Tuesday, May 3, 2016

Submission on the review of the New Zealand Emissions Trading Scheme (ETS)

Submitter: Professor Euan G. Mason

Profile: Euan Mason is a Professor at the New Zealand School of Forestry, University of Canterbury, where he teaches silviculture, statistics, modelling, and research methodology.  His research interests include forest growth and yield modelling, tree physiology, and silviculture.  He has published numerous peer-reviewed articles relating to climate change and forestry, and has been employed by government ministries and political parties to advise them on climate change issues from time to time.  He is a New Zealand citizen, born in Invercargill.  He was educated at universities in New Zealand and the United States of America.

Symptoms of ETS failure

New Zealand has so far failed to live up to the spirit of its obligations to other countries to reduce net greenhouse gas (GHG) emissions.  This position is not morally defensible.  Claiming to contribute to global GHG mitigation efforts while implementing policies that only pretend to do so would be considered unethical in all ethical systems. This is obviously true with Kantian ethics, and also ethics of care.  Some might make an argument that our duplicity might be defensible in a utilitarian ethical framework, but the small financial benefits that would accrue to New Zealand would be far outweighed by the wider harm such behaviour would do, particularly when it was discovered.  All people contribute to climate change, and none can be exempt from contributing to a solution without endangering global efforts to solve the problem.  New Zealand is also vigorous in its efforts to contribute to global climate change negotiations, and duplicity undermines our credibility.

Our climate change policies are failing (Mason, 2013). New Zealand’s greenhouse gas emissions per capita are fifth highest in the world at approximately 18 tonnes of CO2-e (source: NZ Ministry for the Environment).  Our gross greenhouse gas emissions grew by 22% between 1990 and 2011 (source: UNFCCC), and our net emissions (gross emissions minus sequestration by forests) grew by almost 100% during the same period (Source: NZ Ministry for the Environment, although sources differ substantially on this estimate).  We met our Kyoto obligations during the first commitment period only because we agreed to get our net emissions between 2008 and 2012 down to the level of our gross emissions in 1990. Meeting even this soft target was a close run thing, and was only possible because large areas of new forest planted during the 1990s sequestered enormous amounts of CO2 during that period.  We are widely recognised as poor climate change mitigation performers internationally, having been awarded “fossil” awards for this poor performance in 2012 and 2015.  The commentary associated with our 2012 award was:

New Zealand has demonstrated exceptional blindness to scientific and political realities.


While New Zealand may have helped drown the talks for another year, New Zealand's small and vulnerable Pacific neighbours should take heart that they have not been forgotten - New Zealand intends to drown them too.

It is particularly galling that our government apparently plans to use environmentally worthless hot air credits to meet our 2020 target to reduce emissions in 2020 to 5% below 1990 levels. It is unclear whether the target is gross to gross, net to net, or net to gross emissions, but the latter is likely, making this yet another very soft target.  Even this soft target will be met with credits that represent no environmental gain rather than real mitigation activities, and our net greenhouse gas emissions will continue to rise.

If we continue to behave in this way, we shall cement our reputation as an international pariah on climate change.  It is only a matter of time before other countries devise ways to punish us for our misbehaviour.

The ETS has failed because policies have ensured that the price of New Zealand Carbon Units (NZUs) is too low, and because sectors are treated unequally in the ETS. Figure 1 shows the spot price of NZUs since 2009.  

Figure 1 – Spot prices for New Zealand Units (Source: CommTrade)

Bogus “Hot air” credits

The price of domestic carbon credits, NZUs, dropped substantially late in 2011 when New Zealand began to import cheap “hot air” credits (ERUs) from eastern Europe (Mason, 2013) that represented no real environmental gain (Figures 2 and 3) (Alessi and Fujiwara, 2011).  The price of these bogus, imported credits was as low as $0.17, and many New Zealand greenhouse gas (GHG) emitters bought and surrendered them instead of NZUs in order to meet their obligations.  Clearly such prices provide no incentive to reduce GHG emissions or to plant trees in order to sequester CO2.  Manley (2016) has modelled likely responses of the forestry sector to varying NZU prices, and even current NZU prices close to $10 would lead to minimal new planting.

Last year the New Zealand government outlawed the surrendering of imported credits, and this has led to a modest increase in the price of NZUs (Figure 1).  However, that was not the only flaw in ETS policy.

Figure 2 – Transition in types of carbon credits surrendered under ETS regulations from 2010 to 2011.  Fixed=fixed price offer, AAU=international Kyoto assigned amount units, NZUf=NZUs generated by forest sequestration, NZUo=other sources of NZUs (usually grandfathered to emitters), RMU=removal units, CER=certified emission reduction units from developing countries, ERU=”Emission reduction” units (hot air from Eastern Europe) (Source: Ministry for the Environment)

Figure 3 – Volumes of different types of carbon credit surrenders from emitters under ETS regulations in 2013 (Source: Ministry for the Environment). ERUs were almost all hot air from Eastern Europe. Note also the lack of NZU surrenders, which led to a giant hoard of thin air NZUs in our registry that had been gifted to companies for “allowed emissions” of GHGs.

