Analysis: The Government has received a stern telling off from the Climate Change Commission, after Cabinet’s decision to ignore expert advice led to the carbon market crashing and put climate targets in jeopardy.
It’s the latest stage in a series of disagreements between the commission, which is statutorily independent, and the Government. At the centre is the Emissions Trading Scheme – New Zealand’s most important climate policy, which forces greenhouse gas polluters to pay a carbon unit (NZU) for every tonne they emit. The scheme puts a soft cap on greenhouse gas emissions and a price on carbon, which filters through into fuel, energy and industrial costs.
In its first annual batch of advice on the ETS in July, the commission proposed major changes. These would curtail the number of units auctioned into the scheme in an effort to draw down a stockpile of units already held by polluters, which were obtained when the price of carbon was low. They would also increase the floor on the carbon price substantially and drastically increase a soft price ceiling, to better allow the market to find the right price to cut emissions.
Instead, in December, Cabinet rejected both the commission and Climate Change Minister James Shaw, who had advocated the recommendations be adopted. The overriding concern for ministers was the impact of a rising carbon price on household budgets at a time of cost of living pressures. The Government allowed more units into the scheme than the commission had recommended and didn’t change the price controls, other than to adjust for inflation.
‘Shot across the bows’
Now, in its next annual advice on the ETS, the commission has hit back. Though some commentators had theorised it might aim for a middle ground between its July proposals and the Government’s approach, the new advice is substantively identical to last year’s batch. Where changes have been made, they seek to fix the damage wrought by the Government’s decision in December.
“If the Government chooses to adjust the settings in line with our advice, the NZ ETS will play a strong role in aligning emissions with emissions budgets,” commission chair Rod Carr wrote in the introduction to the advice.
“If Government chooses to constrain price discovery, the NZ ETS will play a weaker role and the Government – now and in the future – is more likely to need to adjust the emissions reduction plan to include further regulations and other policies to drive emissions reductions and ensure budgets will be met.
“If the Government expects the NZ ETS to contribute significantly to the abatement needed for budgets and targets, the NZ ETS must be given the room to do so. Weakening decisions on NZ ETS settings and climate policy in general during times of adverse economic conditions, which climate change is only likely to exacerbate, is not sustainable in the long run and will greatly compromise our chance of meeting the climate change targets set out in the act.”
Climate policy expert Christina Hood said the harsh language in the report was the most critical the commission has been of a Government decision.
“This is much clearer and stronger than anything we’ve seen the commission come out with before. It’s a real shot across the bows,” she said.
“They obviously think that the Government has made a mistake and are not pulling any punches in saying so.”
“If you’re running a marathon and you’re slow out of the start gate and you’ve got a target time, you’ve got to run faster later. It’s as simple as that. There are consequences to delay,” Carr said.
When asked whether he felt told off by the commission, Shaw pointed out he had backed it in Cabinet discussions. Should his ministerial colleagues feel scolded, then?
“You’d have to talk to them about that,” he said.
There is a broader issue here, Shaw conceded, of the commission’s legitimacy as the Government’s top, independent climate advisors. If this becomes an ongoing, intractable point of disagreement, that could set a precedent and create room for future governments to disregard other advice from the body too.
“There is always a risk of that. And that was a risk that we discussed when we did the original [Zero Carbon Act] legislation and punted for a political decision-making process,” Shaw said. He had wanted the commission to set ETS unit limits and price controls directly, like the Reserve Bank sets interest rates, but was blocked by New Zealand First.
In an interview with Newsroom on Thursday, Carr said the reasons behind last year’s recommendations hadn’t changed.
“It’s not entirely surprising that the same evidence base and expert opinion would say, if it was good solid advice then and we’ve had an opportunity to review it and informed by what we heard in consultation and by Treasury’s advice – given all of that, yes we still stand by the recommendations we had,” he said.
Fundamentally, the Zero Carbon Act requires the ETS to align with the budgets. Because the budgets are hard numbers, the commission’s methodology will keep spitting out the same results if given the same inputs.
There are a few different inputs this time around – most of which have to do with the Government’s rejection of its advice. The ETS settings for this year can’t be changed and the settings for 2024 and 2025 can only be changed in exceptional circumstances, which the commission doesn’t believe have happened. So its advice for 2026 through 2028 has to adjust for Cabinet’s decisions.
