Brian Fallow: Kyoto road map proves far too hard to follow

The Government is having second thoughts about the climate-change policy it rolled out three years ago.

That was inevitable after it became clear that one of the underlying assumptions of that policy - that New Zealand would comfortably meet its Kyoto target and would be a net seller of carbon credits on the international market - is most unlikely to be true.

And it is debatable whether a carbon tax, the central plank of the policy, would pass the new Parliament. It would probably come down to whether the Maori Party supported it.

The conclusions of an officials' review of climate change policy remain under wraps while the Cabinet scratches its collective head.

But if the Treasury's advice to the incoming Government is anything to go by, radical change, not tweaking, is in the offing.

It says present measures will contribute little to meeting our Kyoto obligations (average annual net emissions between 2008 and 2012 no greater than in 1990) but at a relatively high cost.

While the prospect of a carbon tax tilts the playing field in favour of renewable electricity generation, at the level initially set (equivalent to 4c a litre on petrol) it would lead to almost no change in transport use. As a price signal, it is pretty feeble compared with the loud and clear one already being delivered by international oil prices.

Nor is it clear, the Treasury says, that negotiated greenhouse agreements with large industrial emitters will deliver material reductions in emissions.

It argues that the carbon tax would be distortionary because it exempts methane and nitrous oxide - the greenhouse gases arising from the farming sector - which account for about half of New Zealand's emissions.

Not that the farmers have been conspicuously grateful for this subsidy from other taxpayers, given their vehement opposition even to fronting up with the originally agreed contribution to some research on reducing those emissions, the so-called fart tax.

The Treasury recommends scrapping the proposed tax on the carbon content of fossil fuels and the associated negotiated greenhouse agreements, under which large emitters secure exemption from the tax in return for achieving world's best practice in emissions for comparable plants.

Instead, it favours devolving a large part of New Zealand's climate change obligations to firms and individuals and allowing markets to determine the most efficient way of meeting the country's emission reduction goals.

On the other side of the ledger, this would include devolving forest sink credits and the Kyoto obligations for deforestation.

The briefing document does not elaborate on how this emission trading system would work.

But it is likely to involve allocating a fixed number of carbon credits or tradeable rights to emit greenhouse gas to firms on some basis, perhaps grandfathering or a tender.

Those expecting to exceed their allocation would have to buy extra credits to cover the excess from those who had them to sell, such as the owners of "Kyoto" forests, established since 1990 on land not previously forested.

For the transport sector, the point of obligation would most likely be the oil companies.

They, it is safe to assume, would pass on the cost to consumers, giving them a price signal not just about how to use existing vehicles but more importantly about what to buy when it comes time to replace them.

For large industrial emitters, the system might not be different from the negotiated greenhouse agreement, one which, in effect, determines a baseline of emissions they are allowed before penalties apply.

But it is far from clear how emissions trading might be applied to the agriculture sector.

That large exemption seems to have led to one of the least satisfactory elements of the present policy, the decision for the Government to retain ownership of (or confiscate as the foresters see it) the credits created under the Kyoto Protocol for forest sinks.

The subsequent drying up of new forest plantings cannot solely be attributed to that decision - weak cyclical prices have also contributed - but it has not helped and is responsible for much of the Kyoto-related hole which has opened up in the fiscal accounts.

But while Kyoto forest owners might rejoice at a flipflop of that policy (which is on the table in negotiations the industry has been having with Jim Anderton), the flipside would be devolving to forest owners obligations under Kyoto when the change in land use goes the other way, from trees to grass, which is increasingly common.

Clearly, then, the design and implementation of a domestic emissions trading regime would not be easy, whatever the theoretical advantages of using the market and continually varying prices to allocate the resource instead of the crude and sticky instrument of a tax.

And such a system would have to interconnect in some way with international trading in carbon credits as New Zealand as a whole is now expected to fall short of its target.

One element of the policy which has not been on the table in the latest review is the possibility of pulling out of Kyoto and reneging on international obligations solemnly entered into.

But one of the major uncertainties overhanging all this is what sort of international regime there will be after Kyoto's first commitment period expires at the end of 2012.

Talks are under way in Montreal to draw up some kind of road map for arriving at a successor to Kyoto.

The geopolitics of climate change remain as challenging as ever, however.

The Bush Administration continues to set its face against any quantified target, yet that is fundamental to the Kyoto approach. So long as that view prevails in Washington, the world's largest emitter will remain outside the system, seriously weakening it.

And the question of what obligations it is reasonable to impose on developing countries remains a vexed one, even though their collective emissions are expected to overtake those of the developed countries within 20 years.

As the Treasury sees it, the Government faces a strategic choice.

One option is to relax the goal of moving the country on to a downward path for emission by 2012 and awaiting the outcome of negotiations on a post-2012 regime.

This amounts to waiting and seeing if Kyoto collapses under the weight of its free-rider problems and lets us off the hook.

The other path would be to accept that more stringent climate change targets are inevitable in the longer term and that sustainable policies are needed to move towards them at least cost.

That is the future-proofing option.