Brian Fallow: Carbon bill time bomb for taxpayers

The deal struck this week between the Government and the Maori Party on emissions trading writes a large post-dated cheque on the account of the New Zealand taxpayer.

Most of the amount - nine zeros - has been filled in. Only the number of billions remains uncertain.

Although described as amendments to an emissions trading scheme, in effect it sets up a carbon tax, at a relatively low level of $12.50 a tonne, until the end of 2012.

It does introduce a carbon price into the economy from the middle of next year. That is long overdue.

But prices should tell the truth. At best, and only at first, this will tell a half-truth. So it sets up a price shock for consumers in 2013 when the transition period ends.

That is not the worst of it, though. The changes agreed are all about transferring cost from the emitter to the taxpayer, and to that extent it defeats the purpose of the exercise.

Amidst all the intricate detail it is easy to lose sight of some basics. The cost to New Zealand of combating climate change is determined by three things: the level of our emissions, the extent to which under international treaties we take responsibility for our emissions, and international prices for carbon (tradeable rights to emit).

The ETS and other domestic policies are only about how to apportion that cost. The less it falls on those who are responsible for the emissions, whether as producers or consumers, the more it will fall to the taxpayer. And it is emitters' behaviour that needs to change, not taxpayers'.

The changes announced on Monday mean that transport, electricity and industrial emitters will be brought into the scheme from mid next year.

But for the first 2 years it will be on a buy one, get one free basis. They will only need one emissions unit for every two tonnes of emissions for which they are liable.

And crucially they will have the option of simply paying the Government $25 cash instead of buying that unit on the market. This effectively caps the cost of emissions (to emitters, not to the country) at $12.50 a tonne until 2013.

The current market price for secondary CERs (the most relevant internationally traded units) is $26.50.

That is the price at which carbon is trading in a world only now starting to emerge from a severe recession.

It reflects the fact that US cap-and-trade legislation, which could put the United States in the market for something north of a billion tonnes a year, is only 40 per cent of the way through the legislative process.

And it reflects uncertainty about the level of ambition the successor treaty to the Kyoto Protocol will embody. All those factors suggest the price of carbon is going to rise, not fall, over the course of our transition period and potentially quite steeply. So the Government's estimate of the fiscal cost of the latest concessions, $400 million by 2013, is a lowball number.

But that is just the start of it.

The really expensive watering down of the scheme relates to industrial emitters and agriculture, between them the source of two-thirds of the country's emissions.

The Greenhouse Policy Coalition, representing the trade-exposed, energy-intensive sector, has got almost all of what it had lobbied for.

The changes mimic the Australian carbon pollution reduction scheme. The allocation of free units to large emitters will be on an intensity basis without any overall cap.

Instead of drawing an historical line as the current law does, 90 per cent of 2005 emissions, and requiring emitters to buy and surrender a unit for every tonne emitted above that, the benchmark will be an industry average for emissions per unit of output.

Just how those benchmarks will be determined and whether firms will be exempt for every tonne up to that average or only some proportion remains to be seen. The timetable for sorting that out is dauntingly tight, if the sector is to come into the scheme by the middle of next year.

The independent experts' advice to the select committee reviewing the scheme outlined the pros and cons of this approach.

The benefits are less risk of "leakage", where emitting industries simply migrate to countries where their carbon costs are lower or nil, at the expense of the country they leave but to no advantage to the global environment. It would allow allocation to be on a firm-by-firm basis, it provides for new entrants on the same basis as existing ones, and it aligns policy with Australia.

The downside is that it represents a fiscal risk. As an output-related subsidy it weakens the signal to reduce emissions, and national emissions might increase.

The argument about the risk of leakage is hard to appraise. On the one hand a country running chronic trade and current account deficits and which is up to its nostrils in debt to the rest of the world cannot afford to be cavalier about risks to the viability of major export industries. On the other hand many factors influence the location of enterprises. If a subsidy really makes the difference to whether one stays or goes, the case for that use of taxpayer's money needs a lot of scrutiny on an individual basis. That is not being proposed here.

Another key change is to the rate at which free allocation would be phased out. This column was critical of the stringency of the phaseout enshrined in the current legislation. It reduces free allocation by 8 per cent a year starting in 2019 so that by 2030 emitters would face a carbon cost on every last tonne of their emissions - even though it is very unlikely the country would face so onerous a target.

By contrast the new regime errs on the side of leniency, phasing out the free allocation at the gentle pace of 1.3 per cent a year from 2015 so that by 2050 it will only have been halved.

It is understood, though Monday's announcement is silent on the point, that this will apply to agriculture as well, which is now not due to come into the scheme until 2015.

In reality the phaseout rate is a number that should be seen as only pencilled in. It is a parameter that would be revisited in the five-yearly reviews of the scheme, and adjusted in light of international developments.

The Government's response to charges of fiscal recklessness is to point to Treasury projections that the existing scheme would deliver a cumulative fiscal gain to the Crown of $21 billion by 2030, and say that the ETS should not be a money-making scheme for the Government.

But that number involves a lot of guesswork about the future path of global carbon prices, the stringency of the country's emission-reduction target under future agreements and the extent of the cuts actually achieved. Even on those projection assumptions the Crown would not be seriously in the money until the 2020s and a lot will change between now and then.

The bottom line? It is hard to quarrel with Greenpeace's Geoff Keey: "We now have on the table a pathetic ETS which won't actually do anything to reduce emissions. Our emissions will just keep climbing and taxpayers, rather than polluters, will have to pay for them."