Review of proposed New Zealand Emissions Trading Scheme

The Government's proposed Emissions Trading System (ETS) is overall an impressive piece of policy development. The design embodies much of the best international thinking: it responds to lessons learned from economic theory and from the evaluation of existing emissions trading systems and other environmental markets in unprecedented ways. The proposal takes significant steps toward achieving the Government's political goals without severely compromising the long-run effectiveness, efficiency or true equity of the system. In particular the choice of points of obligation in the liquid fuels, stationary energy and industrial processes sectors that emphasise comprehensive coverage and low compliance costs have advantages for the environment and for efficiency, as well as making compliance relatively transparent. This is in contrast to most previous emissions trading systems (notably the European system) where the point of obligation was influenced by sectoral lobbying and the choice made led to serious implications for coverage, for treatment of new entrants and exiters - which created perverse incentives, and for (mis-)allocation of free units.

The comprehensiveness of the system is also an international first. It creates an architecture that makes any future NZ commitments credible. It avoids many of the problems of National Allocation Plans in the European Union system because no inter-sectoral emissions allocation decisions need be made - all emissions are covered by one system. It is the first system to even seriously contemplate including non-CO2 emissions from agriculture or sequestration/removals in forests.

These characteristics, if effectively sustained and carried through to demonstrate an environmentally effective, economically efficient, politically feasible domestic policy could be one of New Zealand's most significant contributions to international climate change mitigation efforts. That said, several very important aspects of the proposal require further development:

• the environmental contribution - short and long run;
• the need for clear thinking on interrelated leakage and allocation issues;
• how to achieve a smooth, low-risk transition; and
• the use of science in regulation (simplicity and modelling).

These issues are exacerbated by the comprehensive nature of the proposed system and are in some cases issues where international literature and experience is less helpful. These are the issues on which my review will focus. This review draws heavily on discussions with the Climate Change Policy Dialogue group and the short papers prepared for that group.