Parker: Designing an emissions trading scheme
Hon David Parker
Minister responsible for Climate Change
issues
7 August 2007
Speech notes
Designing an emissions trading scheme
Address to Buddle Findlay
seminar
5.15pm, 7 August, Buddle Findlay, L17, State
Insurance Tower, Wellington
1. Pleasantries
It’s
a pleasure to be here to deliver the third seminar in the
Buddle Findlay sustainability seminar
series.
2. Introduction
Sustainability and climate
change. Two terms that I’m sure you are all very familiar
with. Terms that the entire population is becoming
increasingly concerned about. They are more than just buzz
words. They represent real and tangible challenges that
societies around the world must strive to overcome if they
wish to sustain their way of life for generations to come.
To facilitate this transformation, governments around the world have begun to implement policies and regulations which encourage sustainable actions and discourage unsustainable behaviour.
For this government, sustainability is a core priority. We aspire to achieve sustainability across the four pillars of our economy, society, environment and culture.
At the launch of this seminar series, Prime
Minister Helen Clark outlined the suite of policies that
this government has introduced, or is considering, to meet
the sustainability challenge. These approaches include
price-based tools, incentives to change behaviours, direct
regulation and educational programmes.
Today, I am here
to talk in particular about what we are doing about one
aspect of the sustainability challenge - climate change. In
particular I have been asked to speak about emissions
trading.
I will begin by giving you a brief overview of emissions trading and how it works. From there I will explain the rationale price-based measures and will explain some of the differences between emissions trading and a carbon tax. I will then touch on some of the main design issues that are being worked through, to give you a feeling for how an emissions trading scheme could work. Although I must stress that Cabinet is yet to make final decisions.
3. What is Emissions Trading?
First, a
little background: what is emissions trading?
Emissions trading is a flexible market-based mechanism for reducing greenhouse gas emissions. It’s flexible because it allows participants to find the cheapest way to meet their emission reduction targets.
A ‘cap and trade’ model is one kind of emissions trading scheme.
Under the ’cap and trade‘ model, participants within the scheme must match their emissions with tradeable emissions units. The number of units that are initially allocated into the market is limited – hence the term ‘cap’.
The trade part comes from the requirement for participants to get their emissions units from somewhere. Participants may purchase these units from the government, from other participants or from offshore. They may acquire some free and have to buy some, or have to buy them all.
Those who can reduce emissions for less than the market price of emissions are likely to do so and may sell any surplus emission rights.
The price of
emissions gets passed down the supply chain and flows
throughout the economy. This creates an incentive for
producers to reduce their emissions and for consumers to
increase demand for lower emission products.
A 'cap and
trade' scheme requires several key features:
- There must
be a functioning and liquid emissions trading market
-
There must be established methodologies for monitoring,
reporting and verification of emissions
- There must be
an effective penalty regime for non-compliance; and
- The
scheme must be flexible enough to adapt to future changes in
the international climate change policy framework.
4. Rationale for Implementing a NZ ETS
So why is the
government looking at emissions trading or in fact any
price-based method to reduce greenhouse gas
emissions?
There is a growing international consensus, based on robust scientific and economic analysis, that market-based approaches are an important part of the response to the very real threat of climate change.
A greenhouse gas emissions trading scheme has been up and running in the European Union since the beginning of 2005, and there are also proposals for greenhouse gas emissions trading in Australia and the US. In fact the Kyoto Protocol itself is a global (cap and trade) emissions trading scheme.
New Zealand ratified the Kyoto Protocol in 2002 as part of its commitment to supporting international efforts to mitigate climate change. Under the Kyoto Protocol, New Zealand will become liable for its emissions come January 2008.
There are good reasons for taxpayers to shoulder
some of that cost. There is also good reason for those who
create emissions, and who benefit from them economically, to
face some of the cost. Price-based mechanisms achieve this.
And the bulk of the New Zealand public supports this
notion. During the recent round of consultation on climate
change policy, submitters were overwhelmingly in support of
implementing a price-based measure in New
Zealand.
Reducing greenhouse gas emissions does come with
a price tag – but this price tag is manageable and
emissions trading can help minimise that cost.
As part of the Government’s 2005 Review of Climate Change, various scenarios of the impact of greenhouse gas pricing were modelled.
One, which priced carbon at 13 New Zealand dollars a tonne, predicted that GDP would increase by 0.04 percent less in the period to 2010 relative to the projected business as usual figure. In other words, the impact on projected growth is not one percent, not one-tenth of a percent, but only 4 one-hundredths of one percent. This means that while emissions trading might reduce growth a fraction, we will still be wealthier as a nation than we are now.
Another scenario illustrated that at a price of 51 New Zealand dollars per tonne, GDP would decrease by 0.24 percent relative to business as usual over five years. So even with substantially inflated emission prices, it would only shave growth by a small fraction.
This is because most of the impact of an emissions trading scheme is to redistribute costs and resources within the economy. Changing the relative cost of high-emissions products and services will create an incentive for changes in behaviour to reduce emissions.
We should also bear in mind the cost of doing nothing to limit climate change. Research has shown that the benefits of early action to prevent climate change considerably outweigh the costs. If greenhouse emissions in our atmosphere continue to increase there could be a very big price tag indeed, both economically and environmentally.
5. Tax vs. emissions trading?
There
are two main price-based measures for reducing greenhouse
gas emissions: emissions trading or an emissions tax.
