Net-zero carbon requires serious innovation

8 May 2018

The Emissions Trading Scheme needs rethinking if we are to achieve net-zero carbon by 2050, says Basil Sharp.

The Productivity Commission’s report about transitioning to a low-emissions economy, released in April 2018, made it very clear that carbon prices need to be considerably higher than current levels – possibly over $200 per tonne – if the existing emissions trading scheme is going to put New Zealand on a path towards a low-carbon economy.

The reality is, if the community accepts the goal of net-zero carbon by 2050, then the design of the New Zealand Emissions Trading Scheme (ETS) is in need of serious repair. The commission is correct in recognising the importance of institutional design going forward – but let’s not underestimate the challenge of the changes needed to make it work.

The ETS in place in New Zealand follows a rights-based approach. The idea behind this approach is that those emitting pollutants require a right to cover their emissions and rights are tradable.  Those with rights surplus to their requirements can sell them, and those in need of additional rights can buy what they need in the market. Market price emerges from trade. Ronald Coase, a Nobel laureate, proposed this approach many years ago.

However, in its current shape, New Zealand’s ETS is a poor example of a rights-based mechanism. There is no cap; coverage is incomplete; emission units have, in the past, been handed out at no cost to some sectors; and title is insecure. These shortcomings need to be fixed if we are to rely on an ETS that will deliver the goals of net-carbon zero.

So where do we start?

Firstly, establishing a cap on emissions is essential. Because the economy’s response to higher carbon prices – which the commission sees as necessary – is uncertain, it makes sense to undertake periodic reviews of the cap. One could imagine working back from the 2050 target with reviews embedded as necessary in legislation. However, these reviews should be independent and beyond the influence of elected officials.

Next, coverage. In principle, all sectors should be included in the ETS – leaving some sectors out would impact carbon prices and create distortions in the economy.  Many greenhouse gas-emitting businesses, including agriculture, are multi-million dollar enterprises and their ability (or motivation) to make reductions will vary. Some will readily adjust to low carbon-equivalent production, others will not. This is to be expected. But those investing in low carbon technology will require reasonable certainty, and emission permits need to be defined in such a way that they are tradable and secure.

There are many options available to achieve this. One is to define the permits as a percentage of the cap with periodic reviews carried out to reconsider – and possibly adjust – the cap in light of progress toward the 2050 target. The percentage right does not change. This is done in other rights-based systems such as New Zealand’s quota management system, where commercial rights to harvest fish are defined as a percentage of harvest limits set by government. The economic life of low-carbon technology can extend beyond 20 years and investors need to know that their entitlements will endure. Uncertainty in the carbon market would impact investment.

Finally, there is the problem of who gets the rights. I suspect some form of grandparenting rights is likely to be politically acceptable – although auctions are a possibility. Grandparenting the allocation of rights would be based on initial greenhouse gas emission levels.

So, in short, the Productivity Commission report has clearly laid out the broad high-level implications of transitioning to a low-carbon economy. Achieving this goal will require business investment and innovation in low-carbon technologies. Now, there is a need for government to be innovative and design a robust and durable emissions trading scheme to support this transition and the goal of net-zero carbon by 2050.

Read the published article:

Basil Sharp

Basil Sharp is Energy Education Trust of New Zealand Professor of Energy and Resource Economics at the University of Auckland Business School, and Director of the School's Energy Centre.



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