Getting down to the business of climate change

The New Zealand Stock Exchange and several leading companies recently announced that they intend to establish a New Zealand-based carbon trading market to service the Asia- Pacific region. The Government has also indicated that it will be making cabinet decisions on emissions trading over next few months. In this article, Bell Gully partner Simon Watt provides some background on emissions trading and the growing body of support for using emissions trading as a means for businesses to reduce their carbon footprint.

Climate change is an area of public policy where grandstanding, prevarication, self-interest, hypocrisy and breathtaking U-turns are all virtually de rigueur.  So it was surprising to see a cross-party consensus on emissions trading emerge at a recent Environmental Defence Society forum held in Bell Gully's Auckland office.

Likewise there was common ground among the mix of suits and dreadlocks in the audience. They sent a collective message to our politicians: they must work together to develop a more cohesive response to the threat of global warming.

Although emissions trading has more than a ring of market mechanism about it, Green Party co-leader Jeanette Fitzsimons accepted that emissions trading was at the core of the Kyoto Protocol, which her party supports for want of any more ambitious international agreement to limit greenhouse gas emissions.

National Party Environment spokesperson Nick Smith supported emissions trading as an efficient and effective economic instrument, while the Minister for Climate Change Issues David Parker had shed earlier scepticism and foreshadowed the roll-out of emissions trading at least initially in the electricity sector.  The Government has also signalled a possible requirement for deforesters converting to alternative land uses to hold tradable emissions permits.

So what is emissions trading, as it would apply to business?  In essence it involves setting a cap on the emissions any one company can produce each year.  If a company historically emitted 100 tonnes of CO2 each year it might be capped at 90 tonnes and allocated 90 emission units – encouraging it to find ways to emit less.  If the company reduces its emissions to 80 tonnes of CO2, it will have 10 units to sell.  If it still emits 100 tonnes of CO2 in a year, it will have to buy 10 more units at the market price from a company that has managed to cut back.

This system drives efficient behaviour as it encourages emissions to be cut first where it costs least to do so – unlike a regulatory system which could force all companies to make the same level of emission reductions regardless of cost. The attraction of the system is that there is still an overall cap on emissions, so there is more certainty about the actual level of emissions achieved.  In contrast, a carbon tax would not guarantee reductions and might simply be absorbed and passed on like many other business costs.

It is not only politicians who are getting excited about emissions trading. Business is at the forefront, no doubt reflecting a lack of confidence in Parliament’s ability to deliver the best outcome.  Business New Zealand is leading a project from which will flow a recommended framework for an emissions trading market in New Zealand. NZX has announced that it will establish its own emissions trading market, which it expects will be in operation by 2008. Chief Executive Mark Weldon sees New Zealand as well placed to be the centre for carbon trading in the Asia-Pacific region.  This might be along the lines of the Chicago Climate Exchange, where emission units are actively traded. However, at this stage NZX is still working through the market’s framework, including the ownership structure, trading rules and whether a carbon credit will be classified as a future, a spot product or a security.

Some are impatient and are trading already.  The initial trading is sporadic but largely made possible by the Government’s (now suspended) Projects to Reduce Emissions mechanism. Under that mechanism a number of local businesses and councils were awarded rights to emission units for a range of projects – such as wind farms – which will reduce emissions.  Projects were only eligible if they would have been uneconomic and would not have gone ahead without the cash injection offered by the grant of emission units.

Some of the recipients have already forward sold their future rights to emission units.  For these and indeed all recipients under the Projects mechanism, the challenge will be to implement the rigorous systems required to verify the emission reductions they have promised to achieve.  It has to be an unusual market where someone pays cash for thin air (or strictly speaking for the value of a reduction in thin air!) so there are some significant hoops to jump through before anyone will pay for this intriguing property right.

With many businesses rushing headlong towards carbon neutrality – not least for the marketing and reputational advantage – carbon off-sets are in short supply, particularly tradable emission units such as those arising out of the Projects mechanism.  More will come on stream between 2008 and 2012, the period recognised by the Kyoto Protocol when emission reductions can be off-set against Kyoto liabilities.  In the meantime, the value of non-Kyoto compliant units is significantly discounted because they don’t reduce any immediate financial exposure.

If all this talk of emissions trading has whetted your appetite for a dabble in the market, how do you get started? First, recent amendments to the Climate Change Response Act have made it possible for businesses and individuals to hold accounts in the national registry for Kyoto-compliant emission units, although it will be at least mid-year before the registry is up and running.

Unfortunately the European Union's Emission Trading Scheme is still off-limits to non-EU companies, although New Zealand's Climate Change Office is talking to the EU about extending the scheme to enable an exchange of units with New Zealand. Other countries are doing likewise.

If you have a few thousand dollars to spare that will buy you entry to the Chicago Climate Exchange.  Emission units are currently trading on that exchange at around US$4 so it wouldn't be too expensive a place to start familiarising yourself with the market, while furthering your quest for carbon neutrality.

Closer to home you can purchase carbon off-sets via the carboNZero scheme (a Google search for that word will take you straight there).  The scheme is administered by Landcare Research, a Crown Research Institute.

These steps may just be a precursor to trading Kyoto-compliant units under a broader New Zealand emissions trading scheme if Government policy does embrace the emissions trading route .  Recent statements from David Parker signal that the Government is likely to do so with final decisions on emissions trading being taken by cabinet from May to July this year. David Parker has indicated that the scheme will be economy wide to prevent market distortions, however the transition periods for implementing the scheme are likely to vary in different sectors. He has also noted that the existing devolution of credits and tradable permits schemes in the forestry sector would be likely to be merged into an emissions trading scheme should it proceed.

The political issues and technical complexities of emissions trading are such that it is likely to progress more quickly and effectively if it is also driven upwards by the markets (such as the new carbon trading market, TZ1, proposed by NZX) than top-down from Parliament.

Either way climate change has met the market and the momentum is gathering.

Simon Watt leads Bell Gully's Climate Change Practice. An abridged version of this article was first published in The Independent Financial Review on 28 March 2007. The article has been updated to reflect recent developments. For further information about carbon trading visit NZX’s new website for its regional carbon trading market, TZ1 at www.tz1martket.com. On this site you’ll find a paper entitled “Carbon Markets 101” To view David Parker’s press release on the Government’s emission trading timeline visit the Government’s website at www.beehive.govt.nz.

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