The case for a carbon dividend in two charts

A carbon dividend takes the revenue from auctions of emissions units for the ETS and gives it back to households. This year, the sale of emissions units will raise around $1.3 billion.* That is around $750 per household.

The following two charts show a) low-income households spend more of their incomes on carbon than other households, but b) have a smaller carbon footprint.

Source: Figure 4.3, Report 2.

Source: Figure 4.2, Report 2.

The charts come from a UK analysis by the London School of Economics. I know of no equivalent analysis for New Zealand, although these findings from Infometrics appear consistent.

So what does this mean?

Carbon pricing is generally thought to be regressive because low-income households spend a higher share of their incomes on goods and services which produce or lead to emissions.

However, a carbon dividend reverses this, making carbon pricing progressive. Giving households the revenues from the sale of emissions units disproportionately benefits low-income households. This is because their absolute carbon footprint is smaller than other households, meaning less exposure to the carbon tax, but dividends are paid on (something like) a flat rate.

Studies find different carbon dividends are progressive under most allocation rules, including a simple flat payment per person. Here is a list of studies on the equity effects of carbon dividends.

Studies also find that carbon dividends mean carbon pricing overall is a net benefit for a majority of households. The mid-range estimate seems to be around 60% of households. Low-income households benefit the most from a dividend: one of the studies, from the US, estimates 84% of low-decile households would receive a net benefit from carbon pricing after a dividend payment.

So if you are worried about protecting the most vulnerable households from the costs of lowering emissions – and many who work on climate change say they do – then a carbon dividend should be attractive to you.

On the other hand, if you are concerned about whether it will be possible set a carbon price that is high enough to achieve emissions targets without compromising popular support, then a carbon dividend should be attractive to you. A carbon dividend allows governments to go faster and harder on raising the carbon price, since payments back to households are shelter from higher power bills and petrol prices that necessarily follow from pricing carbon. The fact that dividend means most households win from carbon pricing, with the largest proportionate benefits going to those on low incomes, should increase voters’ tolerance for aggressive efforts to lower emissions.

So, a carbon dividend ticks a lot of boxes.

Naturally, the government has all-but ruled out a dividend. One the few concrete new policies in last week’s Emissions Reduction Plan was to dismiss the dividend idea. Here is what the government said (pp. 34-35):

Given the breadth, scale and duration of the transition to low-emissions economy, we need to ensure adequate, durable and certain public funding for climate action. The Treasury and the Ministry for the Environment are currently considering how the public finance system can provide this, including:

4. how we can recycle revenue from the New Zealand Emissions Trading Scheme (NZ ETS) into climate spending.

I understand James Shaw has subsequently confirmed no dividend.

Next time you hear Shaw or the PM or any other minister talking about a “climate crisis” or “climate justice,” keep in mind that they have ruled out about the closest thing you can find to a magic bullet in climate change policy. The one thing, other than a carbon price, that could do more to cut emissions and protect the most vulnerable, simply and easily, than anything else.

That’s what they rule out first.

* Excluding revenue from the sale of 1.6 million “backed” units. These are additional units, issued and sold at the auction on 1 September to defend the ETS price cap. Backed units have to be offset by the government in some way such that they do not raise global emissions.

Not about emissions

With its Emissions Reduction Plan released last week, the government is promising unprecedented control over every aspect of your life.

How you move. What you eat. Where you live. How you heat your home.

It is little short of a revolution. Between its emissions plan and next year’s Budget, which will also be about climate change, future governments of this country will have more to say about everything.

The problem is that existing policies already have this country firmly on track to deliver emissions targets.

In both its draft and final reports, the Climate Change Commission said current policies and a $50 carbon price will be enough to deliver net zero emissions in 2050. Its analysis did not show undue reliance on removals by exotic trees, although Ministers and officials have repeatedly made misleading statements about the Commission’s findings.

Today’s carbon price is $65. So we are ahead of schedule.

Which makes the government’s Emissions Reduction Plan redundant. We get to our targets without the Plan. Emissions will come down about as quickly with the plan as without.

New Zealand should get more credit for its progress on emissions. On a per-capita basis, greenhouse gases have been falling since 2006. They are down 22% overall, and down 34% if agriculture is excluded.

Net emissions of long-lived greenhouse gases – relevant for the net zero target – are down 25% per person.

And it is not pine trees that are doing all the work. More than 100% of the fall in net emissions is due to lower gross emissions.

