New Zealand passes legislation finalizing ETS reforms

On 16 June 2020, the long-awaited reforms to the New Zealand Emissions Trading Scheme (NZ ETS) were finalized, as the Climate Change Response (Emissions Trading Reform) Amendment Act (the Act) successfully passed its third and final reading in the New Zealand Parliament.

The Act amends the Climate Change Response Act 2002, which forms the basis of New Zealand’s climate legislation. It passed its final reading with 63 votes to 57, as opposition MPs sought to delay the Act for at least a year in order to assess the economic impact of Covid-19. The Act, to be implemented from next year, provides the legislative framework for the planned reforms of the NZ ETS and calls for regulations to be made with detailed settings for implementation. The government last week made decisions on these settings, which will become regulations under the Act later this year, putting New Zealand on track to implement the bulk of reforms beginning 2021. The Act legislates a broad array of reforms to the NZ ETS, summarized below.

The reforms stem from a 2015 statutory review of the NZ ETS, which found that, while the NZ ETS had helped New Zealand meet international obligations, it had not significantly incentivized businesses to reduce emissions. Crucially, the NZ ETS was found to lack the regulatory certainty and stable long-term policy settings needed to drive low-carbon investments and was not aligned with New Zealand’s Paris Agreement contributions. This kicked off a fundamental review and reform process, incorporating extensive stakeholder consultation on a diverse range of ETS design issues. The key decisions on reforms were taken in 2018 and 2019, and finally realized with the passing of the Act this week.

In parallel to ETS reforms, New Zealand has also developed a high-level climate law, the Climate Change Response (Zero Carbon) Amendment Act 2019, which was passed in late 2019, establishing new long-term domestic targets, the mandate to establish emissions budgets, and an independent Climate Change Committee to advise consecutive governments. The Zero Carbon Act further amends the Climate Change Response Act 2002, keeping all key climate legislation under one Act.

The Emissions Trading Reform Act legislates a broad array of reforms, including the main ones outlined below, as well as measures to enhance compliance and transparency and an array of technical and operational updates. With the passing of the Emissions Trading Reform Act this week, New Zealand now has, in the words of the Climate Change Minister James Shaw “…the foundations in place for long-term, meaningful climate change action in New Zealand”.

The Act introduces a cap on emissions under the NZ ETS, in alignment with New Zealand’s emissions budgets and long-term targets. It establishes a process for setting the cap five years in advance and updated annually on a rolling basis. The cap-setting process is based on the (provisional) national emissions budget and establishes the volume of New Zealand Units (NZUs) that will be made available for auctioning each year.

Regulations under the Act will provide the detailed settings necessary for implementation, with the government last week announcing decisions on the emissions budget, cap, auctioning volumes, and rules, as well as price containment volumes and triggers.

The newly established process for calculating the cap and auctioning volumes takes into account units from free allocation, forestry removals, potential international units, and the stockpile of units already in circulation, as well as units that may be introduced under the price-containment measures. These include both a Cost Containment Reserve as a price ceiling and an Auction Reserve Price as a price floor, setting up a price corridor for the auctioning of units, while keeping in place the Fixed Price Option during the transition to auctioning.

The Act includes provisions for the phase down of free allocation to emissions-intensive and trade-exposed (EITE) industries. Free allocation will reduce at a modest rate of 1% per year from 2021, increasing to 2% from 2031 and 3% from 2041. The Climate Change Commission will be able to recommend changes to the rate of phase down after 2030, depending on the ongoing risk of emissions leakage.

The forestry sector reforms include simplified accounting measures for new entrants, with the introduction of “averaging” for all post-1989 (voluntary) registrations from 2023. Forest owners that use averaging will earn NZUs through forest growth up to the average age. Thereafter, they will neither earn more units nor be liable for paying back units at harvest time. A new “permanent forest” category will also be introduced, incorporating an existing companion policy under the NZ ETS framework.

Multiple technical and operational improvements aim to reduce both the costs and complexity of engaging with the NZ ETS for forest owners. Furthermore, the implementation of some forestry changes are to be pushed back one year to 2023 to give foresters time to adjust and to align changes with a new forestry data system currently being developed to replace the Climate Change Information System (CCIS). This is aimed at providing users with streamlined processes, improved administration, and additional tools and guidance.

Biogenic emissions from agriculture (methane and nitrous oxide) will face a carbon price from 2025 at the latest, with a levy/rebate system planned to operate in parallel with the NZ ETS. Under the planned system, emissions will be priced at the farm-level point of regulation for biogenic methane and at the importer/manufacturer level for nitrogen fertilizers.

Progress towards implementing this on-farm pricing policy is to be made under a new partnership between the government, primary industry organizations, and indigenous Māori, called “He Waka Eke Noa”. The initiative will be reviewed by the Climate Change Commission in 2022, and if progress is not forthcoming, the Act includes provisions for agricultural emissions to be brought under the NZ ETS at the processor level from then.

The detailed settings for implementation will be formalized in regulations later this year. However, the Climate Change Commission is due to develop a set of 10-15-year emissions budgets and give advice on policy settings by the beginning of 2021, which will supersede the provisional emissions budget on which the current 2021-25 settings are based. Some minor changes to the cap and supply volumes may then be expected.

Ongoing work on gaining access to high-integrity international offsets may also be fruitful, which may lead to a decision on whether and how to introduce these under the cap. Looking ahead to implementation of the reforms, the first NZ ETS auctions are planned for March 2021. Until then, the necessary infrastructure needs to be in place. More broadly, a separate work program of the Ministry for the Environment will continue work on improving market governance of the NZ ETS. The work will incorporate earlier decisions to prohibit insider trading, counter market manipulation, and find a suitable regulating entity for New Zealand’s carbon market.

The New Zealand Minister for Climate Change, James Shaw, summarized the outcome of the reforms. "Finally, there will be a sinking lid on the pollution that we put into the atmosphere. There will be, finally, a proper price on pollution. We will now, finally, play our part in tackling the climate crisis, and we will do so in a way that it is fair and transparent and affordable."