A Smorgasbord Approach

Last week I called for 1.3 million hectares of new forest in New Zealand. That’s nearly 5 per cent of our total land area.

The obvious question is: How do we pay for it?

In my view, the only feasible way is to take a “smorgasbord” approach—that is, to put on the table as many different funding sources and revenue streams we can think of. This is partly because the scale of the target is so vast, too large for any single funder. But this is also because the target land is mostly private land. By providing a smorgasbord of funding, landowners can draw on funds that best reflect their circumstances and preferences.

One part of this smorgasbord could be New Zealand’s Emissions Trading Scheme (NZ-ETS). The ETS can’t provide upfront capital for planting, but it can provide revenue by rewarding forest owners with carbon credits for the public good of sequestering carbon. As I wrote here earlier, however, the price of these carbon credits hasn’t been substantial enough to incentivise new planting.

To address this problem, the NZ-ETS is currently under review yet again. (Public consultation finishes this Saturday at 5pm on 30 April.) This means that there’s still a chance to reform the ETS to support goals like 1.3 million hectares of new forest. As I wrote in Our Forest Future, “Ask not what forest can do for the ETS, but what the ETS can do for forest!”

So what can the ETS do?

Below I discuss four changes we can make: (1) raise the price of carbon; (2) create a Permanent Forest Unit; (3) solve the ETS’s accountability deficit; and (4) not put all our eggs in one basket.

1. Raise the price of carbon.

Emissions trading isn’t the only way to create a carbon price. But in New Zealand—for now—it’s the only game in town. It is, therefore, the obvious lever for turning around our present trend toward net forest loss, and getting us onto the pathway of net forest gain.

In 2012, Motu researchers estimated that, if the carbon price was NZ$25, we would have 370,000 hectares of new commercial forest by 2030. That’s in the same ballpark as Bruce Manley’s prediction that, at the same carbon price, we’d see 22,700 hectares of new forest every year.

This alone would take us to nearly one-third of Our Forest Future’s 1.3 million hectare target. But it would likely go further, because these estimates don’t include permanent forest expansion, even though this would also be incentivised by a decent carbon price (more on that shortly).

The current ETS Review opens the door to various changes that would boost demand and price for NZUs: reducing the free allocation of carbon credits to emitters (Questions 11 & 12 of the review), creating a decent price floor (Questions 21 & 22), or adopting full surrender obligations for emitters (consultation closed). It’s hard to predict the effect on price or on price volatility—and we might never find out the true effect if the price ceiling is retained at only $25 (Questions 21 & 22).

It all goes to show how “managed” our carbon price really is—except that it isn’t managed to discourage emissions. The ETS isn’t a “free market” where price reflects real supply and demand. Nor does it reflect the future costs of climate change. Nor does it any longer reflect international prices. Rather, our carbon price is generated simply by domestic policy settings; and buyers and sellers’ expectations of changes to those settings. But those settings are largely guided by a concern to minimise costs to emitters, not to advance the ETS’s proper purpose which is to incentivise the transition to a low-emissions economy.

One way to impose rationality upon our ETS is to add an absolute emissions cap. The cap would progressively limit the number of credits within the ETS, and carbon price would reflect this scarcity. In other words, the tighter our carbon budget started to squeeze, the higher the carbon price would rise, which would discourage emitters from emitting in the first place. While an absolute cap isn’t on the agenda (although there’s room to mention it in Questions 1 & 2), a de facto cap could be introduced through the auctioning option, by limiting how many credits are auctioned (Questions 17–19).

Yet, given how “managed” our carbon price already is, we could simply “manage” our carbon price more openly and transparently by working out what price we need to meet our long-term emissions targets, then setting a price floor and price ceiling that reflects this (Questions 21 & 22).  These “price corridors” would shepherd our carbon price toward substantive outcomes, while also creating the certainty around future carbon price that far-sighted businesses have long been calling for. For forest owners—who plan into future decades by necessity—this would provide an assurance that the environmental benefits of forest planting would be recognised.

2. Create a Permanent Forest Unit.

If we’re serious about reforesting 1.3 million hectares of New Zealand, our priority should be permanent forest.

This isn’t just for sentimental reasons. It is because commercial forestry generally isn’t appropriate for the target land of urban areas, waterway margins, and highly erosion-prone land. Much of the latter won’t even be cost-effective for forestry, because it is too remote, or too steep to harvest easily.

Fortunately, we have the Permanent Forest Sink Initiative (PFSI). This is basically a sub-section of the ETS, catering for permanent forest only. Participants put at least one hectare of forest under covenant with the Crown for no less than fifty years, during which time the forest owner is provided with NZUs for the carbon they sequester. Because PFSI participants don’t cut their forests down, they can freely sell all those carbon credits on the market—unlike commercial foresters who have to pay back the majority of their carbon credits when it’s time to harvest their logs.

But the PFSI has floundered for the same reason as the ETS has floundered: the lack of a meaningful carbon price. For PFSI participants, the lack of revenue is especially challenging, because they aren’t allowed to exit their covenants, yet they need money for pest control, forest maintenance and forest insurance. Unsurprisingly, there’s a reluctance to join, with the PFSI covering only 15,900 hectares of permanent forest.

