Brian Fallow: A new game with a blank rulebook

We are still working on it but it's really hard, you know.

That was the somewhat disappointing message from Tuesday's eagerly-awaited update on the state of climate change policy.

Nine years after the Kyoto Protocol was negotiated, and 18 months before its first commitment period begins, New Zealand does not have a policy.

The Government scrapped its 2002 package late last year without, as Climate Change Minister David Parker admitted, having seriously tried to muster the parliamentary numbers to pass the carbon tax.

Meanwhile, the scientists' warnings are ever more emphatic, emissions continue to increase while the forest estate does not, and the cost of buying credits to cover the now-inevitable shortfall from our Kyoto target goes up as the dollar falls.

Will anything pragmatic and durable emerge from this paralysis by analysis phase? There are some hopeful signs.

Perhaps the most significant statement in Parker's Cabinet paper was: "In the longer run the most effective policy mix is likely to include policy mechanisms that introduce a price [cost] of greenhouse gas emissions."

This is crucial. Prices matter. And while there is a dazzling array of technological ideas for reducing emissions at various stages of development, they all confront the problem that it is hard to compete with free.

In principle, introducing a carbon price or cost of emitting greenhouse gases into the economy and letting the market determine how best to respond should be the most efficient way of addressing the problem.

It is better than piecemeal ad hoc regulatory interventions which amount to the Government picking winners and losers - like banning the import of gas-guzzling vehicles or requiring that a proportion of transport fuel must be biofuels or electricity generated from renewables.

But such measures, all of which are being considered, are better than nothing, which is what we have now.

How do you introduce a carbon price into the economy? The crude option of a "broad-based" tax has been rejected. Its scope was already limited by applying it only to the carbon content of fossil fuels and excluding agricultural emissions, which are half the national total.

A narrow carbon tax on large emitters such as coal- and gas-fired power stations remains an option.

But some provision like the previous negotiated greenhouse agreements would presumably be needed for major emitters whose international competitiveness would be threatened.

There would be no advantage for the world's atmosphere if plants such as the Tiwai Point aluminium smelter or the Glenbrook steel mill were forced to close and the demand for their product was then satisfied by plants in, say, China instead.

And a carbon tax on electricity generating is liable to increase the variability in power prices between dry and normal years, which might not be a good idea.

That leaves a cap-and-trade mechanism along the lines of fishing quota or the European emissions trading system.

Recent perturbations in that market demonstrate the importance, and difficulty, of getting the initial allocation of permits right.

Businesses are wary of a market in a commodity whose supply and demand are politically determined.

But that is inevitable, as it is in effect a new property right that is being created.

Liquidity is also likely to be an issue unless New Zealand can link in some way to the European market.

With such difficult design issues, emissions trading regulations have been ruled out until after 2012.

A more pressing issue is forestry.

The Kyoto Protocol allows "sink credits" for the carbon held in forests established since 1990 on land not previously forested. There are corresponding debits for forests felled but not replanted.

Sink credits were supposed to see us right during Kyoto's first commitment period, more than covering the projected increase in emissions.

But new forest planting has dwindled to almost nothing, and existing forests are shrinking alarmingly.

The potential deforestation liability between 2008 and 2012 is now estimated to be nearly double the level - 21 million tonnes of carbon dioxide - that the Government has said the taxpayer will bear.

Who will pay the rest - hundreds of millions of dollars - is completely unclear.

Passing deforestation liabilities on to forest owners is entangled with two other vexed issues - the owners of Kyoto (post-1990) forests' continuing resentment that the Government has retained ownership of the sink credits they engender, and the fact that some of the forests which might give rise to a deforestation liability are subject to Treaty of Waitangi claims.

Kyoto Forestry Association spokesman Roger Dickie welcomed indications the Government would consider passing sink credits to the owners of Kyoto forests.

But Forest Owners Association president Peter Berg said his group was alarmed that the deforestation cap, which he described as a proposed new tax on those who converted forests to other land uses, remained on the table.

It is a mess.

Parker has said that a policy to hack through this Gordian knot should see the light of day before the end of the year.

Whether it will get agreement from a fractured and fractious industry is another matter.

The broader, international context remains as challenging as ever.

Policies drawn up for the longer-term have to confront the fact that the only multilateral agreement with any teeth, Kyoto, does not cover our two largest trading partners, Australia and the United States, or any developing country, including China and India where emissions are growing rapidly.

With the possible exception of Canada, where the new Government is distinctly unenthusiastic, members of the Kyoto club are committed to negotiating a successor agreement for after 2012 when the first one ends.

But as they represent a dwindling share of world emissions, so the free rider problems are only growing worse.

It is world climate change we are talking about, so a multilateral solution is clearly needed.

But the beggar-thy-neighbour approach which looks like sinking world trade talks may also prevail in climate change.

There is longstanding opposition in Washington to the US undertaking emissions targets while major developing country emitters have none.

But these countries ask why they should undertake obligations when the world's richest country will not.

Parker believes New Zealanders understand the need to combat climate change.

"But we don't have to be too hair-shirted about this and do ridiculous self-sacrificial things that other parts of the world aren't doing."

The Government might have to make some assumptions about what the level of international commitment on the global warming issue would be, and say that if that commitment did not eventuate it, would have to look at the matter again, he said.

Businesses, especially energy-intensive ones with long-lived assets, desperately need some certainty about what the rules of the game will be, and some assurance they will apply to their competitors too.

The international environment suggests those needs will go unmet for some time yet.