New Zealand remains committed to the Paris agreement on climate change, Prime Minister Bill English assures us - notwithstanding President Donald Trump's "disappointing" decision to pull out of it.

That means the Government has some decisions to make about how to render the emissions trading scheme effective and fit for purpose, in a very different world from the Kyoto Protocol era for which the Mark I version of the ETS was designed.

Happily, it can draw on a major piece of work by the Wellington economic and public policy research house Motu, informed by a year of discussion among representatives of emitters, carbon brokers, NGOs, academics and officials.

Nothing that Trump or any other politician does can change the laws of nature or mathematics.


Plenty of Americans, from governors, mayors and heads of Fortune 500 companies, to individual consumers, understand that and are making economic decisions accordingly. The momentum towards a decarbonised future is clear and at worst can only be slowed somewhat by egregious policy error at the federal level, not stopped or reversed.

The danger posed by Trump's decision is not a surge in US emissions cooking the planet, but rather to the still new and fragile architecture of the Paris agreement.

It is entirely voluntary and bottom-up. The penalty for a country falling short of its commitments is reputational rather than financial. The constraint is moral rather than legal.

Climate change is inherently liable to free-riding behaviour. The fact that the world's largest economy - and second largest emitter - is reneging on its commitment risks a contagion effect if governments conclude: "Well, that lets us off the hook, for the time being at least".

It will not derail the Paris locomotive, but could cause it to lose traction and momentum. And time is not on our side.

Fortunately, the international reaction has been swift and staunch, with the other major emitters - China, India and Europe - all reaffirming their intention to stick with the plan.

For New Zealand, that means the Government taking seriously its own projections of net emissions climbing, when they need to be hauled down.

This country's central policy response to the climate challenge is the ETS, in place since 2008 but currently in a hopeless state of limbo.

It is a cap-and-trade system without a cap. Imagine the quota management system for fisheries without any quota.

For two years, emitters with obligations under the scheme have had no access to international emission reduction units generated under the Kyoto system. And just as well, since unfettered access to them completely subverted and stultified the ETS Mark I.

A key message of the Motu-led work is that no access to international units will continue to be the case for the foreseeable future.

While the Paris accord allows for the establishment of a new centralised international carbon market, that will take years to negotiate, especially as the largest emitters have indicated they do not intend to use international trading to meet their commitments.

Meanwhile, developing countries, which were one source of international units under Kyoto's Clean Development Mechanism, now have their own commitments to meet.

The alternative of bilateral linkages with other emissions trading schemes is a bad idea, even if willing partners could be found, as New Zealand would inevitably be a price taker in a market designed to meet someone else's climate goals. It would be comparable to adopting some other country's currency and monetary policy.

So the New Zealand ETS will remain a closed system for the foreseeable future, freed of the idea that there is such a thing as "the world price of carbon" - as fatuous a notion as "the world interest rate".

At the moment, the only source of supply to the ETS is the large backlog of banked New Zealand units which were crowded out of the market by the torrent of worthless imported emission reduction units which emitters were able to use to meet their obligations.

But crucially, market participants have no idea what the future balance of supply and demand in the market will look like. It is useless as a guide to the kind of investment decisions that need to be made to deliver a low-emissions future.

So central to the Motu proposal is that the Government start to set a cap, a fixed supply of units for the next five years and updated annually.

The cap, which would be lowered over time, would drive the price, which would rise over time. That, after all, is the point of the scheme.

Most of the units would be auctioned. Others would be allocated free, as now, to trade-exposed emissions-intensive sectors, so they only face a carbon price at the margin. Potentially, that could include agriculture. The model is agnostic on that.

And some would go into a unit reserve which the Government could use to deliver a second key feature: a price band with a floor and a ceiling. The floor provides some security for forest owners and the clean tech sector; the ceiling some comfort for emitters wary of a price spike.

The narrower the band, the more it would look like a carbon tax; the wider, the more it would rely on market forces.

The model is designed to strike a balance between the certainty investors need and the flexibility and adaptability required to cope with inevitable shocks.

A third feature would be for the Government to provide an indicative trajectory for both the cap and the price band for 10 years beyond the rolling five-year horizon of the near-term cap and band.

It also envisages an independent body, perhaps modelled on Britain's Climate Committee, to review and advise on climate policy decisions, especially in the event of major shocks.

But the Motu proposal is clear that climate policy cannot be outsourced. It has to remain within the realm of political accountability.

There are key judgment calls the Government would have to make when setting and resetting the cap:

• What should New Zealand's global contribution to tackling climate change be?

• How much of that should be met by domestic action and how much by funding emissions reductions abroad?

• What are the options for, and potential costs of, domestic mitigation efforts?

• How should the domestic effort be split between sectors within and outside the ETS? And what complementary measures are available?

The Motu model is neutral on those things.

We still await the outcome of phase two of the Government's review of the ETS. The more it resembles the Motu proposal, the better.