Legislation intended to render the emissions trading scheme fit for purpose has nearly completed its passage through Parliament.
The committee stage of the Climate Change Response (Emissions Trading Reform) Amendment Bill was completed last week.
Its hundreds of pages cover a lot of ground but the three main things it does are:
• Enables a cap to be set on emissions covered by the ETS.
• Sets up a mechanism for the Government to auction units (rendering the scheme more tax-like).
• Addresses at least some of the impediments to wider participation in the scheme by eligible forest owners.
As the scheme has worked over the past four years — since the end of the calamitous policy of allowing emitters to use cheap and environmentally worthless international units to meet their obligations — the ETS has essentially been a mechanism whereby money flows from a subset of emitters to a subset of forest owners.
It adds about 6c a litre to the cost of petrol at the pump. It has made a negligible difference to emissions.
The basic concept of the ETS is a cap-and-trade scheme akin to fishing quota. In practice, however, it has lacked a cap.
Now, together with the Zero Carbon Act already passed, we have a mechanism for establishing a budget or cap for net national emissions (net, that is, of carbon sequestered by forests established since 1989 on land not then forested).
It has been provisionally set at 354 million tonnes for the next five years, but most emissions will still escape a carbon price.
That is because 194 million tonnes, largely representing the methane and nitrous oxide emissions from pastoral farming, fall outside the ETS. Farmers are, however, under notice that they have to demonstrate a willingness and ability to account for and reduce their methane emissions on a farm-level basis, or they will face the rough justice of having those emissions included in the ETS at the processor level.
Of the remaining 160 million tonnes, just over a quarter is earmarked for free allocation to emissions-intensive, trade-exposed enterprises. About 80 firms get this subsidy, but the big four — NZ Steel, NZ Aluminium Smelters, Methanex and Refining NZ — account for two-thirds of the cost, which at a carbon price of $25 a tonne is around $230 million a year.
The futures of two of those four, the smelter at Tiwai Point and the refinery at Marsden Point, are under review by their owners.
The Government believes the level of allocation is likely to be greater than is needed to address the risk of leakage — where a local emitter is rendered uncompetitive by carbon pricing which its international competitors do not face and closes, to no benefit to the planetary climate.
The legislation whittles down the free allocation by 1 per cent a year from next year and at a faster rate from 2031, but allows for this to be slowed if the Climate Commission is persuaded there is still a risk of leakage.
Firms responsible for the remaining third of the provisional net emissions budget will have to cover their obligation by surrendering units acquired from one of two sources:
• Either units which have been issued to those eligible forest owners who have opted into the scheme and who opt not to hold them to cover their own obligations upon harvest;
• Or units to be auctioned by the Government.
The supply of forestry units is liable to be limited by two factors: only about half of the eligible forests, by area, are in the scheme, mainly the largest ones; and the biggest surge of planting was in the mid-1990s, which means that those trees are reaching the age when they are likely to be harvested and flip from being a carbon sink to a source.
In a bid to encourage more planting and increase participation in the ETS, the legislation introduces, after some complicated transition arrangements, a system of averaging. This is designed to reduce the financial risk that participating forest owners face under the existing "sawtooth" model.
Climate Change Minister James Shaw told Parliament during the third reading debate that the forestry-related changes in the bill were anticipated to result in an increase in planting to 23,000ha a year, which would still only be about a third of the rate prevailing during the mid-1990s peak.
But any confidence those changes might inspire is at risk of being squandered by Shane Jones' innocent-sounding Forests (Regulation of Log Traders and Forestry Advisers) Bill, which has attracted widespread criticisms on both process and substantive grounds.
It remains to be seen whether the Labour members of the environment select committee can muster the fortitude to delay that bill and subject it to proper scrutiny.
Much of the emissions trading reform legislation relates to how auctioning of units, expected to start next year, will work.
It enables the Government to set a price floor and ceiling, initially set at $20 and $50 a tonne respectively. The idea is to reduce uncertainty.
The $20 floor would deliver exactly no torque to the axle of real emissions reductions.
And the prospect of a ceiling price has drawn fire from Wellington economist Dr Geoff Bertram.
"The economic literature on use of market-based instruments to address environmental externalities is crystal clear on one central point: an economic instrument can set price, or quantity, but not both at once," he said in his submission on the bill.
"A carbon tax can set the price of emitting, but it is then up to the market to reveal the volume of emissions at which marginal abatement cost just matches the cost of paying the tax.
"A quantity instrument such as cap-and-trade can fix the allowed quantity of emissions, but the market mechanism then determines, through trading of permits, the carbon price at which emissions are constrained to that quantity."
The idea embedded in the legislation's "Cost Containment Reserve" provision, that somehow the emissions price can be capped below that price without causing emissions to increase beyond the target level, is economically incoherent, Bertram said.