Incoming New Zealand government faces important decisions on NZ ETS reforms

In June this year, the New Zealand Government launched a series of public consultations on the future of the New Zealand Emissions Trading System (NZ ETS). The consultations came in the wake of official recommendations by the Climate Change Commission (CCC) to reform the NZ ETS to achieve gross emissions reductions rather than overly relying on CO₂ removals from forestry. The outcome of the consultations could lead to significant reform of the system, with potential long-term repercussions for key stakeholders, such as forestry businesses, indigenous Māori groups, and rural communities.

The NZ ETS is the only system worldwide that covers the forestry sector, both as a source of emissions and removals. Commercial forestry, consisting mainly of fast-growing exotic species for timber, has been covered by the NZ ETS since 2008. The carbon price acts as an incentive to expand the sector and help New Zealand meet its climate targets. However, concerns have emerged regarding the role of forestry in the NZ ETS. There are currently no limits on the supply of New Zealand allowance units (NZUs) that can be created from forestry removals. The CCC highlighted this issue in a recent report, noting that the current ETS settings will likely drive net emissions reductions through afforestation in the near term, while slowing efforts to reduce gross emissions at their source.

Under the NZ ETS review consultation, the government is considering four options to better incentivize both emission reductions and removals:

• Option 1: Using existing levers, e.g., reducing the number of NZUs sold through auction. This would incentivize emissions reductions and removal activities equally.
• Option 2: Increasing demand for NZUs by allowing government and/or international buyers to purchase them. This would also incentivize emission reductions and removal activities, although it is unclear how effective it would be as international demand for NZUs is unknown.
• Option 3: Reducing the incentive for removals. To do so, the government could place restrictions on the use or generation of NZUs from removal activities.
• Option 4: Creating separate carbon markets for emission reductions and removals. This option would give the government the most control over managing different incentives for reductions and removals but would involve fundamental reform of the NZ ETS.

In parallel, a separate consultation was opened on the future of the Permanent Forest Category. It considers a range of options to address concerns over the rapid expansion of exotic forestry, its impact on the rural landscape and biodiversity. One important consideration is whether the system should be altered to favor the regeneration of native forests, which is a slower and costlier process compared to planting exotic species.

Responsibility for concluding the review of the NZ ETS will fall to a new government, which is currently being formed after the national election on 14 October 2023 saw the ruling Labour Party fail to secure a third term. The results of the NZ ETS consultations, which closed in August, are due to be presented to the new government in December as a basis for their decisions.

The new government will also need to consider the proposed agricultural carbon levy, a new carbon pricing instrument for biological emissions from agriculture, which makes up around half of New Zealand’s emissions. In August, the outgoing Labour government announced its final plan for the instrument to be introduced in 2025. However, the incoming government, likely led by the center-right National Party, have signaled their opposition, stating that the introduction of such an instrument could be delayed until 2030. Even so, with agricultural emissions legislated to enter the NZ ETS from 2025 in what is known as the “ETS backstop”, the new government will soon need to decide on their policy approach to the sector.