Brian Fallow: Rough guide to emissions trading scheme

Oil companies will be looking to pass on the costs of the emissions trading scheme to their customers. Photo / NZ Herald

Amid the welter of claims and counter-claims from partisan politicians, industry lobby groups and environmental organisations, people could be forgiven for being thoroughly confused by now about how emissions trading is supposed to work.

Who will bear the costs and who will get the benefits? If we have to pay, where will the money go?

So for those who have had better things to do than get their heads around all this, here is a rough guide.

Under the Kyoto Protocol, New Zealand is accountable to other Kyoto countries for greenhouse gas emissions in excess of its agreed target.

The annual target for the period from 2008 to 2012 inclusive is what emissions were in 1990. We are expected to overshoot the target by around 22 per cent, or 76 million tonnes.

To be accountable for those extra tonnes means the Government will have to front up with emission units or carbon credits to cover them, each of which represents one less tonne of carbon dioxide (or its equivalent in other greenhouse gases) in the atmosphere. They all come at a cost.

One potential source is removal units, or forest sink credits, representing carbon which has been removed from the atmosphere by trees as they grow. Not any old trees, however. They have to have been planted after 1989 on land not previously forested.

The catch is that when the trees are felled the carbon locked up in them is deemed to be released back into the atmosphere, so whoever got the credits for the carbon as it accumulated has to surrender an equivalent number to cover those emissions.

So if the Government, as the default owner of tens of million of tonnes of such units, uses them to cover the country's Kyoto obligations in the short term it will create a carbon debt for the taxpayers of the 2020s when the forests are harvested.

A second potential source is certified emission reductions, or CERs. These are units arising from projects in developing countries which a United Nations body has certified represent a reduction in emissions (which would not have occurred without the income from selling the units).

The problem with these is the potential for demand to outstrip supply as Kyoto countries take on more stringent targets post-2012 and the United States adopts its own cap-and-trade scheme, adding hundreds of millions of tonnes per year to global demand for offsets.

That could do unpleasant things to the price of CERs. If the Crown is going to buy any, it might be wise to do so soon.

The third potential source is surplus units from former Soviet bloc countries. Kyoto's year zero, 1990, also marked the collapse of the Soviet empire, when a lot of chimneys in that part of the world went cold.

But the years since then have seen a recovery in eastern Europe and the governments concerned may opt to bank any excess units for their own future use. It is unclear how much of this "hot air" will be on the international market.

So one way or another, sooner or later, there will be a financial cost for New Zealand's excess emissions. The emissions trading scheme (ETS) is about how to allocate that cost to emitters because it is their behaviour that needs to change, not taxpayers.

At current CER prices, the cost would be about $2 billion for the 2008 to 2012 period.

How much more it is in the following period depends on how much more stringent the national emissions target is - the Government has indicated 10 to 20 per cent below 1990 levels - how much emissions increase over that period and how high international carbon prices go.

Who bears the cost?

It depends what period you are looking at.

For the 2008 to 2012 period it is overwhelmingly taxpayers, albeit future taxpayers. The Sustainability Council estimates taxpayers will end up with 84 per cent of the cost, with households and the SME sector bearing most of the rest.

That makes sense. The emissions trading scheme is due to kick in, pushing up prices at the pump and in power bills, in the middle of next year but that is already halfway through the 2008 to 2012 period.

For the remainder of the period the half of national emissions arising from agriculture will be entirely exempt and about another sixth from the smokestack sector will be about 90 per cent exempt.

The trade-exposed sectors - farming and heavy industry - make up about two-thirds of national emissions. Even the remaining domestic energy consumers will benefit from transitional measures to soften the impact on them.

Come 2013, however, it is a different story. Then the cost shifts to energy users - apart from those which are large and trade-exposed because they will continue to be largely protected from the cost of their emissions.

Domestic energy users will have to pay for up to three times their share of national emissions.

The way it works is that oil companies and power companies will have to buy and surrender to the Government emission units for every tonne of emission for the fossil fuels they sell, in the case of the oil companies, or burn, in the case of the generators.

They will pass the cost on to their customers (except, again, that the big ones will get a compensating allocation of free units from the Government).

But remember that the Government will not have to answer internationally for every tonne of emissions, only for the excess above the national target. By 2013 the target might be 15 per cent below 1990 levels, but not 100 per cent below.

The Government in short will over-recover from domestic consumers, who will in effect cross-subsidise the trade-exposed sectors.

It is not quite as unfair as it sounds.

Although the trade-exposed sectors produce about two-thirds of emissions they represent a much smaller percentage of the growth in emissions since 1990.

Farm emissions have risen only 12 per cent over that period while national emissions have risen 22 per cent, implying that the non-farm sector's emissions have grown by nearly a third.

Many of the big industrial emitters also claim relatively low emissions growth, if only because energy is a major cost to them so the incentive to use it more efficiently is ever-present.

We have to be mindful of the fact that New Zealand's external accounts are in dreadful shape. To stabilise them at a sustainable level we need to be running trade surpluses of 2 to 3 per cent of GDP, the Reserve Bank says. Instead we have run trade deficits for nine of the past 10 years.

Clearly, decisions about how to allocate between sectors the cost of meeting our international climate change commitments have to be careful of the impact on those which export or compete with imports.

But to the extent that the ETS acts as a tax on energy consumers it a regressive one.

The burden is heavier on those on low incomes who spend a higher percentage of their incomes on petrol and electricity and who have fewer options to reduce their energy use.

This has not, of course, escaped the Maori Party in its negotiations with the Government over support for the current amendment bill.

So in the short term it is taxpayers who (eventually) bear most of the cost of emissions, and in the medium term it is domestic energy users and the scheme is broadly fiscally neutral. But that is as good as it gets from a finance minister's point of view.

Over time as the national emission target gets more stringent and carbon prices bite, the extent to which the Government over-charges domestic energy consumers will reduce.

And the longer the price signal to trade-exposed emitters remains as faint and feeble as it will be under the Government's amendments to the scheme, the more their emission will grow both in absolute terms and as a share of the national total.

The cross-subsidy will wear thin and the taxpayer will be in the gun again.