So current policies are already doing the business demanded by environmentalists. There is no need to add thousands of dollars to the cost of vehicle imports, or any of the many other impositions being looked at, since we are already on track to deliver the stated goal.

There should be no question existing policies will deliver all of our emissions targets if they are given the chance. That is because, apart from methane, New Zealand has set net emissions targets. Both domestic law and international agreements recognise three pathways to lower net emissions: lower gross emissions; removals by trees and other carbon capture technologies; and offshore mitigation.

Removals and offshore mitigation are each affordable and scalable enough on their own to deliver net zero emissions in 2050.

But voters prefer reductions. Fine.

So the task for emissions policies is to assemble a mix of reductions, removals and offshore mitigation which

  • delivers emissions targets; and
  • reflects the premium voters are willing to pay for more reductions, less removals and less offshore mitigation.

The government is not thinking about climate change this way. In fact, it does not seem to be thinking about emissions at all. It has published an Emissions Reduction Plan which will bring down emissions by about the same amount as existing policies to achieve the same emissions targets.

What, then, is the point of an Emissions Reduction Plan if it does not reduce emissions?

Judging from its effects, the point is control. The plan will have two clear effects. Ministers will decide how and where emissions come down, not you. Second, you will pay more – ten times more, on the government’s own analysis – for the benefit of their judgment.

What a terrible deal. For the environment. And for your back pocket.

And all based on the twin lies that reducing emissions requires central control, and that the government’s Emissions Reduction Plan reduces emissions.

How do officials think about the costs of expropriation?

The government has introduced legislation which will allow the Minister of Health and the Director General to take over private companies doing COVID testing (further description is here). The likely target of this change is Rako, which has sought a commercial negotiation with the government for the last year. The amendment, which is before the Select Committee, will give the government the option of taking Rako’s property and unilaterally determine compensation.

So, what do officials see as the costs of de facto nationalisation of COVID testing?

Here is what the Ministry of Health has to say in its Fact Sheet 5: Regulating COVID-19 laboratory testing and managing testing supplies and capacity:

The proposed change will not have any direct impacts. Orders made under the new provision may impose obligations or restrictions on testing laboratories to ensure quality of testing, integration of test results with the public testing repository and regulation of testing consumables.

It is important to note that an Order to requisition supplies or redirect capacity to the public health response would only be made if there was significant COVID-19 resurgence where there is insufficient testing capacity in the public system.

Here is what the Regulatory Impact Statement says about costs:

There may be modest costs to the Crown in administering any regulatory regime should this be required. There may also be administrative and other costs for public/private laboratories depending on what is proposed. These costs would be assessed at the time any order is made.

The RIS essentially repeats that last sentence when it says, “A full cost assessment would be undertaken should a COVID-19 Public Health Order (Order) be proposed using the new provisions.”

As for benefits, the RIS says “[t]his proposal will ensure flexibility in the legislation to make orders to effectively manage laboratory testing (if required) to ensure appropriate regulation of quality control and minimum standards in relation to testing, integration of COVID-19 test results into the public health, management of the supply of testing consumables.”

Set aside the fact that officials who cannot secure MIQ or order vaccines on time obviously cannot deliver any of those benefits.

Focus on costs. Officials seem to operating with a cost model that threatening to take a company’s IP is costless, and costs crystalise only when property is actually taken.

I wonder what Rako’s investors and employees think about that view? In fact, I wonder what every owner of intellectual property in every sector thinks about the Ministry’s view.

Because the cost of taking companies’ property is not the administrative overhead, as officials suggest in the RIS.

The cost is all the investment in innovation that will not happen in the future.

Those costs are large, big enough to be measured in percentages of GDP. So it is laughable that officials could list administrative costs as the only real downside of their proposal.

Do officials at the Ministry of Health understand how investment in specific assets works? Do they understand that investment in intellectual property, and in all sunk assets, depends on the credibility of the government’s promise not to take the property once it is created? Do officials recognise that even threatening such opportunism in one sector could have wider ramifications about security of property elsewhere? That prospective investors in wind turbines or EV charging infrastructure won’t notice the government putting in place machinery to take the property of medical companies?

Could officials and the government be any more short-sighted?

Just when you thought it could not get any worse

Having banned saliva testing for more than a year, the government is now proposing to take it. As in, expropriate inventors and manufacturers of COVID testing products.

