the Climate Change Response Act 2002. The Climate Change Response Act 2002 implements New Zealand’s obligations under the Kyoto Protocol to establish a national registry system. Many of the features for a New Zealand ETS already exist under the Climate Change Response Act 2002, although some require modification. The purpose of the Climate Change Response Act 2002 will also need to be amended to provide for a New Zealand ETS that continues beyond 2012. The bill to amend the Climate Change Response Act 2002 is called the Climate Change (Emissions Trading and Renewable Preference) Bill.

Implementation of the NZ ETS will establish the business operations required to give effect to the government’s emissions trading policies described in The Framework for a New Zealand Emissions Trading Scheme and the Climate Change (Emissions Trading and Renewable Preference) Bill.

The key business operations will be delivered by a group of Ministries governed by the respective chief executive officers and senior officials to ensure effective cross government integration. These functions comprise:

  • (a) Policy Advice: providing policy and economic advice, establishing emissions factors, developing allocation plans, undertaking international negotiations and gateway management, and management of the Crown’s obligations.

  • (b) Administration: providing the registry, sector administration, compliance and enforcement.

  • (c) Education and communications: providing the integrated delivery of information and training.

Cross government governance

To implement these business operations, an implementation programme covering the following functions is underway:

Policy advisory functions

Policy advice and co-ordination:

  • legislative development and statutory review:

  • policy and economic advice:

  • cross government policy co-ordination.

Emission factors:

  • emission factor development by sector.

Future allocation:

  • allocation policy and national allocation plans.

International linking:

  • international negotiations, cap setting, and gateway management.

Crown obligations:

  • purchasing Kyoto units:

  • buying and selling NZUs.

Education, communication, and consultation:

  • Management Advisory Groups:

  • consultation with iwi:

  • public consultation:

  • information and guidance about:

    • NZ ETS start up phase:

    • climate change policy.

Administrative functions

Registry and sector administration:

  • ETS register including allocation, verification, reporting, and banking:

  • assessments and registration of participants and traders.

Compliance and enforcement:

  • monitoring compliance requirements of participants:

  • enforcement of compliance requirements.

Crown obligations:

  • purchasing and trading role of Government.

Education and communication:

  • public guidance about:

    • registry start up phase:

    • administration of Registry.

NZ ETS education and communication functions

Communications strategy—cross government.

Education programme—cross government.

The key implementation dates over the next two years are likely to be:

  • 20 November 2007—Bill approved by caucus and tabled in the House

  • December 2007—New Zealand Emissions Unit Register for Kyoto units goes live

  • 1 January 2008—ETS obligations commence for forest land owners

  • 1 March 2008—Carbon Accounting Standards for forests documented

  • 1 April 2008—Draft regulations for carbon measurement, carbon certifiers and cost recovery

  • 1 April 2008—Draft regulations for NZ ETS administration and NZU Registry operation

  • 1 July 2008—NZ ETS Registry operational

  • 1 July 2008—Carbon calculators available to calculate pre 1990 forest deforestation liabilities and post 1989 forest credits and liabilities

  • 1 July 2008—Forestry Carbon Certifiers trained and able to be registered

  • 1 July 2008—Forestry Participants with pre 1990 forests can apply for exemptions and those with post 1989 forests can apply for inclusion into the NZ ETS

  • 31 July 2008—Forestry GIS goes live

  • 1 December 2008—NZ ETS compliance and enforcement processes operational

  • 1 January 2009—ETS obligations commence for liquid fossil fuel providers

  • 30 June 2009—Deadline for applications by landowners of less than 50 hectares of pre 1990 forest land for exemptions

  • 31 December 2009—First deforestation returns lodged with the Administrator

  • 31 December 2009—First liquid fossil fuel emission returns lodged with the Administrator

  • 31 December 2009—Allocation of NZUs to pre 1990 forest Participants

  • 31 December 2009—First date for surrender of NZUs

  • 31 December 2009—Deadline for applications by people wishing to be participants in respect of post-1989 forest land (until 1 January 2013).

The Administration role of the NZ ETS established by the Ministry of Economic Development will be reviewed by the accountable chief executives within three years of establishment (December 2010).

