Tuesday, July 25, 2023

Eric Crampton: With friends like these, does the Emissions Trading Scheme need enemies?

There is no chance it is deliberate. Deliberateness would require more coordination than government is able to manage these days.

But if the government wanted to undermine the Emissions Trading Scheme, would policy over the past year have looked much different?

The government has made too many decisions that weaken the Scheme, that encourage emitters to ignore the price signals it sends, or that throw the market into chaos.

Not too long ago, if your company were deciding whether to replace a coal boiler with one running on electricity, or biomass, it could just look to the bottom line. Look at the lifetime running costs for different kinds of equipment, factor in carbon prices, and make a call.

That call would often be to shift away from coal.

Burning a tonne of coal creates more than a tonne and a half of carbon dioxide emissions that must be covered through the ETS. Even at $50 per carbon credit, emissions permits are expensive relative to the underlying cost of coal.

By late 2022, coal use had fallen to the lowest level in three decades.

But today, would you be doing right by your shareholders if you made that call without calling on the government first?

In May, the government provided $140 million to NZ Steel for an electric arc furnace. It was hardly the first subsidy announcement from the Government Investment in Decarbonising Industry (GIDI) fund. There may even have been defensible grounds for the subsidy.

But it was very large and set an example.

One week later, Radio New Zealand reported that Fonterra wanted $100 million in government assistance for its own decarbonisation investments.

This week, the government pledged up to $90 million in co-funding for Fonterra’s $790m in planned investment.

Fonterra had already been making laudable progress in converting away from coal boilers. In 2019, it committed to stop installing new coal boilers; in 2021, it announced it would be ending coal use by 2037.

But with the example that has been set, Fonterra would not have been doing right by its shareholders if it hadn’t made the request.

Even if the subsidy means a faster pace for Fonterra’s decarbonisation, it is difficult for these kinds of subsidies to help. If carbon prices already justified the investment, the subsidy would not be needed. And if carbon prices did not justify the investment, then the subsidy would be a bad idea.

Previously, we could expect companies to invest in decarbonisation when carbon prices meant that those investments made sense.

Now, it would almost be foolish to proceed with any large investment in decarbonisation without first seeking government assistance. Even if the project would be worthwhile on its own merits, why not take a punt that someone else will pay for it?

The government is muting the signals sent by carbon prices in favour of signals sent by officials about which projects might draw subsidies.

At the same time, the government has been skewing carbon price signals more directly.

The Zero Carbon Act set the country with a target of net zero emissions by 2050. The Emissions Trading Scheme was designed to target net emissions.

But reviews of the role of carbon forestry, and of the role of carbon removals as compared to gross emissions reductions, have driven deep uncertainty about the property rights that underlie the scheme.

Earlier this month, carbon prices dropped from about $55 per tonne to $35 per tonne. Regulatory changes could particularly hit carbon credits generated by growing trees.

In CarbonNews, one carbon market participant reported, “We’ve been speaking to some very angry forestry people and some very confused emitters. Foresters don’t know if they can plant and emitters don’t know if they can use those units to offset after 2025.”

Carbon prices have since rebounded, but not because forestry issues have been resolved.

The High Court last week told the government to look back over last December’s decisions about ETS auction settings. Those decisions had resulted in the carbon price falling by almost 60%. They had also resulted in consecutive auctions of government-issued carbon credits this year not meeting the government’s reserve price.

And the next carbon credit auction will happen before the government is due to respond to the High Court.

If the government had wished to throw sand into the ETS’s gears, both to make the ETS work less well and to make everyone less responsive to the signals carbon prices send, it could hardly have done a better job.

A sufficiently advanced incompetence is indistinguishable from malice, but the former still seems the more likely explanation.

Let’s hope the government’s response to the High Court, and the final review on forestry, shows a bit more competence. Getting this right matters.

Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE

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