Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Anti-rort law hits forest good guys

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Legislation pushed through under cover of Budget night also hurts those playing by the rules, writes Brian Fallow

Under its equivalent of the cover of darkness Parliament has legislated to stop a rort by a subset of a subset of participants in the emissions trading scheme.

But in the process it has inflicted gratuitous collateral damage on other forest owners who have acted in good faith, in accordance with the rules of the scheme and with no intention of gaming the system.

It has meanwhile left entirely intact the corporate welfare the scheme allows. And it has trampled on any semblance of good legislative practice.

Announcing the passage of the entirely unheralded Budget night legislation on May 16, Climate Change Minister Tim Groser said, "We have acted to remove an unintended consequence from the operation of the ETS that, if left unchecked, could create reputational and integrity risks to the ETS and fiscal costs to the Crown."

Too late, minister. The integrity of the scheme lies in an unmarked grave somewhere.

The ETS allows the owners of "Kyoto" forests -- those planted since 1989 on land not previously forested -- to opt into and out of the scheme.

If they opt in they receive an allocation of carbon credits called New Zealand units (NZUs) which recognises the carbon dioxide their trees have sucked out of the atmosphere.

The catch is they become responsible for the CO2 deemed to be emitted when the trees are eventually harvested and will have to surrender units to cover that. But in the meantime if they choose to sell their NZUs it is a source of cashflow while the trees are growing.

They can also deregister or opt out of the scheme if for instance they consider the compliance costs, which are not insignificant, are not worth the candle. In that case they also have to surrender units to square accounts with the Government.

The problem arises because, in common with others with obligations under the scheme, instead of surrendering NZUs they can substitute cheap imported Kyoto units which originate in somewhere like Ukraine and which can be bought on the international carbon market for a few cents a tonne or about a 10th of the price NZUs have been trading for.

This arbitrage opportunity arises because of the collapse in international carbon prices and because the Government has rejected all calls to follow the European Union and limit the ability of emitters to use them for compliance proposes.

As a result some 97 per cent of the units surrendered in the 2012 compliance year were cheap Kyoto credits, compared with just 5 per cent two years earlier before the price collapse.

The particular rort that the Budget night legislation, the Climate Change Response (Unit Restriction) Amendment Bill, addresses is called reregistration arbitrage.

It is the ability for Kyoto foresters to game the system by registering (and collecting NZUs), then deregistering (surrendering cheap Kyoto credits and pocketing the difference) and then registering the same land again to repeat the process.

The regulatory impact statement accompanying the legislation says that in the second half of 2013 the Ministry for Primary Industries received 550 applications to deregister land from the ETS, representing about 40 per cent of the Kyoto forest land in the scheme, and that 208 of them had subsequently applied to reregister.

Clearly the Government can't have that. But the way it has opted to close this loophole hits not only the target group -- those planning to reregister and game the system -- but also those who were planning to pull out of the scheme full stop and who have already bought Kyoto units to cover their obligations.

The amendment requires post-1989 foresters to use only NZUs when deregistering from the scheme.

They may see this as unfair, officials concede, because it restricts their use of Kyoto units while other sectors, like the oil and power companies and emissions-intensive trade-exposed emitters, continue to have unrestricted use.

Forest owners who simply seek to exit the scheme for good not only face a higher barrier to exit but may now be stuck with Kyoto units which are effectively worthless.

That is because New Zealand emitters will only be able to use them for compliance purposes for one more year, the Government having managed to get New Zealand excluded from international carbon markets. From this time next year New Zealand emitters will be able to use only NZUs to meet their obligations.

Knowing this (it was confirmed six months ago) the big end of town have filled their boots with cheap perishable Kyoto units and stockpiled NZUs.

This is where the corporate welfare comes in. The ETS is designed to ensure that large emissions-intensive trade-exposed operations like the Tiwai Point smelter or the Glenbrook steel mill are only exposed to a carbon price at the margin -- and a pretty narrow margin at that.

The way this is accomplished is by the Government giving them free NZUs to cover the overwhelming majority of their emissions. The idea was that they would pay those back, topped up by units they had to buy to cover the last few per cent of their emissions, or if they did better than their target leaving them with some to sell.

But the collapse in international carbon prices has presented the smokestack sector with an arbitrage opportunity too.

They have been able to hoard their NZUs, in the expectation they will be more valuable in the future, and meet their obligations in the meantime with cheap imported Kyoto units instead.

The result is an overhang of NZUs in the system, whose magnitude is virtually impossible to calculate accurately from publicly available information.

The regulatory impact statement is unhelpfully redacted on this point: "The high surrender rate of Kyoto units by all sectors in the ETS has led to [withheld] NZUs being held in private accounts (representing [withheld] years' worth of obligation) and increased the Government's holding of Kyoto units beyond the level required to meet its international commitments," it says.

Sustainability Council executive director Simon Terry says large emitters and foresters who have been issued NZUs should all have been forced from the beginning to surrender only NZUs until they had used up all they had been issued with.

Forest Owners Association chief executive David Rhodes said arbitraging did not benefit New Zealand or the climate in any way.

"We, along with Maori interests, the Parliamentary Commissioner for the Environment, and environmental groups have repeatedly told the Government that these units undermine New Zealand's ability to address climate change," he said.

"Finally they have decided to act. But why now? Why with such urgency? Why retrospectively? And why only forestry?" Rhodes finds it deeply ironic that the only industry that has consistently criticised the use of international units in the ETS has been singled out in this way.

When other changes have been made to the scheme, for example excluding some international units of particularly dubious environmental integrity, they have applied to all participants.

Carbon brokers point out that the collateral damage to forest owners could have been avoided if the Government had engaged in even perfunctory consultation.

It could have dealt with the reregistration arbitrage issue by allowing only post-1989 forest land to be registered once in any five-year period.

Officials considered this option unfair "as it effectively excludes any land that is deregistered for genuine reasons (for example due to the sale of the forest) from being reregistered".

That, they argued, would be likely to discourage participation in the ETS.

Well, not nearly as much as the chilling effect of an unheralded, retrospective, highly selective rule change pushed through Parliament under urgency on Budget night, with no opportunity for consultation or select committee scrutiny.

Sometimes it seems the sovereignty of Parliament is entrusted to some pretty unworthy hands.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

Brian Fallow is the New Zealand Herald's economics editor. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

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