Market Forces

What can New Zealand’s forestry sector tell us about carbon pricing policy?

By Suzi Kerr / Published: August 21, 2023

New Zealand is currently reconsidering how its forestry sector can contribute to meeting its long-term climate change targets, and what this means for its emissions trading scheme (NZ ETS). A recent paper from researchers at Motu Economic and Public Policy Research and the Environmental Defense Fund sheds light on New Zealand’s innovative treatment of forestry in the NZ ETS, its impacts so far, and questions about where to go from here.

To help inform future policy choices in New Zealand and other countries, the research team examined patterns of behavior in New Zealand’s forestry sector under emissions pricing. While the NZ ETS has mobilised new forest planting and cut deforestation, the outcomes have not always supported policymakers’ intentions. Further policy changes will be needed to help New Zealand meet its climate targets through 2050 and beyond.

What is the New Zealand Emissions Trading Scheme?

To achieve a low-emissions economy, New Zealand has both international and domestic emissions reduction targets:

Under the 2015 Paris Agreement, New Zealand’s net emissions (including forestry) must be reduced 50% below 2005 gross emissions (excluding forestry) by 2030. This can be met through domestic emissions reductions and forestry removals (sequestration) as well as purchasing offshore mitigation.
In domestic legislation, New Zealand’s emissions of methane from agriculture and waste must be reduced at least 10% below 2017 levels by 2030 and 24-47% by 2050. For all other greenhouse gases, the target is net zero by 2050 and beyond. Five-yearly emissions budgets, set 15 years in advance, create stepping-stones to the 2050 target and must be met primarily through domestic action.

New Zealand’s unique economy, however, creates challenges in reaching these ambitious commitments. In 2021, over 50% of gross emissions came from agriculture. Powered by over 80% renewable electricity, New Zealand’s biggest energy emitters were from transport and industry. At the same time, New Zealand’s growing forests created net emissions removals from land sector, which offset 21% of its gross emissions. From 2008 to 2020, New Zealand relied heavily on domestic forestry and offshore mitigation to meet its international targets and gross emissions remained relatively flat.

Since 2008, the NZ ETS has served as the government’s main climate change policy tool. By linking a regulatory limit on total emissions to an emissions price in the market, the NZ ETS incentivises companies, consumers and investors to reduce their climate impact. The NZ ETS remains the only system in the world designed to cover all sectors and greenhouse gases, although pricing has been deferred for agriculture.

What lessons can other countries learn from the NZ ETS’ inclusion of forestry? Our study revealed the following findings:

Emissions pricing has driven change in New Zealand’s forestry sector

Between 2008 to 2022, New Zealand’s ETS has proven the feasibility of including forestry in an ETS at a sectoral level.

A successful cross-sector carbon market has been established in New Zealand and a significant proportion of post-1989 afforestation (new forest planting and growth) has been registered in the NZ ETS (60% as of September 2022). With broad coverage and clear liability provisions for landowners, the system has overcome key challenges to project-based forest crediting: accounting for leakage (where emissions are simply displaced, instead of actually reduced—such as deforestation moving from a protected plot of land to an unprotected plot) and permanence (where credited sequestration is reversed, such as when a protected forest sheds its stored carbon due to forest fires or illegal logging).

The research found emissions pricing influences forestry outcomes. Deforestation has generally declined with increasing emissions prices and increased when emissions prices dropped. Similarly, rising emissions prices have incentivised afforestation. This effect has been most pronounced following NZ ETS reforms in 2020. As emissions prices rose from NZ$12.7 to NZ$23.9 between 2016 and 2020, levels of net annual afforestation leaped from 2,692 hectares to 40,145 hectares (see the figure; note prices are in 2006 NZ$).

Figure: Annual area of net afforestation of post-1989 forest land and deforestation of pre-1990 forest land in New Zealand. The NZU price is shown by the black line beginning once the NZ ETS was implemented. NZU data are from Jarden and afforestation data from the New Zealand Ministry for the Environment. Refer to the paper for references.

In sum, the NZ ETS has clearly boosted forestry’s contribution toward New Zealand’s climate change targets over 2008–2020 and set the stage for further afforestation to accelerate under current policy settings.

Policy uncertainty, price, and the system’s shortcomings have dampened its impact

Despite this effect, over the first decade of operation, many factors likely limited the effectiveness of the NZ ETS in changing forestry outcomes. And recently the scheme has driven forestry removals but the focus on forests may have weakened the effect on gross emissions reductions in other sectors.

