KEY POINTS:
Oil companies and fossil-fuelled electricity generators would have to buy rights to emit greenhouse gases under an emissions trading scheme proposed by New Zealand corporate heavyweights.
The plan is described in a 190-page report by the New Zealand Institute of Economic Research, commissioned by Business New Zealand and
a group of big corporates: Fletcher Building, Fonterra, New Zealand Steel, Rio Tinto Aluminium (formerly Comalco), Solid Energy and three major electricity generators, Genesis, Contact and Mighty River Power.
Three basic propositions underpin the NZIER approach.
One is that the broader the market, the more efficient it will be at discovering the lowest cost options to reduce emissions.
Another is that calls for the polluter to pay overlook the fact that in the end it is always the consumer who pays.
And thirdly there is no advantage to the global environment in having policies which merely drive major emitters overseas - a real danger in a world where countries are not equally committed to reducing emissions.
So under the NZIER scheme, whether firms which have to hold entitlements are required to buy them or get them for free depends on whether their competitiveness would be at risk if they had to buy them.
Firms which need to buy their entitlements could get them either from the Government, through periodic tender rounds, or on the international market. But they would need to be high quality Kyoto-compliant units, which the Government could ultimately use to discharge its obligations to other Kyoto countries.
Credits from forest sinks would be fully exchangeable with emissions entitlements.
"From a New Zealand perspective this is critical due to the likely efficiency of sinks relative to direct abatement [emissions reductions], even if it is of limited importance in other countries," NZIER says.
Oil companies, which can easily pass on the cost to consumers, would have to buy their permits, but the New Zealand Refining Company, whose output has to compete with imports, would get an allocation free.
However, NZIER does not favour simply grandfathering existing emissions for large emitters whose competitiveness is at risk.
Rather it would be based on world's best practice for a comparable plant. If the local firm's emissions exceeded that level it would have an incentive to lift its game and reduce them, provided that was cheaper than buying entitlements to cover the excess.
For smaller firms an allocation of less than 100 per cent of historical emissions could be made.
Anticipating the objection that this approach gives the largest emitters something for nothing, NZIER points out that they already have the right to emit and in many cases have borne substantial Resource Management Act costs to secure it.
The object is to give them incentives to reduce emissions. That will happen if, and only if, it is cheaper for them to do so and sell any surplus entitlements, than to hold on to their entitlements or buy additional ones.
Electricity generators would have to buy entitlements to cover emissions from the natural gas or coal they burn.
Since these firms would pass on virtually all the cost to consumers a gratis allocation would just provide them with a windfall.
However, generators from renewable sources will gain as electricity prices will rise but their costs will not.
NZIER argues against hitting them with an ad hoc windfall profit tax.
Such "opportunistic" behaviour by the Government would not be a good look to international investors, it says.
NZIER would like to see agriculture included in a national emissions trading scheme. It acknowledges the difficulties of measuring on-farm emissions but says using proxies such as the number of animals risks removing incentives to find ways to cut emissions per animal.
It also regards agriculture as a sector whose international competitiveness is to some extent at risk, as most agricultural production is destined for export markets where it is a price-taker.
Most of the world is outside the Kyoto system, and in the European heartland of the Kyoto community agriculture is excluded for the coverage of the European emissions trading scheme.
So the inclusion of agricultural emissions in an emissions trading scheme is likely to involve a substantial degree of gratis allocation or grandfathering, even when enough progress has been made on the measurement issues to include it.
Because of the importance of nitrous oxide emissions - twice as much as the electricity sector - it proposes imposing emissions obligations on fertiliser suppliers based on the volumes they sell.
Among the preconditions NZIER sees for the introduction of emissions trading is agreement among a "significant number" of countries on emissions reduction targets.
Climate Change Minister David Parker has also talked of the need for what New Zealand does to reflect the pace of what is happening internationally.
Domestic preconditions include an accurate and comprehensive system for monitoring and reporting emissions, so that they can be reconciled with allowances and credits.
Accounting, financial reporting and tax rules will need to be clear.
In addition, it says, there would need to be a public, and political, consensus that emissions trading would deliver the intended outcome of curbing emissions, without significant unintended side-effects.That would require a thorough cost-benefit analysis of the potential impacts.
Credit system
* Business New Zealand has released a report by the New Zealand Institute of Economic Research on the way an emissions trading scheme could work here.
* It would require emitting firms which are in a position to pass on the cost to buy entitlements to emit, either from the Government or internationally.
* But firms whose competitiveness would be at risk from international competitors with no similar obligations would get theirs free - up to a point.
* That treatment is likely to extend to agriculture too.