New Zealand ratified the Kyoto Protocol in 2002, thereby committing to limit its green-house gas emissions over the first commitment period – 2008–2012 – to 1990 levels.

Under the ETS, this emissions reduction has been pursued by allocating trading units equivalent to 310 million tonnes of carbon dioxide.

How it works

Participants in the New Zealand ETS surrender emission units that match their annual emission levels. A New Zealand Unit (NZU) is the primary domestic unit of trade. To meet obligations under the scheme, participants can surrender free units, if they have any, at the rate of 1 for every 2 tonnes emitted. Otherwise, participants have to either pay the fixed price option, or purchase NZUs or other Kyoto compliant units.

Participants in the ETS are obliged to register and set up monitoring and reporting systems to record unit transactions. Failure to comply with obligations under the ETS attracts significant liabilities. For example, failure to surrender units attracts a penalty beginning at $30, increasing to $60, per tonne.

Industry implications

The primary industries sector

The forestry industry entered the ETS in January 2008. It was the first sectorto enter because of the importanceof forestry to New Zealand’s ability tomeet its international obligations for reducing greenhouse gas emissions.

Owners of post-1989 forest land can choose to enter the ETS and earn NZUs for carbon sequestered as their forests grow. Owners of pre-1990 forest land face obligations if they deforest and receive a one-off allocation of NZUs to partially offset the decrease in land value arising from decreased land flexibility.

Figure 1 shows New Zealand’s emissions profile in 2008. Unlike other Annex 1 countries, where carbon emissions from energy dominate the profile (80 per cent), New Zealand’s highest share is attributed to agriculture (46.65 per cent), predominately in the form of methane and nitrous oxide emissions, followed by energy (45.32 per cent).

Agriculture is scheduled to enter the ETS in January 2015. Setting the point of obligation for agriculture, is an important challenge. At present there are about ten upstream fertiliser firms and 25 meat/dairy processing firms. In contrast there are literally thousands of farms contributing to New Zealand's most significant greenhouse gases.

The costs of monitoring and enforcement will be lower if the point of obligation is set at the processor level, but this may not create the incentives necessary for low-cost reductions at the farm level. Current policy settings have the processing level as the point of obligation.

The industrial sector

In 2009 a National-led coalition amended the ETS, which delayed the entry date of stationary energy, liquid fossil fuels and industrial processors to July 2010 and established a transition phase through December 2012. During this period participants are required to surrender 1 NZU for every 2 tonnes of carbon dioxide equivalent emitted. A fixed price option of $NZD225 per carbon dioxide equivalent emitted is also available.

Concessions

Free allocations of units were given to sectors considered competitively at risk, such as the fishing and industrial processes sector. Participants can bank excess units for use in the future but these units cannot be exported.

Pricing carbon

The spot price of NZUs has been hovering around $NZD20.

In 2005, New Zealand was in deficit by about 36 million units and the Government was exposed to a liability of around $300 million. By February 2011, Figure 2 shows the net position having changed dramatically, a surplus of approximately 10 million units and valued at $300 million. The change from deficit to surplus is largely attributed to accounting for land-based carbon sequestration.

Purchasing units offshore

Certified Emission Reduction (CERs) units are the most likely source of offshore units created under Kyoto’s Clean Development Mechanism (CDM). CERs, created from emission reduction projects in developing countries, can be purchased from developers or through secondary markets. The price of CERs fell dramatically at the end of 2010, likely due to the clearing of a backlog of CERs for release into the market and pending restrictions on CERs generated by industrial gas projects.

Analysts attribute the March 2011 peak in CER prices, seen in Figure 2, to the Fukushima tsunami and nuclear reactor tragedy. The German government placed a three-month moratorium on extensions to 17 nuclear reactors which has implications for increased utilisation of coal and the need to cover increased carbon emissions under the European ETS. Ramping up thermal production could drive the current international carbon unit prices of $A26 to $A57 by 2018.

Summary

New Zealand has implemented a bold initiative to meet its Kyoto commitment. As a first-mover trading nation, the risks of diluting our competitive advantage in commodity markets is a concern. New Zealand’s carbon market is thin; dependent on the supply of NZUs brought into the market; and, is not integrated with the European ETS. On the positive side our commitment to the ETS reinforces the country’s clean image.