Newsroom ($) quotes the Chief Executive of Rako, Leon Grice:

There is other legislation where the Government can come in and expropriate or requisition private property – that’s the Public Works Act. But that has more protections, like a process to determine a market rate that the Government must pay…. They can just insist we give up our stock and our reagents and our premises that we need to do our work.

This is real. The government really is proposing to give the Minister of Health the right to “insist we give up our stock and our reagents and our premises that we need to do our work.” The COVID-19 Public Health Response Amendment Bill (No 2) 2021 says:

11 Orders that can be made under this Act

(1) The Minister or the Director-General may, in accordance with section 9 or 10 (as the case may be), make an order under this section for 1 or more of the following purposes:

(e) requiring the owner or any person in charge of a specified laboratory that undertakes COVID-19 testing to—

(i) deliver or use, in accordance with directions given under the order, specified quantities of COVID-19 testing consumables that the Minister considers necessary for the purposes of the public health response to COVID-19:

(ii) undertake COVID-19 testing solely for the purposes of the public health response to COVID-19 while subject to the order, whether or not the laboratory is contracted by the Crown for that purpose.

The bill says the Minister will be able to set quality control standards in labs, manage the supply of testing consumables, and set different rules for different classes of testing.

Presumably the government’s target is Rako.

The bill provides for compensation and appeal:

11A Compensation or payment relating to requisitions

(1) This section applies if an order is made under section 11(1)(e).

(2) The owner of a testing laboratory injuriously affected by the requisitioning of testing consumables is entitled to receive compensation from the Crown at the market rate for the consumables requisitioned.

(3) The owner of a testing laboratory required to undertake COVID-19 testing solely for the purposes of the public health response to COVID-19 is entitled to be paid by the Crown for its services at the market rate for those services.

(4) All questions and disputes relating to claims for compensation or payment under this section must be heard and determined by the District Court, whose decision is final.

However, the bill does not define “market rate” or say who decides it. If the answer is Ministry of Health officials – the purchaser – then clearly there is a problem.

As I understand it, Grice has been asking for a commercial negotiation for the best part of a year. How is expropriation even on the table?

Expropriation is likely even if the quoted provisions are never used. The government will have a commanding position in any commercial negotiation when in its back pocket it has the option to take the property of the counterparty and decide compensation.

It is… breathtaking that a government which is borrowing a billion dollars a week wants to nickel and dime the developer of the one thing we need more almost than anything else right now: a rapid fast, saliva-based PCR test for COVID. If Grice’s technology means ten fewer minutes of lockdown, pay him. Let him have his millions. Or make a deal with a competitor. Either way, it’s worth it. And not just for COVID-19. We want the Leon Grices of the world to turn up in the next pandemic, too.

But, no. This government is threatening to take the property of the one company which could do more than any other to get us out of lockdowns. I look forward to the government’s explanation for how that is in the public interest. The judgment seems astoundingly poor. This looks like world class bad faith from officials and ministers.

Another worrying aspect of the bill are the proposed changes for section 12. The government wants to remove the prohibition which says a COVID-19 order “may not apply only to a specific individual”. Changes in section 12 and elsewhere in the bill are clearly designed to enable the Minister and Director-General to issue orders to specific individuals.

This is draconian legislation, yet it seems to be slipping under the radar. It deserves attention.

Here is the legislation: https://www.legislation.govt.nz/bill/government/2021/0068/latest/LMS552303.html

Here is where to make a submission, which closes next Monday, 11 October:

https://www.parliament.nz/en/pb/sc/make-a-submission/document/53SCHE_SCF_BILL_115898/covid-19-public-health-response-amendment-bill-no-2

Here is the Ministry of Health analysis and RIS: https://www.health.govt.nz/our-work/diseases-and-conditions/covid-19-novel-coronavirus/covid-19-response-planning/covid-19-public-health-response-amendment-bill-no-2-2021

Here are marked up changes to section 11: https://www.dropbox.com/scl/fi/vpqwry2bzd0v6fypz1hs4/11_diff.docx?dl=0&rlkey=armucq7yh1w4qejp8yy7ppf1c

And to section 12: https://www.dropbox.com/scl/fi/sidz80ck8yaalfx50d2ss/12_diff.docx?dl=0&rlkey=7mbivhxfbo5bayrkcvtj53phz

A climate policy framework

John Cochrane has written a long essay in National Review called ‘Climate Policy Should Pay More Attention to Climate Economics’ with a subtitle of ‘Without numbers, we will follow fashion.’