The NZ ETS will need to evolve to reflect changes in future international arrangements. It is also likely that ongoing refinement of the details of the ETS will be necessary as firms and administrators gain more experience of the ETS. It is therefore proposed that the NZ ETS undergo a regular policy review. The Minister responsible for the Administration of the Climate Change Response Act 2002 will be responsible for this review, examining the operation and effectiveness of the Act within 9 months of the end of each commitment period or at the end of each five year period, with the first period beginning on 1 January 2013.

Consultation

Ministers and officials have undertaken an extensive engagement process with stakeholders and Maori since the release of the NZ ETS on 20 September, including:

  • (a) 3 cross-sector emissions trading workshops

  • (b) 13 regional hui

  • (c) A national hui for Maori

  • (d) 7 regional forestry meetings

  • (e) 4 workshops for firms that may be ‘participants’ in the ETS

  • (f) An NGO forum

  • (g) Numerous ‘one on one’ meetings with key stakeholders

  • (h) The establishment of a Climate Change Leadership Forum.

During engagement, a distinction was made between the 2007 decisions (those that pertain to items to be contained in the legislation introduced this year) and 2008 decisions (those decisions that will be made next year after the initial legislation is considered, including decisions about allocation within the agricultural and industrial sectors).

Feedback on the NZ ETS framework has generally been positive—in particular, many groups have vocalised their support for an emissions trading scheme over a tax. The engagement has been notable for the lack of opposition; and the all sectors, all gases approach of the NZ ETS has been well-supported. Further to this, many stakeholders are improving their knowledge of the NZ ETS proposals through the engagement process and, as a result, are becoming more interested in the workings of the scheme as opposed to being critical of the design. The major policy issues arising from engagement can be classified as follows:

  • (a) Allocation—the timing of possible phase-out of free allocation.

  • (b) Allocation—intensity compared with absolute obligations and the treatment of growth in emissions.

  • (c) Allocation—whether to provide assistance to firms for increases in costs associated with liquid fossil fuels (or other inputs such as wood-waste used in boilers).

  • (d) Unit of trade and liquidity in the market.

  • (e) Options for accounting for pre-1990 forests.

Allocation: timing of possible phase-out of free allocation: stakeholders from both energy-intensive industry and agriculture have expressed concern about the current proposal (phase out free allocation by 2025, starting from 2013, to be reviewed once the shape of international negotiations becomes clear). Their underlying concern is that international competitiveness will be eroded as they will face a price of carbon that many of their international competitors do not.

The signals sent around future levels of free allocation will affect investment decisions in emissions-intensive industries going forward. Yet it is important to recognise that support for one business or sector comes at a cost for the rest of the economy. It is not in New Zealand’s interests to attempt to shield certain domestic firms from the impact of imperfections in the design and coverage of the Kyoto Protocol and its successors, unless these imperfections are clearly expected to be temporary. Otherwise, New Zealand’s interests are best served by ensuring our business environment encourages growth in areas of the economy that maximise New Zealand’s economic advantages, taking into account the carbon-footprint of specific activities.

The current proposal is still the preferred approach. However, the generality of the argument is being raised with the Climate Change Leadership Forum to provide some initial thinking on different options that exist, including a more moderate phase-out and a gentle phase-out. These are discussed more in the accompanying Cabinet paper.

Allocation: intensity of absolute obligations and the treatment of growth in emissions: some stakeholders have suggested the best approach for addressing competitiveness and leakage concerns would be to adopt an intensity-based approach for key sectors, such as agriculture. Under this approach, participants would only be responsible for meeting their emissions over and above a best practice benchmark level of emissions per unit of output.

This approach has not been favoured because intensity-based approaches, in addition to being administratively difficult, provide an incentive inconsistent with New Zealand’s economic signal received under the Kyoto Protocol (expressed in absolute terms). It is therefore recommended that there be no change to the proposed policy (obligations are to be on an absolute basis as opposed to intensity-basis and that growth in emissions from all sectors should face the full cost of emissions).

Allocation: assistance for increases in costs associated with liquid fossil fuels (or wood waste): a concern was raised by some sectors with a particular exposure to price increases in liquid fossil fuels (eg, tourism, fishing, and mining industries), that the assistance package does not equitably reflect cost increases throughout the economy. However, as noted above the price increase for liquid fossil fuels arising from the ETS is expected to be relatively small. Furthermore, the administrative challenge would increase significantly if assistance were to be provided for increases in costs of liquid fossil fuels, due in large to the numbers of firms potentially affected, the variable size of the firms, and the operational structures of the firms (eg, high use of contractors and external providers).

