Comment: Why our ETS is a plastic fork for a gun fight

New Zealand's ETS is not fit for purpose says Nigel Brunel of OMF

COMMENT by Nigel Brunel

The New Zealand Emission Trading Scheme (ETS) is our primary mechanism for dealing with climate change. But, as it sits right now – it's neither fit for purpose to meet our commitments under the Paris Agreement to combat climate change nor will it allow New Zealand to meet the net zero carbon target of 2050.

If climate change is humanity's ultimate battle - we're currently packing a plastic fork for a gun fight.

New Zealand has the second oldest federal ETS in the world. It has cross-party support in Parliament.

Established by the outgoing Labour Government in late 2008, it was adopted and substantially changed by National the following year and now is in the hands of Labour's coalition partner – the Greens.

The main reason the ETS is not up to the job, is the lack of carbon credit supply in the ETS to meet future demand.

At present, the main printing press in the ETS is forestry. Forest owners register their forests in the ETS and earn carbon credits annually for the amount of carbon they sequester, some or all of these they can sell to emitters and the balance is repaid if and when they harvest.

While New Zealand has managed to meet its previous and current Kyoto commitments through forestry and international units, this will change once the Paris Agreement starts in 2021. This is due to the fact that any surplus New Zealand has at the end of the second Kyoto commitment period (2020) will not be carried over into Paris.

We have agreed under Paris to limit our emissions to 30 per cent below 2005 levels by 2030. The graph below shows our business-as-usual as the blue dotted line and our Paris commitment (carbon budget) as the red dotted line. The grey bars between these two lines are the amount of emissions we need to reduce over the period. It's about 200 million tonnes. We will only be able to do about half domestically, primarily through forestry sequestration with very small growing amount of reductions through more renewable energy, electric vehicles and overall energy efficiency. The rest will have to come from international markets.

That's just Paris - we then have to track on towards our net-zero carbon target in 2050.

The government has a body of work underway to both rework the ETS to meet our Paris commitment and put the economy on track towards the net zero carbon target of 2050.

The Zero Carbon Bill, which will put in place the rules needed for New Zealand to hit the 2050 target, has had its first reading in Parliament and is now going through the select committee process. It is expected, assuming the government has the numbers, to be passed into legislation by the end of the year.

In addition to this are a number of changes to be made to the ETS through changes to the Climate Change Response Act (CCRA), this is also expected to be passed by the end of the year.

These changes include:

• Introduce a five-year rolling cap on emissions and introduce auctioning
• Replace the $25 and possibly introduce a floor price
• Start a minimum phase-down rate, applied equally for all industrial activities
• Consider bringing in agriculture at 5 per cent level at the processor level from 2021
• Establish an independent Climate Change Commission to advise the government of the day

But these changes are not enough. The Government is not alone in needing to be more blunt and upfront about the magnitude of the changes needed to meet the commitments and targets set. The changes and the costs (or benefits) of them will impact every economy, every market, consumer and investor around the globe.

The impact on New Zealand capital markets from these changes and the transition to a low/no carbon economy is an interesting question.

The overall view is that the higher carbon pricing will be a headwind to the economy weighing down GDP. However it's not easy to model and there are economic benefits of transitioning the economy from fossil fuels to renewable energy.

There are some companies that will benefit and some that will need to adjust to impacts from carbon pricing. The beneficiaries that spring to mind are electricity generators which are entirely renewable such as Meridian Energy, Tilt Renewables and NZ Windfarms.

Trustpower and Mercury are close to entirely renewable. Contact Energy has quite a balanced generation portfolio with a lot of optionality as to whether they burn carbon or not. Genesis Energy also operates a mix of renewable and thermal generation assets, including Huntly Power Station.

As the country's largest generation facility with its gas and coal units, Huntly sits firmly on the other side of the ledger. If electricity prices are high and Genesis Energy is setting the marginal electricity price (which includes carbon), the other generators will benefit from selling electricity at that price as they don't realise a carbon price impact. Genesis Energy however will have to buy carbon credits to offset its emissions.

Z Energy recently purchased a majority shareholding in energy retailer Flick Electric which can be seen as a move to offset the impact EV's will have on their business. Photo / 123RF

On the fuel side, Z Energy is an interesting case. In some regards Z Energy doesn't emit - it sells the fuel to us and collect the carbon in the fuel price we pay. The likely impact on this business is the rate at which New Zealand moves to electric vehicles (EV) and stop buying fuel on the forecourt.

Z Energy recently purchased a majority shareholding in energy retailer Flick Electric which can be seen as a move to offset the impact EV's will have on their business by being able to offer EV charging nationwide.

The other impacts on all listed companies globally is coming from the ESG (Environmental, Social Governance) community. ESG Investing is a term that is often used with sustainable investing, socially responsible investing, mission-related investing, or screening.

Many fund managers are now taking a sustainable approach to the companies they invest in, often divesting from those companies that are not deemed to be a steward of nature.

There have been more than 1,000 climate change related court cases globally where activists have taken on companies that fail (in their view) to address emissions. This fear or concern is moving into the boardroom where boards are now realising they have a fiduciary responsibility to ensure they address and reduce emissions.

There is also a growing group of the population known as LOHAS – Lifestyles of Health & Sustainability.

This group are the ones who choose products and services that support their views on sustainable lifestyle, choosing to offset their flights, drive EVs, ride bikes and change their diets to more plant based.

It's estimated this group could be as high as 10 per cent of the global population (and growing). Companies that deliver products and services aimed at these consumers will win over those who don't.

The government is well aware the ETS is not fit for purpose and changes are underway to fix it and transition the economy to net zero by 2050. Companies and businesses will be required to adjust to these measures but it's also becoming clear that consumers are expecting this from business as well.

For New Zealand to be net zero by 2050 will require significant changes. Addressing agricultural emissions is the big challenge as well as changes to our transport system. Planting trees is not a solution - it's a transition.

If we have not found the cure for agricultural emissions and changed our transport system by the time our forest sinks are full of carbon in 30 to 50 years - we'll be in the same place we are now. We will need more weapons in the tool kit than the ETS. We will need significant investment and innovation to create the technological advancements to solve these challenges.

Nigel Brunel is a Director of Institutional Commodities for OMF, a member of the Jarden Group.