Barter is the best way to cut emissions

By BRIAN FALLOW economics editor

Cooperative international action to address the problem of reducing emissions of the greenhouse gases blamed for global warming will almost certainly include some sort of "emissions trading" regime.

The United Nations' Intergovernmental Panel on Climate Change (IPCC), which is the nearest thing to an authoritative voice on the science, has just revised up its estimate of how much the planet is likely to warm over this century to a range of 1.4 to 5.8 degrees.

To put that in scale, over the 20th century the increase was 0.6 degrees, and the difference between now and the last Ice Age is about 5 degrees.

Trading of permits to emit greenhouse gases is central to the 1997 Kyoto Protocol, which is in some disarray but still the closest we have come to an effective international agreement to at least start to reverse the trend of rising emissions.

At Kyoto, 34 developed countries agreed to quantified targets for reducing emissions in the "first commitment period," 2008 to 2012. In New Zealand's case, it is to get net emissions back to 1990 levels.

Each country's cap of allowed emissions could be parcelled up into tradeable units, most likely tonnes of CO2 equivalent.

The idea is to use a market mechanism to discover the marginal cost of reducing emissions, so that the most cost-effective measures are undertaken at any stage, regardless of where in the world that is.

Those required to reduce emissions can decide whether it is cheaper to undertake the necessary physical measures or to buy surplus permits from someone else.

A similar system has been used within the United States to curb emissions of the pollutants responsible for acid rain, and to encourage the switch to unleaded gasoline.

Suzi Kerr, who heads Wellington economic consultancy Motu, literally wrote the book on global emissions trading.

"From an environmental point of view it doesn't matter who reduces emissions, so long as it is done," Dr Kerr said in an interview with the Business Herald.

"The fact that people have agreed to bear a greater cost doesn't mean they have to do the emission reduction themselves. They are responsible for paying for it. That is essentially what trading does, it separates those two things."

Some European Governments and environmentalists are wary about emissions trading and want to put limits on it.

In some cases that may reflect the mistaken belief that trading is a substitute for real action and would not reduce emissions, Dr Kerr said, or a sort of moral attitude - "we've been bad, we should suffer for it."

But there is also a legitimate concern about the credibility of compliance.

That is fundamental to an emissions trading regime. The commodity being traded exists only if the compliance regime is effective - people will not pay for the right to do something they can do for free with impunity.

"If we agree on a system and start, there is the potential that some countries will change their minds halfway through the programme and simply stop complying. Some countries might agree and then grossly fail to deliver. Or a country might have an economic boom and discover that their emissions are a lot higher. The question is whether trading increases or decreases those risks," Dr Kerr said.

"The Europeans believe trading increases the risks."

They doubt the commitment of former Soviet bloc countries to the system, so they see it as trading the certainty of a reduction in Europe for the uncertainty of a reduction in, say, Russia.

"The trouble is the commitment period is five years and trading would happen within the commitment period. You don't know if you have totally complied until after the commitment period. You are not trading things you have already proven you have done."

The potential for non-compliance is a problem with the Kyoto agreement as a whole, not with trading as such.

But it should be remembered that countries had voluntarily chosen to be involved, Dr Kerr said. "Therefore you can expect most of them will want to comply."

To impose limits on the extent to which countries could use trading to discharge their Kyoto obligations would destroy a lot of the benefits of trading.

"You would get a lot of instability in the global price of permits because a country suddenly dropped out of the market. Everyone would be trying to work that out, but inevitably they would get it wrong."

An emissions trading regime would require some difficult political decisions at national level.

The Government would have to decide which greenhouse gases to include in a trading regime. New Zealand is unusual in that more than half of its greenhouse gases come not from the combustion of fossil fuels, but from agriculture, especially methane belched by sheep and cattle.

Dr Kerr said it would be simpler to have a trading system for carbon dioxide, because it is directly related to fossil-fuel consumption, which is easy to monitor, and deal with ruminant methane in other ways.

Another key decision is where to impose the obligation to surrender permits; in other words, who should need to have them.

Upstream is best, Dr Kerr believes.

There are only a few places where fossil fuels are produced in New Zealand or imported into it. For comprehensiveness of coverage and ease of administration those are the best points to regulate.

Forestry presents another set of issues. The Kyoto Protocol recognises that planting a new forest creates a carbon "sink" and should be counted as offsetting a country's emissions of greenhouse gases.

"A forestry tradeable permits programme at farm level would require someone to go out and measure the trees on each farm and decide how much carbon was in them, and then monitor them every five years. Maybe that can be done, but it might be very complicated," Dr Kerr said.

Where would the line be drawn? "If I plant a pohutukawa in my back yard, should I get a credit for that?"

Fully integrating forestry into an emissions trading regime risked importing uncertainty into the system and undermining its credibility.

There are other things a Government can do to encourage forestry; at present there is a tax incentive.

Finally, there is the issue of how the Government should allocate the initial stock of permits - valuable property rights.

The fairest and economically soundest approach would be to auction them, Dr Kerr said.

"Auction would mean you could cut taxes somewhere else. That would share out the gains to people who ultimately bear the cost.

"The estimates are you can actually lower the cost of the programme by 30 to 50 per cent. They are not minor gains."

The alternative approach, grandfathering, might be adopted for pragmatic political reasons.

Grandfathering would distribute permits free to existing emitters, such as the Glenbrook steel mill.

On the face of it, this would provide an incentive for the use of existing technologies, by allowing firms to carry on without facing the full cost of permits to cover all their emissions.

But they would face the opportunity cost of keeping permits and would have an incentive to sell them if they could reduce emissions by moving to new technology.

"The companies which win [with grandfathering] will be the strongest, most politically powerful ones and they are not necessarily the ones who hurt," Dr Kerr said.

In the long run, the costs are borne by consumers and people in coal-mining communities. "They benefit not at all by giving [permits] to companies," Dr Kerr said.

Herald Online feature: Climate change

Intergovernmental Panel on Climate Change

* Draft summary: Climate Change 2001

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United Nations Environment Program

World Meteorological Organisation

Framework Convention on Climate Change