According to landowner surveys, extended periods of policy uncertainty impacted afforestation and deforestation decisions. This included reviews of the NZ ETS (in 2009 and 2011) along with international negotiations on post-2012 forestry rules. Moreover, weak emissions price signals (particularly over 2011–2016), along with an expectation that emissions prices would not recover, may have discouraged some landowners from investing in new forests. The NZ ETS had an unlimited linkage to the international Kyoto market from 2008 to mid-2015 and this markedly depressed emissions prices. For example, millions of seedlings established while emissions prices were high were mulched in 2014, when it became uneconomic to plant them after emissions prices fell due to linkage. When prices began to rise after the ETS was delinked from the international market it took several years for investors to begin to plant trees in response. And a hard price ceiling in place from 2010 through 2018 continued to constrain emissions prices after delinking occurred.

Through 2020, the NZ ETS resulted in increased afforestation but not costly emissions reductions in other sectors. Over 2008 to 2020, national gross emissions (excluding land use, land-use change and forestry) declined only 2.6%; however, this was during a period of growth in population, income and dairy production. In part, the past failure to invest in significant emissions reductions in other sectors enough to much more than offset those growth pressures is likely to be due to the same forces – weak price incentives and policy uncertainty – that affected forest investments. The option to rely heavily on forestry to help meet emissions reduction targets has also likely reduced political pressure to act in other sectors.

Forestry investment involves long time horizons, so market confidence and policy stability are crucial for harnessing the sector’s mitigation potential. Relying on blunt emissions price signals alone will not necessarily deliver desirable mitigation outcomes across all sectors.

EDF’s Chief Economist Suzi Kerr and Sandra Cortes Acosta planting trees.

Trees planted by EDF Chief Economist Suzi Kerr, three years later.

Emissions pricing for forestry has not always supported broader environmental outcomes

NZ ETS incentives have favoured exotic over indigenous forest species, because of significant difference in mitigation costs driven by planting costs and growth rates, and driven land-use changes that impact landowners and communities in both positive and negative ways. Many Māori, New Zealand’s indigenous people, have strong interests in the system because of their large land holdings, their involvement in forestry businesses and their commitment to kaitiakitanga (guardianship).

As of September 2022, 89% of the forest registered in the NZ ETS was exotic. Although all forests provide co-benefits, indigenous and mixed-species forests can support higher levels of biodiversity and may offer improved resilience to pests, natural disasters, and climate change impacts. Many stakeholders have raised concerns about the environmental, economic and cultural implications of extensive exotic afforestation, both plantation and permanent, while others emphasise that exotics produce faster climate benefits and can help supply the bioeconomy. Some see the potential for exotic forests to transition to indigenous over time.

In February 2023, Cyclone Gabrielle sent forestry slash and other woody debris across northern communities on the North Island, contributing to further devastation that prompted a ministerial inquiry. The panel reported that “forestry has lost its social licence because of its activities.” Its recommendations included restrictions on land use and forestry practices in the region as well as NZ ETS reforms.

Further reforms are needed to both the NZ ETS and other policies to shape forestry’s contribution to climate change mitigation and broader environmental outcomes.

Conclusion

The NZ ETS will not remain fit for purpose in coming decades. Under current cap and price settings, high levels of afforestation will depress emissions prices, slowing decarbonisation in non-forestry sectors unless they are also regulated in other ways. As key sectors like stationary energy and transport approach zero emissions, the demand for forestry credits in the ETS will diminish. However, forestry removals will still be required in the long term to offset unavoidable emissions outside the ETS. New Zealand’s Climate Change Commission called for changes to the treatment of forestry in the NZ ETS in its 2023 draft advice report on New Zealand’s second emissions reduction plan. In June 2023, the government initiated a policy review of the NZ ETS to consider both relative incentives for emissions reductions and forestry removals and policy settings for permanent forestry,

In Aotearoa New Zealand, emissions pricing has proven to be a powerful tool in driving afforestation and discouraging deforestation at a national scale. Enabling the NZ ETS to deliver an environmentally desirable and socially acceptable balance between gross versus net emissions reductions, plantation versus permanent forests, and exotic versus indigenous species in the longer term will require further reforms to the NZ ETS as well as land-use policy and regulation.

Catherine Leining contributed to this post in her capacity as a Policy Fellow at Motu Economic and Public Policy Research and not as a New Zealand Climate Change Commissioner.

