Brian Fallow: Winners and losers in ETS wealth shift

Providers of renewable power are likely to gain big windfall profits from the emissions trading scheme. Photo / Simon Baker

Over the next two and a half years the emissions trading scheme will effect a substantial transfer of wealth.

From whom, most people understand by now - us, as energy consumers.

To whom is less well understood. It is not the Government, for one thing.

A full account of the complexities of the ETS requires a book and indeed one has just been published, a trenchant critique entitled The Carbon Challenge and written by economist Geoff Bertram and Simon Terry, executive director of the Sustainability Council.

So what follows is necessarily a simplification.

First of all, how much money are we talking about?

Officials estimate that demand for emission units from those with obligations under the scheme - mainly the oil and power companies and large industrial emitters - will total 47 million tonnes by the end of 2012 (which is when the Kyoto Protocol's first commitment period ends).

What that costs will depend on the price of emission units but at $25 a tonne, the level at which the Government has capped the price, it would be $1.17 billion.

But in addition there is the best part of $600 million in what Bertram and Terry call the "collateral damage" from electricity pricing, in other words windfall profits to renewable generators.

Even though most of the electricity we consume - about 75 per cent over the next two and a half years on Electricity Commission estimates - is from renewable sources, the impact of emission costs is amplified by the way the wholesale electricity market works.

It is the marginal generator which sets the price in any given half-hour period; that is, all generators get the price required by the most expensive generating unit needed to meet demand in that period.

Except when demand is quite low, that tends to be plant burning either natural gas or coal, both of which will need to cover the cost of their carbon emissions.

Bertram and Terry estimate the effect will be to boost generators' revenues over the next two and a half years by $769 million, of which only $203 million will be needed to buy emission units, leaving $566 million in windfall profits for generators.

All told a cost of around $1.74 billion by the end of 2012.

The bulk of that will flow to those who will have emission units to sell to the oil and power companies and large industrial emitters. Who are they, and how come they have units to sell?

First there are the owners of exotic forests planted before 1990 (the Kyoto Protocol's year zero). Collectively they are to receive 16.9 million units "to help offset the decrease in land value due to decreased land-use flexibility".

Under Kyoto's rules these trees earn no credits for the carbon locked up in them but there is a liability if this land is deforested, that is, if upon harvest it is not replanted in trees.

At a carbon price of $25 a tonne this would amount to $20,000 a hectare and is likely to be a prohibitive barrier to switching to another and more rewarding use of the land.

How realistic such a land use change is will depend on physical factors and relative prices, which will vary from one forest to another and over time.

But rather than try to target the allocation of free units to the landowners for whom a switch to, say, dairying is feasible, the ETS spreads the allocation across all but the smallest of the owners of pre-1990 forest land.

At $25 a tonne it presents a transfer of more than $400 million by the end of 2012, with the promise of more after that.

For most recipients it will be a windfall. For the minority for whom a land use change is otherwise feasible it will cover at best 3 per cent of the deforestation liability.

Hence the "chainsaw massacre" as people felled sometimes immature forests before the regime came into effect.

For Bertram and Terry this kind of arbitrary and counter-productive outcome highlights the essentially political nature of decisions about how to respond to compensation for changes in asset values as a result of the ETS.

"The more serious climate policy gets the larger the potential for windfall gains for those who can deliver renewables and storage and the windfall losses for those who are stuck with high-emission technology," Bertram said.

"Not touching the windfall gains of renewable generators was just as much a political call as providing units to pre-Kyoto forest owners."

The decision to compensate the pre-Kyoto forest sector was driven primarily by the fact it is dominated by some very large companies and iwi.

"These are politically important groups the Government did not feel able to take head on."

But the loss of value was real and had to fall somewhere, Bertram said. By allocating units to landowners the Government reduces the stock of units it has to pay the country's Kyoto bill in 2015.

The same applies to the potentially much larger allocation of units to Kyoto foresters - owners of forests established since 1989 on land not previously forested.

Under Kyoto's rules New Zealand is able to claim credits for the CO2 these trees absorb as they grow, but is liable for the emission of that CO2 when they are cut down.

The surge of planting that occurred in the early and mid-1990s will lead to a surge of harvesting in the 2020s, when forests will flip from being a net sink to a net source of carbon, with fiscally painful consequences.

If the owners of these forests opt to receive units from the Government they can then sell them either to New Zealand emitters or, after conversion to another form, to other Governments with Kyoto obligations.

The catch is that they also accept the obligation to surrender units upon harvest. How many will do this is not clear at this point.

As Bertram and Terry point out, however, the only difference this makes is to when the taxpayer gets hit with the Kyoto bill.

The more units get devolved to Kyoto forest owners over the next two and a half years, the more the Government will need to buy from other sources in order to square accounts with other Kyoto countries in the 2015 wash-up.

But by the same token the more units devolved to Kyoto foresters now, the more the owners of those trees will have to surrender to the Government in the 2020s when they are cut down, reducing the taxpayer's bill then.

This, of course, assumes that the regime survives until then and some forest owners are effectively betting that it will not.

The loss of credibility is not an unreasonable inference from all the twist and turns and progressive waterings-down which have marked policy debate on climate change over the past decade or more.

The scheme has been weakened to the point where it is an environmentally ineffectual exercise in corporate welfare, Bertram and Terry argue.

"Uncertainty is the killer for this kind of thing. You are trying to influence investment decisions and change the structure of the economy in a cost-minimising way," Bertram said.

The other main recipients of free units are trade-exposed firms, who face competition in export or local markets from foreign competitors not exposed to a cost of carbon.

Details of this allocation are still being finalised but the most recent officials' estimate is that 11.7 million units will be allocated, plus a further 700,000 to the fishing industry. Bertram and Terry put the figure at 20 million tonnes.

In any case it is another transfer running into hundreds of millions of dollars.

"But where is the detailed risk assessment? Where is the analysis of what is the benefit to New Zealand Inc of a particular level of payment to a particular firm?" Terry said.

In an unprecedented move the Treasury had made it plain in the explanatory note to the legislation amending the ETS late last year that this analysis had not been done.

"The system has shown itself very vulnerable to pressures from large emitters, and agricultural producers, to gain taxpayer subsidies that have yet to be properly assessed for their economic benefit to the nation," he said.