Thursday, August 11, 2011

A review of the Report on the NZ ETS

This is a guest post from Robin Johnsons Economics Page.

On 1 August 2011, New Zealand Minister for Climate Change Issues Nick Smith released the first progress report on the implementation of the New Zealand Emissions Trading Scheme (NZ ETS).

I have now read the Report on the New Zealand Emissions Trading Scheme and have a few comments - having been distracted by the chartjunk in the Minister's foreword.

Perhaps the first point to make is that the NZ ETS has now been though a complete compliance period, the six months from 1 July 2010 (when energy and industry entered) to 31 December 2010. In that period emitters and foresters were in the emissions trading market. The emitters, in energy and industry (about 45% of New Zealand's greenhouse gases) are "participants" in ETS jargon.

These participants had an obligation under the NZ ETS to measure their greenhouse gas emissions and to obtain and surrender a matching number of emissions units to the NZ Government. The Report on the New Zealand Emissions Trading Scheme documents these transaction so it should help us make an assessment of how the NZ ETS is working.

The same underlying infromation, emissions units issued and surrendered in the 2010 compliance period, has already been available from New Zealand's "central bank" for emissions units - the NZ Emissions Unit Register, run by the NZ Ministry of Economic Development. The NZ Climate Change Response Act 2002 requires certain information on emissions trading to be disclosed annually. The Ministry for the Environment's Report on the New Zealand Emissions Trading Scheme is really this same trading information with some, ugh, "100% Pure" photo shoot pictures, quite a few junk charts and several text-boxes.

The Ministry for the Environment report and Dr Smith's press release received some media coverage. The best reporting, with no junk charts, is Brian Fallow in the NZ Herald.

Dr Smith's narrative is that the NZ ETS is going well and Fairfax/Stuff repeated this angle, as did the National Business Review and even Reuters said the NZ ETS was working as intended. The Sydney Morning Herald even reported that the NZ ETS had "performed to expectations."

In terms of raw numbers, there 96 mandatory "participants" (emitters) in the NZ ETS at 31 December 2010 - compared to 500 planned for Australia's proposed emissions trading scheme. Of the 96 participants, 76 are in the energy sector.

There were 1,216 voluntary participants, of which 1,206 were in the forestry sector; forestry having entered the NZ ETS from 1 January 2008 mainly in terms of sequestering carbon in forest carbon sinks and receiving units in return. The NZ ETS creates its own specific emission unit, the New Zealand Unit (or "NZU") as well as allowing the use of most Kyoto Protocol units.

In the six months from 1 July to 31 December 2010, 12.8 million NZUs were gifted to participants by "free allocation"; 9.4 million NZUs were transferred to mostly to foresters for forest carbon sequestration and 8.3 million units were surrendered to the Government (Surrender means to obtain units equivalent to a participant's GHG emissions and to transfer them to the Government's account at the NZ Emission Units Register).

We may then ask "So what?" in response to these raw facts. Well, lets think how the NZ ETS performed according to the expectations of someone who has written a book on the NZ ETS - the economist Geoff Bertram. In the book The Carbon Challenge, Bertram and co-author Simon Terry analysed the NZ ETS as a market for emission units/carbon credits and in terms of supply, demand and price.

The supply of NZUs into the market for the six months from 1 July to 31 December 2010 was 22.2 million NZUs, made up of 12.8 million NZUs gifted to companies by "free allocation"; and 9.4 million NZUs transferred for forest carbon removals.

The demand from the market participants (the emitters) is the 8.3 million units surrendered in 2010. The NZ Emissions Unit Register report tells us that the 2010 year GHG emissions were 33.4 million tonnes and the NZ ETS-liable emissions from 1 July 2010 to 31 December 2010 were roughly half that at 16.3 million tonnes. Remember Nick Smith's 2-for-1 deal to surrender 1 unit for 2 tonnes of GHGs? That explains why only 8.3 million units were surrendered, when 16 million tonnes of GHGs were reported.

For me the critical issue here is that supply (22.2 million units) exceeded demand 8.3 million) by 13.9 million units (or by 267%). There were 13.9 million units left over after emitters satisfied their 2010 NZ ETS surrender obligations.

As we know from basic economics, when supply exceeds demand, the price drops. The MfE report and Dr Smith's press release make no mention of the NZ ETS carbon price. However, the reliable Westpac carbon update provided this chart which shows the declining price of NZUs in 2010-2011.

The excess 2010 units have no expiry date and will carry forward to 2011. In 2011 and 2012, as well as starting with excess units, the 2010 template will be repeated for 12 months not six. More units will be allocated for free to industrial emitters and more units will be given to pre-1990 foresters as compensation, and to post-1989 foresters for carbon sequestration. The 1-for-2 deal carries on as well to 2013. These features are embedded into the structure of the NZ ETS and will ensure that for the rest of the Kyoto Protocol commitment period to 2012 that the NZ ETS market will be over-allocated with NZUs which will trade at a discount to other internationally marketable Kyoto emissions units.

Geoff Bertram and Simon Terry made a number of predictions in The Carbon Challenge. Here's one.
"In the New Zealand scheme, arbitrage between the NZU and the Kyoto currencies sets a ceiling on the carbon price, with no quantity limit. Local emissions volumes will change only insofar as the price of the Kyoto currencies constitutes an incentive to change behaviour; and NZUs will be used to cover liable emissions only insofar as they are a cheaper alternative to Kyoto currency units"
(p 58).

My conclusion is that, contrary to Dr Smith's narrative, the MfE report on the NZ ETS is completely consistent with Geoff Bertram's prediction that the NZUs would be over-allocated, would be priced at a discount to international units and as a consequence the NZ ETS will not provide a sufficient price incentive to reduce GHG emissions.

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