Te Arotake Mahere Hokohoko Tukunga - Review of the New Zealand Emissions Trading Scheme

All of these assumptions depend on estimates, the validity of which I have no way of testing. However, what is clear is that if the supply of units exceeds demand, the price will fall; and if supply of units is less than demand the price will rise. The accepted truth at present (including from the Climate Change Commission) is that the market is oversupplied (or will become so in the medium term) with NZ Units and consequently the market price is likely to trend down at some point in the future. A reducing price is likely to favour emitters buying units on the market to offset emissions rather than invest capital to reduce their gross emissions.

I do agree that if it is cheaper to buy mitigation units, emitters will not be incentivised to invest money to reduce gross emissions. This is basic economics, so I do agree that if the market is over-supplied with units that can be used to offset gross emissions, all else being equal, they will not invest in reducing emissions.

Observations are that since the government opened ETS participation to "permanent exotic forest" owners, land conversions and planting have ballooned to approximately 600,000 ha of new forestry planting per the discussion paper. Again, this is simple economics, that if the fast-growing exotics can attract more revenue by selling carbon credits then land will be converted wholesale to do that.

However, this is part of the wider problem- attempting to use the ETS to achieve too many goals.

The problem relates to the category of permanent exotic forests, which is the subject of other submissions. Briefly, many of the negative impacts relate to the wholesale planting of permanent exotic forests. Production forests, while subject to future increasing risks of climate and wildfire etc, are located in proximity to mills and ports, so they are restricted by the economics of the operation to locations with certain characteristics. They require to produce a return from the crop with whatever carbon credits they might earn being something of a by-product.
I believe we are in danger of throwing the baby out with the bathwater if some of the proposed changes to the ETS are made. The potential is to do significant damage to a productive and important part of the New Zealand economy and damage export earnings as a result.

This is surely the whole point of the Emissions Trading Scheme- to send price signals to emissions-intensive industries that make them either invest in less emissions-intensive means of producing the same or equivalent goods or services, or go out of business.
There is no way to compensate for losers in the move to a low carbon future within the ETS itself. Climate change is going to affect everybody. For example, there may be areas in New Zealand which can no longer accommodate certain industries, or even housing. The ETS is not the appropriate place to try and put policies in place to mitigate the social costs of those affected by these events or conditions. If sea levels change, much of the desirable (and expensive) beach-front or seaside property may become at risk of erosion and destruction. This is something the ETS is trying to slow or reverse through reduction of emissions, but it cannot directly be the means of compensating those who are most affected.
Compensating those faced with increased costs (say households) is a political policy decision. If a "carbon dividend" were to be used, then the dividend needs to have come from the proceeds of selling units into a properly functioning market.
Paying a carbon dividend is a social policy the government might use to reduce the impact on households. These payments or grants might be direct to households or to communities; and they might be unconditional or conditional on or used for the purpose of reducing household emissions, for example, installing solar or wind generators and household battery storage capacity, funding reduction of waste etc so that communities do mot face all of these costs on their own.
Reducing gross emissions via the ETS can only be achieved by seeing the price of emissions rise. For that to happen, supply must be less than demand until some low carbon equilibrium is reached. The same applies to creating a carbon dividend. For that to happen, government must take out of the ETS market sufficient money to distribute, but without flooding the market with units.

The long term goal is to reduce our dependence on emissions-intensive activities. Therefore, the carbon price needs to rise to signal that and incentivise emitters to reduce their emissions. Some reduction strategies may become available at different price levels, but it is unlikely that we can ever have zero emissions, so removals will be necessary to offset those that remain.

The perceived problem is the surplus supply of units in the ETS or that will be issued to forestry in the future. The supply side of the market is already within the government's control. The Climate Change Commission (CCC) has set out pathways to assist the government manage the supply side. These include reducing the free industry allocation and the annual figure supplied at auction.

None of these is without risk of collateral damage, for example to trade-exposed emissions-intensive industries. That is a fact of life, that no policy of any sort can be implemented without consequences, some of them unintended.

Existing production forests have a limited number of units they can sell, which is the "free " units allowed for in the averaging accounting methodology. Once those units are sold, the forest continues ad infinitum without effectively sequestering any more carbon (or selling any more units). The incentive on production foresters therefore is to trickle out their units when prices are high and hold them when prices are low.

Permanent exotic forests, which should not include any species that cannot support healthy and growing trees of less than 75 to 100 years (therefore excluding most production forest species such as pinus radiata and Douglas Fir) should require resource consent from the local authority where they are proposed. Indigenous permanent forest should be allowed as of right on any land. This I know is part of the other proposal being submitted on, but suffice it to say here that the number of units likely from production and permanent forests are unlikely to flood the market if short-lived exotics are excluded from the category of permanent. The economics of transition forests to me look dubious but again the volumes are not likely to be extreme if they are allowed in the permanent category (with conditions- see the other submission).