A similar concern was raised in regard to the use of wood waste as a source of fuel or an input into the production of wood products. The potential price increase for wood waste could be significant for a small number of affected firms. However, the price increase is not a direct result of the price of emission units, but rather wood waste being used as a fuel is a second round response to the increase in other fuel choices (ie, coal). The valuation of the impact is therefore fraught and difficult. Coverage of assistance for second round price increases such as wood waste would almost certainly mean that firms would lobby for other price increases to be covered by the assistance policy package.

Unit of trade and liquidity in the market: stakeholders expressed concerns that there may be insufficient liquidity in the New Zealand market and that firms will be poorly placed in the international carbon market, thus forcing New Zealand firms up towards the top of the price scale. Concerns have also been raised from an environmental and reputational perspective on whether there should be greater constraints on the types of units allowed into the NZ ETS, such as AAUs from Russia and the Ukraine.

It is preferable to have New Zealand firms operating effectively within the international carbon market, rather than relying on the government. Yet it is important to ensure the NZ ETS operates effectively and price-based distortions are avoided, especially in the short term. The accompanying paper recommends Cabinet consider a number of areas to assist the development of the New Zealand carbon market (underpinning this is a desire to set the rules as quickly as possible for what types of Kyoto units are able to be surrendered in the NZ ETS).

In terms of acceptability of certain AAUs into the ETS, clear trade-offs emerge. Placing no restriction on the entry of AAUs into the NZ ETS could potentially reduce the cost of compliance for New Zealand. The open nature of the NZ ETS has also been welcomed by some domestic stakeholders. No restriction would, at the very minimum, come with some reputational risk, as well as reducing the prospects of linking with other ETSs in the future. Further, to the extent that there is the ability to restrict certain AAUs from the Kyoto system in the future, allowing those units into the NZ ETS would, to some extent, undermine its environmental integrity. Although it is difficult to predict, a very large inflow of AAUs (with a resultant significant decrease in the price) appears unlikely at this stage.

One option for Cabinet to consider is clarification that under the NZ ETS, direct private sector purchases of AAUs be limited to selected jurisdictions such as the European Union, Norway, Switzerland, Iceland and Japan. This would effectively exclude the import of AAUs from countries where a very significant proportion of these AAUs were not generated by emission-reducing activities. This would enhance the reputation of the NZ ETS with some stakeholders and may leave open an option value to link to other ETSs in the future, but comes at a potential cost to the economy. The ability to change the list of countries from which private sector purchases of AAUs are permitted should be left open. Such an approach would leave open the possibility of government-to-government arrangements if so desired.

Options for accounting for pre-1990 forests: the proposal for assistance to owners of pre-1990 forest land has been relatively heavily criticised by elements of the forestry industry. There are a small number of key underlying elements to the criticisms:

  • (a) The proposed level of compensation per hectare (through free allocation) is insufficient where landowners have viable alternative commercial land uses available.

  • (b) Owners of pre-1990 forest should be able to receive credit for increasing the level of carbon in their forests.

  • (c) Owners of pre-1990 forest will in practice be locked in to their current land use in perpetuity.

  • (d) Some owners were not aware these changes were coming, or were unable to deforest prior to 2008 due to being tied into long-term forest contracts.

  • (e) The relative treatment of post-1989 forest owners is considered by some to be substantially more generous.

There is validity in some of these criticisms. However, the government is limited in its ability to address them given the current Kyoto Protocol rules, fiscal constraints, and administrative difficulties in targeting assistance to those likely to suffer the greatest costs, and its desire to maintain inter and intra sector equity. The costs of the ETS will not fall equally on all owners of pre-1990 forest land; those with high value alternative uses will be most affected. However, under the in-principle decisions the assistance will be allocated equally across all landowners regardless of the quality of their land. This approach was taken because it is difficult to identify those parties most likely to be affected. It can also be argued that it is fair because the value of all pre-1990 forest land is likely to be affected to some degree. In addition, if a more generous total allocation was given to pre-1990 forests, it is arguably should be a deduction against allocation to post-1989 forests. In addition, a more generous total allocation for pre-1990 forests would undermine the government’s objective of maintaining equity of treatment between the forestry, agriculture and industrial sectors. If an increase in assistance to pre-1990 forests was given, it should therefore arguably be funded through a reduction in the generosity of treatment of post-1989 forests under the ETS.