Agriculture and a fragmented, sector by sector approach

New Zealand has taken a fragmented approach to emissions trading that has greatly reduced the ETS’s effectiveness. In particular, agriculture, which contributes almost half our national GHG emissions has no surrender requirement and therefore no incentive to undertake any mitigation activities. The excuse used for this exception is that “agriculture has no mitigation options” (Hon. Tim Groser, on several occasions), but that statement is false.

At least two very effective mitigation options are available to the agricultural sector.  Nitrous oxide emissions comprise a large minority of agricultural GHGs, and these can be significantly reduced by more efficient use of fertiliser.  In addition, plenty of erosion prone land currently under grass could be planted in trees without significant reductions in livestock numbers on our farms.  With an effective ETS, many farmers would then earn money from their mitigation activities. They currently have no incentive to undertake either of these mitigation options.

The New Zealand School of Forestry at the University of Canterbury has mapped approximately 1.3 million hectares of erosion-prone land currently covered by low vegetation that is not of significant ecological value in New Zealand.  Based on an assessment of likely productivity of this land, we have estimated that extremely large reductions in net GHG emissions could be achieved by planting this land with a modest planting programme of 50,000 ha/annum for the next 26 years (Figure 4). New Zealand’s gross GHG emissions are approximately 80 million tonnes of CO2-e, and as the Figure shows, even with this small amount of land afforested (New Zealand’s land area is 27 million ha), our nation could be completely GHG neutral during some years.

Currently much of this land is owned by farmers, and we anticipate that farmers would profit from afforesting only erosion-prone portions of their land, but they need an incentive to do so.

Note that according to Manley’s (2016) analysis a 50,000 ha/annum planting programme would require an NZU price of approximately $50.  However, with a lower price of $20/NZU we could see 20,000/annum afforested which would greatly assist us in meeting our international obligations.  Note also that at a price of roughly $35/NZU, a “plant and leave” option (Figure 4) becomes much more likely.  

Figure 4 – Projected rates of carbon sequestration per annum from planting 50,000 ha/year for the next 26 years, with a variety of species and management options on erosion-prone land in New Zealand. Year zero is the year when planting 50,000 ha/annum begins.

We anticipate that radiata pine planted and left on most of this land would eventually revert to native forest, so long as local seed sources were available (Forbes et al., 2015a; Forbes et al., 2015b; Forbes et al., 2016). Mason & Morgenroth’s study of carbon forestry potential on erosion-prone land has been described more fully at:


Afforesting erosion-prone land (Figure 5) confers other benefits; less loss of topsoil, and also lower siltation of more valuable, flat land downstream during major storms (Marden and Rowan, 1993).

Figure 5 – Erosion-prone farmland that would be protected if forest was re-established on it

Clearly the agricultural sector could make a large contribution to mitigating its own GHG emissions, but it has no incentive to do so with current ETS policies. Hill-country farming would become more profitable if farmers were encouraged to engage in carbon forestry on their eroding lands, and competition for land between carbon forestry and farming is unbalanced while agricultural greenhouse gas emissions remain unpenalised.

Recommendation: Agriculture should be brought into the ETS immediately, and all sectors should be treated equally in the scheme

Bringing agriculture into the scheme would not solve the ETS’s problems on its own. There are several other issues that need to be sorted out.

Grandfathering of credits

We can make rapid progress at mitigating climate change by adopting the simple principle that those who emit GHGs should either sequester them or pay other people to sequester them.  This principle has been undermined by ETS policies.

The government has engaged in a practice labelled “grandfathering”, where polluters are given credits for “allowed emissions” up to a portion of their actual emissions and then they have to surrender credits for 100% of their emissions.  Grandfathered credits represent no cleaning of the atmosphere and flood the credit market with credits that are at least 50% as bogus as “hot air” credits from Eastern Europe (Mason, 2013).  They also impose awkward administrative difficulties, requiring people to assess “additionality” of climate change responses, and such judgements can at time appear rather arbitrary and costly (Valatin, 2012).