So why not do more to distinguish the PFSI from the ETS? Specifically, why not create a Permanent Forest Unit (PFU) that reflects the premium quality of permanent carbon sinks? Although rejigging the ETS will involve some tricky political and economic trade-offs, we could at least defend the PFSI as the “gold standard” of carbon offsets (Questions 14 & 15 of the review).

Ideally, the PFU would become the carbon credit of choice for business and industry. Better yet, there could be a quota, a minimum percentage of total units surrendered every year that must be PFUs—say, 2 per cent. This would ensure that demand was stable, even if the PFUs secured a premium price. Certainty could be further introduced through a price floor of $25 per PFU.

The PFU could also be uniquely flexible, given that the optimal places for permanent forest are often small or narrow tracts of land—such as riversides, gullies, and ridgelines—and don’t necessarily meet the ETS guidelines of at least one hectare over 30 metres wide. By supporting permanent forest, we could ensure that those 1.3 million hectares are dominated by the kind of forest we need most.

3. Solve the ETS’s accountability deficit.

It isn’t enough to fix the design, or the settings, of the ETS. We also need to fix its “accountability deficit.”

This, in my view, is the ETS’s fundamental flaw. Ideally, when a policy instrument fails to fulfil its purpose, heads will roll. Criticisms are lost in the fog of its complexity and the public’s incomprehension. While the ETS works on paper, it wasn’t prepared for the transition to political reality, proving vulnerable to political manipulation and the influence of vested interests.

The mechanisms of accountability are conspicuously lacking. There are no clear lines of responsibility between policy and outcomes. This is why the ETS’s permissiveness toward dubious offshore credits was only belatedly fixed in June 2015, long after this was known to be a problem. It’s also the reason for why other problems haven’t yet been fixed.

For example, after the 2011 ETS Review, the recommendation was to phase out the one-for-two surrender obligations by 2012 and the exclusion of agriculture by 2015. Yet not only were the Review’s conclusions ignored, these “transitional measures” were made indefinite. So, here we are now in 2016, reconsidering the one-for-two deal yet again, while agriculture has been excluded from consideration entirely.

Why would anyone expect the review’s recommendations to be taken seriously this time around? Even worse, why expect they won’t be overturned by ad hoc adjustments in the future?

These problems of mistrust and uncertainty will linger even if the settings are fixed. A 2013 survey of stakeholders found that over 80 per cent of ETS stakeholders believed that the Government had provided insufficient regulatory certainty. Only half were confident that the ETS would continue past 2020. For businesses making long-term decisions about how to adapt to a low-emissions economy, this is counterproductive.

Perhaps the buck should be made to stop with the Minister for Climate Change Issues. Yet, given the inter-generational nature of the carbon challenge, it’s probably best to create some clear air between the ETS and the whims of electoral politics.

What the ETS most likely needs is independent oversight. As Euan Mason has argued, it is helpful to think of carbon price as a currency, not a commodity. This suggests some analogue to the Reserve Bank, an independent agency which sets caps and targets that correspond to our carbon budgets, and that possess enough statutory power to trim the ETS’s sails, to ensure that its sailing us toward a low-emissions future.

Don’t put all our eggs in one basket.

We must be honest with ourselves: the ETS might not work out.

Emissions trading is an experiment, adopted in part for reasons of politics. While there’s no a priori reason for assuming it won’t work, there’s no a priori reason for assuming it will either. 

If the ETS cannot fulfil its function of generating a carbon price, nor its purpose of changing behaviour, then it will inevitably come to be seen as part of the problem rather than part of the solution. The instrument has few passionate defenders. It is unloved, perhaps even unknown, to most New Zealanders. Given the scepticism that exists among participants, the ETS surely won’t survive if it can’t demonstrate impact on net emissions levels after this review.

In establishing our forest future, we shouldn’t rely entirely on the ETS. We need other strategies to supplement, augment, and reinforce the ETS, perhaps even to take over if the ETS is dismantled.

I’ll talk more about other ways to support forest expansion in coming months. But, for the sake of argument, consider the carbon tax.

The carbon tax is, of course, the policy option that New Zealand abandoned when it first adopted the ETS. Indeed, we still tend to think of emissions trading and carbon taxes as mutually exclusive, as either/or policy options. But they’re not. It is possible to operate both simultaneously. Indeed, various European countries do just that: Ireland, Finland, Sweden, Norway, Denmark, Switzerland, the Netherlands, France, even the UK with its Climate Change “Levy”. They all operate under the EU’s Emissions Trading Scheme while also administering various kinds and shades of carbon tax.

Carbon taxes could be part of a succession plan for the ETS. Or carbon taxes could serve as the ETS’s trainer wheels, creating a meaningful price signal for emitters if the ETS fails to generate one. This tax revenue could then be transferred toward the expansion of our carbon sinks: we could extend the Afforestation Grant Scheme; we could multiply our QEII National Trust covenants; we could improve our forests’ capacity to sequester carbon by funding the Department of Conservation’s capacity to control herbivorous pests.

Admittedly, there’s a moral neatness in emissions trading, in the way that money moves directly from those creating the problem (greenhouse gas emissions) to those creating solutions (like carbon sinks). But as I’ve said before, we must judge the ETS against its purpose— that is, to encourage New Zealand’s transition from a high-emissions economy to a low-emissions economy.

If the ETS can’t help us with this, then it isn’t worth having.

Dr David Hall