Consultation is now open for feedback on proposed amendments to the New Zealand Emissions Trading Scheme (ETS) to reduce reliance on forestry offsets.
The inclusion of forestry in the ETS has been the subject of mounting criticism, most notably by the Climate Change Commission. As a result, the Government has undertaken a review of the ETS and is now seeking public feedback on:
- whether the ETS should be amended to provide a stronger incentive for gross emissions reductions; and
- the future of the permanent forest category of the ETS, which has only had effect since the start of this year.
The Government has identified four options for amending the ETS, and three ‘decisions’ for redesigning the permanent forest category. All are broadly stated. The most drastic of which would create two separate ETS markets so that emitters would not be able to use forestry units to offset their emissions. It would also see exotic forests become ineligible to enter the ETS.
Reforming the ETS and redesigning the permanent forest category are significant matters that will affect the ETS and the carbon market as we know it and will have potentially material implications for existing and future participants.
We summarise the drivers for change and the potential impacts of the various options.
To read the consultation documents issued by the Government, click here.
The current ETS settings have been under scrutiny because they incentivise the planting of forestry rather than the reduction of gross emissions.
New Zealand is the only country that allows unlimited planting of trees in its emissions trading scheme. The ETS does not differentiate between reducing emissions and emissions reductions from trees absorbing and storing carbon (known as removals).
Under the current ETS settings, it is more cost effective for emitters to meet surrender obligations by earning or buying New Zealand Units (NZUs) than it is to reduce gross emissions. In other words, it is cheaper to buy NZUs than undertake most other steps, like improving energy efficiency or considering low-carbon alternatives, to reduce actual emissions or buy NZUs at auction.
There is concern that this has incentivised investment in exotic forestry. According to the Government, modelling shows the NZU supply generated by these forests may exceed the number needed by emitters in the future. If there are too many lower-cost NZUs available, the price will drop and further weaken the incentives to emitter to reduce emissions.
In addition to concerns about the balance of gross vs net emission reductions, investment in exotic forestry has also raised concerns about the environmental, social and economic impacts of land conversion.
Amending the ETS
The Government is considering four possible options to amend the ETS, which will affect the way that forestry participates in the system.
In 2021, the Climate Change Commission provided advice to the Government on New Zealand’s first emissions reduction plan. In that advice, the Commission recommended that the Government amend the ETS to strengthen incentives for gross emissions reductions and to manage the amount of exotic forest planting driven by the ETS, in line with its advice on emissions budgets. The Government agreed to do that, subject to the outcomes of a targeted review of the ETS.
As part of this review, yesterday the Government identified four broad options to amend the ETS:
- Adjusting existing regulation in the ETS to reduce the supply of NZUs and increase their price (i.e. using existing levers to strengthen incentives for emissions reductions). For example, the Government could reduce the number of NZUs supplied at auctions to decrease the number of NZUs available in the market (and therefore increase the price of NZUs).
- Creating increased demand for NZUs by allowing additional entities such as the Government and offshore buyers to purchase them from outside of the ETS. This option is designed to reduce the number of NZUs that emitters can access in the secondary market and therefore increase the price of NZUs.
- Changing the incentives for removals by imposing restrictions or conditions. This would change the way that NZUs earned from forestry are valued by (a) restricting how many forestry generated NZUs emitters can use to ‘pay’ for their emissions; (b) reducing the number of NZUs given out for forestry, relative to the amount of carbon removed from the atmosphere (e.g. changing the basis on which forestry NZUs are earned), or (c) restricting the time removal units can be held (i.e. applying an expiry date).
- Creating two separate ETS markets; one for emissions reductions and another for removals. Under this option, emitters would not be able to use forestry NZUs to meet surrender obligations for their gross emissions, they would have to purchase them from the Government. A second ETS market would be available for removal activities, and NZUs earned from those activities would be sold directly to the Government.
No preferred option has been identified, however, there is a clear preference for option four which would result in a whole new ETS scheme.