The article is beautifully written, hardly a single one of the 3,500 words is wasted. In arguing for economics in climate policy, Cochrane covers many of the major ideas for thinking about how to reduce emissions. The article is comprehensive enough to be a framework.

In this post, I attempt to distil the main ideas in Cochrane’s article.

To avoid doubt, Cochrane (and I) believe climate change is real and is a problem which justifies a policy response. He disputes none of the climate science. He takes the findings from science as given and thinks about the consequences for climate policies. He highlights the harmful mismatch between scientific findings and popular rhetoric on climate.

Most of the following text is directly from Cochrane, with or without quotes. I have put my favourite soundbites in italics:

Climate science and climate policy are different. Climate science concerns the relationship between greenhouse gas emissions and climate. Climate policy is about reducing greenhouse gas emissions. Attacking policy is not attacking the science. “You don’t have to argue with one line of the IPCC scientific reports to disagree with climate policy that doesn’t make economic sense.”

Climate change is not that expensive. “The U.N.’s IPCC finds that a (large) temperature rise of 3.66°C by 2100 means a loss of 2.6 percent of global GDP. Even extreme assumptions about climate and lack of mitigation or adaptation strain to find a cost greater than 5 percent of GDP by the year 2100… Five percent of GDP is only two to three years of lost growth. Climate change means that in 2100, absent climate policy or much adaptation, we will live at what 2097 levels would be if climate change were to magically disappear. We will be only 380 percent better off [instead of 400%]. Or maybe only 950 percent better off [instead of 1,000%]… Northern Europe has per capita GDP about 40 percent lower than that of the U.S., eight times or more the potential damage of climate change. Europe is a nice place to live.”

The central uncomfortable fact is that the output of an advanced industrial economy like the U.S., moving headlong into services, is just not that sensitive to climate or weather. The worst heat waves, floods, and storms just do not move national GDP.

To be clear, a modest cost is no reason not to act on climate. But a modest cost places a modest cap on the benefits of emissions policies, so caution is necessary to avoid emissions policies doing more harm than good.

Growth risk is an order of magnitude larger than climate risk. “The cost of climate change to India is trivial compared with the benefits India could obtain by adopting economic institutions more like those of the U.S. — which themselves are far from perfect.”

If the question is, “What steps can we take, perhaps costly today, to improve GDP in the year 2100?” hurried decarbonization is not the answer. If the question is, “What steps can we take to improve the well-being of the world’s poor?” climate policy is not the answer, with many zeros before you get to the decimal point. Sturdy pro-growth policies, however unpopular to so many in today’s political class and incumbent businesses and labor organizations, are the answer.

GDP is imperfect, but if anything it understates the benefits of economic progress. “It leaves out a lot — the tremendous value of free or nearly free goods, the value of clean air and water, good health, long life, a free and egalitarian society, and so forth. But all of these things are better when GDP is better, and far worse where GDP is worse.”

If the question is how to blunt the economic impact of climate change, adaptation has to be a major part of the answer. There seems to be a great disdain for adaptation, clearing the brush, building dikes and dams, moving to higher land, installing air conditioners, moving or engineering crops and so forth. Spread over a hundred years, the costs of adaptation are not large. Perhaps climate-policy advocates dismiss talk of adaptation because, by reducing the damage that might be caused by greenhouse-gas emissions, it makes emissions less scary. Climate models are also short on adaptation and innovation, perhaps for the same reason.

Miami might be six feet underwater in 2100, but Amsterdam has been six feet underwater for centuries. They built dikes. By hand. Amsterdam is a very nice place, not a poster for dystopian end of civilization. Buildings decay and need to be rebuilt every 50 years or so. Just start building in drier places.

We need rigour in climate policy. “For a small donation, pictures of cuddly animals might do. For trillion-dollar costs and regulations, they do not. To justify such costs, we need some dollar value on specific environmental damage of climate change. Yes, the numbers are uncertain. But those numbers are the only sensible framework to discuss spending trillions of dollars on climate now.”

Cost-benefit analysis matters for making the best use of limited resources. “Naming costs and benefits is particularly useful to analyze whether some of those trillions are not better spent on other environmental issues. For example, species extinction is a real problem. We are in the middle of a mass extinction. But the elephants will die from lack of land and poaching long before they get too hot or dry. For a trillion dollars, how much land could we buy and turn over to complete wilderness? How many more species would we save that way, rather than spending similar amounts of money on high-speed trains and hurrying the adoption of electric cars? The oceans are in trouble. For a trillion dollars, how much over-fishing, chemical pollution, plastic garbage, or noise could we fix? Economics is about choice, and about budget constraints.