Posted in Uncategorized / Leave a comment

Fueling Research, Advocacy, and Community: Economic Internships at the Environmental Defense Fund

By Suzi Kerr / Published: July 17, 2023

The climate crisis requires not only urgent action, underpinned by a robust framework of proven economic-driven solutions to effectively address its multifaceted challenges. Given the increasing urgency, we need economists at the forefront, conducting rigorous research and informing policy decisions. Recognizing this critical need, the Economics team at EDF is dedicated to nurturing economists who are eager to contribute to the climate fight.

The Economics team at EDF hosts exceptional interns who make significant contributions to our work. Through internships, we aim to create lasting partnerships with talented individuals who will continue to make a positive impact in the field of economics.

One notable past example is Dr. Christopher Holt, who focused his internship on addressing how wholesale electricity market design can facilitate the transition to a decarbonized energy system. His pre-doctoral fellow work was published in our Economics Discussion Paper Series in September 2020 and set a high precedent for future papers. Dr. Holt is still actively engaged in environmental economics and is working for the Institute for Policy Integrity at NYU School of Law, a close collaborator of EDF.

As we forge ahead, we are dedicated to fostering an inclusive and collaborative environment where emerging economists can flourish. This summer, we are thrilled to welcome our talented economic interns and contractors joining us to support our mission.

Meet the Summer 2023 Economics interns below!

Anna Cheyette, Economics and Policy Intern

Joining us from UC Berkeley’s Master of Public Policy program, Anna is passionate about energy and environmental policy. With a background in economics and environmental studies, her experience at the University of Chicago’s Energy and Environment Lab greatly enriches our team. Anna is primarily supporting our Economics Team’s work on methane emissions from oil and gas, advancing analytical tools, and contributing to federal and state-level advocacy efforts in North American oil and gas methane work.

Xian Hu, Contractor, Doctoral, Temp

Xian, a PhD student in the School of Economics and Management at Tsinghua University and a visiting fellow at Harvard China Project, brings a wealth of expertise in environmental policies and global economic development. She has expertise in applying empirical approaches and developing general equilibrium models to evaluate the implications of China’s energy transition and global carbon price policies for various stakeholders. Together with EDF’s Doctoral Intern in Climate Finance, Xian is supporting EDF’s work on climate finance in China, including examining the role of both public and private sources of finance, with specific attention to China’s Emissions Trading Scheme (ETS).

Emmanuella (Ella) Obeng, Doctoral Intern, Climate Finance

Ella is currently pursuing her PhD in finance at CU Boulder, specializing in the mobilization of finance for climate mitigation in developing countries, including the potential role of carbon markets. Collaborating closely with Xian Hu, Ella is assisting EDF in crafting a dialogue with external participants on climate finance and helping EDF to identify open research questions that would benefit from deeper investigation.

Max Snyder, Doctoral Economics Intern, Climate Resilience

Max, currently pursuing a PhD in environmental economics at UC Berkeley ARE, is dedicated to exploring the potential of public policy in mitigating climate risk and promoting a clean energy transition. Drawing on his valuable expertise from his previous roles at the Energy Policy Institute and the Environmental Law and Policy Center, Max is supporting EDF’s research on the Risk Rating 2.0, a recent reform to the United States’ National Flood Insurance Program. He is analyzing the effects of this reform on climate adaptation investments and access to flood insurance across diverse socioeconomic groups.

Margerie Snider, Federal Climate Innovation Graduate Intern

Margerie is a Master of Science student in the School of Environment and Sustainability at the University of Michigan, specializing in environmental policy and justice. She brings a wealth of experience in data analysis and visualization from her previous role at the Department of Justice. Her current work with Detroit’s Office of Sustainability focuses on accelerating solar development in the city. At EDF, Margerie is supporting projects at the intersection of economics and climate innovation, including the development of a Climate Vulnerability Index. She conducts research to identify drivers of vulnerability across U.S. communities and analyzes the potential role of hydrogen in a clean and equitable energy transition.

Helena Garcia, Doctoral Intern, Resilience

Joining us from the Environment, Ecology, and Energy PhD Program at UNC-Chapel Hill, Helena specializes in using machine learning methods to investigate the impact of consecutive flood events in North Carolina on economic stability and probabilities of migrating for households of different socioeconomic backgrounds. At EDF, she is helping to explore flood insurance penetration and differential claims treatment using National Flood Insurance Program (NFIP) data.

