Emissions Trading Scheme basics

The NZ Emissions Trading Scheme (ETS) is part of the Government’s primary response to global climate change.

‘Emissions trading’ is a financial market-based approach for reducing emissions of greenhouse gases. Emission units – sometimes called ‘carbon credits’ – are traded between participants in the scheme.

The scheme introduces a price on greenhouse gas emissions to provide an incentive for people to reduce those emissions and plant forests to absorb carbon dioxide.

Emissions trading provides flexibility in how participants in the scheme comply with their obligations, enabling them to choose the least-cost way to reduce their emissions.

The New Zealand scheme covers emissions of the following six greenhouse gases: carbon dioxide (CO₂), methane (CH4), nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), and sulphur hexafluoride (SF6). These are the greenhouse gases covered by the Kyoto Protocol to which New Zealand is a signatory.

The emissions trading scheme has been designed to support efforts to reduce greenhouse gas emissions while maintaining economic productivity. The emissions trading scheme:

• will include all sectors of the economy and all greenhouse gases by 2015
• is internationally linked and reflects international climate change rules
• uses self-assessment for monitoring, reporting and verifying emissions produced by participants.

The Government has made a number of amendments to the emissions trading scheme passed into law in September 2008. One of the changes is to introduce a transition phase to the scheme between 1 July 2010 and 31 December 2012. During this period, participants will be able to buy emission units from the Government for a fixed price of $25. In addition, participants in the energy, industrial and liquid fossil fuel sectors will have to surrender only one emission unit for every two tonnes of emissions they produce.

For more information on the Government’s changes to the emissions trading scheme see questions and answers about the amendment Act.

An emission unit is a unit of trade within the emissions trading scheme.

The primary unit of trade in the New Zealand Emissions Trading Scheme is a New Zealand unit (NZU) issued by the Crown. Participants are required to surrender NZUs to the Crown to meet their obligations under the scheme. During the transition phase (July 2010 to December 2012) one NZU will be required to cover every two metric tonnes of greenhouse gas emissions in a calendar year. After this, one emission unit will be equal to one tonne of emissions. Participants can also surrender a range of ‘Kyoto units’ which they can buy overseas.

After the transition phase, the price of an NZU will be determined in the trading market and will tend to match the international price of emission units. Participants can sell NZUs internationally by exchanging them for Kyoto units, within the limits on international sales set by the Kyoto Protocol.

For more information about emission units see emissions units.

The Government has included as many industry sectors as possible in the emissions trading scheme to make sure all sectors are treated equally. Also, the broader the coverage of the scheme, the more opportunities there are to reduce emissions at the least cost.

The emissions trading scheme covers the following sectors of the economy: forestry, transport fuels, electricity production, industrial processes, synthetic gases, agriculture and waste.

The Climate Change Response Act 2002 specifies the activities that are automatically included in the emissions trading scheme for each of the sectors above. People carrying out these activities are required to participate in the scheme.

The Act also specifies activities that are optional under the emissions trading scheme. People carrying out these activities can choose to participate in the scheme.

Most participants are required to meet their obligations under the scheme by surrendering emission units. Surrendering a unit means it cannot be used again, for example, it cannot be given to another participant.

Some participants, such as those with forests planted after 1989, are able to earn emission units for carbon dioxide stored or removed from the atmosphere by their activities.

The participant is not necessarily the business at the actual point where emissions are produced. For example, a coal producer would be required to surrender units for the coal it sells, even though the actual emissions will occur when the coal is burned.

Alongside those who are required to participate in the scheme and those who can opt in, other people may also hold and trade emission units. These people are commonly referred to as ‘secondary market traders’.

Businesses participate in the emissions trading scheme in different ways.

• Some have a legal obligation to acquire and surrender emission units to cover their direct greenhouse gas emissions or the emissions associated with their products. These participants are generally ‘upstream’ operators, for example transport fuel producers or importers bringing in products to New Zealand.
• Some have the choice to apply to opt in to the scheme if they carry out a relevant activity.
• Some receive free emission units that can be used to meet their own obligations or to sell to other firms, for example landowners with forests planted before1990.
• Some do not have to take part in the emissions trading scheme, but trade emission units in the same way that stockbrokers or real estate agents trade in their respective markets. These are secondary market traders. They may have specialist expertise in linking those who can reduce their emissions and have spare emission units with those wishing to buy these units.

