The changing face of the NZ ETS

On 25 November 2009, Parliament passed the Climate Change Response (Moderated Emissions Trading) Bill (the Amendment Bill). As its title suggests, the Climate Change Response (Moderated Emissions Trading) Act 2009 (the ETS Moderation Act) does not seek to re-invent the framework for the New Zealand Emissions Trading Scheme (NZ ETS). Rather it moderates the impact that the NZ ETS, established by the Climate Change Response (Emissions Trading) Act 2008, has on business in the first few years at least. In this article, senior associate Kate Radka outlines the key changes brought about by the ETS Moderation Act and discusses their significance.

Last minute changes to the Amendment Bill

The Finance and Expenditure Select Committee released its report on the Amendment Bill on 16 November 2009. The Committee was unable to reach agreement on the suitability of the Amendment Bill, and accordingly the report contained no majority recommendations and no amendments to the text of the Amendment Bill.

With little chance of securing a deal with Labour in time to have the Amendment Bill passed prior to the New Zealand delegation heading to Copenhagen in December, National secured the support of the Māori party. In exchange for the Māori party's support, National has agreed to:

• the inclusion of a comprehensive Treaty of Waitangi clause;

• changes to the deforestation liabilities that iwi owners of pre-1990 forests would otherwise face under the NZ ETS;

• an agreement for iwi to enter contracts to plant forests on marginal Department of Conservation or other Crown-owned land, including an afforestation fund to cover the cost of the planting;

• measures to improve outcomes for Māori businesses in fishing, farming and forestry; and

• support for vulnerable households.

Amendments resulting from these negotiations as well as amendments to address technical and drafting issues raised during the select committee process were introduced by way of Supplementary Order Papers delivered on the floor of the House on 24 November 2009.

Delays to sector entry dates

As foreshadowed in our Winter 2009 Commercial Quarterly, the ETS Moderation Act delays the entry of the stationary energy and industrial processes sectors into the NZ ETS by six months to 1 July 2010. The delay was recommended by the NZ ETS review committee to enable the allocation plan for trade-exposed businesses to be finalised prior to the energy and industrial sectors' introduction into the NZ ETS. That said, with the changes to the allocation model and the need to implement regulations prior to consulting on and finalising an allocation plan, officials will be hard-pressed to have a finalised allocation plan in place before the entry date of 1 July 2010.

The delay to the entry of the energy and industrial sectors is relatively good news for firms in those sectors which would otherwise have faced uncertainty over the impact of the NZ ETS on their costs of production. However, it is not welcomed by foresters and other prospective vendors of emission units (including those international trading banks and other traders selling units into New Zealand), which would have expected stationary energy and industrial sector participants to be strong early purchasers of their emission units.

The entry date for the agriculture sector has also been delayed from 2013 to 1 January 2015, with the point of obligation being placed at the processor rather than farm level (although Parliament may place it at the farm level in future), thus decreasing the number of prospective purchasers of emissions units from that sector. This is good news for those looking to trade units into New Zealand to the extent that it will be easier to target bigger bundles of emission units to a smaller and more readily identifiable number of buyers.

Conversely, the liquid fossil fuel sector's entry date has been brought forward six months, and this sector will now enter the NZ ETS at the same time as the energy and the industrial sectors.

Transition phase

One of the most significant changes brought about by the ETS Moderation Act is the introduction of a transition phase to operate until 31 December 2012, which moderates the impact of the NZ ETS on businesses with compliance obligations in the energy, liquid fossil fuel and industrial sectors. The transition phase will have a significant impact on the demand from these sectors for emission units in the short term, with the imposition of:

• a 50% obligation (i.e. to surrender only one unit for every two tonnes of CO 2 emitted); and

• a NZ$25 fixed price option (whereby businesses can opt to pay the Government NZ$25 for emission units that would be surrendered immediately as opposed to buying emission units from the market).

To ensure that the NZ$25 fixed price option does not result in the New Zealand Government in effect subsidising businesses or governments in other countries to meet their compliance obligations, the export of New Zealand Units (NZUs) – which would be converted to AAUs for the purposes of export – will not be permitted during the transition phase unless the NZUs/AAUs are those awarded to forestry participants under the NZ ETS or the Permanent Forest Sink Initiative (PFSI). This restriction, along with the 50% obligation and $25 fixed price option, is unlikely to be welcomed by prospective purchasers of NZUs/AAUs (including those international trading banks and other traders purchasing units from New Zealand) as it significantly reduces the number of emission units that will be available for sale and delivery in the short term.

