Opinion: The Climate Change Commission has advised the Government that the Emissions Trading Scheme (ETS) isn’t incentivising emissions reductions because it’s cheaper for business to buy carbon credits than invest in finding ways to cut emissions.

New Zealanders have now been invited to have their say on the ETS and the forest category. The problem is Climate Change Minister James Shaw looks to the scheme as a mechanism that can incentivise emissions reductions and carbon removal by forestry. This is trying to kill two birds with one stone – or bag two objectives with one policy. History tells us this rarely works.

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The Government’s discussion document lays out four options to revise the scheme – ranging from maintaining the status quo to creating separate incentives for gross emissions reductions and emissions removal.

I suggest it needs a radical revision that would take forestry out of the equation – ie create one mechanism for carbon reduction with emission limits guided by Climate Change Commission recommendations that meet our international commitments.

The Government created a valuable property right but then eroded its value, creating conditions for the flood of the market, and to boot, eroding demand by allocating free property rights to some businesses.

That may sound counter-intuitive, given trees sequester carbon, and how much we have invested in forestry as a nation. But our reliance on forestry to meet our obligations on emission reductions is not sustainable.

The ETS created a property right – NZ Units (NZUs) – through which forestry owners receive valuable credits for the carbon dioxide sequestered by their forests. Commercial decisions to convert land into forestry would have factored in the financial return from sequestration over the life of the forest, and the relative profitability of forestry versus pastoral farming.

Growing trees became the business to be in; you could grow them, harvest them, and export them, and earn an income from your carbon credits while they were standing there sequestering carbon. Consequently, the ETS is delivering a massive increase in forest conversion, which has swamped the market with NZUs – in effect delivering a wrecking ball to the Government’s ETS.

The supply of NZUs has boomed, but demand has remained relatively low. This was predictable enough. Businesses participating in the ETS must acquire NZ Units to cover their emissions, or they can avoid paying for NZ Units by investing in emissions reduction.

A key problem is trade-exposed businesses (such as NZ Steel) received free allocations of NZUs, which only limits demand. Economics 101 alert – balancing incentivised growth in the supply of NZ Units against a relatively low static demand led to the Government’s ETS market tanking. No surprises there. If you were running a business, what would you do? Pay $50 per unit of carbon credits, or $75 per unit to avoid liability for emissions?

The Government created a valuable property right but then eroded its value, creating conditions for the flood of the market, and to boot, eroding demand by allocating free property rights to some businesses.

Government could become a player in the market – just as it did in the early days of the quota management system – and buy up NZUs to create an incentive for businesses to decarbonise, and sell NZUs when prices are too high. Possible, but in my opinion not viable.

There has been some talk of developing international trade opportunities, of certified credits. This would open the market to foreign businesses seeking cover. But given the glacial pace at which international agreements move, I don’t see this happening in the near future.

Of course it would be provocative to suggest agriculture could be included in the Emissions Trading Scheme – currently it isn’t, though it accounts for about half of our greenhouse gas equivalent emissions. Yet we do know how to readily convert methane into a common unit alongside carbon dioxide. Expanding the scheme to include agriculture would also soak up a considerable number of forestry-created units. No, I don’t see this happening either.

There are myriad ways of tinkering with the ETS, and it has had numerous iterations. Changing the incentives for forestry removal directly affects the value of property rights of forest owners. To illustrate: decreasing the rate at which a unit of sequestered carbon is converted into an NZU could increase price and create a greater incentive to decarbonise – but this could have an adverse impact on the profitability and commercial value of forestry. We could expect litigation if the value of property rights – created by government – were reduced.

The most radical option, and I think one that has merit, is to create two markets – one for units sold at auction and the other for forest removal. Mandating the purchase of NZUs only by auction clearly enables government to achieve emission reduction targets.

Government could run a reverse auction aimed at delivering a quantum of forestry removal units (however determined) at least cost. Government would then have two functions – one, releasing units for auction, the other buying up removal units from forestry. This in effect removes forestry from the ETS but does not completely sever the link between removal and units sold at auction. Designing a forest-removal market that does not dilute the value of forest property rights – would be a worthy challenge.

The idea underpinning the design of the scheme was to incentivise both emissions reductions and the removal of carbon through forestry. It has led to a remarkable increase in land being forested, but as an emissions reductions scheme, it isn’t working.

It may have been designed with the best of intentions, but we should judge policy by its results.

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