The Emissions Trading Scheme is designed to offset the production of greenhouse gases.
Treasury warned ministers that higher prices needed to reduce emissions would send electricity, gas and petrol bills rising by between 3 and 8 per cent - and send the price of industrial and commercial energy even higher.
The advice, released to the Herald under the Official Information Act, fed into Cabinet’s decision to reject advice from the Climate Change Commission and supported by Climate Change Minister James Shaw to change the Emissions Trading Scheme (ETS) settings and allow carbon prices to rise much higher than they had done in the past.
Treasury believed a carbon price of $120 - roughly double recent prices - would increase residential electricity prices by 2.88 to 5 per cent and increase commercial and industrial electricity prices by as much as 7.49 per cent.
Petrol prices would rise 4.77 per cent, diesel prices would rise 8.18 per cent and coal prices would rise 36 per cent.
Fossil gas prices would skyrocket - not so much for households, which would see bills rise by 6.53 per cent on 2021 prices - but for commercial and industrial users, whose prices would increase by 12.12 per cent and 25 per cent respectively.
The New Zealand Emissions Trading Scheme is a tool to help the country meet its domestic and international climate change targets, including the 2050 target set by the Climate Change Response Act 2002.
The advice used an ETS price of $120, which is where prices might have gone had the advice from the Climate Change Commission been accepted. After the advice was rejected, carbon prices fell and now sit at below $60 a unit.
It appears Cabinet’s decision to reject the Climate Change Commission’s advice, while supporting lower household bills, has undermined confidence in the ETS, leading to a crash in the price of units.
The advice from the Climate Change Commission came as part of an annual update of ETS settings by the Government - although this was the first time the Commission had offered its own advice on ETS settings since it was established in 2019.
The papers, which were also released to the National Business Review, shed light on the difficulty politicians have with the ETS - an ETS price high enough to drive gross emissions would also have the effect of making life more expensive for households, particularly during the current period of historically high inflation.
They also show the significant disagreement between Treasury and the Climate Change Commission on how the ETS should be used to drive emissions change.
“The commission has recommended a significant departure from status quo settings, with an underlying assumption that the ETS should shift from driving net emissions reductions to primarily driving gross reductions,” Treasury officials said.
“Adopting their recommendations in full is likely to significantly increase price within a relatively short timeframe,” the advice warned.
Shaw acknowledged that the impact of a rising price on consumers was a concern to ministers.
“When you have a rise in ETS price, that increases prices on fossil fuels in particular,” he said.
“Of course, we are still utterly reliant on fossil fuels, particularly when it comes to transport and a portion - a tiny portion - of our electricity, so there could be a flow-through effect to household prices.
“That was a concern around the Cabinet table.”
But Shaw added that the commission advised ministers the ETS should be allowed to signal an appropriate carbon price, and if this price ended up having social consequences, these should be dealt with through other policies.
“However, the Commission also advised that you shouldn’t try [to] achieve social policy outcomes through the ETS - that you should let the ETS do its price, but that you should also have social policies in place to manage any kind of distributional impact,” Shaw said.
Treasury was also sceptical that a higher emissions price would actually drive emissions reductions.
The Treasury paper warned that “in the current economic climate” there was a “risk that higher NZ ETS prices may fail to achieve modelled emissions abatement and instead translate into an economic ‘pain point’ through exacerbating cost of living pressures and driving broader distributional and economic impacts”.
This is because there are not always readily available low-emissions alternatives to switch to - meaning that as emissions prices rise, people and companies would just have to face higher bills, particularly for things like petrol and energy, which are difficult to simply stop using.
High interest rates and labour constraints meant there was not necessarily the slack in the economy for businesses to make large investments to switch to low-emissions alternatives, the advice warned.
“Investment in low-emissions substitutes requires availability of technically feasible and economic alternatives, and often time to make these investments or phase them into asset management cycles.