The Kyoto process also adopted grandfathering and it has encouraged people to think irrationally about what it means to be “GHG neutral”.  For instance, “Greencarbon”, a company devoted to measuring and brokering carbon credits, runs a New Zealand website (http://www.greencarbon.co.nz/certification-overview/step-3--purchase-carbon-credits, accessed on November 29th 2012).  A quote from that website is as follows:
“A wind farm provides electricity from wind, a plentiful renewable source. Carbon Credits are awarded for the carbon emissions that have been avoided as compared with electricity generation by burning fossil fuels.
The Te Apiti Wind Farm by Meridian Energy is located in the lower North Island of New Zealand. It is a 90MW wind farm made up of 55 Vestas 1.65MW wind turbines. The wind speeds at the site are on average 9.3 m/s giving an annual output of over 325 GWh.  The wind farm reduces GHG emissions by approximately 203,125 tCO2e/year....
.... In order to be able to promote your business as 'Carbon Neutral', and earn the label of 'Green Carbon: Carbon Neutral Certified', you must first Measure your carbon footprint, Reduce your emissions where possible, and then purchase and retire the correct amount of carbon credits.”
These quotes are typical of those engaging in carbon trading.  The idea is that we can claim “GHG neutrality” or “carbon neutrality” by purchasing carbon credits to offset our emissions, but purchase of credits derived from lowering pollution below the level of a free allocation (essentially a kind of domestic emission reduction unit) does not confer GHG neutrality.  This can easily be seen by using the example above.  Suppose an energy company generated enough domestic ERUs through wind power generation to reduce its GHG emissions to exactly half of its free allocation of credits (In the NZ ETS, some companies get an allocation of free NZUs that means they are allowed to pollute without penalty up to a certain level).  It could then use the credits it generated to account for its remaining emissions and claim to be GHG neutral even though it was still emitting 50% of its original allowed GHG pollution. This kind of irrationality arises from the Kyoto concept that we need only reduce emissions down to our level of gifted credits, and below that level we can sell credits that have been “grandfathered” to us as “allowed” emissions.  The energy company could be said to have reached some kind of target if it reduced its GHG emissions to 50% of its allowed pollution, but it is irrational to reward it with sellable credits that people can use to claim “GHG neutrality”. Unfortunately this irrationality has contributed to the undermining of New Zealand’s emissions trading scheme.  Only credits derived from sequestering GHGs in sinks can be sensibly used to confer GHG neutrality on purchasers’ activities, and these credits are an important key to changing the way we live and solving the problem of climate change.
Grandfathering of credits for allowed emissions also contributes to inflation of our carbon credit currency.  Credits created from thin air and grandfathered for allowed emissions increase the number of bogus credits in circulation, and although they theoretically should be surrendered to government, effects of any slop in emission/sequestration measurement, or any schemes such as arbitrage with imported credits are amplified by these excessive numbers of credits.

Recommendation: Grandfathering should be stopped. Instead, polluters should be required to surrender credits only for emissions beyond their allowed levels of pollution within any given time period.

Credits as a commodity

Carbon credits are a currency that should be used to secure the least-cost way of meeting our climate change mitigation targets.  If it is cheaper or more expensive to pollute and then clean the atmosphere by sequestration than to reduce pollution, then credit prices will reflect this. Unfortunately much carbon trading has been speculative and some people have seen carbon trading as a means to make money by doing nothing of value.  They simply clip the ticket and extract value as credits pass through their hands.  This means that relative values of sequestration versus pollution reduction are improperly valued by the currency, leading to poor market outcomes.  At an extreme, an individual could amass a large proportion of credits and effectively control marginal prices by selling only a few at a time.  This would result in volatility which is a disincentive for long-term sequestration activities such as forestry because it increases people’s perceptions of risk.  Speculators profit from price volatility, whereas a stable credit price will promote long-term investments in sequestration.

Recommendation: The credit market should be structured to maintain a stable credit price so as to promote long-term sequestration activities.  This means, as much as possible, removing middle-men and allowing transactions only between polluters and sequesterers.

Random gifting

From time to time the government has randomly gifted “thin air” credits, that represent no environmental gain, to entities or people whom they wish to encourage or mollify.  These credits represent no cleaning of the atmosphere and are of no greater value than Eastern European “hot air credits”.  Such gifts are very tempting for a government because they enable a “reward” to be delivered without any immediate impact on government accounts.  Gifts include allocations of credits to a power company for building a wind farm (the reward for a wind farm is power generation that requires no credit surrenders, hence these credits were a double payment), or an allocation of many millions of credits to pre-1990 forest owners to partially account for losses in land value (suffered when they were forbidden to generate sequestration credits but were required to surrender credits for emission of carbon stored in trees when land use changed).  In this latter case any compensation should have been in cash, but a more rational approach would have been to treat all forest equally irrespective of the date of forest establishment.  Gifting thin air credits floods the ETS with credits that represent no environmental gain and so contributes to credit currency inflation.

Recommendation: Random gifting by government should be illegal.

Managing the price of New Zealand Units

Currently the most effective sequestration activity is new forest establishment, a long term investment which requires a stable credit price.  Perceptions of risks of future credit price increases dissuade people from establishing carbon forests.  This is because, quite rightly, when trees are harvested carbon foresters need to surrender credits to account for losses of carbon storage. Policies that stabilise credit prices will greatly improve the ETS as a tool for meeting our international obligations because sequestration investments will be seen as less risky.

