To Minister Shaw: Please explain

Yesterday, in the Herald ($), I challenged Climate Change Minister James Shaw to explain how his Emissions Reduction Plan lowers emissions.

In this post, I want to head off what he is going to say. His lines are, frankly, not right. So let’s get that on the table and go through the argument before he says it.

Shaw’s plan is vast. It covers every sector of the economy. The government could regulator, tax or subsidise anything or everything in the name of reducing emissions.

But Shaw’s plan is not going to reduce emissions.* The government has already placed a quantity cap, a sinking lid, on emissions with the ETS. Legislation passed in 2020. It is widely accepted that cap-and-trade schemes neutralise other emissions policies. If the cap determines total emissions, policies under the cap do not.

This neutralising effect of an emissions cap is called “the waterbed effect”.

Here is how a cap-and-trade scheme will neutralise an EV subsidy, for example:

Imagine an economy normally produces 100 tonnes of emissions. This year, the government decides to cap emissions at 80 tonnes. It issues 80 emissions permits and demands the surrender of one permit per tonne of CO2. Emissions fall to 80 tonnes.
Next year, the government issues another 80 permits and introduces a new EV subsidy. The subsidy successfully reduces transport emissions by five tonnes.
Total emissions remain at 80 tonnes. Why? Because there are still 80 emissions permits available. The five permits which transport no longer needs due to the subsidy will be used elsewhere. They will raise emissions (or postpone reductions) by exactly five tonnes somewhere else in the economy.

So, the EV subsidy reduces emissions from one sector. But overall emissions do not change. This is the waterbed effect.

Now, before I go any further, let me say that “The ETS Is Not Enough”™ is not an answer. That line is a mantra in Wellington. It is useless except for the fact it has fooled everybody who hears it.

Somehow, nobody has noticed “The ETS Is Not Enough”™ does not make any case for doing other policies if those policies are going to be neutralised by the cap.

Even if the ETS leaves you short of your emissions target (because it is Not Enough™), the waterbed effect is still in play.

So even if the “The ETS Is Not Enough,”™ complementary emissions policies don’t help. If they are neutralised by the cap, then those policies are going to leave you exactly as far short of your target as if you had not done them.

Every day, this advanced logic escapes hundreds of public servants who do nothing except think about climate change policy at your expense. You pay their salaries but I assure you they are not working for you.

Anyway, if Shaw’s Emissions Reduction Plan is to reduce emissions, it has to find a way around the waterbed effect.

Shaw has previously spoken about how to avoid the waterbed effect. His solution seems obvious: lower the cap as policies bring down emissions.

Here is Shaw speaking to Carbon News earlier this year:

[W]hat they’re talking about is something called the ‘waterbed effect’. If you cut emissions in one area and that takes things below the cap then it allows others to pollute more in the meantime.
But if you’re successfully lowering the cap every time then you minimise that effect because you’re saying, ‘Yes we’re taking emissions out here with the feebate and also with the ETS and then next time we set an emissions budget it will take account of the fact that emissions are lower.’
The way it works is you’ve got your 2050 target which is sort of long term. Then you’ve got your three five yearly budgets and each one is smaller than the one before. Every five years, at the start of each budget period, if circumstances dramatically change since you set the budget five years earlier, you can adjust at that time and say, ‘hey look things have moved far quicker or in unexpected ways we can adjust the budget to take account of that emissions budget.’

Shaw’s logic, as I understand it, is this: Ministers set the cap; Ministers can link the cap to complementary policies (EV subsidies, for example); complementary policies therefore lower emissions.

In the earlier example, emissions stayed at 80 tonnes after the EV subsidy had cut transport emissions. That is because there were still 80 emissions units in circulation. The intuitively obvious solution is to lower the emissions cap to 75 tonnes. Total emissions come down in line with the emissions benefits of the EV subsidy. Problem solved.

No. Problem not solved. That logic is not right.

Linking the cap to the policy does not make the policy lower emissions. It is the cap, not the policy, which lowers emissions. The policy is actually redundant. We explain why in our submission earlier this week on Shaw’s plan:

[Linking] the cap with complementary policies may imply the policies lowered emissions. However, this is an illusion. To see why consider this from the earlier example:

# If the government reduced the cap to 75 tonnes without the complementary policy, emissions would fall to 75 tonnes.
# If the government did the complementary policy but left the cap at 80 tonnes, emissions would remain at 80 tonnes.

