ETS needs fixing, not replacing

04:40, Jun 04 2014

The Green Party has announced a proposal to introduce a $25/tonne carbon tax. The argument for the carbon tax is that the Emissions Trading Scheme (ETS) has failed, particularly because emission prices are low and there has been little reduction in emissions.

In contrast, a tax would ensure that New Zealand would reduce its emissions. But reducing emissions in New Zealand is not necessarily the best way to tackle climate change.

An ETS is a better way for New Zealand to meet its emission commitments. New Zealand's ETS needs fixing, not replacing.

The ETS has had a bad press since its introduction, partly because its role has not been widely understood in the wider context of international action on climate change.

It was introduced with two objectives. Emission reduction was one of them. The other, more important, one was to help New Zealand to meet its international obligations on climate change. 

Climate change is not like other environmental issues. With few exceptions, environmental problems have largely local effects. Unlike other air pollutants which are rapidly removed from the air and do not spread far, CO2 is so problematic because it is so long-lasting.


Once emitted, CO2 is effectively in the atmosphere for ever; it is only removed very slowly through absorption by plants or by the ocean.

Being long-lasting means that emissions from any one place mix thoroughly in the atmosphere - New Zealand emissions affect the globe and global emissions affect New Zealand. But this also means emission reductions by New Zealand would have no noticeable effect on the New Zealand climate.

With the exception of some large countries, every country faces this same dilemma and hence no country has an incentive to act alone. It is for this reason that climate change policy is driven by an international agreement to limit emissions.

The UN Framework Convention on Climate Change (UN FCCC), and its daughter the Kyoto Protocol, have been the foundations for international action. Various options were considered for the nature of obligations, including commitments to specific policies and technologies, but the agreed approach has been national emission limits accompanied by international emissions trading.

This gave individual countries an initial allowed level of emissions and a means for exchanging emission allowances so that some countries could emit more and others less. But the system set a limit on total emissions from the countries with commitments, and the point is not that New Zealand reduces emissions but that the world does.

New Zealand was part of the Kyoto Protocol up until 2012 and is currently operating the ETS on its own while awaiting the next set of international commitments; but the expectation is that the future will look like the past and international emissions trading will be part of any commitments for after 2020.

In this global context it does not matter how much New Zealand emits. What matters is that there is a limit on emissions globally and that New Zealand has allowances equal to its emissions. So long as this occurs, New Zealand is contributing properly to the international commitment.

The ETS was introduced to help achieve this commitment through the obligations to hold emission permits (or 
units) resting with the emitters.

This achieves two things: first, it is economically sound in the sense that those able to reduce emissions cheaply would so and those with higher costs for reducing emissions would not; secondly, it is fair - someone in New Zealand must pay if there are emissions - it makes sense if the one who emits is the one who pays rather than the taxpayer.

Despite this logic, the ETS was never fully implemented as first envisaged. Agriculture was excluded and obligations were only partially passed on with companies having to hold one emission unit for every two tonnes rather than one for one.

When New Zealand is part of an international commitment, purchasing emission units is a real cost of doing business. Effectively taxpayers are subsidising the dairy industry by paying part of its costs.

Agriculture is certainly a great export earner for New Zealand, but it is only in New Zealand's best interests if it is also covering all its costs. Being included in the ETS ensures that it covers its emission costs. The same argument applies to all other sectors that have been given only partial commitments.

Taxpayers have been paying for emissions and subsidising everything from steel and fertiliser production to inefficient vehicles.

The ETS if introduced fully, including all sectors that produce emissions and with an obligation of one emission unit for one tonne of emissions, is the way for New Zealand to meet its emission commitments at least cost and to do so fairly. An ETS that is working effectively like this will result in a price for emissions in New Zealand that reflects the global cost of reducing emissions.

The current price is low for three reasons.

1. The global recession has led to reduced economic activity and lower emissions. But this is a good balancing mechanism. If businesses are struggling everywhere, emission prices are less of a burden. Low emission prices are not increasing emissions; the overall number of emission allowances still limits total global emissions.

2. The exclusion of the major developing countries, China and India, from emission limits.

3. The poor regulation of the clean development mechanism (CDM) under which certified emission reductions (CER) units can be "produced" in countries with no emission limit commitments through projects shown to reduce emissions below what they would be otherwise. But proving what would have happened otherwise has always been difficult and 
the CDM has flooded the emission market with low cost units. Recently and sensibly, the Government has banned their use in New Zealand.

Low emission prices are not a problem per se. They reflect the international regime and circumstances, particularly the exclusion of China and India. 

The Green Party's proposal aims to increase the costs of emitting in New Zealand without changing these international fundamentals. This has no real impact on global emissions - New Zealand is a small emitter and it has high emission reduction costs, so even a $25/tonne charge (the level proposed) will have only a small effect on emissions, and will have no effect on climate impacts on New Zealand. It will simply increase costs. 

From a climate change policy perspective, the arguments for doing more emission reductions in New Zealand would be either that doing so encouraged other countries to reduce their emissions further also, or that introducing a price early will better prepare New Zealand for the future.

It is pure speculation that New Zealand's actions would have any effect on other countries. The better preparation argument is possible, but the effects are equally achieved under the ETS. With the ban on importing CERs, and a finite number of NZUs, market prices will already be starting to reflect the (discounted) expected price after 2020. 

If New Zealanders and the Green Party want to do more to tackle climate change they need to be smarter. It is only reforms to the international regime that will make any real difference to emissions and effects. And given the nature of the international regime, an ETS remains the best policy.

The accompanying argument that a carbon tax is simply a good revenue-raising tax, allowing tax reductions elsewhere, may well be correct. But it needs to be considered alongside other proposals for good taxes and not in isolation.

- Tim Denne is a director of economic consultancy Covec.