Again, it is within the government's purview to allow additional sequestering activities into the ETS should the existing participation not produce sufficient offset capacity long term. Constraints on encouraging undesirable environmental outcomes because of the incentive of a high carbon price can and should be imposed by the legislation that properly exists to constrain them, such as the Resource Management Act or its successors

I agree that Maori have a special interest but they are not alone in being apprehensive about the future affects of climate change. I think their special interest is especially relevant to the issue of permanent exotic forest on Maori land.

N/A not competent to answer

Maori tend to be poorer than the population as a whole, therefore may have a claim for additional social support to help mitigate the impacts of climate change. However, poorer citizens from all ethnic backgrounds have the same claim in my view.

Where Maori have a special claim is with land use in my view. I consider Maori land should be exempted from restrictions regarding permanent exotic forests that should apply to land generally, ie permanent exotic forest might be allowed on Maori land as of right. This might include short-lived species with a rigorous and coherent management plan. As kaitiaki of the land, we should be able to rely on good sense to manage the land for the future and for good environmental outcomes, with the additional revenue that such forests might earn.

See above- additional revenue from forestry carbon credits to improve the overall community. As I understand, Maori land registered as Maori land amounts to about 200,000 ha so a limited environmental risk could translate to a bigger social gain.

Generally, however, I reiterate that social costs of transition to a low-carbon economy should be mitigated in social policies, not the ETS.

See above.

See earlier answers- reducing emissions is the primary objective and for that the price of units, which emitters have to buy, needs to rise.

The ETS can only send price signals. This does not preclude adoption of other policies such as lending money to operators to adopt new technology (eg NZ Steel) or directly subsidising uptake of new technology, such as the clean car discount or penalising unwanted behaviour such as the dirty car tax.

Yes, but total supply of units needs to be managed as stated earlier. Removals will be incentivised by higher carbon unit prices encouraging the increase of supply. The total allowable new units coming to market needs to recognise that existing production forestry will maximise its contribution by say the early 2030s, and we do not want to over-incentivise land use changes which do not fit with other non-ETS objectives.

This means removing short-lived exotics from the category of permanent forest, since they are incapable of producing such a forest and the risk is of degraded land quality after high-yielding forests have been abandoned because all the carbon credits were sold into the market and the original cost of the land was insufficient to restrain the carbon unit sales.

Broadly, yes. There is a limit to what the ETS can manage, through price signals. But broadly, the objectives and considerations are what the ETS can be managed to achieve in my opinion. Alternative and additional policies to encourage/discourage behaviours, manage land use and incentivise certain technologies may be necessary in addition, but appropriate price signals in a stable market will work.

Yes. The recent behaviour of the market has been caused by political interference and the creation of gross uncertainty in the market.

One thing the government must take note of if this market is to work is the fact that all policies and changes in policies must be signalled well in advance and be carried through in accordance with what was announced. In other words, this is an artificial market and certainty is everything. Interference or politicising the ETS will destroy it through the manifestation of political risk, which has destroyed it as a functioning market at the present time.

Markets operate by matching supply and demand to reach an equilibrium. Participants in an artificial market need to know how both supply and demand will be managed. The normal function of a "natural" market is not manipulated to achieve a goal, as is this one. A natural market will encourage supply until the marginal cost of production is reached. This market is not like that, since both demand and supply are managed. The CCC has set out for the last two years its recommendations to manage these, but these were ignored by the government. The result, we observe, is patently obvious.

It appears that too much emphasis is placed on the analysis on Options 3 and 4, without enough on Option 1 in the document in my opinion. Option 1 allows for both incentivising emissions reductions and can allow for generating the long-term removals amount needed, through the operation of a single market. The fact that it might not be in balance now does not mean that it cannot be brought into balance in a reasonable timeframe.

I am of the opinion that policy objectives can be met by properly managing supply and demand through the ETS market as presently constituted.

If this option requires a change to the governing Act requiring the government and CCC to take account of additional factors which affect supply and demand, then that does not seem to me to be a major impediment.

Option 1 allows for both the incentivising of reduction through raising the price of emissions-intensive activity, and can incentivise offsetting through forestry (and if that's not enough, through other qualifying activities that might be allowed in the future, with the proper science and lead time)..

Yes, I acknowledge that balancing both is difficult, but it's what the ETS was designed and built to do. Both supply and demand can be managed by the government, to reach a price that effectively incentivises both desired behaviours.

The government controls supply almost directly, through caps, free allocations and auction results etc. The only element it does not have direct control over is forestry, but how difficult is it to take the registered land, determine the ages of the trees from the mandatory returns and calculate the timing of the units issuance? No, you cannot calculate when those units might appear on the market, but often participants in all sorts of activities are surveyed as to their intentions. The government can indirectly control forestry issuance by determining what type of forestry or other activity can be approved for registration.

Similarly, the demand for units is predictable based on what activities have to buy them to offset their emissions. Managing overall supply and demand, allowing for any perceived surplus in the market, to reach equilibrium at a price trajectory that matches intended policy outcomes will not be a five minute exercise, but it does not seem theoretically impossible.

