Brian Fallow: Parties fundamentally split on ETS

Climate Change Minister Nick Smith has been at pains this week to rebut claims that the Government's planned changes to the Emissions Trading Scheme are fiscally reckless.

At the same time the release of paper trails by Labour and the Government over their negotiations show that a lot of common ground had been reached.

But the main issue still dividing them is a crevasse - not wide, perhaps, but deep, revealing fundamentally different ideas of why you would want to price carbon emissions at all.

There is no argument that the transition period running to the end of 2012 will cost the taxpayer money, largely because of provisions intended to soften the blow to consumers of electricity and transport fuels.

The official estimate of the cost, $415 million, is predicated on current international carbon prices. If prices rise over the next three years that estimate will be low.

So far, so uncontroversial.

What is surprising, though, is officials' estimates, released by Smith on Tuesday, that over the following five years, 2013 to 2017 inclusive, the Government expects to save money, compared with the fiscal cost of Labour's version of the ETS enacted late last year. The mid-point of the range is just under $500 million over that period.

This is counter-intuitive, to say the least. It would suggest major emitters have miscalculated their own short-term interests in pressing for changes in the way free emission units are allocated to them.

The calculation has several moving parts which would either increase or reduce the fiscal cost.

One change that is clearly at the taxpayer's expense is to defer by two years until 2015 agriculture's entry into the scheme. Together with more liberal rules for the allocation of free units to the sector, the estimated cost of that is $840 million by 2018, assuming a carbon price of $50 a tonne.

But another change is taxpayer-friendly. Under the existing scheme the phaseout of the free allocation would not begin until 2019. Under the amended scheme it begins in 2013, albeit at a much gentler pace of 1.3 per cent per annum. All else being equal that would reduce the allocation of free units by 6.5 per cent over five years to the end of 2017.

But all else would not be equal. The big change for trade-exposed emitters is the shift from a capped scheme, where the pool of free units is limited to 90 per cent of their collective emissions in 2005, to an open-ended intensity-based scheme with no cap.

The new model is based on relative, not absolute emissions. It is not anchored in historical emissions, but rather benchmarks based on Australasian industry averages.

If a large emitter's emissions per unit of output in 2005 was bang on the average for its industry in this part of the world, its allocation of free units would be the same under both models. If it is below par it would be worse off, if above-average better off.

The other key difference relates to any increase in output. Under Labour's absolute model any increase in emissions above 90 per cent of 2005 levels would have to be fully covered by buying emission units.

Under the modified scheme the taxpayer will pick up most of the bill for the increase in emissions.

So it is a surprise that officials reckon that the net effect of all these changes is that there will be fewer free units allocated under the new scheme than under the old, representing a saving to the taxpayer of up to $920 million compared with the current scheme (at a carbon price of $50 a tonne).

They seem to be discounting the possibility that New Zealand's large emitters will turn out to be better than average in emissions intensity, which would reduce the net flow of units from them to the Government, or that they will increase their output and emissions over the coming eight years.

Yet there is a one word objection to that sanguine view: Holcim. The Swiss-based cement maker has plans for a much larger and more efficient plant in Canterbury to replace its ageing, more emissions-intensive one on the West Coast.

It has long argued that intensity-based allocation makes more sense from the standpoint of global emissions as well as being in its commercial interests. What are the chances it will now take advantage of the more benign policy environment on offer?

Which brings us to the heart of the disagreement between the National Government and the Labour Opposition.

Under Labour's model historical emissions of trade-exposed sectors, including eventually agriculture, are grandfathered - 90 per cent of them anyway - but any increase in emissions above that level would face the full cost of carbon.

Any expansion of production which did not make commercial sense including that cost would be a misallocation of the country's limited resources of capital, land, energy and so on.

To expand production of milk or cement or whatever, when that is only viable with the taxpayer subsidising the carbon cost, would be to travel further down an economic cul-de-sac, entrenching distortions like over-inflated dairy land prices.

Only full carbon pricing at the margin would fulfil the object of the scheme, which is to shift relative prices in favour of a sustainable, low carbon future.

National regards all that as too pure by half. It agrees that the effects that matter occur at the margin.

However the object of the exercise as it sees it is not to curtail production and growth, but only to provide producers with a financial incentive to adopt technology to reduce emissions, whenever the cost of doing so is less than the market price of units needed to cover the emissions avoided.

On this view it is all about opportunity cost. If the cost of reducing emissions is less than the market value of carbon it is rational to make that investment.

It does not matter if the emitter avoids the cost of buying emission units, or has the opportunity of selling some it got for free. The effect on the uptake of clean technology should be the same.

But not the effect on the Government's accounts.

Clearly the Government's model, under which to produce more is to increase your entitlement to free emission units, represents a wealth transfer from taxpayers to emitters that Labour's capped model - rough justice as it may be - does not.

But the Government would argue that a country struggling to earn a first world living in a wicked protectionist world cannot afford the purist approach, at least not until the international playing field is a lot more level than it is now.

Both parties' positions are arguable, and both entail a cost.

It is probably too much to hope that a foreshortened select committee examination of the amendment bill to be introduced tomorrow will get to the bottom of quantifying the costs and benefits of both approaches.