Further advice is being prepared on options to ameliorate concerns with the treatment of pre-1990 exotic forests (such as targeting assistance on the basis of land-use capability or alternatively, targeting on key characteristics). All of these options have weaknesses. Engagement is continuing on the issue of whether to include indigenous forests in the NZ ETS and if a policy change is desirable, Ministers will report this to Cabinet as well as on any further issues arising out of the national Maori forestry hui on 8 November.

Feedback on 2007 decisions is discussed in more detail in the accompanying Cabinet paper. The Cabinet paper does not recommend any fundamental changes to the ETS design previously agreed in principle by Cabinet, although some specific measures aimed at improving levels of liquidity in the New Zealand market are proposed.

A separate consultation programme has been run by the Department of Inland Revenue on some of the potential income tax and GST implications of the NZ ETS. Consequently, the Climate Change (Emissions Trading and Renewable Preference) Bill will include consequential amendments to tax legislation to provide certainty on the tax treatment of income and expenditure arising from the ETS for the forestry sector.

The ETG also arranged for three external reviews of the NZ ETS by:

  • (a) The International Energy Agency (IEA). IEA is an autonomous body within the framework of the Organisation for Economic Cooperation and Development (OECD). IEA promotes rational energy policies in a global context.

  • (b) The International Emissions Trading Association (IETA). IETA is an international association of companies from around the world and across all sectors involved in emissions trading. IETA’s aim is to provide a neutral platform for its members to meet and interact to promote effective market based trading systems for greenhouse gas emissions.

  • (c) Dr Suzi Kerr Motu Economic and Public Policy Research, Wellington. Dr Kerr has considerable experience in New Zealand and abroad as an academic scholar in the subject area of market based instruments.

The IEA review has been received and released; other reviews will be released once received. The IEA praised New Zealand for a well-integrated strategy, which takes a very realistic approach. The IEA noted the NZ ETS framework seeks to introduce as broad a price signal as possible, including through its allocation of emission obligations to fossil fuel producers and importers, who will pass the cost onto consumers through (higher) fuel prices. It commented that this should further encourage adoption of a more rational use of energy. The IEA is particularly interested in the way the NZ ETS links to existing Kyoto Protocol mechanisms, which it says offers a lower cost method for reducing New Zealand’s emissions.

In regard to 2008 decisions, possible changes to the discussion of allocation and the phase-out of free allocation are signalled in the accompanying Cabinet paper. These and other 2008 decisions will be the subject of ongoing dialogue with those sectors that are later entrants to the NZ ETS. Key mechanisms for this are:

  • (a) Climate Change Leadership Forum: the Forum is comprised of 32 senior representatives of sectors and firms subject to the ETS, community and NGO, academics and the chief executives of the government departments responsible for advising on the ETS. At its first meeting on 8 November, the Forum formed two cluster groups to consider a) markets, international linking and units of trade; and b) equity and assistance. Ministers will consider any feedback from the Forum on these issues and the major policy issues (as noted below). The Forum will continue into 2008 and their considerations will be taken into account through the legislative process.

  • (b) Peak Group on Agriculture and the ETS: the Peak Group will consist of key representatives from Maori, the forestry and agriculture sectors and local government. Its members will set the strategic direction on the development and implementation of the Sustainable Land Management and Climate Change Plan of Action and advise on the implementation of the Forestry and Agriculture components of the ETS.

  • (c) Technical Advisory Group on the Agriculture Component of the ETS: this is the principal tool for engaging with the agricultural sector on the technical design elements of the NZ ETS. It will be an independently chaired group of 12 or fewer policy and technical experts appointed by the Director General of the Ministry of Agriculture and Forestry (MAF).

The government is also proposing another Technical Advisory Group for the stationary energy and industrial process component of the NZ ETS. It would comprise technical and policy specialists from the industry and energy sectors, science/technical community and government. Many of the challenges for these sectors are highly technical in nature and are attributable to issues such as the complex and specialised nature of industrialised processes, complexities in markets and distribution networks for electricity and gas, and associated issues of measurement and verification. The goal is to ensure that the NZ ETS functions in a sensible a nd practical manner for the stationary energy and industrial process sectors.

Regulatory impact statement

Limit on new thermal capacity

Executive summary

In the New Zealand Energy Strategy (NZES), the government has stated a clear preference that all new electricity generation be renewable, except to the extent necessary to maintain security of supply. In support of this principle, and providing time for the full introduction of a price on greenhouse gas emissions, the government’s view is that there should not be a need for any new baseload fossil fuel generation investment for the next 10 years.