The key to it is openness, except for things like the auction reserve price, thorough which the government has a very significant supply lever, in the overall management of supply and demand. Following the CCC's recommendations which points the way several years ahead would be a really good start in transparently managing these factors.

No.

I will say, however, that effectively splitting the supply and demand functions into separate markets is the most likely to fail in my opinion. If the objective is to incentivise some forestry, making the government the monopoly buyer is not likely to be a success.

The level of trust of the current market I would assess as practically nil at the moment, largely brought about by political interference. I wrote in an earlier submission regarding cost recoveries by MPI of the costs of running the ETS that far from the units a forester may hold having the value assessed by the people developing the submission discussion document and questions, I would assess the value at zero because of political risk. That risk has demonstrated itself much sooner than I could have imagined, but clearly any holder of units at the moment has a practically worthless asset. Over-engineering these reforms and reducing trust in the market will likely destroy the market altogether.

The recent experience of the collapse of the market, coupled with MPI's consideration of imposing charges of $30 a hectare on forestry participants may in fact incentivise a lot of forestry participants to leave the scheme, and hand their units back to the government. This may actually be the intention, but it is likely to be counter to policy intentions regarding any possible offsetting and thus reduce the desired objective of using offsets to offset those emissions we cannot realistically reduce. This would force the government of the day to buy units on an overseas market, the cost of which could be crippling.

Peripheral policies such as land use policies, forest (permanent, transition and production) management policies, and social policies to mitigate the impact of the changes on the households least able to afford coping with them, including those households from minority ethnic communities.

The ETS itself can only send price signals. Other determinants of supply and demand will need other policies to keep them properly matched within a range of unit prices that delivers desired outcomes. Changes to these settings always need to be well signalled ahead of time, so that participants can adapt to the proposed new conditions and understand what changes the market might undergo as a result of them.

I am of the opinion that the Climate Change Commission should be the body which carries out this regulation of supply and demand in the market, to take it out of government's hands, in much the same way that the Reserve Bank operates monetary policy in accordance with a published policy objective framework set by government.

N/A. Not competent to answer.

Encouraging permanent indigenous forestry, for example, might be additionally encouraged by other incentives such as the one recently proposed by one political party, whereby land use changes and retirements might be replanted with permanent indigenous forest. The forest so subsidised could then be registered in the ETS and the financial rewards the ETS would provide as revenue would allow the landholders to manage the forest into the future and extract some economic value for the land.

While these grants could be used for encouraging non-forest environments such as wetlands, for example, which also sequester carbon, these should only be allowed for registration in the ETS if the forest category, including the new plantings of permanent forest incentivised by the environmental grants, were not producing enough units to meet the removal objective or demand.

This would likely be a long term issue, since initially the perceived issue is an over-supply rather than an under-supply of units.

The co-benefits that the ETS can encourage are limited to those that fit with the primary objectives of the ETS. Operating the market with the levers available to manage supply and demand to achieve its main objectives may also achieve others, but the prime policy objectives should not be diluted otherwise the market will fail due to uncertainties introduced. Remember, the entire market is a political construct so deviation from well publicised and declared objectives will only throw it into uncertainty.

It is possible to envisage that carbon credit units for new indigenous plantings could be accelerated, or indigenous forest might earn a premium of some sort (paid separately to ETS-tradeable units). Similarly with other forestry- at some point in the future it might be necessary to restrict the number of units that can be sold, or impose some form of compulsory acquisition of future units at a pre-determined price, if there are too many forestry units in the market to achieve the removals goal.

Any policy adopted, such as the examples above, has to fit into the objective of bringing the ETS price to and keeping it within the price pathway that achieves its objectives, and any adjustment to either supply side or demand side conditions needs to be signalled well ahead of implementation.

But see above. If the existing removals categories prove inadequate, then other categories could be carefully considered for inclusion. The supply of units from such inclusions would need to be carefully managed so as not to dilute the unit price and put in jeopardy the goals of the scheme.

See above. Grants etc to achieve, for example, environmental objectives, by stimulating retirements on unsuitable land, conversion to wetlands or any other desired outcome. These do not have to impinge on the ETS at all if not needed for the ETS to meet its objectives- eg including wetlands, if supply and demand are managed appropriately without their inclusion.

I have written in answer to other questions several general comments.

For the market to work effectively it must be understood, be transparent and maintain a price trajectory that achieves its goals. Long term plans for managing supply and demand are published by CCC and these are the best guide to achieving a stable market with the ability to provide meaningful price signals.

This is best achieved in Option 1 in my opinion, utilising the market we already have, but with more clearly understood and publicised use of the levers available. But that's the thing- the levers need to be used. We have a surplus in the market, we need to be told how it is to be cleared. The current year gives the government the option of setting the reserve for both future auctions high enough to restrict sales of units to zero, thereby eliminating a portion of that surplus. But this means no revenue for government, which means no investment funds for reductions and no future fund for mitigation of the economic consequences for households.

Political interference, and tacking on other policy goals that are not compatible with those of the ETS, will destroy confidence in the market which is the situation we have now. My advise is to task the CCC with formulating the application of levers available.