The Carbon Chronicle – July 2010

This edition of the Chronicle is devoted to the introduction of ETS into the stationary energy and transport sectors.  It covers the reasons for having an ETS, and what it means for New Zealanders, identifying the winners and losers.

Global leaders?

On July 1^st, New Zealand joined most of the countries in the developed world by having a carbon cost included in the cost of electricity.

There are already 29 countries in the OECD which have emissions trading schemes (ETS) covering their electricity sectors, making up over 75% of the countries with Kyoto commitments.  At present ETS is the favoured way for countries to meet their Kyoto obligations (note 1). 

However, New Zealand is going a step further than most other Kyoto countries, by also introducing a carbon charge for the transport sector (note 2) and for large industrial processors.  Most existing ETS only cover the stationary energy sector (electricity, gas, etc.).

To incentivise or not

The overwhelming advantage of using an ETS (or indeed a carbon tax) (note 3) to generate funds for meeting Kyoto obligations, is that it passes costs onto the emitters (i.e. those who are responsible for carbon emissions).  In this way, there is an incentive for action by the emitters to reduce the activity that causes the emissions.

The alternative is for governments to use general taxation to pay for the Kyoto bill.  This approach does not encourage behaviour change.  (By delaying the introduction of an ETS, the Australian government is effectively passing the Kyoto obligation onto its general taxpayers.)

Protecting trade

A key issue is the effect of a carbon charge on the competitiveness of businesses which are competing in international markets. 

If all countries were engaged in an international carbon market then all businesses would be playing under the same rules.  But, with Kyoto limited to developed countries (except the USA) and excluding developing countries (including giants like China and India) then businesses in Kyoto countries are potentially at a disadvantage.

The NZ ETS addresses this issue.

Agriculture and other trade-exposed industries are protected from many of the deleterious effects of a carbon charge on their international trading opportunities. 

Most agricultural activity does not enter the scheme until 2015, from when the sector will initially only be responsible for a small percentage of their emissions (i.e. they will get free allocation).  Other emissions-intensive trade-exposed industries (such as steel and aluminium) will be affected by the scheme from July, but they will also only be responsible for a small percentage of their emissions.  Those businesses which are more efficient than their industry norm (in carbon emission terms) will receive additional benefits (extra free allocation).

A fair system?

The general taxpayer will cover the Kyoto (and post-Kyoto) obligations for agriculture and these businesses for many years to come (note 4).

As well as this taxation subsidy on behalf of the farmers and big business, everyone in New Zealand will effectively pay a carbon charge for their use of fossil-based energy.  Electricity, gas use, and transport fuels will all be covered by the scheme from July. 

Energy providers will have the direct obligation for the emissions from the use of fossil fuels.  But, because these activities are only provided by domestic providers, then the full costs of the obligation can be passed onto the consumer, through price increases.

However, until 2013, the impact on energy consumers has been halved by the transitional changes recently made to the ETS (through a price ceiling for carbon units, and a two-for-one unit obligation for emitters). 

Impacts on households

The impact for the average household is estimated to be $180 per year (note 5).  Electricity prices are estimated to increase by up to 5%, with petrol and diesel increasing by about 2%. 

Some of the electricity providers (Contact and Mercury) have already announced price increases, but of 3%, less than Government estimates.  Most fuel companies have also announced price hikes.

Of course, the intention behind the price rises is to effect behaviour change and encourage more efficient, and reduced, energy use.  In theory, the increases can easily be negated by reducing unnecessary electricity use and changing driving behaviour.  But the price signal, and supporting action (e.g. awareness-raising of energy efficient behaviour), needs to be strong enough to bring about the desired change.

The complexities of the electricity market (with the setting of wholesale prices based on marginal cost of supply) make it difficult to anticipate the precise effects of the carbon charge on electricity generation.  However, it makes it more unlikely that new coal-fired plants will be commissioned (unless carbon capture and storage techniques become viable).  New gas plants might be developed to provide peaking supply, but renewable generation (hydro, geothermal, wind, and possibly tidal) is likely to dominate new generation.

Carbon neutral, feel good?

A key concept behind the design of the ETS is that the obligation covers the full carbon impact of each in-scope activity; it doesn’t just cover the Kyoto commitment.  For Kyoto, only the carbon emissions over and above the 1990 baseline level are relevant. 

Therefore, in theory (and assuming the international market is working efficiently and effectively), electricity and transport users are fully covering the (operational) climate change impacts of their activities. 

This should make users feel good, but, and it is a big but, there are severe limitations with the current carbon market.  Not until there is a truly international market, with all countries having obligations, and more accurate assessment of carbon emissions and their impacts, can there be this confidence and potential for the feel-good effect.

The overall carbon system is fiendishly complex, but the NZ ETS is a start and it means that New Zealand has joined those in the international community which are taking action.

Notes

1. Of course, there are some notable exceptions, including Australia, who have signed up to Kyoto, but not yet introduced the CPRS, their version of an ETS.  And, the Bush-led USA did not sign up to Kyoto, so have no obligation. <Back>

2. However it should be remembered that in many other countries, especially in Europe, the existing taxes (fuel duty charges) on transport fuels are much higher than in NZ.  A recent study showed that NZ has the 4th cheapest fuel in the developed world, due to the lower tax. <Back>

3. Technically, emissions trading schemes or taxation are ways of internalising external costs.  External costs are those costs which are borne by society rather than the party (or business) which is responsible for them.  The effects of pollution, such as air or water, are a classic example of external costs.  One of the key issues is finding an accurate way of assessing the damage, and therefore pricing these external costs. Carbon pricing is an attempt at this. <Back>

4. There will be a Government review of the ETS in 2011, to take account the latest international developments in agreeing a post-Kyoto treaty. <Back>

5. The average household is assumed to use 8000 kWh of electricity/gas and have two cars each travelling 14,000 kilometres. <Back>

For further information please contact Phil Jones (philj@co2group.co.nz).