The
key difference between an emissions trading scheme and a tax
is that a tax sets the price emitters have to pay per unit
of emissions, and has only an indirect effect on the volume
of emissions. In contrast, a trading scheme sets the volume
of emissions, and leaves the market to determine the price
of emission units.
From an environmental perspective, an
instrument that regulates the volume of emissions is
preferred.
Emissions trading offers several significant
advantages over a greenhouse gas tax:
- Emissions
trading is more flexible than a tax. It recognises that
emissions reductions can occur more cheaply in some sectors
than others by giving all participants equal access to
least-cost emission reduction opportunities
- Emissions
trading allows resources to be shifted around the economy,
and around the world, to where the least cost reduction in
emissions can take place
- Emissions trading allows the
price to adjust automatically whereas tax prices need to be
manually adjusted
- Emissions trading has emerged as the
preferred approach internationally
- Emissions trading
provides the flexibility to adapt to changing international
and domestic circumstances
- Emissions trading creates
new business opportunities for New Zealand, such as the
development of trading infrastructure and new mechanisms for
engaging with foreign markets, and incentives to invest in
new technologies and renewable energy
The recent consultation process also revealed growing (although not universal) support among the general public and the business community for the concept of emissions trading, as a preferred approach relative to a tax.
6. Latest thinking:
possible design features of a NZ ETS
Agreeing to progress
the design of an emissions trading scheme is, however, only
the first step. The design and implementation of a trading
scheme will need to take into account the unique
characteristics of any country.
As many of you will know, since April this year there has been a dedicated cross-departmental Greenhouse Gas Emissions Trading Group (ETG) based at Treasury investigating the details of how a broad-based emissions trading scheme could work in New Zealand.
The team at the Treasury has been working hard over the past few months to work through the design issues. This is a big task, but we are not starting from scratch. We are drawing from a tremendous amount of work done in New Zealand and elsewhere on climate change and on the design of emissions trading schemes.
No final decisions have been
made at this stage but some of the issues that we are
considering include:
- The coverage of an emissions
trading scheme
- How it could be phased in for different
sectors
- How to allocate permits
- Whether to link
the scheme internationally
- Where in a sector’s supply
chain it would be applied
- How to design the scheme so
that it can adapt to any changes in future international
climate change agreements
- How an emissions trading
scheme would work in with other existing and proposed
climate change policies
- And we are also working through
administrative details such compliance, enforcement and
operation of an emission unit register.
I will now briefly touch on the first four of those issues: coverage; phasing different sectors into a scheme; allocating permits; and linking the scheme internationally.
Coverage
In
terms of the coverage of an emissions trading scheme, we
have already indicated that we are pursuing a design that
will be economy-wide, over time, and include all sectors and
all gases. There may be some minor exceptions and again I
note that no final decisions have been made at this
stage.
One of the primary reasons for wanting a broad coverage is that emissions reductions can occur at the lowest cost when there are many participants and many units for trade in an emissions trading scheme. This is because the broader an emissions trading scheme is, the greater opportunities there will be for those seeking out the most cost effective options for offsetting their emissions.
Exempting one sector of the economy simply raises the cost faced by other sectors and the economy as a whole.
Broad coverage also ensures that the all sectors play their part in reducing greenhouse gas emissions. It is the fairest approach.
Virtually all submissions that commented on coverage in the recent consultation period emphasised the need to include as many sectors as possible in the long term in a New Zealand emissions trading scheme, for equity reasons, to encourage liquidity in the market and to enable least-cost reductions.
A phased approach
Some
sectors are able to participate earlier than others due to
technical and administrative capabilities. Different sectors
also have different capacities to respond to emissions
pricing including their ability to pass on costs, and
measure and reduce emissions. A phased approach for entry
into an emissions trading scheme could take into account our
unusual emissions profile and the particular challenges in
our country for reducing emissions.
International emissions trading schemes such as the European Union scheme have also adopted a phased approach. The European Commission has indicated that it wishes to include all sectors and gases over time.
Allocation
How to allocate
permits is a particularly complex design decision and will
always be an important issue for participants.
Allocation
decisions require balancing the competing objectives of
efficiency, equity and administrative ease.
Linking
Other important design features include what,
if any, restriction there should be on buying and selling
overseas.
This is one of a number of issues that requires careful consideration.
7. Process
I now want
to take a little time to discuss what the process is from
here.
Over the next month or so Cabinet will decide
whether to proceed further with a New Zealand emissions
trading scheme. That requires Cabinet to consider some
initial in-principle core design features.
Following those decisions, the government will engage with stakeholders to gain feedback and input on core design features.
After considering public feedback, Cabinet will make decisions on the core design features of a New Zealand emissions trading scheme before legislation is introduced. Select committee processes would follow, and provide an opportunity for the public to make formal submissions on the scheme.
Decisions around allocation of units, and timing of entry of sectors could be made later.
The Government will also continue to work with stakeholders as the international climate change policy framework evolves.
Other climate change measures are equally important.
A few examples of
complementary policies include the biofuels sales obligation
and the contestable marine energy deployment fund, funding
for (agricultural) methane-related research, measures to
improve energy efficiency in homes and in the vehicle fleet,
and renewable energy policies that fall within the New
Zealand Energy Strategy.
Final decisions on many of
these policies are expected in the next few months.
8.
Conclusions
I look forward to working with many of you
over the next few weeks and months as climate change and
other sustainability policies evolve. Together we can
maximise the opportunities arising from our transition to a
more sustainable economy.
ENDS