The cap is doing all the work.
Accordingly, it is wrong to say that linking the cap to complementary policies means complementary policies reduce emissions. The connection is arbitrary. Ministers could link the cap to, say, cumulative rainfall, but nobody would suggest last week’s storm had lowered emissions. It is the cap, not the complementary policies, which lowers emissions. Complementary policies are still neutralised by the emissions cap. The waterbed effect is not avoided.

The cap is doing all the work. So long as the government has the option to reduce emissions simply by tightening the cap, other policies cannot cause emissions to come down (provided they are subject to the cap). The other policies are redundant.

The next obvious question is: what happens when the government does not have the option to simply tighten the cap? What if carbon prices rise to the point that voters or Parliament will not countenance any further tightening? Can complementary policies help further reduce emissions then?

This does open the door to complementary policies reducing emissions, but only by the smallest amount. Our submission walks through the weird permutations which are needed to get complementary policies to to cut emissions under an emissions cap. Short answer: we see no real way for complementary policies to cut more than a little extra emissions, at best.

If anything, complementary policies are more likely to raise emissions because of their lower economic efficiency and likely political inefficiency. The high cost of top-down emissions policies probably translates to a higher burn rate of political capital per tonne of emissions. That may seem like a fairly esoteric metric, but it matters in principle when the limiting factor on further reducing emissions is political feasibility.

Think about it this way: if the reason the ETS becomes politically constrained is because voters don’t like its cost of living effect, then how can policies which spend far more per tonne of abated emissions be any solution?

Complementary policies only have the opportunity to make any difference to emissions, up or down, if the ETS first becomes politically constrained.

It is hard to see any way the ETS is going to become politically constrained before 2050. New Zealand is already comfortably on track to achieve net zero emission in 2050 with existing policies. We include a list of reasons why in our submission. Nearly all of the evidence shows existing policies get us there.

I need to be clear about what “politically constrained” means. I mean it in the sense that a future government has no politically feasible way to net zero emissions.

Sure, the government could force the ETS price all the way to $500 if it stamps hard enough on trees and other removals technologies and rules out offshore mitigation entirely. That is what this government wants to do. And voters could well object to paying $500 per tonne of carbon.

But the ETS is not politically constrained if the government has the option to just stamp a bit less hard on trees or open the door slightly to offshore mitigation. Politically constrained is when the government cannot tighten the ETS any further, it cannot plant more trees, it cannot commission other removals technologies, and it cannot go offshore, and it is still short of net zero emissions.

Not going to happen. See the submission for why.

So, there is no question at all that right now we have legitimate, affordable, genuine pathways to net zero emissions, and we have options. We can plant a less trees and still get to net zero. We could plant no more trees and get to net zero. None.

Which means the government will always have the option to tighten the cap.

Which makes complementary policies under the cap redundant, including existing emissions policies.

Which means James Shaw’s vast plan is not going to reduce emissions. Not by one tonne.*

* For policies covered by the ETS cap, which is nearly everything except agriculture.

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.

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.

Numpties

Let’s Get Wellington Moving wants to spend $350 million to reduce emissions by 1,000 tonnes. That is a bad deal – for you, the environment, just about everyone except Let’s Get Wellington Moving, it seems. Here is part of the summary of a plan called “City Streets”:

Let’s pretend for a moment that the government had not capped emissions with the Emissions Trading Scheme last year. Let’s ignore the statutory cap on emissions.

At a discount rate of 6%, Treasury’s standard rate for public spending, $350 million has an annual cost of $21 million. Which means Let’s Get Wellington Moving is proposing to spend $21,000 per tonne of emissions avoided.

Spending that much on each tonne means the country goes bankrupt before we get to net zero. At $21,000 per tonne, net zero emissions costs 230% of GDP.

Of course, we have an ETS, domestic transport is in the ETS cap, and the ETS cap is the law. As a result, LGWM will reduce emissions by exactly zero tonnes. You’re not helping your grandchildren by borrowing to pay for emissions policies that don’t cut emissions. You’re just saddling them with debt and making them poorer.