Essentially, by allowing more units to be auctioned up front, the Government will have to curtail its auctioning later in the decade. Otherwise, if it proceeds on its current path, the Government is “currently at risk of being out of step with Aotearoa New Zealand’s emissions budgets, the Nationally Determined Contribution (NDC) and the 2050 target to lowering global emissions reductions under the Paris Agreement”, the commission’s advice said.
From 15.3 million units on auction in 2025, volumes should nearly halve to 8.5 million the next year.
“Decisions have consequences,” Carr told Newsroom. “This is a long game. If you’re running a marathon and you’re slow out of the start gate and you’ve got a target time, you’ve got to run faster later. It’s as simple as that. There are consequences to delay.”
The Government’s tinkering with unit limits was one result of its focus on cost of living. But the greater impact was Cabinet’s decision to stick with status quo price controls.
At the time, a special bank of credits which are released into the market if auction prices rise too high had been fully emptied in two consecutive years. The mechanism, the cost containment reserve (CCR), is designed to keep the carbon price from rising too high.
Analysts feared a “magnet effect”, in which the CCR trigger price was targeted by auction participants to obtain more supply. The commission suggested raising the trigger to astronomical levels, in the hopes of breaking the magnet, but Cabinet feared this would just bring the carbon price that high too.
Now, after further analysis, the commission says there’s no such thing as the magnet effect.
“It is the Commission’s view that the combined influences of signals from the Government about its commitment to climate action, additional information about the costs of decarbonisation, regulatory uncertainty, and price increases in international emissions trading schemes are what led to the shift in market expectations about future prices, rather than a significant price anchoring or ‘magnet effect’ by itself.”
Its advice on price controls is much the same as last year, with the exception that they take effect from 2026 because the settings in 2024 and 2025 cannot be changed.
Shaw said the conclusion on the magnet effect should make a rod for his fellow ministers’ backs when they look at this year’s advice.
“I’m glad that they’ve specifically addressed that because that was obviously a very large part of the Cabinet consideration last year. I think to have more substance on that is going to be helpful.”
The consequences of mucking it up again could be severe, Hood said.
“There’s no free lunch here. If the Government wants to run the ETS at a lower price trajectory, they can do that. It’s perfectly possible to do that. But the way that you go about that is by implementing more complementary policies so that price doesn’t have to do as much to meet the targets,” she said.
Carr agreed, saying the lesser the ETS incentive, the greater the need for additional regulation.
“That’s one consequence. The second consequence is that we know that roughly, the marginal cost of abatement from planting Pinus radiata is somewhere between $25 and $50 a tonne, depending on where you are in New Zealand. Essentially, under the current policy settings, that’s where the ETS price would go in my view,” he added.
Hood said the Government’s approach to price issues was also focusing on the wrong mechanism.
“The role of advisors and consultants is sometimes to live with the consequence that your advice is not taken for various reasons,” Carr said.
“You can’t try and suppress the price by issuing more units because every extra unit that gets issued allows extra emissions and then you miss the targets and that becomes a self-defeating thing. I think fundamentally the disagreement between the commission and the Government here is about whether we’re going to meet the targets or not – not actually so much about price.”
Alignment with targets and the emissions budgets wasn’t the focus of the officials’ advice to Cabinet, Carr said.
“The Government’s advice from Treasury was about a different thing. It was about, ‘Oh we have a cost of living crisis and we wouldn’t want to see anything happen that might add to household costs’. Now, it doesn’t appear to me that that’s a criteria that you could use for setting the settings for the ETS,” he said.
“The ETS is designed to change relative prices in the economy. If you’re concerned about the impact of those prices for vulnerable or low-income households, there are other more appropriate tools to target assistance and support for those households – the obvious being things like the Winter Energy Payment or beneficiaries’ payment rates.”
Does Shaw think the current settings are already aligned?
“That’s why we have the commission, is to offer advice on that. And if what they’re saying is [settings] are out of alignment, then that should be part of the consideration when it gets back to Cabinet later this year.”
Despite the feeling that Cabinet made its decision using the wrong criteria, Carr is realistic about the role he holds.
“We’re the advisor, they’re the decision-maker. To that extent, the role of advisors and consultants is sometimes to live with the consequence that your advice is not taken for various reasons.”