The government expects all generators, including state-owned enterprises, to take its views into account when considering new generation investments, and the government has recently advised state-owned enterprises that it expects them to follow this guidance.

Cabinet [CAB (07) 34/18 refers] invited the Minister of Energy to report back on the desirability of amending the Electricity Act 1992 to reinforce the government’s objectives for limiting baseload fossil-fuelled thermal generation.

A legislative moratorium applying to all generators in the electricity sector would restore competitive neutrality between the state-owned generators and private generators.

Because this is a significant policy that will affect the investment options available to electricity market participants, it should be implemented in the Electricity Act 1992 as primary legislation. However, the operational details of the policy should be able to be created in delegated legislation (regulations).

Even with emissions pricing, fossil-fuelled thermal generation investment may in certain future circumstances (such as a major gas find) become more economic, which could lead to the construction of additional fossil-fuelled generation that could jeopardise the 90% renewable energy target.

A moratorium will augment the Emissions Trading Scheme (ETS) by limiting investment in thermal generation. The direct costs of this intervention are the additional compliance costs that will accrue for the Electricity Commission to administer the policy. These costs will be minor.

The indirect costs of the proposal are the foregone opportunity cost of cheaper gas generation should a substantive gas find be made and/or if it proves relatively expensive to develop wind and geothermal generation. This risk is difficult to quantify.

The policy is not expected to materially increase electricity prices over and above price changes attributed to the ETS, because modelling indicates a sufficient supply of economic renewable generation exists to meet demand growth in the medium term.

A moratorium on new baseload fossil-fuelled generation may potentially affect security of supply. This risk is managed through the design of the moratorium, which will allow exemptions for new non baseload fossil-fuelled generation.

Adequacy statement

A regulatory impact statement was prepared and the Regulatory Impact Analysis Unit considers the analysis on the design and implementation of the proposed moratorium adequate. The RIAU notes that policy decisions on the proposal itself are discussed elsewhere and that further consultation with affected stakeholder will follow.

Status quo and problem

One of the strengths of an ETS is that it allows the market to seek out the lowest cost ways of achieving an economy-wide emissions objective. However, an ETS that is broad-based and linked to international markets is not designed to ensure specific levels of abatement or types of investment within specific sectors. In particular, an ETS does not preclude the possibility of investment in a new fossil-fuelled power station occurring during the early years of an ETS (or at any other time) if the overall economics are sufficiently attractive.

The prospect of a new fossil-fuelled power station being built during the early years prior to the full introduction of an ETS could jeopardise public confidence in the climate change policy.

The government has therefore announced in the NZES that it expects all generators, including state-owned enterprises, to take its view that all new electricity generation be renewable, except to the extent necessary to maintain security of supply when considering new generation investments.

In addition, the government has recently advised state-owned enterprises directly that it expects them to follow this guidance. Such advice if taken only by state-owned generators places them at a comparative disadvantage relative to private energy companies.

As state-owned generators have been directly advised of this policy requirement, introducing legislation is the logical method to ensure that the policy requirement applies to all generators in the electricity sector.

Cabinet [CAB (07) 34/18 refers] has directed the Minister of Energy to report back on the desirability of amending the Electricity Act 1992 to reinforce the government’s objectives for limiting baseload fossil-fuelled thermal generation.

Objectives

Cabinet has previously considered the issues and risks around implementing a thermal moratorium [CBC Min (07) 20/3 refers]. The significant concern highlighted in this risk analysis was the risk to security of supply that a thermal moratorium could create.

The policy objective is to identify a mechanism to prohibit the construction of baseload fossil-fuelled thermal plant over the next 10 years. The design considered in this paper addresses the security of supply concerns raised above [CBC Min (07) 20/3 refers].

Cabinet directive has requested that the desirability of using the Electricity Act 1992 to achieve this policy is evaluated [CAB Min (07) 34/18 refers].

Cost and benefits of intervention using Electricity Act 1992

Modelling in the NZES suggests that renewable generation is expected to be cost-competitive with fossil-fuelled thermal generation, particularly under the range of potential carbon prices envisioned under the Emissions Trading Scheme as indicated in Figure 3 (as included in the copy of this statement on the Ministry of Economic Development’s website www.med.govt.nz).