Participants are required to:

• monitor, record and report activities that produce or remove greenhouse gas emissions
• surrender to the Government emission units to cover emissions associated with their activities each year.

Secondary market traders, such as brokers, can also hold and trade emission units, but do not have to monitor and report emissions and are not required to surrender emission units. They can hold and trade emission units to take advantage of opportunities in the financial market.

The emissions trading scheme can be explained by using a simple example.

• Firm A is an oil company. It needs to buy emission units to cover the greenhouse gas emissions it is responsible for.
• Firm B is a large forestry company that receives emission units for land it is planting in forests. It is also cutting down some trees, leading to emissions for which it has to surrender emission units. Initially, Firm B has a shortfall of units but, as the new forest matures over time, it will have spare units it can sell.
• Firm C is a major industrial user of electricity for which it has to surrender emission units. To help Firm C adapt to these higher costs, the Government gives Firm C a free allocation of emission units, which Firm C can sell to offset its increased electricity costs.

Under the emissions trading scheme, Firm A and Firm B both buy Firm C’s units in the short term to cover their emissions. Because it now has to pay higher energy prices, Firm C finds it is cheaper to invest in energy efficiency.

Over time, as its forest matures, Firm B has spare units available and sells them to Firm A.

This example is also represented in a diagram.

Some participants are eligible to receive a free allocation of emission units from the Government to cover some of their emissions. To find out more about allocation, read Emissions trading bulletin 12.

During the transition phase (July 2010 to December 2012), participants will also be able to buy emission units from the Government for NZ$25 each.

In addition, participants and secondary market traders can buy emission units from the following sources.

• Approved overseas sources
• Another participant or secondary market trader, either directly or by trading through a broker or trading exchange

An electronic register records who holds emission units and is like a share registry. It is called the New Zealand Emission Unit Register (NZEUR). It records:

• who holds emission units and the number of units they hold
• transfers of emission units between holders both within the NZEUR and between international unit registers
• emission units surrendered by participants to meet their obligations under the emissions trading scheme.

As with a share registry, the NZEUR does not record information about the price or financial value of emission unit trades, nor does it provide a mechanism for exchanging cash for units traded.

The Ministry of Economic Development administers the NZEUR.

Sectors will be introduced to the emissions trading scheme gradually over a period of seven years, starting in 2008.

The transport fuels, electricity production, industrial processes and waste sectors will be able to start reporting their greenhouse gas emissions voluntarily two years before their obligations to surrender emission units begin, and are required to report their emissions one year before. The agriculture sector can voluntarily report its emissions four years before its obligations to surrender emission units begin and is required to do so three years before.

Timeframe for sectors to enter the emissions trading scheme

The Government will provide financial assistance for some sectors in the form of free emission units. This will help businesses make the necessary changes to reduce their greenhouse gas emissions and provide a gradual period of adjustment to emissions pricing.

The transition period from July 2010 to December 2012 will substantially lower the cost for participants. During this period participants in the scheme will be able to buy emission units from the Government for a fixed price of NZ$25. In addition, participants in the energy, industrial and liquid fossil fuel sectors will have to surrender only one emission unit for every two tonnes of emissions they produce. This means that participants in these sectors will face a price of carbon that is no higher than NZ$12.50 per tonne.

The emissions trading scheme creates new incentives for participants to reduce their greenhouse gas emissions or to finance emission reductions by other firms. This promotes innovation in energy efficiency and other emission management practices, as well as developing new technology.

The Ministry of Economic Development manages the day-to-day running of the emissions trading scheme. It is the main compliance and enforcement agency, responsible for verifying that participants are complying with the scheme. It also runs the New Zealand Emission Unit Register.

The Ministry for the Environment administers the Climate Change Response Act, which established the emissions trading scheme. It is also responsible for developing emission unit allocation plans and regulations under the Act, except for those relating to the forestry sector, which are managed by the Ministry of Agriculture and Forestry.