Brigitte Castañeda, Contractor, Doctoral, Temp

Brigitte, a Ph.D. student in Economics at the Universidad de los Andes in Bogotá, Colombia, has a strong background in sustainable finance, the energy transition and climate policies. She is currently examining the green labor market in developing countries and analyzing the effects of a carbon tax. Brigitte is supporting EDF’s Just Transition work from the developing country perspective. Her role involves understanding lessons learned and developing policy options to protect workers, communities, and maximize employment benefits for disadvantaged individuals during transitions towards an inclusive and just transition.

Minwoo Hyun, Doctoral Intern, Just Transition

Minwoo, a Ph.D. student in Economics at the University of California, Santa Barbara, has a comprehensive background in chemical engineering, environmental policy, air pollution impacts, and power sector decarbonization. His current research explores the local fiscal conditions, labor reallocation costs of coal decline, crime and health impacts in coal-rich communities, and welfare consequences of pollution alerts. Minwoo supports EDF’s Just Transition work from the developed country perspective, focusing primarily on the United States, to analyze lessons learned from previous experiences of workers and communities during transitions. His goal is to identify policy options that promote an inclusive and just transition, maximizing employment benefits for disadvantaged workers.

Shiv Goel, Project Management Intern

Shiv, a sophomore at Cornell University studying Environment & Sustainability and Information Science, brings a strong interest in networks, organizational behavior, sustainable markets, and ocean conservation to his role at EDF. Shiv is helping to integrate best practices into our team’s work plans and optimize our process for the Econ Newsletter by conducting data analysis and collaborating closely with the communications team to provide actionable insights for improving engagement.

Building North-South cooperation to fight the ‘tragedies’ of climate change

By Suzi Kerr / Published: March 29, 2021

This post draws from a chapter for a book I wrote in 2020: “Overcoming the tragedy of distance – cooperating with our friends’ friends” in Living with the Climate Crisis ed. Tom Doig. Bridget Williams Books, Wellington, New Zealand

I believe that finding ways to work more intensively and effectively with people with very different resources, cultures and life experiences is critical to rapid global decarbonization.

For me, the unprecedented challenge from climate change is that most mitigation has to occur in countries with fewer resources. Key high-emitting countries such as India, China, Indonesia and Brazil, as well as smaller countries such as Laos, Ethiopia, and Peru are all projected, in business as usual forecasts, to have rising emissions as they develop.

These countries have strongly competing priorities, as they also need to address poverty or resolve internal conflict. They are unlikely to mitigate greenhouse-gases fast enough without help. Yet, to stabilize the climate, those countries and all others must reduce their emissions to net zero and the faster the better.

Models by EDF(2019, pp. 200-232) and IETA(2019) suggest that we could double the amount of global carbon dioxide mitigation to 2035 with no extra cost if richer countries can support emerging and developing countries effectively, but that’s hard. ‘International trading’ of mitigation, where richer countries, or their companies, support developing countries to reduce their greenhouse gas emissions, has long been a goal, but it has not yet lived up to its promise.

We will all benefit if we can resolve this together. I also think those of us with more resources owe it to poorer countries to help; they are the most vulnerable to climate change, to which they have contributed little. It seems deeply unfair to also expect them to bear the full burden of their transition to net-zero.

Tragedies of climate change

Humans however often struggle with cooperating and sharing with people who are far away from them, in either a physical or social sense. I struggle to empathize with people in India whom I will never meet, but who will need support when they replace coal-fired power plants with renewables as India moves toward net-zero emissions. I don’t think I’m alone in this and I imagine they feel the same about people like me who are not taking rapid action on climate change even when we can afford it.

Is our fundamental problem in mobilizing resources to support developing country decarbonization this “tragedy of distance?”

“Tragedies” are situations where we humans are brought down by our own flaws. These tragedies make climate change particularly challenging to address.

The “tragedy of the commons” suggests that if we can’t exclude people from use of a common resource, we are doomed to destroy it through overuse. For example, the fish stock in a particular area isn’t destroyed because people can’t see what is happening, but because if others are going to over-fish, whatever one individual does, it is in each individual’s personal interest to go fishing while the fish are still there. They feel they can’t protect it. That’s a self-fulfilling prophecy.

The “tragedy of the horizon” suggests that individual and collective myopia and selfishness lead us to take actions now although they will cause our future selves and future generations to suffer. The phrase was coined by Mark Carney (Former Governor, Bank of England) for climate change, but another classic example is most countries’ inability to invest enough of the wealth that they extract from non-renewable minerals, like oil, to sustain their citizens’ well-being in the future. Again, we can see this coming but struggle to avoid it.

