Our Emission Trading Scheme (ETS) is a central policy instrument for reducing our climate harming emissions, initially developed in 2002 and, after widespread criticism and failure to reduce emissions, revised in 2020.

A strength of the ETS is its multiparty support, which provides some level of certainty for policy direction over successive governments. But is it enough?

Despite that multiparty support for the ETS there remains considerable dispute over the scheme’s ability to do what it is supposed to do – reduce greenhouse gas emissions.  

The Climate Change Commission is to be credited with raising some concerns about the revised ETS (on p131 of its report). In a diplomatically polite way the Commission has suggested the ETS is not fit for purpose unless additional changes are made. 

One of the important issues it raises is the absence of good governance for the scheme. The Commission identifies a host of problems needing attention: “insider trading, market manipulation, false or misleading advice to participants, potential lack of transparency and oversight of trades in the secondary market, money laundering, credit and counter-party risks and conflicts of interest.” A government review is underway to address these concerns.  

But, despite calling attention to continuing problems with the ETS, the Commission accepts it as our main policy tool to reduce emissions – and it does so without addressing many other serious criticisms levelled against it.  

One has to wonder if the Commission’s limited comments on some of the many serious criticisms of the ETS is the result of self-imposed restraint to not upset the important multiparty support which still exists for this scheme.

The basic concept of a cap and trade scheme is fairly simple, but devilish details have made our ETS complex and different from the standard model.

For example, in a pure cap and trade scheme a strictly fixed cap on permits, which declines over time, is an essential feature for the scheme to work. Our ETS is stated to have a fixed cap, but there are loopholes.

If the auction price of permits increases and interferes with the economy the Government can step in and issue more permits to reduce demand (the “cost containment reserve” provision of the recent ETS reform addresses this situation). The economic consequences are that emissions would rise with such non-market manipulation of the permit price, negating the scheme’s purpose. New Zealand could also purchase permits from the yet-to-be-developed global carbon market, increasing emissions in New Zealand. Such tampering with the basic model has contributed to the failures of other nations’ emissions trading schemes.

This modification of the basic, effective cap and trade model is just one feature that has drawn sharp criticism of our revised ETS. Other devilish details that have drawn criticism include: the issuing of free permits to the highest emitters; the low price of permits (high prices are essential to reduce emissions); the large number of outstanding permits that have been banked by some industries for financial speculation; lack of integration with the electricity system which will see increased prices with increases in permit costs (despite reduced operating costs with renewables); and the lack of certainty provided for businesses to adjust to the new realities of a low carbon world.  

Another problem with an ETS is that any resultant price increases to the public are obscure. Because only businesses are involved in the trading scheme, they can pass any increased costs on to consumers.  But consumers have little or no way of knowing whether any price increases are due to the ETS or other factors. And higher prices will unfairly affect lower income families most.

One has to wonder if the Commission’s limited comments on some of the many serious criticisms of the ETS is the result of self-imposed restraint to not upset the important multiparty support which still exists for this scheme.

But perhaps it is time to reconsider alternatives to the ETS rather than ongoing patches to what has not worked to date.  

Viable alternatives to the ETS exist

A carbon tax remains a powerful tool to reduce emissions. Whereas the ETS puts a cap on the quantity of emission permits and allows prices to adjust, a carbon tax works by putting a cap on prices, allowing emissions behaviour to adjust. Certainty of either quantity or prices is essential for either model to work, but neither model can have both. It has been argued that our ETS has neither.

An essential feature of both an ETS and a carbon tax is rising prices.  The obvious negative implications, especially for those with low incomes, would require additional legislation to ensure fairness for those least able to adjust.

A third alternative mechanism avoids creating price increases. It is another quantity control system which puts a cap on emissions (as with the ETS) but by issuing fixed (and declining) emissions quotas. In this scheme quotas are redeemed via a credit card system when making an emission related purchase. Some emission quotas are issued free to households, and others auctioned to businesses, in proportion to each group’s level of emissions. Such quotas would be tradable, so those able to reduce their emissions could sell their quotas to those taking longer to reduce their emissions.

The fixed quota approach would seem to have some advantages over the current ETS, and perhaps even a carbon tax. In itself it does not require price increases (although prices could change for a variety of reasons); there is a sense of fairness in that all households receive free quotas, and businesses which are high emitters have to pay more for more quotas.

Perhaps multiparty support for a simpler, fairer and more effective emissions reduction scheme is now possible.

Perhaps most importantly, such a scheme conveys a greater sense of “he waka eke noa,” as it involves the entire population in working together to minimize emissions as quickly as possible. The scheme makes it in everyone’s interest to do so, something neither the ETS nor a carbon tax does.

Our ETS has been severely criticised and the Commission has to date addressed only some of its important shortcomings. As the most central mechanism to reducing emissions it is critical that we lay a solid foundation for the long journey ahead.

It is the Commission’s role to provide the best independent advice to the Government. It would be helpful if the Commission called for a review of which policy options would be most effective in achieving our climate goals. If a carbon tax, or an alternative fixed quantity scheme, for example, were shown to be superior to the complicated and to date totally ineffectual ETS, then that is what the Government should hear.  

Much has changed in our understanding of the seriousness of the climate threat over the last 20 years since the ETS was created. Perhaps multiparty support for a simpler, fairer and more effective emissions reduction scheme is now possible.

The public’s understanding of the climate threat is also greater, changing politicians’ sensitivities to voters’ wishes. In any event, it is the Government’s responsibility, not the Commission’s, to obtain such multiparty support.

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