KEY POINTS:
Which ever party is in office, it is now clear that future governments will try to harness markets to cut greenhouse gas emissions.
But while the terms "emissions trading" and "carbon trading" are bandied about, firms trying to get to grips with how they might be affected soon
find the questions greatly outnumber the answers.
Now is the time for companies - which face substantial risks from the political response to climate change - to influence the design of the emissions trading regime they will operate in.
Some are already acting.
"The multinationals are probably ahead of where a lot of New Zealand-based corporates are at," says Energy and Climate Change Minister David Parker.
"Their shareholders know it is in their interests to limit carbon emissions because they see a future balance sheet risk attaching to their emissions. That is the way the world is going."
Cement maker Holcim this week released a briefing paper, Creating a Good Atmosphere, outlining how it believes a New Zealand market should be set up, drawing on its experience in Europe.
PricewaterhouseCoopers provides its international perspective in a report released yesterday.
Business New Zealand has set up a group - including most major major emitters - to commission a report from the Institute of Economic Research and Fraser Lindstrom on designing a local carbon market.
And NZX sees a glittering opportunity in exchange-based carbon trading as part of an integrated, 24-hour global market.
But a trading regime requires something to trade. Allowances, or rights to emit greenhouse gases, are something the Government has to create.
And that means policymakers have some difficult decisions to make:
* On the demand side of the market, who will have to hold allowances, and when? How will it be determined how many allowances they must hold? Will the market be open to overseas buyers?
* On the supply side, how will allowances be allocated? Will they be auctioned or allocated free, and if free on what basis?
* Will forest-sink credits, which recognise the benefit of carbon dioxide taken out of the atmosphere by new forests, be part of the system?
* Will allowances created under the Kyoto Protocol's clean development mechanism for climate-friendly developments in developing countries be permitted? And if so to what extent?
* And how are the answers to these questions likely to change over time?
All of these issues influence how far market demand will exceed supply. And that is what will determine the strength of the price signal and the pay-off for companies that invest in clean technologies.
The Government's draft energy strategy does make it clear that the Government is positive about emission trading, although a broad-based system is not likely before 2013.
"If we do proceed down the path of emissions trading it is likely to be in the power generation sector first," Parker said.
That meant the Government would favour transitional arrangements that did not cause a sudden spike in electricity prices as carbon pricing flowed through, he said. There would be no point in engineering an overnight jump in prices if renewable generators could not respond overnight with increased capacity.
"If we went down the emissions trading route, at least during the transition period there would be gratis [free] allocation of some units [to existing thermal generators]," Parker said.
"The most important thing is that we have signalled there will be full carbon pricing for new generation."
It is there, at the margin of investment, that price signals do most good.
Holcim is typical of large industrial emitters. Not only is cement manufacturing energy intensive, the basic chemistry of the process produces large quantities of carbon dioxide.
The Swiss-based multinational has 20 plants in Europe, where the European Union's emissions trading scheme (ETS) has been operating since 2005.
The scheme, which covers 45 per cent of the EU's emissions, requires that at least 90 per cent of the allowances be allocated free for 2008 to 2012. Holcim expects few governments to seek payment for the other 10 per cent, for fear of undermining their firms' international competitiveness.
But it strongly opposes "grandfathering" - allocating allowances on the basis of a plant's historical emissions. Instead allocation should be based on a world best-practice benchmark, so that how much a plant needs to change depends on how far it is from that at the outset.
New Zealand's now-abandoned negotiated greenhouse agreement process involved a similar approach.
Holcim found that perversely, because of variations in the national plans within the EU scheme, some of its dirtiest plants escaped lightly while its most modern and efficient were hit hardest. It favours a transitional system of voluntary agreements that would put large industrial emitters on the path to reducing emissions. Such an approach in the late 1990s led to significant emission cuts.
For companies that value their reputations, voluntary undertakings are more or less mandatory, says Holcim's group manager of energy and climate change, Michael Rynne. But that supposes they would be rewarded and not penalised for early action.
Parker is sympathetic, up to a point. "You don't want to have a system that means there are advantages in staying dirty longer. Neither do you want to have a system that is so punitive that it makes organisations unable to afford to clean up," he said.
Parker has stressed that the stringency of any local regime will take account of what other countries, and our trading partners in particular, are doing about climate change.
Measures that drove our energy-intensive industries to shift to countries that made no attempt to curb greenhouse gas emissions would just cost jobs while doing the global environment no good. But firms would have to do more than invoke the phrase "our competitiveness is at risk" to get an easy ride.
"We are suspicious of that because there's a natural incentive to overstate it," Parker said. "There are a lot more things that go into the location of a business than the price of carbon. Perhaps more material are the sunk cost of investment, labour force skills and market access."
An obvious problem with emissions trading in New Zealand is a potential lack of liquidity, with less than 1 per cent of Europe's population, an electricity sector that is largely renewable already and only a handful of smokestack industries.
That suggests it would been desirable to establish links to carbon markets around the world.
That would bring both opportunities and risks, Parker said. The opportunity would be to earn money by in effect exporting high-quality Kyoto-compliant emissions reductions.
The risk is that overseas companies will snap up emissions-reduction opportunities here, which are cheap by international standards, so that they count towards their home countries' obligations rather than ours.
"That argues for a slow transition towards full integration with offshore carbon markets," Parker said.
Carbon trading lesson for dummies
What is emissions trading and how would it work?
Often called cap-and-trade, it is the buying and selling of rights to emit a given amount of the greenhouse gases blamed for global warming. A Government would set a limit or cap on how much a large emitter like a coal-burning power station or steel mill is allowed to emit. If it exceeds that, it will have to buy allowances from another firm that has cut its emissions by more than it was required to.
It will end up costing the consumer money, right?
That is part of the point of the exercise. Large energy users or small, people are not going to invest in the technology to cut emissions unless it is worth it financially. At least not on the scale required.
Isn't it just a carbon tax in disguise?
No. A carbon tax would set the price (of greenhouse gas emissions) and wait to see what difference that made to the volume of gases emitted. Trading does the opposite. It sets the volume and leaves it to the market to sort out the prices needed to deliver that.
How is it connected to the Kyoto climate change treaty?
The Kyoto Protocol is a cap-and-trade system too, but between governments not companies. A country like New Zealand which emits more than it has agreed to over the 2008 to 2012 period will have to buy allowances from other countries which have done better than their targets. That liability is currently estimated to cost the taxpayer about $600 million but it will go up if carbon prices rise, the exchange rate falls or it turns out we are even further over our target than current projections. Local emissions trading is one way of transmitting that liability from the taxpayer to some of the bigger emitters responsible for it.
Who else is doing emissions trading?
The Europeans have had a scheme running since 2005. The Australian state governments have plans for a nationwide scheme for electricity starting in 2010 extending to heavy industry five years later. California and the EU have begun talks on linking the EU scheme to a binding scheme due to be introduced in California in 2008. Seven eastern US states have signed up for a regional scheme to start in 2009. Some of the largest US corporates back the cap-and-trade approach and the new Congress is seen as more sympathetic.