Even though we don’t really know the economic or environmental cost of carbon, cost–benefit analysis is vital so that we do whatever we do efficiently. Avoid doing incredibly expensive things that save little carbon, and don’t ignore unfashionable things that might save a lot of carbon at lesser cost.

Without numbers, we will follow fashion. Today it’s windmills, solar panels, and electric cars. Yesterday it was high-speed trains. The day before it was corn ethanol and switchgrass. Actually addressing climate change in a sensible and effective way is likely to involve unfashionable technologies, and new technologies without political backers. A focus on cost–benefit, carbon per dollar, is vital to allow different technologies to compete, and new technologies to emerge. The alternative — and current predilection — is for different technologies to compete for political favor, a mechanism we all know well, along with its disastrous results, especially regarding innovation and cost reduction.

[MB: This is an important point. One of the costs of an ad hoc winner picking approach on climate is lower innovation. Subsidising EVs, for example, must reduce incentives for R&D in politically-disfavoured rival technologies, including technologies we do not yet know about.]

The policy prescription is simple: price + carbon dividend + R&D. “From an economic perspective, the ideal policy combines a carbon tax, whose revenues reduce other marginal tax rates, with strong support for basic R&D.”

Thus, if the question is how to reduce carbon as much as possible while damaging the economy as little as possible, an evenly applied carbon tax — even to the coal emissions used to create solar panels and car batteries — is the answer, in place of regulation and subsidies.

A carbon tax bakes in cost–benefit analysis, and otherwise incalculable carbon-reduction pledges. Just buy the cheapest option and you’re doing your bit.

Maybe rather than buying a Tesla, you should move closer to work — or carpool. Maybe cutting out one international trip does more than buying the Tesla. Maybe zoning and permitting reform will allow building houses so people don’t commute in the first place. Is it easier to decarbonize transport, home heating, cement, steel, or agriculture? Only by setting a price can we know the answers, and incent the millions of little daily decisions that go in to reducing carbon emissions efficiently.

A weak consumer response to a carbon tax argues for a carbon tax. “A carbon tax is a win-win. Many climate advocates disparage the carbon tax, on the view that people will not reduce energy consumption and carbon emissions when the price goes up. If so, great! A bankrupt government can raise a lot of money, and reduce other heavily damaging taxes. If people drastically reduce carbon emissions to avoid a small tax, the government doesn’t earn much money. Great! We save the planet at low cost.”

Carbon policy is full of economic fallacies. Mother Earth does not care if solar panels are made in the U.S. or China. She just wants them to be cheap. “Millions of green jobs” are a cost, not a benefit. Financial regulators are now taking on climate change, justifying this dramatic expansion beyond their legal authority by endlessly repeating a fantasy that “climate risk” imperils the financial system in the near future.

There is nothing in the science that justifies uniting “climate” with a left-wing political agenda. Yet even the IPCC mixes climate change with “sustainable development, poverty eradication and reducing inequalities.” Mixing anti-capitalist politics with climate change makes those skeptical of the rest of the agenda wonder about the objectivity of climate science, and whether the planet really is in such danger.

There is nothing in climate science to justify apocalyptic rhetoric. If the question is, “What threatens the collapse of civilization,” war, nuclear war, civil war, pandemic, crop pandemic, and social and political disintegration are far higher on the list. No healthy society fell apart over a slow and predictable change that came over a hundred years. There is nothing in climate science to say life on earth is threatened.

Climate advocates have done themselves and the planet a great disservice by wrapping climate policy in increasingly shrill, apocalyptic, partisan, and unscientific rhetoric. “Global warming” became “climate change,” reflecting in part effects on rainfall or different geographies, but also inviting media commentary on every weather event to become a sermon. In the Green New Deal and comparable movements, it became “climate justice,” wrapping climate inexorably in a far-left-wing politics of anti-capitalism. The required vocabulary moved on to “climate crisis.” Still not enough: In April the (formerly) Scientific American proclaimed that, in coordination “with major news outlets worldwide,” it would start using the term “climate emergency.” Will “climate catastrophe” be next?

Finally, here is what I think is Cochrane’s most important point:

Actually doing something about the climate will require decades of consistent policy. That will not happen by today’s elites crying wolf and cramming regulations down the throats of a disdained and temporarily distracted electorate. [MB: That will also not happen by seat-of-the-pants ad hoc policies, nor will name-and-shame work. Consistent policy means a system – consistent, clear, enduring rules to lower emissions. The ETS is a fine example of a rules-based approach. Policies like 100% renewable electricity are not.]