Notwithstanding the whole not cutting emissions thing, congratulations LGWM. You’re in the hall of fame:

Let’s Get Wellington Moving IBD, August 2021, $21,000/tonne

EECA Low emissions contestable fund, December 2020, $33,000/tonne

Auckland Harbour walkway and cycleway, June 2021, $7,800-$230,000/tonne

Time to get real about emissions

It is nice to see others point out the consequences of an emissions cap. Thomas Lumley gets the logic of an ETS:

We’ve got a cap (more or less). One of the non-intuitive aspects of having a cap rather than a fixed price is that parallel efforts to reduce carbon emission don’t work the way you’d expect them to. If I replace my gas stove with an electric one, my kitchen will emit less carbon (modulo the impacts of making the new equipment). If everyone did it, everyone’s kitchen would emit less carbon (again, ignoring the impacts of making the new equipment). What would happen to NZ’s total carbon emissions? Nothing. We have a cap. Less of the cap would go on carbon coupons for burning natural gas; more of it would be available for cars or trucks or coal-fired power stations. The impact of our kitchen-renovation decisions would be cheaper emissions rights for other polluters, not lower emissions.

Well said, Thomas.

A commenter on Thomas’s post has some fairly standard objections to the argument:

First, the ETS was thoroughly undermined by the previous govt because the carbon price did not rise and companies were able to use dodgy offsets from overseas. If such a thorough undermining of a supposedly brilliant and effective self-regulating system could happen once, then it could happen again (with another change of govt).

This is solved by not opening the window to fraudulent credits. Or a commitment to make good on any credits which turn out to be fraudulent. Or both. That future governments might act in bad faith on emissions is an argument for the transparency of the sort an ETS provides.

Second, how high would the price of carbon have to go to shift people’s behaviour? And at that point is there the chance that you might get a general popular revolt that would undermine the political will to make the system to work as it should.

Good question. The Climate Change Commission says $50/tonne (p91). Basil Sharp et. al. say $85/tonne. In 2018, Concept Consulting, Motu and Public Policy Research said $76-$127/tonne. NZIER estimated far higher costs, also in 2018. None of this apart from NZIER looks scary with 29 years until the net zero deadline in 2050.

Anyway, non-ETS policies are far worse on a cost per tonne basis. Almost everybody acknowledges this. Cap and trade cuts at least cost. If your objection to the ETS is cost, you should be even more worried about other policies. As the joke goes, you do not have to outrun the bear to survive, you only have to outrun your colleague.

Officials have argued that the lack of transparency of non-ETS emissions policies buys enough cover to justify their higher costs. Except we have already had a public revolt mainly (though not entirely) against non-ETS emissions policies. I’d have thought is obvious that policies which add thousands of dollars to the cost of an imported car are going to be easy to spot. In any case, non-transparency is a non-argument for policies which have to work in the long run. Voters are going to it figure out eventually, and one might question the democratic merits of trickery.

Thirdly, there is the danger that emitters, rather than reducing emissions, basically rely on offsets. So, that will be great for increasing forestation, but it still might not change behaviour and reduce emissions

Which is just shifting the goal posts from emissions – you know, the thing that causes climate change – to changing behaviour and disrupting lives per se, which does not cause climate change. A tonne of emissions removed has exactly the same climate change benefit as a tonne reduced. From a climate change perspective, any distinction between reductions and removals is arbitrary. We should just do whatever combination of reductions and removals best helps the climate.

But try explaining to most environmentalists the idea that there is an emissions penalty that goes with arbitrarily insisting on reductions over removals, or domestic over offshore, or EVs over pretty much every other scalable way to avoid emissions. I cannot recall ever seeing an environmentalist say they are concerned we might lose 95% of the emissions benefits of a policy by insisting each tonne has to come from EVs and nothing else. The attitude seems to be who cares if we could have cut 20 times more emissions for the same cost?

I do. And when the rubber meets the road, so will voters. Time to get real.

Forest fires and the power of emissions accounting

It seems forest fires on the west coast of the United States are threatening access to carbon offsets used by BP and Microsoft among others.

Source: Carbon News/InsideCLimateNews.org

Some have claimed forest fires mean the carbon captured in forests could be less than permanent. Here is the Climate Change Commission in their final report (p65):

Climate change exacerbates forest fires, strong winds, storms, droughts, pests and pathogens – so there are also risks associated with the permanence of using forestry to remove emissions from the atmosphere, as these emissions are released if the forest degrades or is destroyed.

But it is easy to make carbon removals by forests permanent even with forest fires. Simply oblige forest owners to report fires and make them responsible for re-capturing each tonne of carbon released into the air, either by replanting the forest or some other offset.

In practice, this is a matter of assigning accounting liability to the forest owner.

Measurement might be complicated in the detail, but the principle is simple: the forest owner is only rewarded for the emissions they capture.

