CCLF Cluster B Meeting 6

Monday 7 April 2008, 2pm
Deloitte

Adjustment costs

‘Scenario 11: Extension to: A stylised look at transition costs associated with the ETS’ – Infometrics

This paper was in response to a request from members to explore the effect of a nominal exchange rate depreciation to offset the real exchange rate.

While some thought this change would have a large effect, the model suggests this is not the case. These findings assume no large-scale macroeconomic effects, for example from loss of business confidence.

‘General Equilibrium Modelling of a Carbon Price:  Further Discussion Pursuant to
A General Equilibrium Analysis of Options for Meeting New Zealand’s International Emissions Obligations’ – Infometrics

This paper draws together previous analysis and in particular shows the relative effects of different carbon prices, the effect of the participation of other countries in Kyoto and the effects of tightening New Zealand’s national commitment.  The paper also discusses the scenarios run for the New Zealand Business Roundtable which assumed that non-ETS climate change regulation such as the ban on thermal generation will generate sufficient uncertainty and variation in effective carbon prices in the economy that it will lead to macroeconomic effects.  These results essentially allow us to compare the possible effect of non-ETS regulation with the likely effects of the ETS.

It was asked whether technological change would alter the relationship between cost and carbon price.  This is not a question the modelling could address because technology change is not endogenous.  This led to discussion of the drivers of technology change and some discussion of the relationship between voluntary and official carbon markets.

In response to a question it was noted that halving our Kyoto allocation would not be exactly equivalent to doubling our carbon price. The total cost of a tighter allocation would likely be proportionally higher as firms would need to buy credits offshore. The group suggested this point should be made clear to Adrian Macey.

Some commented that they had insufficient time to process the model results and paper. It is possible to ask Adolf questions in advance of the next CCLF meeting.

Mitigation

‘Scenario 13-14’ – Infometrics

In summary, a 10% costless fall in agricultural emissions through technology change could soften the impact on private consumption we would expect the decline in private consumption to soften to about 1.9%, from 2.2% in Scenario 6.  If a series of mitigation technologies each contribute a small amount, the overall impact could be significant.

This paper led to discussion about new technologies and whether technology uptake is a function of the carbon price. It was noted that there is often an efficient strategic response to technology uptake following the introduction of tradable permits. Some firms will accelerate technology adoption while others may choose to purchase permits and postpone new technologies until they are making other related investments.

‘Report on the Potential Impacts of the NZETS at the Farm Level’ – MAF

The potential impacts of the ETS on farm profitability are high.  As context, it was noted that net profit for sheep and beef farms was around $48,000 for 2006/07. Net profit for dairy farms was around $72,000. These figures are low, so the levels of change stated may have quite significant effects. These impacts could be offset somewhat with the use of technologies such as N-inhibitors.  An active technology transfer process is currently aiming to enhance this.  It could also be offset through the replacement of some farm land with forestry.  1% of farm land moved into permanent forests could offset all emissions for between 29 and 40 years.

The presentation led to a number of comments summarised below:

Farm profits take into account ways of servicing debt. It would be useful to see how these figures change if we took out new farm owners with high debt.

Forestry is a natural hedge on carbon prices so may have value beyond these simple calculations.

It would also be interesting to see how these figures apply to some of New Zealand’s model sustainable farms to see what impact farm management practices can make.

Adolf Stroombergen commented that the general equilibrium adjustment in the exchange rate was unlikely to offset more than a small percentage (around 25% at $25 per tonne of carbon) of these impacts.

The group were asked to send any comments to the Agricultural TAG.

Leakage and regrets

‘Who would regret what?’ – Suzi Kerr, Motu Economic and Public Policy Research

Suzi Kerr tabled a diagram to help clarify the concept of regrets and help guide decisions on appropriate modelling to estimate the scale of leakage and economic regrets as well as discussions about additional free allocation of NZ units to industry through an extended phase-out. The attached paper includes a brief written description of the diagram, based on Suzi’s explanation at the meeting.