The Government has made it clear that it will still support activities that remove carbon from the atmosphere. Therefore, its suggested options are intended to increase the incentive for gross emissions reductions while also retaining support for removal activities, like forestry.
While no preferred option has been explicitly identified in the consultation documents, our view is that there is a preference for option four.
The Government’s consultation document(s) suggests that options one and two do not go beyond the status quo and the success of option three is uncertain because of the range restrictions that could be explored:
- Option one may boost the price of NZUs in the short-term but it does not address concerns that the supply of forestry units is projected to fully meet emitter demand for units. Therefore, the Government has commented that the ability of this option to successfully deliver rising prices and gross emissions reductions beyond the short-term is likely to be limited.
- Option two may also boost the price in the short-term but it is uncertain whether there is enough interest for this option from overseas buyers and the Government to be successful. As with option one, it also does not address concerns about the focus on net emissions rather than gross emissions reductions.
- The consultation document(s) also cautions that there are potential issues with Option three; its success will depend on the restrictions the Government imposes and there is also a risk that it would disincentivise forestry. The Government has recognised that it would need to provide other incentives outside of the ETS to ensure that New Zealand could still achieve its emissions reduction plans.
In that context, the Government appears to be favouring Option 4:
- Option four represents a significant shift in the design and application of the ETS, which the Government has indicated would be more aligned with the European Union and UK schemes.
- The Government has signalled that this option would give it far greater control over price and therefore the ability to incentivise gross emissions reductions. Participants would only be able to use NZUs sold at auction or received through industrial allocation, to meet their surrender obligations.
- This option appears to be favoured because it would incentivise gross emissions reductions while retaining a market where forestry NZUs could be bought and sold. The Government considers that this is sufficient to ensure that forestry would not be entirely disincentivised. In our view, it might not be that clear cut. It will depend on the incentives available to invest in the alternative ETS system for forestry.
What this all means for existing investment in forestry is unclear; the Government has left it open whether the changes would apply only to newly allocated units from removal activities or also to those allocated prior to any of the options coming into effect.
Redesigning the permanent forest category
To address concerns that the current ETS settings will lead to increasing levels of exotic afforestation in the future, the Government is consulting on three ‘decisions’ to redesign the permanent forest category in the ETS;
- Decision one: Determining which type of forests should be allowed into the permanent forest category so that (a) only transition forests (being exotic forests that are actively managed to transition to indigenous forest over time) and indigenous forests would be able to enter the permanent forest category, or (b) only allowing exotic forests to enter under limited circumstances.
- Decision two: Deciding how to manage transition forests to reduce the financial risks to participants by continuing to allow transition forests to use stock change accounting or applying a new mandatory specific carbon accounting method for these forests.
- Decision three: Reconsidering how permanent forests are managed by determining whether new forest management requirements are needed to mitigate environmental risks associated with permanent forests, and if so, whether they apply to all permanent forests or only those transitioning into the permanent forest category.
For decisions two and three, the status quo is one of the options being considered, but not for decision one. The future of exotics in the permanent category of the ETS is squarely back on the table. If the current Government remains in power following the general election, then the question that remains is when and by how much. The National Party has indicated support for limiting the ability for newly planted exotic forests on converted farmland to enter the ETS so it too may continue to pursue this redesign.
Have your say
The timing of any change is uncertain. The Government has made it clear that it is undertaking consultation before the election but decisions following consultation will be a matter for the next government. So, there is a high amount of uncertainty in the path that will be pursued. We expect more guidance on the preferred options and decisions and the implications after the election.
You can make a written submission on the proposals until 11 August 2023. The Government is also holding webinars and hui about the proposals which are listed on the Ministry for the Environment’s website here.
If you would like further information or guidance on how the proposals may affect you, or if you would like support in preparing a submission, please speak to one of our experts.
This article was co-authored by Holly-Marie Noone, a senior solicitor in our Environment team.
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