Brian Fallow: Big call on greenhouse gas

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The biggest emissions call the Government has to make is what to do about the dairy sector.

It should not be long before we get to see at least the shape of the Government plans for an emissions trading regime.

Behind the jargon about leakage and linkage, gratis allocation and points of obligation lies a fundamental change.

A right (to emit greenhouse gases) which has always been untrammelled will be restricted and rationed by price.

Property rights will be created, wealth transferred, costs imposed.

It involves difficult choices:

* Who will have to pay for their emissions and who will have theirs covered by the taxpayer? The balance to be struck is between reducing emissions on the one hand and preserving the tradeable sector from futile damage on the other.

* Where will the money go?

* Where will the points of obligation be? That is, which companies will have to engage in the market, as opposed to facing what amounts to a carbon tax?

The trade-off is between minimising compliance costs and maximising the flexibility of the scheme, so that emissions can be reduced at least cost.

* What provisions will there be for international linkage with other carbon markets?

The trade-off here is between liquidity and efficiency in the market on the one hand and the risk that our emissions-intensive economy will be stuck with costs determined by policy made in Brussels.

The question of shielding some emitters from the cost of their emissions arises because only a minority of the world's economy has undertaken obligations under the Kyoto protocol.

The risk is called leakage - that imposing a price on carbon emissions simply causes emission-intensive industry to migrate to countries where no such costs are imposed. Jobs and taxes are lost and the trade gap widens, for no advantage to the global climate.

Even the Greens accept that firms whose competitiveness is at risk need protection. The difficulty will be where to draw the line, in the face of intense lobbying.

The same problem arose when the policy was to have a carbon tax. There was provision to negotiate greenhouse agreements, exempting large emitters from the tax provided they were on track towards world's best practice. The negotiations were fraught and in the end only two agreements were concluded.

The biggest call the Government has to make in this area is what to do about the dairy sector.

It has said that all sectors and all greenhouse gases will - eventually - be included. But that is immediately qualified by the need to acknowledge the different circumstance of different sectors.

And the Government has in the past agreed not to expose the farming sector to a carbon price before 2012, although the agreement has provision for review about now.

With world dairy prices having more doubled over the past year the sector can hardly plead poverty, and protection from a carbon price would of course undermine its proud claim to be unsubsidised.

"This is the time dairy can afford it," says Greens co-leader Jeanette Fitzsimons. "It's the largest farming emitter and the only one to have substantially increased its emissions since 1990."

The flipside of the Government's decision to exempt agriculture five years ago was to retain all the value created by Kyoto (post-1990) forests, with calamitous consequences for net afforestation rates.

Assuming that the Government does not repeat the European mistake of wholesale grandparenting - allocating the vast majority of emissions rights free on the basis of existing emissions - it should have a significant amount of money coming in from auctioning or otherwise selling the rights it is going to require firms to hold.

The Finance Minister would no doubt argue that that income is required to meet the liability already in the Crown's books to square accounts with other Kyoto Governments post-2012.

There is no way New Zealand will meet its Kyoto target of reducing emissions to 1990 levels. So it will have to buy carbon credits on the international market to cover the difference.

But the Greens want to ring-fence the auction revenue and use it for climate-friendly projects.

"It's absolutely vital for public acceptance of this scheme that people can see where the money is going," says Fitzsimons.

"If we can say we get the money back in low-carbon infrastructure and warmer homes and renewables, people will buy it. I think it's the single greatest reason the public didn't support the 2002 policy package - the money just disappeared into a black hole."

Another big call is where the point of obligation should be.

To reduce administrative and compliance costs there is a case for putting it "upstream" at the point where fossil fuels are introduced to the economy - for example, by oil companies importing crude or refined products - or consumed in large quantities, as by power stations burning coal or natural gas.

This is the approach favoured by Business New Zealand, all of the major emitters, and the Greens.

The oil and power companies, it is argued, are big and ugly enough to cope with the price risks and compliance costs of emissions trading, and they are in a position to pass their carbon costs on to consumers.

For their customers, which is just about everybody, the effect would be similar to a carbon tax, but one whose level was set by the market rather than by a bunch of lobbiable politicians.

But that approach would limit one of the main strengths of a cap-and-trade approach, its flexibility.

Most businesses would only be able to reduce their carbon costs by reducing the amount of diesel they use or electricity they consume, even if it might be more efficient for them to buy credits for emissions reductions someone else could make more cheaply.

The Greens would get around this problem by having the point of obligation upstream but giving those downstream firms which want it the right to take responsibility for their own emissions and escape the carbon content of their power and fuel bills.

Finally there is the question of international linkages.

Liquidity is liable to be a problem in a carbon market serving only 4 million people.

But to link - that is, have mutually recognised and interchangeable instruments - with the European emissions trading scheme, which is much the largest carbon market, could mean New Zealand emitters face higher prices than policymakers here envisage.

On the supply side Europe is (so far at least) unwilling to countenance forestry-based offsets.

And on the demand side Europe is likely to set an ambitious pace in terms of emissions reductions. It has already adopted a target of a 20 per cent cut from 1990 levels by 2020, regardless of what the rest of the world does.

Contrast that with Apec's Sydney declaration at the weekend. It adopted an aspirational target of a 25 per cent improvement in emissions per unit of gross domestic product by 2030. If the region's GDP doubles by 2030, as it well might, that would imply a 50 per cent increase in emissions.

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