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Climate Change Leadership Forum reports

• April 2008

Untapped, cost-effective mitigation potential in New Zealand

Climate Change Leadership Forum report number: 12
Briefing for the Climate Change Leadership Forum
Prepared by the Ministry for the Environment
Date: 3 April 2008

Executive Summary

The Government has a comprehensive policy package in place designed to encourage domestic emission reductions and removals, through the combination of the ETS price signal and a range of complementary sector-specific initiatives. However, it is possible there may still be areas of cost-effective mitigation potential in New Zealand which the current policy package will not deliver (“untapped cost-effective mitigation potential”). Where such potential exists, further policy intervention might be appropriate. Officials across the relevant agencies are investigating these questions. The Ministry for the Environment maintains oversight of the various agency work programmes. Whatever initiatives are decided upon, they must be well-designed, show additional benefits to the current policy package and not interfere with the price of carbon under the ETS. Experience with the PRE programme showed that even the best designed projects mechanisms suffer from complexity and additionality issues. Officials are interested in the Leadership Forum’s views.

Untapped cost-effective mitigation potential in New Zealand

The ETS will introduce a carbon price signal into the market which will drive investment in domestic emission reduction and removal measures. However, the ETS alone might not deliver all the cost-effective mitigation potential in New Zealand. The reasons for this include:

1. Gaps in ETS coverage:
   • Transitional gaps in ETS coverage – i.e. where the sector is not yet covered by the ETS (e.g. agriculture and waste until 2013).
   • Other gaps or imperfections in ETS coverage - e.g. where the emissions are not attributed to or controlled by an ETS participant; activities not recognised in the New Zealand inventory for Kyoto-compliance purposes; emissions under a de minimus threshold.
2. Market failures:
   • Bridging the so-called “valley of death” (i.e. the space between R&D and large-scale commercial deployment) faced by many new alternative or breakthrough technologies and practices.
   • Lack of information – e.g. fuel consumption of vehicles.
   • Misaligned incentives - e.g. landlord/tenant.
   • Private transaction costs – e.g. energy consumption of appliances, energy consumption of buildings.
   • Lack of capital – e.g. low-income home owners.
   • Technology transfer costs.

The approved/proposed package of complementary measures will address such gaps or barriers in many cases. However, officials have identified the following examples of possible remaining mitigation potential in New Zealand. ¹

Examples of possible untapped mitigation potential in New Zealand

Gaps in ETS coverage:

• Capture and destruction of landfill methane – i.e. collection of methane emissions at efficiency levels above the benchmark set in the National Environmental Standard on landfill gas emissions, or by landfills under the 1 million tonnes size threshold applied in the NES.
• Capture and destruction of landfill methane from closed landfills – only operating landfills will be subject to the ETS in 2013.
• Collection and destruction of end-of-life HFCs – which are unlikely to be influenced by the ETS price signal.
• Capture and burning of coal seam methane – i.e. methane retained within coal structures which escapes due to release of pressure when coal is mined.
• Accelerated eradication of pre-1990 tree weeds (e.g. wilding conifers) – Delaying eradication of tree weeds may increase New Zealand’s Kyoto liability as wildings, if left unmanaged, may become classified as forests and/or increase their carbon stock and therefore if deforested may result in a  increased deforestation liability. Landowners will be able to apply to be exempt from obligations to surrender units under the ETS if undertaking deforestation of tree weeds (under the proposed new section 160 of the Climate Change Response Act in the Bill).
• LULUCF – All Article 3.4 activities, namely grazing land management, cropland management, re-vegetation, and forest management (such as management of browsing pest in indigenous forests). However, it is important to note that undertaking these activities will not contribute to meeting New Zealand’s Kyoto obligations as New Zealand has elected not to account for these activities during the First Commitment Period.
• Agriculture - e.g. reduced application of nitrogen fertiliser, nitrification inhibitors, biochar, dairy waste management practices (e.g. stand-off pads or herd homes for dairy cows, timing of application of waste to pasture), avoiding anoxic soil conditions (e.g. stand-off pads or herd homes for dairy cows).

Market failures:

• Deployment of certain nascent technologies – i.e. those that may need assistance through the “valley of death” - e.g. second-generation biofuels, marine generation, carbon capture and storage, and electric vehicles are possible examples.
• Transport – measures to reduce traffic congestion, with potential associated GHG emission reductions.

Evaluating the appropriate policy response

Where there are areas of untapped mitigation potential in New Zealand in significant amounts, the Government will consider the appropriate policy response. Any policy intervention would need to be cost-effective, in the sense that the net cost (i.e. costs less co-benefits²) is not significantly more than the cost of buying a Kyoto-compliant unit. Another important factor is whether the area of mitigation potential would be recognised by the UN for Kyoto-compliance purposes. Other considerations include: environmental integrity (delivering real, additional emission reductions), general effectiveness (at unlocking the mitigation potential), administrative cost/complexity, and transactional cost/burden.

The appropriate policy response will vary depending on the sector and type of activity (reflecting the different drivers and barriers at play). In some cases, expansion of, or additional funding for, existing complementary policy programmes might be the most cost-effective policy response. In other cases, new policy measures might be needed – for example, regulation (e.g. standards, feed-in tariffs), financial grants, public procurement initiatives, issue of units under a projects mechanism, or other kinds of market-based instrument (e.g. green/white certificate schemes) – might be the most cost-effective policy response.

