Reform of the emissions trading scheme: changes on the horizon

Last week, the Aotearoa New Zealand (NZ) Government announced that it is reviewing the NZ Emissions Trading Scheme (ETS) to assess whether changes are needed to provide a stronger incentive for businesses to transition away from fossil fuels while also supporting greenhouse gas removals.

While at this stage the only details that have been released about the review relate to scope and timing, rather than substantive outcomes, NZ organisations that stay informed and engage with the review will be best prepared to respond to any changes. In that regard, organisations will have the opportunity to provide feedback on the proposals that emerge from the review and cabinet papers released with the announcement suggest that this consultation will occur in Q2 of this year.

Implications of the review for NZ organisations will depend on the manner in which the organisation in question interacts with the ETS (for example, as a direct participant in the ETS or as a passive recipient of market pricing) and the proposals that ultimately emerge from the review. Organisations could be affected in a number of ways by the review. For example:

• Ongoing uncertainty in relation to the policy settings of the ETS is already causing changes to the prices of New Zealand Units (NZUs) in the ETS, with prices dropping steadily since the end of last year and continuing to decline following the announcement of the review. These price changes will affect organisational decision-making in relation to matters such as investments in lower-emissions technologies and investments in forestry projects, and the trade-offs between different options.

• Given the review is focussed predominantly on the balance of gross vs net emissions and will also consider incentive for indigenous afforestation, we expect that significant changes may result for the forestry sector, which is the primary source of emissions removals in NZ.

• To the extent that changes to the ETS emerge, new compliance requirements could be imposed on participants in the ETS (both those with surrender obligations and those entitled to receive NZUs through forestry or other activities).

• The review may lead to new opportunities for businesses to take advantage of changes incentivising gross emissions reductions. To take just one example, the scope of the review (detailed further below) will include consideration of inclusion additional sources of emissions removals, which may open the door for some businesses to receive NZUs for activities that have not been previously covered by the scheme.

Further details in relation to the review are set out below. If you would like to discuss the impact of the review on your organisation or assistance engaging with the reform, please get in touch with one of the experts below or your usual Russell McVeagh or Te Whakahaere contact.

Background to the review

The balance between gross emissions reductions (eg through reducing dependence on fossil fuels) and net emissions reductions (eg through forestry removals) driven by the ETS has been controversial in recent years, as rates of afforestation have increased in NZ and with it concerns around matters such as biodiversity risk and the scientific differences between emissions reductions and removals from forestry. Against that background, the Climate Change Commission (Commission) has called for a greater emphasis within the ETS on incentivising gross emissions reductions and managing the amount of exotic forest planting driven by the scheme. The Government has accordingly committed, through New Zealand's first emissions reduction plan, published in May of last year, to considering this issue. The review represents the Government's implementation of that commitment.

Key details released

While the announcement of the review may be welcome news to organisations looking to understand the future direction of travel, cabinet papers proactively released alongside the announcement stop short of indicating what the final shape of the ETS will look like once the review is complete. Instead, they outline the scope and process for the review, with key takeaways including:

• The scope of the review is broadly focussed on determining both the balance of gross and net emissions that should be incentivised through the ETS and proposals that can support the preferred balance (further details as to the scope of the review are set out below).

• Responsible Ministers are expected to back to Cabinet on the review this quarter, seeking agreement to a package of proposals to amend the ETS to drive gross and net emissions reductions in line with the preferred balance.

• The Government will consult on proposed changes to the ETS in the second quarter of 2023. Cabinet considers that this timing aligns with the Commission's recommendations to have developed and implemented proposals to strengthen ETS incentives for gross emissions and manage the amount of exotic forest planting driven by the ETS by 31 December 2024.

• The review sits alongside other climate change work programmes, and it is important for organisations to consider this latest announcement in the context of those other piece of work. For example, work in relation to the ETS that is ongoing includes:

  • The Climate Change Response (Late Payment Penalty and Industrial Allocation) Amendment Bill, which is currently making its way through Parliament, and which makes changes to (amongst other things) free allocations of New Zealand Units under the ETS.

  • A review of the market governance framework for the ETS. Consultation on this review closed on 27 February 2023 and policy decisions are expected later this year.

  • The ongoing annual process by which the Commission advises the Government on its recommended ETS unit limits and price control settings, which then feeds into the Government's annual update of the relevant regulations. The next round of advice from the Commission (covering the period 2024-2028) will be released at the end of this month, although it remains unclear whether the Government will follow it in full following its rejection of certain aspects of the Commission's advice for the 2023-2027 period in December of last year in light of cost of living pressures.

  • A redesign of the permanent post-1989 forestry category in the ETS.

Scope of the review – further details

According to the proactively released cabinet papers, the review will consider the following questions:

1. What balance of gross and net emissions reductions is expected to be driven by the current design and settings of the ETS, and what are the economic, environmental, and distributional impacts of this balance?

2. What balance of gross and net emissions reductions should the ETS incentivise in the future?

3. How could the ETS be amended to support the government's preferred balance of gross and net emissions reductions?

4. How would the balance of emissions reductions incentivised by the ETS change over time?

5. What are the potential impacts, trade-offs, and risks to society and the economy of the options for shifting the balance of gross and net emissions reductions?

6. What are the options to amend the design and settings of the ETS and strengthen incentives for gross emissions reductions?

7. What levels of net emissions reductions should be from exotic forests and indigenous forests, and how to improve ETS incentives for indigenous afforestation?

8. What role does the ETS currently play in meeting New Zealand's nationally determined contribution, and what role should it play in the future?

In addition, Cabinet has agreed that issues as to the inclusion of additional sources of emissions removals in the ETS and the text to which ETS design should support emissions reductions or a range of co-benefits are in-scope of the review.

Contributors (Te Whakahaere): Mark Baker-Jones and Melanie Baker-Jones
Contributors (Russell McVeagh): Hannah Bain