“Current supply-side and labour constraints, along with heightened inflation and interest rates, are likely to create additional barriers to the uptake of low-emissions technologies as compared to what has been modelled,” the advice said.
The intent behind the Climate Change Commission’s advice was to bring the ETS into alignment with New Zealand’s climate goals.
Treasury warned it might not actually succeed in this, and could bring about significant unintended volatility in the carbon market.
“In our view, a significant departure from the status quo this year is more likely to create significant regulatory volatility risk,” the advice warned.
Treasury officials also warned the Commission’s recommendation to reduce the overall number of ETS units could raise problems like stockpiling. This ran the risk of the market seizing up, which could mean polluters would be unable to buy ETS units to offset their pollution because of a lack of willing sellers.
“If auction volumes are significantly constrained with little notice, participants with compliance obligations may struggle to procure sufficient units, despite sufficient volume theoretically being available from the stockpile.
“Importantly, holders of ‘stockpiled’ units (including those who earn units through forestry removal activities) need to be willing to sell these units at a price that participants with compliance obligations are willing to buy them.
“In a market with expectations of continual price increases, it is likely that stockpile holders will either choose not to sell them or do so at a very high price. This creates [a] risk of significant price increases in the short-term,” the paper warned.
The Government will shortly begin a larger review of ETS settings - again trying to drive down emissions, rather than simply encouraging forestry offsets.
This review was announced in the Emissions Reduction Plan last year, but has not yet begun.
Shaw said the Government had been twice warned “there is likely to be a glut of forestry offsets in the ETS which will cause a collapse in the price in the 2030s that would not be good for landowners who have invested in planting forests. And it obviously would also mean that companies that are polluting companies are less likely to reduce their pollution if the price collapses”.
Recently released Cabinet papers warned that without reform, the ETS will dramatically increase the amount of carbon forestry.
“Under current settings, the NZ ETS is expected to drive considerable net emissions reductions, mainly through carbon sequestration from forests.
“However, the NZ ETS is not expected to drive material gross emissions reductions in the energy, transport, industrial processes and waste sectors. This risks delaying meaningful decarbonisation in New Zealand and a successful and just transition to a low-emissions economy,” the paper warned.
It also said the current settings do not “drive the level of native restoration recommended by the Climate Change Commission to create a long-term carbon sink for hard-to-abate emissions post-2025, nor help us to net negative [net emissions] in the second half of this century as required by the Paris Agreement”.
Current ETS settings are expected to contribute between 0.6 to 3.1 megatonnes of CO₂-equivalent net emissions reductions to the first emissions budget. This is a relatively significant contribution, considering the first emissions budget is meant to reduce net emissions by about six megatonnes from the current trajectory.
Forestry could, the paper reckoned, contribute 121 to 169 megatonnes of CO₂-equivalent emissions removals over the next three emissions budgets.
But this could have significant drawbacks, like the rapid conversion of rural land to forestry. The paper also warned the ETS was on-track to drive “between 410,000 and 670,000 hectares of new forests by 2035″.
An analysis from ANZ Bank said this would mean the conversion of approximately 2,000 farms into forestry and lead to a 20 to 30 per cent increase in the area currently planted in exotic forest.
Shaw hinted at a possible change, noting that in other countries, forestry offsets were only allowed on a “more limited basis”, forcing polluters to reduce pollution rather than rely on offsets.
“In the Californian emissions trading scheme, you can only surrender a portion of your total pollution obligation with forestry offsets - the rest of it has to come from actual reductions in pollution,” Shaw said.
The New Zealand Emissions Trading Scheme helps reduce emissions by doing three main things:
The Government sets and reduces the number of units supplied into the scheme over time. This limits the quantity that emitters can emit, in line with New Zealand’s emission reduction targets.
Businesses that participate in the NZ ETS can buy and sell units from each other. The price for units reflects supply and demand in the scheme. This price signal allows businesses to make economically efficient choices about how to reduce emissions.
- Source: Ministry for the Environment.
Expectations tempered around return to surplus in 2027/28.