Although the transition phase is due to end on 31 December 2012, the commentary to the Amendment Bill and other official reports foreshadow the possibility, should the NZ ETS and Australian Carbon Pollution Reduction Scheme (CPRS) align, that a price cap and associated prohibition on trading outside of New Zealand and Australia may be implemented during an initial period of such alignment. With the CPRS far from settled, this remains a possibility only, but one which international traders are likely to oppose and therefore something to watch with interest.

Allocation to emissions-intensive trade-exposed (EITE) businesses

The ETS Moderation Act changes the absolute emissions basis of allocation for trade-exposed businesses to an emissions intensity model, which closely aligns the free allocation models in the NZ ETS and the proposed CPRS. Under such a model, an eligible business will be allocated emission units to cover up to 90% of its emissions in the first couple of years, with the percentage of Government-allocated emission units reducing slowly over time. While the newly proposed emissions intensity model allows for allocations to increase/decrease in line with production levels, there is still an incentive to improve energy efficiency as allocations will be based on an "industry average" for energy intensity.

It is likely that the defined EITE activities will mimic those, to the extent possible, already defined in Australia. Whilst this provides some guidance to those who consider themselves to be carrying out activities which are EITE, the list of defined activities is not yet complete in Australia and the regulations have yet to be released for consultation in New Zealand. Understandably, businesses in the industrial processes sector are eagerly awaiting the release of the regulations to have some certainty as to whether EITE allocation will be available for one or more of the activities they carry out and if so, the extent of that allocation.

Impact on foresters

Other than the changes brought about by the Supplementary Order Papers, the ETS Moderation Act in essence changes very little in relation to the forestry sector, which entered into the NZ ETS with effect from 1 January 2008. Whilst the transition phase 50% obligation applies to the energy, liquid fossil fuel and industrial sectors, the forestry sector still has a "100%" obligation to surrender one unit per emission for any deforestation of pre-1990 forests, or net carbon stock decrease for those foresters who opt in to the NZ ETS in relation to their post-1989 forests.

The transition phase price cap of NZ$25 is not welcomed by the forestry sector, although the prohibition on international trading of non-forestry NZUs/AAUs does support domestic trading to an extent (albeit it effectively caps the price at NZ$25). We expect foresters will focus on international trading, particularly to international trading banks, businesses in Japan and the United States, as well as governments in Europe.

Will the Government need to buy units?

While the ETS Moderation Act moderates the impact of the NZ ETS on businesses with compliance obligations, it results in the Government and ultimately the taxpayer carrying the slack. With an emissions intensity based allocation model with no fixed pool of units and a transition phase that reduces compliance obligations for energy intensive sectors by 50%, the Government bears a greater risk of having to front up with emission units should New Zealand as a nation not meet its Kyoto target for CP1. Without detailed reporting from emissions-intensive trade-exposed entities and evidence of renewed forestry planting it will be difficult for officials to forecast accurately the Government's needs. There is a reasonable possibility that the New Zealand Government will be seeking to purchase emission units to meet any shortfall arising in CP1 as a result of a moderation of the NZ ETS.

Linking with Australia

Many of the changes introduced by the ETS Moderation Act are designed to enable the NZ ETS and the proposed CPRS to link in the short to medium term. While there are benefits in linking with Australia, not to mention wider economic benefits in reducing the possibility of carbon leakage to Australia, there is a danger associated with mimicking aspects of the proposed CPRS to enable alignment when the legislation in Australia is by no means certain. It is possible that New Zealand's moderated ETS may, although currently aligned with important aspects of the CPRS, differ significantly from the final shape of the CPRS emerging out of the negotiations between the major political parties in Australia.

Bell Gully's climate change team is available to advise in detail on the NZ ETS and its implications, and on carbon trading in general. Bell Gully partner Simon Watt, an expert in climate change issues, including emissions trading, has been advising New Zealand and international organisations for a decade as they become involved in trading or prepare for new climate change laws. One of just seven lawyers world-wide identified as leading legal experts in climate change by researchers, he was called upon by TV3's Nightline news programme on 26 November to help explain the new emissions trading scheme. View the news clip.

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.