The ETS is extraordinary

Just a reminder of what an extraordinary achievement the New Zealand Emissions Trading Scheme (ETS) is. Introduced in 2008, the ETS covers around 96% of GDP. Apart from the carve-out of agriculture, the ETS has no domestic exceptions. Many offshore schemes exclude small businesses, and/or transport. Ours does not, making it probably the most comprehensive carbon price in the world. Agriculture, our main export earner, is on track to introduce some form of carbon price from 2025.

Look at how different things are in the United States, even under a Democratic White House. From John Cochrane:

[C]arbon taxes are right now a political nonstarter. You can see this most clearly in the hilarious plea from the White House for OPEC to increase production in order to keep gas prices down. This from the same administration that canceled Keystone, “suspended” the issue of new oil and gas leases on federal lands, and is spearheading a “whole of government” move to rapid elimination of fossil fuels before alternatives are in place, all of which must raise the price of gas. What’s going on? Well, clearly, governments find they must take underhanded, obscure regulatory steps to drive up the price of gas, with plausible deniability, rather than enact simple, transparent, much more effective and much less costly carbon taxes, which voters will notice.

The fact that we have an ETS which is comprehensive and puts a hefty $60 per tonne price on carbon, while remaining feasible, is exceptional.

Big picture, people

According to a tweet by the NBR, pundits are calling the Emissions Trading Scheme (ETS) dysfunctional after its $50 price cap was breached at Wednesday’s auction.

Big picture, people.

Wednesday’s auction was roaring success for the credibility of the ETS system, of the government’s emissions budgets, and of the political sustainability of a carbon price north of $50. The market told us it thinks carbon pricing is here to stay and that current and future governments will maintain the commitment to lower emissions.

As far as I know, Wednesday’s auction was functional and orderly, played out according to the legislated and regulated rules.

The market operator received bids. It determined an interim clearing price that was above $50. All 7 million units in the Cost Containment Reserve were made available for an offer price of $50. There were enough bids for all of those units to sell them all. The final clearing price was $53.85. You can read a step-by-step walkthrough of the price-setting process here.

Note that although the government offered those extra 7 million units at $50 a piece, it received the final clearing price for those units, $53.85 – fair market value at the time of the auction. Later, market prices shifted to reach $59 the following day.

The breach in the price cap was not surprising. Prices for New Zealand Units (NZUs) were trading above $50 on secondary markets in the days leading up to the auction, a clear sign that a breach in the price cap was a possibility.

Remember, the reason why the price cap can be breached at all is because of changes in 2020. The government exchanged price certainty for quantity certainty. That is, it gave the ETS a hard emissions cap, with the tradeoff being a soft price cap. Until 2020, it was around the other way. The government would issue unlimited emissions units to defend the price cap, thus raising emissions. Now it only has 7 million units to defend the cap.

The extra units issued to defend the cap will not raise emissions. The legislation requires any extra units must be backed. That means the government must offset the extra units elsewhere so that overall emissions do not increase. The government can choose to back units here or overseas, and it has at least three years to solve this (non-trivial) problem.

Structurally, this is a sound setup. Combining a price cap with a backing rule gives the government a way to manage the domestic carbon price, which is essential, without putting the country’s emissions track at risk. However, while the structure is right, settings need to change because as it stands the government does not have control of the domestic carbon price.

Governments need control of the domestic carbon price to protect the system. The ETS and emissions reduction more generally has to be politically sustainable every day between now and 2050 and beyond. I will talk about this further in future.

The outcome from Wednesday’s auction was predictable and inevitable. The process which delivered it was fully functional.

Wednesday was also a significant win for the environment, a vote of confidence in the commitment to lower emissions and reach its emissions targets, and that the ETS – widely understood to be the most effective tool we have to lower emissions – is here to stay.

That is worth celebrating and is a credit to the Climate Change Minister James Shaw.

Only ten beers on the table

The response by James Shaw to today’s breach of the ETS price cap has reminded me of the most helpful analogy I have heard to describe how a binding ETS cap really does neutralise every policy under the cap under nearly all foreseeable circumstances. The analogy comes from Eric Crampton. It involves beer.

