PCE report on “Farms, forests and fossil fuels”: One lump or two?

by Catherine Leining, Policy Fellow, Motu Economic and Public Policy Research

On 26 March 2019, the Parliamentary Commissioner for the Environment (PCE) released a report on “Farms, forests and fossil fuels: The next great landscape transformation?” It looks at the challenges in decarbonising New Zealand’s economy and asks whether a fundamental restructure of the New Zealand Emissions Trading Scheme (NZ ETS) will be needed. 

The PCE usefully reinforces three important points: targets and policies should reflect differences across greenhouse gases (GHGs), fossil carbon dioxide (CO2) emissions need to reach zero during this century, and management of New Zealand’s land sector would be enhanced by a landscape approach that integrates climate change and other considerations.

The PCE makes a valid argument that if New Zealand continued to rely solely on a blunt price instrument designed to deliver least-cost compliance with short-term targets, as it did for the past decade, then participants could rely too heavily and too long on low-cost afforestation and procrastinate on the higher-cost energy-sector transformation that will be essential to supporting the global temperature goal. Furthermore, our forest sinks are finite, impermanent, and vulnerable to pests, diseases, natural disasters and climate change itself.    

The PCE’s proposed solution is to create separate emissions trading systems for fossil and biological emissions. The fossil system would deliver zero emissions of fossil CO2 and fossil methane, CH4, by later in the century, supported by offsets from permanent carbon capture and storage technologies. The biological system would achieve reduced (but not zero) emissions of biological CH4 and biological nitrous oxide, N2O, supported by forestry CO2 offsets, perhaps at a discounted rate to reflect non-permanence and other risks. The fossil system does not appear to include non-energy industrial emissions; the report suggests these may not be price responsive and could benefit from ongoing free allocation or auction revenue recycling. The logic for this is not clear given CO2 needs to go to zero and some fossil fuel uses will also be difficult to replace. The report signals landfill emissions could potentially join the biological system.

If New Zealand was starting to design mitigation policy with a blank slate, the proposed two-system approach could be a valid choice. However, the same concerns raised by the PCE can also be addressed within a single all-sectors, all-gases ETS using the readily available toolkit of GHG metrics, forestry rules, free allocation, and application of additional standards, regulations and policies to drive sector-specific change. Whether using a one-system or two-system approach, it is possible to achieve different marginal emission prices and emission outcomes for different sectors. Under a single system, if progress with reducing fossil CO2 emissions seems too slow, the cap can be tightened and energy-sector standards, regulations and policies strengthened to accelerate progress. If forest sequestration or biological emissions seem too high, forestry rules, GHG metrics or agricultural free allocation can be adjusted.     

New Zealand’s government, businesses and foresters are already heavily invested in a single ETS. Experience suggests policy volatility can be harder to manage – and more important for long-term investment – than price volatility. The September 2017 election marked the first time ever that New Zealand had some semblance of carbon pricing policy continuity across a change in government. In this context, adjusting the existing ETS wisely and rapidly with cross-party support could do a lot more for domestic decarbonisation than engineering a complicated transition to a new and uncertain set of policies.