It is feasible, however, that a combination, for example, of a high exchange rate and low gas price (as could arise from a major gas discovery) could mean that, even with emissions pricing, fossil-fuelled generation investment may become more economic than is indicated in Figure 3 (as included in the copy of this statement on the Ministry of Economic Development’s website www.med.govt.nz). Unexpected high costs or other barriers to consenting new renewables could also make thermal generation more economic.

New Zealand is a small electricity market by international standards. In this scenario, if gas investment becomes more economic relative to renewable investment options, then the advent of a small number of new baseload thermal plants in the early years of the ETS could effectively displace or crowd out a significant volume of renewable generation.

Such an expansion of thermal operation could place the government’s 90% renewable target in jeopardy, and could result in a significant increase in greenhouse gas emissions (leaving aside the long-term possibility of emissions reduction if carbon capture and storage prove viable).

The scenario described is a sensitivity case to the expected outcomes for the ETS. While it represents a worst case in terms of emissions reductions, because it is a plausible outcome of a major gas find, and because future gas supply is so uncertain, steps are necessary to mitigate this risk.

The policy is not expected to materially increase electricity prices because during the 10-year period of its operation modelling from the NZES indicates that a sufficient supply of economic renewable generation exists. However, a moratorium could increase electricity prices if the assumptions underpinning the NZES were to prove to be overly optimistic.

The identifiable direct costs of this measure are the additional costs for the Electricity Commission and participants to comply with the process. These costs are expected to be comparatively small.

The indirect costs of the measure are the forgone opportunity costs of cheaper fossil-fuelled generation if a major gas find is made. Whether these forgone opportunity costs are potentially significant or not will depend on the extent and duration of the gas find, and any flow-on to reduced hydrocarbon exploration and development.

Cabinet has previously considered the issues and risks around implementing a thermal moratorium (CBC Min (07) 20/3 refers).

Alternative options

Status quo

State-owned generators have been advised in writing of the government’s policy not to build thermal plant. Privately owned electricity companies, while aware of the government’s views through the NZES, will not be bound by the same level of compulsion as the state-owned enterprises, and therefore there is a risk that private energy companies may continue to construct baseload thermal plant over the next 10 years as economic circumstances allow.

Even with emissions pricing, thermal generation investment may in certain future circumstances (such as a major gas find) become more economic. As the status quo does not limit private generators from constructing thermal generation plant in these circumstances, there is a risk that this construction would occur.

While the construction of significant volumes of baseload thermal plant could be economic relative to renewable alternatives, this outcome would depend on the extent and duration of the gas find and the contracts entered into. Irrespective of such price considerations, the construction of significant volumes of new thermal generation would jeopardise the 90% renewable energy target.

The status quo of doing nothing therefore will not meet the policy requirement to prohibit the construction of baseload fossil-fuelled thermal plant over the next 10 years, as it does not restrict a significant proportion of the energy sector from constructing fossil-fuelled baseload plant and increasing greenhouse gas emissions.

Ex post moratorium

Under this design, the Electricity Commission would have an ongoing compliance role to monitor the annual load factor of all fossil-fuelled thermal plant. Operating prohibited new fossil-fuelled thermal plant of a size above the de minimis capacity threshold that exceeded a permitted load factor threshold would be an offence under the Electricity Act 1992.

The Electricity Commission would, however, be able to recommend operations in excess of the permitted load factor for security of supply in an emergency situation in accordance with predefined criteria.

The practical effect of this design is that by placing a significant penalty on non-compliance, it creates an economic disincentive on investors to construct and operate prohibited (baseload) thermal stations.

The advantage of the ex post method is its comparative simplicity largely because the lack of a complex application process will reduce compliance costs.

The disadvantage of the ex post method is that it is wholly reliant on ex post enforcement for compliance, based on historical calculation of load factor or emissions. While the ex ante method also uses enforcement for compliance purposes, this is secondary to the pre-checking of exemptions that will provide greater certainty that prohibited generation plant will not be built and ex post enforcement will not be required.

Preferred option

Ex ante moratorium

The ex ante moratorium is the preferred option. This method provides greater certainty that the policy objective can be met by banning all thermal generation above the de minimis level and requiring all banned generation to apply for an exemption to the Electricity Commission.