These tragedies are not inevitable. Some communities solve them impressively (e.g., the many examples from the work of Nobel Prize winner Elinor Ostrom and her colleagues, or Norway’s Sovereign Wealth Fund). Others find partial solutions. New Zealand avoids the worst problems of overfishing by limiting catches through the Quota Management System, a system which, though imperfect, has now lasted for more than thirty years. Humans also have relatively good ‘institutions’ for making intergenerational decisions. Families tend to have strong bonds for at least a couple of generations. We may not make “efficient” decisions for our own future selves and our descendants, but we do, generally, care.

Climate change is an issue where all tragedies—of distance, of the commons, and of the horizon—are fully engaged. Climate change is global and cumulative, with extremely long-term, long-lived impacts. Although it is now clear that people alive today are already experiencing the impacts, the major benefits from our mitigation actions today will be experienced not by older people like me, but by our children and grandchildren.

We have worked hard for nearly thirty years to build institutions at the international, national and local level to coordinate mitigation efforts. We need to keep doing this. Despite our lack of obvious success so far, we have made considerable progress. However, these approaches depend very much on a hierarchical approach. That approach is appealingly elegant and logical in responding to a global problem, and is a critical part of the solution, but it’s not working fast enough. And having only one coherent institutional approach is inherently fragile.

We need both coordination and cooperation

United Nations climate agreements try to replicate the success of economic institutions in managing human activity. However, in contrast to institutions that aim to address climate change, many international economic institutions, such as those that govern commerce and banking are essentially addressing a coordination problem. Their success is not easily replicated when dealing with a global cooperation problem like climate change.

Maybe the approaches of more traditional and Indigenous societies have something to offer us as a complement. These societies have broad networks of relationships that extend into the natural world and rely on these and shared belief systems rather than institutions to manage goals and conflicting interests. Traditional ways of thinking of Māori, the Indigenous people of New Zealand, contrast strongly with the hierarchical assumptions about how humans relate to each other and the natural world, “the Great Chain of Being,” common in much contemporary Western thought.

Can we harness shared belief systems and existing North-South relationship networks and reduce the tragedy of distance? Could that help us build deep collaborations among small groups of countries to support the large-scale transfers of resources needed for efficient global climate action?

Is it better to think about transfers to support mitigation in developing countries as primarily about establishing networks of relational contracts, and the strong communication and trust that supports them, rather than centralized carbon commodity trading systems where all have to trust one system?

Posted in Climate Change, emissions, International / Leave a comment

Four reasons why China’s 2060 net-zero goal is so important

By Suzi Kerr / Published: October 16, 2020

A shift in ambition, narrative, global cooperation and likely support for mitigation in least-developed countries

Shanghai Bund skyline landmark ,Ecological energy renewable solar panel plant

The announcement by President Xi Jinping at the UN General Assembly last month makes me optimistic.

First, on its own, achievement of this goal will contribute to a reduction in expected future temperature by 0.2 to 0.3 degrees.

Second, having a clear and ambitious end goal will shift the narrative within China from incremental slowing of emissions growth and reductions in some sectors to a focus on how emissions can be eliminated entirely (or close to it).

A vision of transformation toward a low-emissions China will complement the vision of a “Beautiful China.” Pollution control efforts are highly complementary with climate mitigation actions – e.g. moving to renewable energy from fossil fuels, restoring ecosystems – and can dramatically improve the wellbeing of the Chinese people. A clear and attractive vision can mobilize a wider community to seek and implement the multitude of small and large changes needed. It will increase confidence in the future of China’s new national ETS, the strengthening of which will almost inevitably need to be part of China’s strategy. That confidence will make the ETS more effective by generating realistic prices and greater certainty for investors.

Third, it changes the climate cooperation ‘game’, significantly.

Economists think of climate cooperation as a game because each player’s (in this case country’s) decisions depends on what they think other players/countries will do – like chess, or rugby. China’s latest ‘move’ responds to others’ earlier moves and anticipates and will influence later ones. Global cooperation on climate change is hard, because of temptations to free-ride. We can use game theory to explore ways to improve humanity’s odds of a good outcome. We know that humans can sometimes cooperate when it’s a repeated ‘game’ – we get many chances to try to cooperate, observe others, reward or sanction and then try again.

And it’s not a binary outcome where we either win or lose. Any level of cooperation is better than nothing. It might be optimal to aim for no more than 1.5 degrees above pre-industrial temperatures but even if we don’t achieve that, 2 degrees would be better than 2.5 degrees.

