Emissions Trading Scheme most durable path to net zero carbon goal

Dr Eric Crampton
The Dominion Post
8 March, 2021

Amid all of the discussions of the Climate Commission’s draft report on New Zealand’s climate change response, it is too easy to lose track of the target.

The goal isn’t to reach specific electric vehicle targets, though we would expect more people to shift away from petrol as petrol costs increase and as electric vehicles become more competitive.

And the goal isn’t to flip household heating systems and hobs from gas to electric, though some households might also make that shift if gas prices rise more quickly than electricity prices.

The goal rather is to ensure that New Zealand complies with the climate change commitments it made in the Paris Agreements and in the Net Zero legislation.

And, if the government is serious about it, it will want politically and economically sustainable ways of achieving the goal. The two work hand in hand. Less costly ways of achieving net zero mean less harm to those who bear the costs. Because the costs overall are lower, it is easier to compensate people who bear an inequitable share of the burden. And an effective compensation regime helps ensure political support for the system over the decades to come.

Getting to net zero requires institutions that are politically durable, rather than fragile. There is a very clear way to reach the target, and it is not the path that the Climate Change Commission has recommended in its draft report.

The most durable path to Net Zero is built on our Emissions Trading Scheme. The ETS now works very well. In every sector covered by the ETS, an emitter must surrender one New Zealand Unit – the trading unit in the ETS – for every tonne of carbon dioxide emitted. The government auctions a fixed number of those permits every year which creates a binding cap on net emissions. Net emissions from sectors covered by the cap cannot exceed the capped amount.

The government will reduce the quantity of emission credits it sells into the market over time, bringing the cap down in accordance with the government’s commitments. This will result in rising carbon prices.

The Climate Commission has taken potentially high carbon prices as a reason to avoid relying on the ETS; high prices could be politically unsustainable. Some energy companies have warned that rising ETS prices could pass through directly into power prices until new sources of renewable electricity generation are built.

But higher carbon prices could instead help build support for the ETS. The government could provide every Kiwi with an annual carbon dividend based on the amount that the government expects to raise in that year’s ETS auction. And if the Crown’s dividends from its ownership stake in hydroelectric generators increases with ETS prices, at least in the short term, those earnings could be added to the carbon dividend.

Richer households spend more on everything than poorer households, and emissions are embedded in everything. An even split of the funds the government raises at ETS auction would then likely be a rather progressive transfer. The government could always decide to provide higher carbon dividends to families with Community Services Cards if it wanted to increase progressivity.

Setting a carbon dividend would help build support for the scheme and for rising carbon prices. The system would be self-sustaining. Why set regulations that increase the overall cost of getting to net zero while keeping ETS prices down if higher ETS prices can instead help ensure support for achieving net zero?

The Commission has also worried that relying heavily on the ETS would encourage substantial forestry conversion because forestry conversion is one of the more cost-effective ways of reducing net emissions. Reaching net zero through forestry conversion would require continued tree-planting, or other adjustments, after 2050 if gross emissions did not drop. And land is not infinite. Consequently, the Commission has recommending restrictions on forestry’s contribution.

But this too misses the point. New Zealand needs to reach net zero, and to remain at net zero after 2050, but the response can change over time.

Planting trees is currently rather cost-effective in bringing down net emissions. But the economics of forestry conversion will change as more trees are planted – the land most suitable for forestry will be the first land converted. And the best non-forestry ways of bringing down emissions will change in unpredictable ways over the next three decades.

And the Climate Commission is not the only actor in the system. Some councils will restrict forestry conversion if those conversions have too great an effect on local communities. The Commission does not need to try to anticipate and regulate around every potential adverse consequence of rising ETS prices. It could instead maintain a focus on ensuring that the ETS is sound, and trust in the competence of other parts of government in their areas of responsibility.

New Zealand can get to net zero. But if the path there is seen as banning things that people love, like their gas hobs and petrol vehicles, it will be unnecessarily difficult. Relying on the Emissions Trading Scheme, along with a carbon dividend, would simply work.

Stay in the loop: Subscribe to updates