To recap today’s events:

  • Earlier today, the government issued an extra 1.6 million ETS emissions units to defend the price cap
  • Those extra units will raise New Zealand’s emissions by 1.6 million tonnes
  • Shaw is looking at ways to neutralise the extra units so that they do not raise overall emissions. One of those ways is to issue 1.6 million fewer units in the future. Shaw is correct that this will indeed neutralise the emissions from the extra units issued today.

Shaw’s implied view is that in order to neutralise the extra units under a binding ETS cap, you have to reduce the cap. Right on. Shaw did not say he is also looking at more EV subsidies to neutralise the extra units. That is good because it would not work.

So here is my adapted version of Eric’s beer analogy, the takeaway being the cap is the cap is the cap:

Each Friday, Alex, Bob and Cath drink beer together. Alex always drinks 3 pints, Bob 4 pints, and Cath 5 pints. They have all 12 pints delivered to their table at the start of the night and go home when the last glass is empty.

Tonight, the pub has run dry. Only 10 pints arrive at their table. The friends discuss how to divide up the smaller number of beers. They come up with all kinds of elaborate schemes.

Further complicating things, the pub owner is friends with Alex and decides to charge her only half price for whatever she has to drink. It is such a good deal that Alex ends up drinking four pints, more than her usual three.

So what effect does the owner’s subsidy and all the elaborate schemes have on the total number of beers consumed? Zero. Exactly 10 pints are consumed, because that is all the beer there is. The subsidy and the schemes change how the beers are divided – but do not and cannot change the total number of beers consumed.

And so it is with a binding ETS cap. Subsidise EVs all you like. Raise taxes on petrol. Ban new gas connections. Do all the elaborate, tricky policies you want. They will have zero effect on total emissions. Because total emissions under a binding cap is solely determined by the cap – the number of emissions units issued by the government.

Next month, the government will commit tens of billions of dollars-worth of new emissions policies under its Emissions Reduction Plan. Nearly all of them will work under a binding ETS cap. As a result, they will not change total emissions by a single tonne. We will be no closer to our emissions targets, not by one gram. We will just be poorer.

Hundreds of officials, perhaps thousands, working away on their elaborate plans to lower emissions cannot see the obvious truth. Whatever their plans, there will be ten beers on the table.

Why not subsidise more EVs, Minister?

This morning’s Emissions Trading Scheme (ETS) auction resulted in a clearing price of $53.85, breaching the $50 price cap.

The government issued an additional 1.6 million ETS emissions units from a reserve to defend the cap.* These extra units will raise New Zealand’s emissions by 1.6 million tonnes. The law requires the extra units to be backed, or offset, so that they do not raise emissions overall. A sound mechanism.

As James Shaw said in a statement:

The Government is committed to balancing out the additional units released today to ensure there is no overall impact on emissions released into the atmosphere.

Great. Shaw went on to say how the extra units could be neutralised:

Officials are currently looking into the best way to achieve this, including by changing the volume of units available to purchase at future auctions.

Excellent. Issuing 1.6 million fewer emissions units in the future will indeed neutralise the extra units issued today.

Another way to neutralise the extra units are actions (reductions and/or removals) which are outside the ETS. For example, buying and shredding EU ETS units, or planting trees provided those trees are excluded from the ETS now and forever.

But what about, say, more EV subsidies to neutralise the extra units? If not, why not, Minister?

The answer, of course, is that EV subsidies will not – cannot – neutralise the extra units issued today because EVs are already in the ETS.

You can subsidise EVs until you are blue in the face. But that will not change the fact there are 1.6 million more emissions units in circulation which means 1.6 million tonnes’ more emissions from the areas of the economy covered by the ETS (which is nearly all of it).

No action which is covered by the ETS cap can neutralise the extra 1.6 million tonnes of emissions unless it changes the number of units in circulation. Why? Because the action – more EVs, for example – will simply free up emissions units for someone else to use. There will still be 1.6 million more units in circulation which means 1.6 million tonnes more emissions.

Which is exactly why EV subsidies and pretty much every other government emissions policy are a waste of time and money: virtually all of it is already in the ETS. EV subsidies can’t neutralise the extra units issued today for the same reason they have no effect on overall emissions: they are covered by the ETS cap, the cap is binding, so total emissions are determined solely by the cap (for the parts of the economy covered by the ETS).

Shaw is right (I hope) to rule out using more EV subsidies and similar policies to neutralise today’s extra emissions units. That would be futile. It’s just that this logic should rule out doing EV subsidies and policies like it at all. Those policies cannot neutralise today’s extra units because they do not lower overall emissions.