Cooperation is easier when some players take leadership, and that’s what China has done. They are not the first emerging economy to set a net-zero target (Bhutan, Chile, Costa Rica, Fiji, the Marshall Islands and South Africa are examples of others), but China’s size makes its announcement a game changer in several ways. The Chinese have shifted the focal point for emerging country contributions to a more ambitious level.

In addition, the rewards to other countries from helping to encourage and sustain China’s efforts rise – if they act in ways that lead China to draw back from this commitment there is more to lose. The costs of mitigation will fall as China learns and shares its new knowledge and technology. Finally, there is less risk that efforts to lower emissions in one country will lead to movement of high emitting-activity to China thereby having no global impact.

Fourth, it means that China, a really large player, will now need to engage even more seriously in helping less developed countries accelerate their mitigation.

Reaching net-zero will be much easier for the Chinese if they can buy high-quality internationally transferable mitigation outcomes (new United Nations Paris Agreement language for international credits). Their engagement in this market could firm up the rules and, critically, mobilize the skills and financial and technical resources that the poorer countries who could credibly sell such credits will need to embark on their own transformational emission reductions journeys.

As China mitigates more aggressively domestically it will develop technology and know-how that it can also export, as it has already on a smaller scale. Some exports will be particularly useful for countries where lower-cost Chinese technology, such as electric buses or cars might be more attractive than expensive European or North American ones. China’s Belt and Road Initiative offers a critical mechanism that can be turned to this purpose. If China can help poor countries develop strong mitigation policies, through strong South-South cooperation, they could transform global cooperation further and strengthen markets for this technology. This would make me even more optimistic.

Posted in china, International / Leave a comment

Canaries in the mine of climate cooperation

By Suzi Kerr / Published: August 9, 2020

Strong emissions trading system prices encourage and facilitate climate action but also reflect private sector confidence in governments’ commitments to long-term transformation.

Every evening in my Brooklyn neighborhood we come out onto our stoops with our children, dogs, bells, horns and pots (my contribution – inspired by the Colombian cacerolazos I witnessed protesting – non-violently, though I can’t say quietly – in Bogotá). We make a big noise to thank and celebrate the generosity and selflessness of the medical personnel and essential workers who are keeping life going during the crisis. Their example is an inspiration to us all and reminds us that humans are at essence a cooperative species. This same spirit of cooperation, backed up by strong social and political institutions including effective emissions trading systems, can help protect our climate in these difficult times.

Our focus now must be on flattening the curve, caring for the sick and vulnerable, and then getting back to work. But as we recover from this crisis, we need to do so in a way that helps us confront the next one: global climate change. Lawmakers in many countries are beginning to pivot from relief to recovery, focusing on the longer-term work of getting the economy back on track. We need that economy to have low greenhouse gas emissions.

No one should take false hope from the temporary decline in greenhouse gas emissions we have seen recently. In the short term, when economic activity falls, pollution falls. During the financial crisis of 2007-9 global greenhouse gas emissions did drop, slightly and briefly. The current economic crisis is deeper but will also pass and when it does, so too will the dip in climate pollution.

To make declines in emissions permanent, we need to seize this moment of fundamental change to ensure effective, efficient, resilient policies to lock in economic and behavioral shifts that do contribute to a transition to a low emission future where all people thrive.

One key element of the policy mix in an increasing number of countries and jurisdictions is an Emissions Trading System. These systems limit greenhouse gas emissions while allowing flexibility around where and when emissions occur. They provide price signals to help guide clean investment and other climate actions. The limit, or cap, controls emissions; the marginal cost of achieving that limit, which depends on technology and other climate policies among other things, drives the ETS price.

What drives emission prices?

Those ETS price signals have been affected by COVID and its economic consequences. The climate challenge is no less urgent, but is the private sector feeling less pressure from governments to act? Are the canaries who sing in the healthy cooperation mine falling quiet?

Initially both the European Union and New Zealand ETS prices dropped dramatically, but they have since clawed back much of their initial losses. Will they recover and even move to levels consistent with modeled estimates of prices required to stabilize the global at less than two degrees above pre-industrial levels? A recent survey by IETA suggests not. It finds private sector expectations of emissions prices over the next 10 years have fallen relative to expectations a year ago by 12% (EU and the Western Climate Initiative (WCI) – California and Quebec), 27% (Regional Greenhouse Gas initiative), and 35 – 38% (New Zealand and Mexico). What does this mean?