Under this method, all plant above the de minimis capacity threshold would be required to apply for an exemption under one of the available categories. Prohibited plant would be plant above the de minimis capacity threshold that had not received a specific exemption, while permitted plant would be plant above the de minimis capacity threshold that did receive a specific exemption, or plant below the de minimis.

The categories under which an exemption may be granted would be defined in legislation, with the criteria to be considered by the body granting the exemptions defined in regulations.

The Electricity Act 1992 should provide that operation of a plant under an exemption may only be in accordance with the purpose for which the exemption was granted. The Electricity Act 1992 should also allow the grant of exemptions subject to conditions to achieve this purpose. For example, these provisions should prevent approved peaking plant being operated as de facto baseload plant.

The scope of the power to grant an exemption would be limited to that required to ensure that the exempted plant is used only for the purpose of the exemption. Effectively, this would require the grantor to impose conditions on the scope of an exemption. For example a plant to be used for short-term emergency purposes should have a time-limited exemption, while a plant intended for peaking purposes should have a limit placed on its frequency of operation (or load factor).

The Electricity Commission is the proposed agent to process exemptions. This is appropriate because the Electricity Commission is the party best able to make an assessment that takes into account security of supply. Exemptions would be assessed by the Electricity Commission against the criteria defined in regulations recommended by the Minister of Energy.

The proposed categories for exemption, to be set out in primary legislation, are that the plant—

  • is required for the purpose of short-term local supply in an emergency:

  • is required for security of supply purposes and has been procured under contract by the Electricity Commission:

  • has either a load factor or an emissions level below the cap defined in regulations for baseload plant:

  • is required for a small isolated community with no viable non fossil-fuel based alternatives:

  • is part of a cogeneration process that improves overall production efficiency above specified level (eg, 80%):

  • uses an acceptable mix of renewable and fossil fuels (eg, waste incineration).

The Electricity Commission would be required to conduct a public consultation on an exemption to be granted before finalising its recommendation to the Minister of Energy. This would provide greater transparency to the process.

The exemption would be gazetted by the Minister of Energy after approval.

The Electricity Commission would be required to monitor compliance with any conditions of an exemption.

Breaching the moratorium by connecting a plant without authorisation, or exceeding conditions of an exemption, would be an offence under the Electricity Act 1992.

The Minister of Energy would need the power to revoke or suspend an exemption in appropriate circumstances. The conditions under which an exemption could be revoked or suspended would need to be developed, but could include after an offence has been proved in court, or an exemption holder is in breach of conditions.

There would be no explicit appeal process for exemption applications. Judicial review would provide a remedy for decisions in breach of administrative law.

The advantage of the ex ante method is that it allows for a comprehensive analysis of the application by a neutral party (the Electricity Commission) who can then make reasoned judgement of the need for the application against relevant criteria and impose conditions on approval should these be required.

A further advantage of the pre-checking provided by the exemption application is that the application process will provide the Electricity Commission with greater flexibility to consider implications and requirements for security of supply.

The method will provide greater certainty to the applicant of what is allowable or permitted.

Implementation and review

A consequence of a legislative moratorium is that, because it would apply to all generators in the electricity sector, it would restore competitive neutrality between parties with regard to the type of investments they can undertake.

A legislative moratorium will have a significant effect on stakeholders in the electricity market by restricting their generation investment options, raising potential concern over security of supply. This concern is mitigated by allowing for exemptions to the moratorium if necessary for security of supply.

Other issues, such as the risks of a reduction in hydrocarbon exploration, are more difficult to quantify and mitigate and will require ongoing monitoring by the Ministry of Economic Development.

In November 2006, the Minister of Energy conducted a review of the electricity market [CAB Min (06) 45/6 refers]. This market review concluded that the performance of the electricity market was mixed, and while some improvement was possible, alternative arrangements did not appear to offer sufficient improvement to outweigh anticipated transition costs and risks.

A thermal moratorium, with the Electricity Commission as the only party who can recommend new thermal investment for security of supply, represents an intervention in the market of similar size and scope to several other market alternatives that were rejected in this prior market review because of likely high cost and consequences.

Although the Minister’s market review assessed alternatives against a range of objectives (as opposed to minimising emissions), the moratorium could potentially create outcomes that might warrant a more fundamental review of the electricity market in the future.

Consultation

The Treasury, the Energy Efficiency and Conservation Agency, and the Electricity Commission were consulted in the development of this paper. The Department of the Prime Minister and Cabinet was informed.