Friday, May 23, 2008

Climate change: how big is the cap?

How does emissions trading work? The textbook answer is that the government sets a cap on emissions, issues that many permits, then demands that polluters return enough to cover their emissions. Polluters trade permits amongst themselves to determine who gets the right to pollute within the cap. Pared down to the basics like this, one thing is immediately apparent: every ton of CO2-equivalent requires a permit, so the environmental effectiveness of the scheme is determined solely by the size of the cap. The lower the cap, the less carbon dioxide is emitted, and the greater the financial incentive to invest in efficiencies or simply stop polluting entirely.

The key question for New Zealand's ETS then is "how big is the cap"? In its first phase, the EU ETS made the mistake of overallocating, distributing so many permits that polluters had no need to reduce emissions and no incentive to do so. We don't want to make the same mistake as them.

Fortunately, there's a clue in the Budget. The Notes to the Forecast Financial Statements includes a note on provisions for ETS credits. This is basically a way of tracking the expenses and revenue as the government allocates credits (the loss of an asset, and hence an expense) and then has them returned (the gain of an asset, and hence revenue; I'm not sure where actual revenue from the sale of credits is booked or forecast). Divide those numbers by Treasury's current carbon price (NZ$22.18/ton, according to their latest estimate) and you get an idea of how many carbon credits the government plans to allocate. Using the "expenses" line (which is the value of credits allocated), the numbers come out like this:

  • 2009: 33.77 MTCO2-e
  • 2010: 16.05 MTCO2-e
  • 2011: 23.58 MTCO2-e
  • 2012: 23.58 MTCO2-e

For a total of ~100 MTCO2-e over CP1.

The next question is "how does this compare with demand"? Different sectors enter the ETS at different times, but the government's Net Position Report 2008: Projected balance of emissions units during the first commitment period of the Kyoto Protocol [PDF] has some details on projected emissions. Here's some rough figures:

  • Forestry: The government plans to allocate 21 MTCO2-e to cover deforestation for the whole 5 years, but the latest net position only expects the forestry sector to use 17 MTCO2-e (it can sell the rest for profit).
  • Energy (excluding transport): This enters the ETS in 2010. Projected emissions are on p42, and average 18.32 MTCO2-e a year over the period. However, that includes around 5 MTCO2-e / year of "other fuel combustion" (agricultural and forestry machinery) and fugitive emissions. The former will be included from 2011 under liquid fossil fuels, while the latter doesn't seem to be included at all. Call it 13.32 MTCO2-e a year for a nice, round number, for a total demand of ~40 MTCO2-e.
  • Industry: This enters the ETS in 2010, and projected emissions average 4.3 MTCO2-e / yr. So that's ~13 MTCO2-e over the whole period.
  • Liquid fossil fuels: This now enters the ETS in 2011, and projected emissions are 14.2 MTCO2-e / year. To that we need to add the 3.2 MTCO2-e / year of "other fuel combustion", for a total demand of ~35 MTCO2-e.

So total demand will be ~105 MTCO2-e. Which means someone is going to come up short and either have to reduce their emissions, or buy in credits from overseas to cover them. Which they do doesn't matter - a ton of carbon is a ton of carbon, and the atmosphere doesn't care where it comes from (or rather, doesn't come from); the important thing is that we're not overallocating, and that emitters are going to have to do something in order to stay within the cap.