Emissions trade could help in battle against warming -- but it won't be easy

The Paris Agreement on climate change ticked one essential box from a narrow national point of view: it countenances the use of international trading in carbon credits to meet countries' emissions targets.

Without that, New Zealand's pledge would not have been worth the paper it was written on.

That is because it is conditional on New Zealand having "unrestricted access to global carbon markets" -- which at this stage don't exist.

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New Zealand's commitment is for emissions in 2030 to be 11 per cent below 1990 levels. They are already more than 20 per cent above 1990 and climbing -- unrestrained by any effective policy to restrain them -- at a rate the Government estimates will have them about 30 per cent above 1990 by 2030.

So if the 2030 target were to be met entirely within New Zealand, emissions would have to be cut by nearly a third over the next 15 years.

That is simply not feasible. Not when nearly half the emissions arise from the bodily functions of livestock. Not when the electricity sector (which most developed countries are looking to for emission cuts) is already 80 per cent renewable and rising. Not when the country does not have a lot of smokestack industry.

That is not to say that nothing can be done. Biofuels and an expanding forest estate spring to mind.

But it does mean that the Government is relying on importing carbon credits to meet the lion's share of the gap -- the yawning chasm -- between where emissions are heading and the Paris commitment.

Modelling it commissioned from Infometrics indicates that at a carbon price of $50 a tonne, about 80 per cent of the reduction would have to occur somewhere else in the world.

And in principle there is nothing wrong with that.

The global climate does not care where emission reductions are achieved or who pays for them.

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A credible and rising global price on carbon, with futures trading and all of that, would be very helpful to businesses, governments and individuals making the decisions that collectively will determine whether catastrophic climate change is averted.

The difficulties are practical. The international trading mechanisms set up under the Kyoto Protocol provide gruesome lessons in how easy it is to get this wrong. Those lessons, the Paris Agreement notes, must be learned.

The global climate does not care where emission reductions are achieved.

It is not entirely clear from its veiled and perfunctory language, but what it seems to envisage is a system akin to Kyoto's Clean Development Mechanism (CDM).

Under CDM, emissions-reducing projects in developing countries give rise to credits others can buy and count toward their emission targets, offsetting domestic emissions that it would be more costly to cut.

The emission reductions have to be certified as real and permanent and they have to meet an "additionality" test -- that is, that they would not have occurred without this source of finance. As the Paris Agreement puts it, they have to deliver an overall mitigation in global emissions.

This presents a problem: it is hard enough to figure out what is happening in the actual world, never mind what would have happened or not in other possible worlds.

And there has to be robust accounting, to avoid any double counting where two countries claim credit for the same tonne of emissions avoided.

But the most important lesson from the Kyoto markets is that it is essential to avoid a glut.

For a while CDM worked as intended.

The World Bank estimates it supported investment of around US$90 billion in emissions-reducing projects in developing countries.

But when the European Union -- which was dubious of the environmental integrity of some of the units available -- restricted the right of its emitters to use Kyoto units to meet their obligations under the European emissions trading scheme, while issuance continued to climb, prices crashed. Units which had traded in a US$15 to US$20 a tonne range collapsed to few cents by 2013.

By allowing New Zealand emitters unrestricted access to those units, the Government rendered our ETS worse than useless.

Not only has there been no real price on carbon, but the overhang of New Zealand units that were crowded out of the market will distort the supply side for years.

A review of the ETS has just begun, which has to rehabilitate it from the policy-induced coma it has been in.

So a crucial question as the United Nations sets about designing a successor to CDM is whether there will be enough demand in this market to match the potential supply.

Any number of countries will be happy to participate on the supply side, seeing money and know-how flowing their way.

But where will the demand come from?

Both the European Union and the United States declare in their pledges to the Paris process they do not intend to use international trading in meeting their targets. Japan has its own system involving a series of bilateral agreements.

In fact, among the G20 countries -- the 20 largest economies, which make up around 85 per cent of global output -- only Canada, South Korea and Turkey have said they expect to be buyers in an international carbon market.

New Zealand and Switzerland do too.

And Australia is among 18 countries (just 10 per cent of those at Paris) supporting a New Zealand-led Ministerial Declaration supporting carbon markets.

Australia's Environment Minister Greg Hunt has been reported as indicating that it could turn to international markets in what he described as the likely event it was asked to increase its 2030 greenhouse gas reduction targets as part of five-year reviews the Paris Agreement mandates.

The same may yet be true of other countries so far non-committal on international carbon trading.

We can only hope.

The new trading mechanism will need to ensure there is a rough balance between supply and demand. In fact, there needs to be excess demand to ensure the price keeps rising.

The market is not an end in itself. It is only worth the trouble if it delivers a carbon price that will drive behaviour in ways that put us on a path to zero net emissions in the second half of the century.

Ensuring we have international and domestic carbon markets fit for that purpose is a daunting challenge.

Carbon gap

NZ's promise for 2030: Emissions 11 per cent below 1990 levels

Where we are now: Emissions 20 per cent above 1990 and climbing