During a recession, when capital is scarce, because ETS units are assets their price will also tend to fall in a similar way to other assets. As the financial sector recovers, asset prices should also recover. These price adjustments, like those driven by new information about mitigation technology provide useful signals. However, general economic factors and new information about the true costs of achieving our climate goals are not the only drivers of these changes in prices.

Because an emissions trading system is a market created by regulation, the price in each ETS is deeply dependent on expectations about the future stringency of that regulation. Because allowances in emissions trading systems are ‘bankable’ (they can be saved for future use by those who emit less and hence surrender fewer allowances today), as long as there is a ‘bank’ of units available their price depends on what people expect demand and supply will be in future, not just on current scarcity. That makes ETS prices a barometer of both the stringency of policy that politicians are willing to implement—and also of the private sector’s expectations about how stringent policy is likely to be over the long term.

In 2008 there was some international optimism about climate action. The Kyoto Protocol had come into force in 2005; obligations began in 2008. Climate policies were gaining traction in many countries. The EU emissions trading system started its second phase with a healthy price, and New Zealand’s ETS kicked off with similar prices. These reflected that optimism. In the US, the Regional Greenhouse Gas Initiative held its first auction in 2008, and California was moving forward after passing the ambitious Global Warming Solutions Act in 2006. But by December 2009, the price of carbon allowances in the EU emissions trading system had fallen, partly as a result of economic contraction, and more importantly things were beginning to fall apart internationally starting with an unsuccessful U.N. Climate Summit in Copenhagen. By the end of 2012 emission prices had largely collapsed (though prices in the California ETS, launched one year later, were protected by a price floor). Recession was not the only driver, and it’s always hard to disentangle various causes, but the financial crisis did not help.

After the financial crisis and recession, the private sector clearly did not believe that policy makers would impose stringent caps in emissions trading systems; this kept prices low. Optimism around government-led climate action had evaporated. Emission prices, and the signals they provide to investors and companies, only really recovered after 2016 in New Zealand and 2018 in Europe. We can’t wait that long again.

How we can protect climate action from shocks like COVID

Recessions don’t have to lead us to fall even further behind in addressing climate change. The way we manage ETS can help protect the continuity of climate efforts and returns on clean investments against short-term loss of confidence in governments’ commitments to climate cooperation. Possibly the smaller shifts in expectations of prices in the EU and in California and Quebec reflect their more mature institutions and price management approaches—the Market Stability Reserve in the EU and the auction price floor in California and Quebec. Market players have more confidence that the institutions will manage short-term shocks. Critically though, they also have more confidence—though still not enough—that these jurisdictions have a sustained commitment to real long-term change.

When ETS participants believe in society’s commitment to long-term, transformational change to low emissions, ETS prices will reflect only the cost of achieving that.

Recent reductions have come at an enormous cost to human wellbeing. This is not what a transition to a low-emissions economy looks like. The good news: there is still time to stop climate change in ways that allow people and nature to prosper together, and human well-being to burgeon. But the window for such action is rapidly closing. We need a positive and attractive transformation, not economic crises that cause distress and bring only temporary reductions.

We can’t avoid the worst impacts of climate change unless we transform our energy and food systems—changing not only our production but also our culture and the stories we tell ourselves about how we can flourish in balance with our environment. This requires a shift in the fundamental assumptions of all key actors (politicians, business people, officials) and a change in institutions (public and private—e.g. banks, regulations, education, supply chains) so they support of a new set of clean investments and activities and discourage emissions-intensive activities. This won’t happen through forced change. It needs leadership and steady effort.

Once the immediate health crisis from COVID abates we don’t want policy makers (and the public) to lose sight of climate policy and action and focus only on short-term economic concerns. This is what we experienced after 2009 when unemployment levels stayed high long after the global recession passed. We need to find a way to address these critical economic needs while also moving even more aggressively towards a strong, longer-term economic future that offers high wellbeing in a stable climate.

When ETS market players believe we are really on this track, ETS prices will reflect their prediction of the costs of achieving global climate goals—not their assessment of political will. Maybe we are closer than we think. Prices in the EU-ETS recently passed €30 for the first time since 2006 (briefly before falling a little with bad economic news) and NZ-ETS prices have reached their highest level ever around NZ$34 despite the announced closure of a major emitter. I’m optimistic. The canaries are singing again. We need to help them to sing even louder.

