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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.

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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.

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.

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.
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.


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