Some gaps or imperfections in ETS coverage might be best dealt with by adjusting the relevant ETS emission factor to capture those emissions. Where a standard emission factor applying to all participants in a sector does not capture improvements in practices made by some of those participants to reduce emissions, then, where administratively feasible, it may be preferable to simply allow those participants to use a specific lower emission factor for the activity (and therefore report lower emissions). Alternatively, where it can be shown that particular emissions-reducing technologies or practices have been widely adopted in a sector, a reduced emission factor could be applied to the sector in general to reflect this.

Scope for a projects mechanism within the ETS

A projects mechanism is one policy option that might be suitable for some areas of untapped mitigation potential in New Zealand. There was some discussion of this option in section 4.9 of the NZETS Framework Document published in September 2007. A projects mechanism would reward parties for voluntarily undertaking specified activities that reduce or remove emissions. The activities would be packaged as discrete actions (“projects”). The reward could be either money, or tradable emission units (e.g. NZUs or an NZ project credit), which parties could sell or use towards meeting their own obligations under the ETS (where relevant). It would be possible for such a scheme to cover mitigation activities both within and outside ETS-covered sectors.³

New Zealand already has experience with a form of projects mechanism through the Projects to Reduce Emissions (“PRE”) programme launched in 2002 – see Annex 1 for a summary of “lessons learned” from the PRE programme.  And of course, there will be recognition of certain forestry removal activities (through issue of NZUs) under the ETS. A projects mechanism within the ETS could be used:

• As a transitional incentive in the agriculture and waste sectors until 2013.
• As a longer-term incentive to correct other gaps or imperfections in ETS coverage which are not amenable to simple adjustment of emission factors (e.g. collection and destruction of end-of-life HFCs), or to enable break-through technologies in sectors covered by the ETS.⁴

A distinguishing feature of a projects mechanism - compared to alternative policy instruments - is that, depending on design, it offers another compliance option for ETS participants and could improve ETS market liquidity⁵. However, projects mechanisms pose technical and administrative challenges that would need to be carefully considered – in particular:

• Complexity: Projects mechanisms traditionally work by establishing baselines of “business as usual” emissions, and then identifying and rewarding activities that are “additional” to this baseline (i.e. in the sense that they would not have occurred in the absence of the projects mechanism). This can be a highly technical and resource-intensive process.⁶ It can make projects mechanisms inaccessible for some project proponents, or be unfeasible for some project types. There is a trade-off, however, as additionality testing can reduce the risk of over-rewarding projects compared to other policy instruments.
• Over-rewarding projects: Even with rigorous “additionality” testing, it is inevitable some funding or credits will go to activities that would have occurred anyway, which could result in a net cost to the nation. This risk can be minimised through careful scheme design, but it cannot be eliminated. Some argue that projects mechanisms reduce the risk of over-subsidisation more than other policy instruments due to their rigorous additionality testing.

New Zealand has limited resources to implement policy packages such as the ETS.  Focussing resources away from the implementation of the major policy planks should be done sparingly - and where there are clear benefits in doing so. 

Annex 1 - Projects mechanisms - Lessons learned from PRE

The Government commissioned two reports evaluating the performance and “lessons learned” from the PRE scheme. Key findings from these reports are summarised below.

1. "Lessons Learned from the NZ PRE Scheme" (prepared by Ecofys UK and Global Climate Change Consultancy (GtripleC) in January 2007) found:
   • The design of PRE is considered to be among best practice world-wide, and the programme was implemented in a robust manner. Due to the detailed additionality test used in PRE, free-ridership, while unavoidable in any incentive programme, has been at a lower level than in other approaches to incentivising renewable energy. 
   • Like New Zealand, other countries with Kyoto commitments were implementing a variety of policies, e.g. to incentivise renewables, in the pre-2008 period. Such policies all have some costs (e.g. direct subsidies for renewable energy), and analysis has shown that these are relatively high compared to the cost of the PRE scheme. If PRE projects are truly 100% additional, i.e. definitely would not have happened in the absence of PRE, the emission reductions have occurred at no net cost to the Crown (except for the relatively small transaction costs of running the programme). Where the ratio of units awarded to tonnes reduced is less than 1.0, the Crown benefits. As long as PRE projects do reduce emissions in New Zealand’s inventory, the worst-case cost to the Crown will be the international value of the Kyoto units provided as an incentive.
   • The Report echoes the finding of the 2005 report by the Allen Consulting Group that ”the cost effectiveness of PRE needs to be judged against the performance of other greenhouse gas initiatives with lower levels of transparency and potentially higher abatement costs.”
   • The PRE programme would have benefited from a clearer articulation and ‘sign-off’ of objectives, and the establishing of clear indicators and procedures for future assessment, as it was being implemented. This might have avoided the subsequent ‘second guessing’ of the value of the PRE programme, which seems, in part, to have resulted from differing interpretations of the key objectives and a lack of established assessment procedures.
2. "Performance of the Projects to Reduce Emissions (PRE) Programme: advice on agency analysis of PRE additionality" (“the Allen Report”) in September 2005 found that:
   • Despite MfE evaluation and safeguards, some proportion of PRE support could have also flowed to projects that would have gone ahead anyway. This is an ‘occupational hazard’ well known to those operating subsidy programs. It is likely that PRE is among ‘best practice’ in terms of incorporating mechanisms designed to minimise these occurrences.

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