Posted in Economics, emissions / Leave a comment

What a small country’s successes and mistakes can teach us about emission pricing

By Suzi Kerr / Published: January 21, 2020

I’m from Aotearoa, New Zealand, and I really love its land and people, but I am fully aware that from a global perspective it appears pretty insignificant – that’s actually one of its charms. But being small doesn’t mean you can’t make big contributions including toward stabilizing the climate. This recently published article highlights some lessons New Zealand’s experience with emissions trading can offer other Emissions Trading System (ETS) designers at a time when effective climate action is ever more urgent.

Talking intensively to ETS practitioners and experts around the globe about their diverse choices and the reasons why they made them has made me acutely aware of the need to tailor every ETS to local conditions. In a complex, heterogeneous world facing an existential crisis, diversity in climate policy design makes us stronger and frankly, improves the odds that the young people we love will live in a world where they can thrive.

New Zealand created the second national emissions trading system in 2008, and the system established a number of firsts, some of which have been repeated widely, like output-based allocation of allowances to combat leakage risk. Others offer cautionary tales, like linking a small country’s emissions trading market to a large emissions trading market over which you have little control.

Simplicity helps make an ETS more manageable and effective

New Zealand’s small scale makes simplicity a key virtue. Our regulators are well educated, but there just aren’t many of them. This simplicity would also be a strength in a country with capability constraints, or where corruption is a problem and simplicity naturally increases transparency and reduces opportunities for manipulation.

Regulating fossil-fuel production and imports (that inevitably lead to predictable amounts of emissions – in the absence of effective carbon capture and storage) at the first point of commercialization, another first, made monitoring simple and, in the New Zealand context, minimized the number of regulated agents needed to cover almost 100% coverage of energy-related emissions including all domestic transport.

An ETS needs to match a country’s profile and culture

New Zealand’s small scale and our unusual emissions profile (around half our emissions are biological emissions from agriculture – cow burps and other unmentionables – and lots of land ripe for reforestation) led New Zealand to aim for an ‘all sources – all sectors’ coverage of emission pricing – and this worked well for our politics. In New Zealand ‘fairness’ is a critical cultural value. New Zealand’s ETS covers energy, transportation and industrial process emissions but also deforestation, reforestation, and fugitive emissions from fossil fuel production and landfill waste management. We are still working out how to cover those challenging cows in a way that allows rural communities to thrive – with the current intention being to regulate with emission pricing at the farm level starting in 2025.

The cultural value of fairness also led to a strong linkage between the motivations for free allocation and th methods chosen. Sectors and companies (sometimes pretty much the same thing in NZ) who lobbied for free allocation had to make a logical case that was publicly scrutinized. Lump-sum allocations were given as compensation to those who were losing the value of stranded assets – e.g. owners of pre-1990 forests, including Māori Iwi (tribes) who lost some of the value of forests they had recently received in Treaty settlements when deforestation began to attract carbon liabilities. Output-based allocation is still provided for industrial activities that are emissions intensive and trade exposed and therefore face a risk of leakage of these economic activities to other countries where climate policy is weaker. By effectively subsidizing the activities that might move, output-based allocation reduces that risk.

Political instability can negatively impact markets

Not all experiences have been positive however. As the report highlights, New Zealand’s ETS has suffered from a lack of policy stability and hence lack of emission price stability. This was partly because our emissions price was largely determined by international markets (from 2008 to mid-2015, New Zealand companies could buy and surrender unlimited amounts of international Kyoto units such as those from the Clean Development Mechanism and Joint Implementation). New Zealand’s emission prices bobbed like a cork on the international market. Another critical flaw: not embedding our ETS firmly in a long-term vision for low-emissions transformation and within a wider non-political institutional framework that gives predictability of purpose in the inevitable ETS evolutionary process.

The ability to guide, enable and incentivize dynamic efficiency (e.g. efficient low-emissions investment) has always been a key argument for emissions pricing, but, as a profession we economists have paid too little attention to the political and cultural stability that is critical to enable this. Policy makers need to regularly adapt and update policies. That process of policy evolution can help guide us efficiently through a low-emissions transformation, or, in the face of powerful vested interests and strong temptations to globally free-ride, it can open up repeated opportunities to undermine ambition.

New Zealand is now engaged in the next step of its ETS evolution, learning from others and through critical reflection on our own positive and negative experiences, but continuing to innovate and tailor ETS solutions to our own unusual circumstances. The direct impact on global emissions will be small whatever New Zealand does with its ETS, but the lessons and the example that even small yet significant countries can act and find new solutions, will hopefully help and inspire others.

Kia kaha Aotearoa

Posted in Cap and Trade, International, Markets 101 / Leave a comment