* Actually the government issued 7 million units to defend the cap, but 5.4 million were already budgeted and therefore did not raise emissions.

How much land do we really need to plant with trees?

Both the government and the Climate Change Commission have misrepresented how much land will be covered in forests in 2050 with current emissions policies.

In its final report, the Commission told the government the existing policies and the Emissions Trading Scheme at $50 will deliver net zero emissions in 2050.

That extraordinary finding put a significant dent in the case for the Commission’s plan which has us paying somewhere between $250 and more than $500 per tonne of emissions – not $50 – to achieve the same emissions goal.

The Commission needed a way to explain why we should not stick with existing policies, which its own modelling shows more affordable and as effective as their plan. Their primary argument is that existing policies plant too many exotic trees.

The Commission and ministers have made various statements to this effect. For example, back in June, James Shaw told Parliament’s Environment Committee this (at 44:07 and again at 44:22):

[T]he pathway to getting to net zero at the least cost… involve[s] converting virtually every farm in the country into pine forestry.

Shaw’s statement is not close to being correct.

In its final report, the Climate Change Commission says getting to net zero emissions with existing policies including the ETS at $50 will require an additional 1.24 million hectares of exotic forests to be planted by 2050.

That is only 11% of the 11.7 million hectares of New Zealand farms which are not already forested. So much for Shaw’s “virtually every farm” claim.

Perhaps Shaw meant some time after 2050? So at what date could the last New Zealand farm be forested if we extrapolate from the rate between now until 2050?

On conservative assumptions, the earliest date exotic forests will cover the last New Zealand farm will be in the year 2250. That is about the same year the USS Enterprise from Star Trek is scheduled to launch.

But that date is based on the most conservative assumptions possible: gross emissions never fall from their current levels; all trees are only planted on farmland; agriculture pays a carbon price near zero; and zero access to offshore emissions units.

More realistically, the last farm land will not be forested until sometime after the year 2500.

Except the last farm will never be covered in trees – ever. We have land markets which mean trees will become an uneconomic way to capture and store carbon emissions long before the last farm is covered in pines.

In any case, the afforestation problem does not have to be solved today and certainly not by the central government. Local councils should be asked to do the job of capping afforestation in their areas, which has the advantage of being democratic and based on the circumstances which confront them in the future.

Remember there is a constituency for trees as well as against. Many landowners like trees because they are profitable. Funny how a carbon price helps do that.

The Commission’s main argument that existing policies will plant too many trees is almost equally applicable to its own plan.

The Commission’s modelling shows its plan will plant a further 4.4% of New Zealand’s total land area in forests. That compares to an extra 5.1% for current policies.

The Commission’s plan plants more native trees and fewer exotics, but this change in composition is hardly earthshaking. With current policies, exotics will make up 24% of all trees in 2050; under the Commission’s plan, 19%. Would anybody but industry insiders notice the difference?

See if you can spot the difference in outcomes between existing policies, which deliver net zero emissions in 2050 with an ETS price of $50, and the Commission’s plan, which has us paying between $250 and more than $500 per tonne of carbon:

By contrast to these minor changes in land use, households and businesses will not fail to notice the effects of the Commission’s plan on their cost of living. With carbon prices of between $250 and more than $500 per tonne, the Commission’s plan will profoundly affect the cost of everything, especially energy and travel. Its worst effects will almost certainly fall on low-income households.

As far as I can tell, the Commission has not considered the consequences of its ruinous plan for households and individuals living on low incomes. Its distributional analysis mainly considers effects across economic sectors of the economy – which is not really a distributional analysis at all. For all the talk about equity, it is not clear the Commission has checked what $500/tonne means for the price of bread, the cost of your daily commute, your power bill, or a flight to Auckland.

Another problem is that the Commission has presented existing policies as relying too much on trees and not enough on gross emissions reductions i.e. reductions at source.

But the Commission’s modelling shows existing policies do far more than just plant trees to lower emissions. Modelling for its draft report (it does not seem to have been repeated for the final report) showed that by 2075, 74% of the reduction in net emissions would come from lower gross emissions with existing policies including the ETS; only 26% from removals.

Is successful delivery of our emissions targets, but with a few more exotic trees and a somewhat more gradual transition in gross emissions, so bad as to justify paying between five to ten times more per tonne of carbon? Consider which option puts our emissions targets at greater risk.