Responsibility for the emissions component of the risk of forest fires should sit with the forest owner, on the principle that risk and control should sit in the same place.

The New Zealand ETS assigns responsibility for the emissions from forest fires to the forest owner. Good. My understanding is that after changes last year, a forest owner has four years to replant their forest after a fire. After that, the owner is assigned an ETS liability equal to the emissions released from the fire. That obligation means the owner must purchase and surrender emissions units back to the government, which effectively funds emissions reductions elsewhere in the economy.

I have used the example of forest fires to demonstrate how an emissions accounting system can make impermanent carbon stores permanent. All that is required is that emissions are measured, surrender obligations are enforced, and there is a system in place to keep track of obligations over time. These do not seem like difficult problems to solve. Where these requirements are met, as they appear to be in New Zealand (at least for the forests in the ETS), forest fires have no effect on overall emissions.

The same logic applies, or can be made to apply, to other problems like pestilence that affect carbon capture and storage of forests.

There does not even need to be a cap on overall emissions. It is enough to just make owners responsible for recapturing emissions or offsetting elsewhere to turn flammable forests into permanent carbon stores.

That is the power of emissions accounting.

So how did the experts at the Climate Change Commission fail to take liability rules into account, especially in their final report after their public consultation had almost certainly alerted them to the idea? How could the Commission not have noticed fires lead to obligations for owners and the consequences of those obligations for emissions?

Here is a presentation I gave on this in March to the Waikato Economics Forum.

What today’s carbon price can tell us about the next ETS auction

For two weeks now, New Zealand Unit (NZU) prices have stabilised at just below the ETS price cap of $50. This morning, NZUs are trading for $48.12.

It is possible that the price of NZUs on secondary markets will rise above the $50 cap. Were that to happen, it will be advance warning that the ETS price cap could be breached at the next NZU auction.

The ETS price cap only applies to the government’s auctions of NZUs. However, there nothing to prevent NZUs trading above $50 cap on secondary markets. The price of NZUs is simply the product of supply and demand. The price cap in auctions affects secondary markets because traders will not pay more than $50 for NZUs if they believe they can buy from the government at no more than $50 in the next auction.

Which is why an NZU price above $50 would be significant. It would be the market’s assessment that NZUs will not be available for $50 at the next auction. In other words, the clearing price at the next auction is expected to be above $50 and the price cap will be breached.

The government gives effect to the price cap in auctions by releasing extra NZUs from a reserve called the Cost Containment Reserve (CCR). The release of reserve units is triggered if the “interim clearing price” for the auction equals or exceeds the price cap.

If the CCR is triggered, the government will offer to sell 7 million NZUs from the reserve for $50 a piece. The release of these units defends the price cap.

But there are only a limited number of units to defend the cap. Once reserve units are exhausted, there will be no more to defend the cap. The clearing price for the auction will be free to rise above $50.

Although the government will offer to sell reserve units for $50, my understanding of the auction rules is that the government could end up receiving more than $50 for those units if there is sufficient demand.

Regulations provide a step-by-step procedure for working out the clearing price of ETS auctions.

An “interim clearing price” for an auction is calculated by filling offers to buy units in order from the highest price to lowest. The interim price is the price of the last buy offer that is partly or wholly filled.

If the interim price is equal to or above the “trigger price” – the $50 price cap – then the government will offer to sell reserve units at $50 a piece.

The market operator then continues down the list of buy offers until either all offers to buy at or above $50 are filled, or the CCR is exhausted. The final clearing price is the price of the last partly- or wholly-filled buy offer.

The final clearing price is the fair value of the units. All buyers pay the clearing price, rather than the price they offered.

There is nothing to prevent the final clearing price being more than $50, even with the release of the additional units from the reserve, if there is sufficient demand. Which is how the government could end up receiving more than $50 for reserve units even with a price cap of $50.

I have emailed the market operator to check my understanding of the rules is correct.

It is right that the government receives fair value for its reserve units. The alternative, a rule that forces the government to receive only $50 for reserve units no matter what, that would bring the risk of a speculative attack against the ETS – the opportunity to pay only $50 for units whose fair value is north of that amount.

Incidentally, a rough extrapolation of the price trend for NZUs over the last 12 months suggests we will reach an NZU price of $60 some time in February 2022. Yes, the CCR gets in the way by releasing more units. But a) the CCR is already priced in, and b) only 1.7 million units in the CCR are additional (the rest are in this year’s emissions budget but held back).