Note here that ‘China’ refers to China and other countries that are not yet signatories to Kyoto.

A delegate asked what would happen to New Zealand’s commitments if ‘China’ did not join the international agreement. Suzi’s assumption is that New Zealand would not lessen current commitments. The current situation where international prices largely do not include a carbon cost would probably persist. If ‘China’ did joint in the leakage issue would disappear but carbon prices would probably be higher because the global agreement would be likely to be more stringent.

The group discussed whether responding to regrets should take into account the needs of shareholders or producers. One view is that producers are a priority since their survival will have greater benefits for workers. Another view is that retaining capital is essential to continue innovation in natural resource processing so that we can take advantage of our wealth of natural resources. 

Should economic leakage/regrets be considered as a subset of emissions/environmental leakage or are we concerned about differences in C prices driven by countries different regulatory responses to being included in the international agreement as well?

Regrets are an issue for the transition. Discussions assume that the world will respond to climate change in a coordinated and functional way in the medium term. This means there will be a global shift in relative prices and therefore changes in some industries. The proposed NZ ETS does not offer long term subsidies (in the form of free allocation) and inefficient firms are likely to shut down. This is particularly an issue for the Agricultural sector. Agricultural land use changes quickly even without a cost of carbon.

One delegate noted that if government can subsidise capital to support workers, they could instead subsidise transition to other employment.

Work at Fletcher Building (SEIP TAG?) is attempting to establish who/what would be classified in the top (‘doomed industries’) and bottom (non-competitiveness at risk) rows of the diagram. It was noted that it is very difficult to identify firms that would be uneconomic with or without a cost of carbon.

Leakage case studies

‘Terms of reference for a case study on the potential for economic leakage based on information supplied by emission-intensive firms’ – Treasury.

It is still to be determined how many firms we would like to case study.

The process is starting shortly with Fletcher Building. This discussion draft has been sent to Catherine Beard, Ralph Matthes and Stuart Frazer for assistance with recruiting firms. It may be possible to target NGA firms through personal networks to speed process. Firms have to be willing to take part.

NZ Steel is an obvious choice and contact with them has been made. Fonterra is also a possibility, though they have concerns about confidentiality.

It was suggested that it would be useful to contrast firms where there is existing production at risk with those where there is new investment at risk. We should not attempt to cover all sectors.

Phase out

 ‘Phase out of Free Allocation: Further analysis for Cluster B’ – Treasury

It was noted that the NZ ETS phase out needs to deal with economic regrets. Environmental regrets are the responsibility of the global agreement.  Additional free allocation to avoid environmental leakage may also be a very expensive way to reduce global environmental impacts. 

Firstly, there is uncertainty about the total level of subsidies we want.

The discussion moved to consequences for changing phase out. Treasury noted that it is easy to work out the costs of moving the phase out, but hard to know the benefits. Another delegate suggested it would be possible to make the phaseout line steeper to better align with mitigation curves and the global environment. We need sensible evaluation criteria for reviews and one line may not fit all sectors. An ETG member set out parameters for a 5-year review process. We would want to know how much change is possible and what the criteria would be. It would need to be clear that there will be a decline in free allocation over time.

Any signal of a phaseout that is not associated with incorporation of C in international prices will have immediate effects on investment.  From a private sector perspective however a delay in the phaseout beyond 2013 is far more relevant than the speed of the later phase out.  It was suggested that the ultimate end of the phaseout might be kept fixed.  This lack of concern for later periods may not be true when we reach 2018 however.  One participant suggested that we could want to extend the subsidy indefinitely if the agreement does not become global.

Next meeting

 It would be useful to think about phase out from a private sector perspective. Chris Baker and Hans Buwalda are to write a paper outlining these issues for the next CCLF meeting. This may include information from the SEIP TAG