We should arrange for independent management of the value of our NZU currency just as our independent Reserve Bank carefully manages the integrity of our dollar currency, except that instead of using the official cash rate, an independent agency would foster the integrity of NZUs by managing percentages of emissions for which credit surrenders would be required. An annual five per cent decline in our net emissions, for instance, would see New Zealand GHG neutral within 20 years. The agency’s job would be to meet such a target by manipulating percentages of emissions for which credits are required across all sectors on an annual basis. Just like the Reserve Bank, the agency would have to use clear and open processes to ensure minimal surprises.  Moreover, oversight by such an agency would reduce the likelihood of ad hoc political interference in the ETS. Credit price stability would vastly improve the effectiveness of the ETS.

Recommendation: Require credit surrenders only for emissions above allowed caps, and have an independent agency such as the Reserve Bank held responsible for setting yearly caps to stabilise the credit price at a level that sets us on target to meet our international commitments.

Dealing with the hoard of credits in our registry

ETS policies allowed many emitters to receive grandfathered, thin air NZUs from the government to cover portions of their emissions (up to 90% in the case of “trade exposed” industries), and their natural reaction has been to hoard NZUs and surrender hot air credits instead (Figure 3).  Hoarding has led to a giant mountain of more than 140 million NZUs in the registry that emitters can use to continue to emit GHGs, an amount equivalent to roughly four years of surrender obligations with current policies. This hoard threatens to undermine the ETS at least until early in the 2020s. There are a number of ways that we might deal with this problem:

1. The majority of credits in the hoard were grandfathered to companies for “allowed” emissions, and then those companies chose to buy and surrender hot air credits from the Ukraine or Russia because they were cheaper than NZUs. This violated the spirit of “grandfathering”, and so one solution is to forcibly buy back the NZUs at a price that is only slightly larger than the purchase value of the hot air credits that replaced them (to allow for a reasonable return on purchase price).  Each credit has a pedigree and so it should be feasible to apply this solution fairly.  That way the original intent of grandfathering will have been met.

2. The Reserve Bank or other ETS controlling agency could greatly increase the levels of emission reductions that are required in order to deplete the hoard more rapidly. This option runs the risk of price volatility because it will take some time for the agency to learn to stabilise the credit price. It also runs the risk of unfairly penalising those who did not engage in hot air credit substitution.

3. We could do nothing about the hoard, but this means that we’ll further delay action just prior to a decade when our national net emissions are predicted to increase markedly due to harvesting of forests planted during the 1990s.

Recommendation: The government should buy back NZUs that were grandfathered and then substituted by hot air credits at prices that reflect the purchase price of hot air credits.

Making a change to a carbon tax

It has been suggested that we might abandon the ETS and instead operate a tax on greenhouse gas emissions.  I am all for anything that solves the problem, but I do not believe that this is a viable solution while simple changes to the ETS can be made that will make the carbon market work properly.  My reasons are:

1) The ETS has been carefully designed and many people have participated in it.  These people will be unfairly penalised if we abandon the ETS. In order to make the change some kind of buy back of NZUs or a temporary substitution of NZUs for tax would be required.  This would increase the likelihood of gaming and it is hard to see how the change might be made fairly.

2) The infrastructure for the ETS is already in place, and a carbon tax would take a very long time to be firstly politically agreed upon and secondly designed.  This would further delay our national response to climate change. Substantial numbers of voters dislike tax, and it is hard to see this proposal being politically feasible in a short time frame.

3) Tax money would accrue to government rather than to sequesterers who were cleaning the atmosphere of pollutants. This means that the principle of finding a least-cost solution would be violated.  Moreover, even if carbon tax receipts were tagged for use by sequesterers, there is a long history of tagged taxation being appropriated into consolidated government accounts and used for other purposes.  The most glaring example of the latter was the appropriation of superannuation contributions by the Muldoon government.


In summary, we have failed so far to respond fairly to climate change and we are rightly regarded as a pariah nation.  Our emissions trading scheme can be made to work properly if we:

•Stop grandfathering credits
•Have no random gifting of NZUs from Government to industry
•Apply the ETS equally to all sectors
•Allow trading only between sequesterers and emitters
    –If you overpollute you pay someone else to clean up
•Buy back grandfathered NZUs that were replaced by hot air credits
•Manage our domestic credits as a currency rather than as a commodity
    –Set reduction targets each year that stabilise the NZU price and allow us to meet international commitments
    –Require surrenders only for “over target” greenhouse gas emissions
    –Plan to gradually reduce our NZU price as the world solves the climate change problem

Euan G Mason
University of Canterbury