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Climate Change Leadership Forum reports

• April 2008

Outstanding Forestry ETS Issues

Climate Change Leadership Forum report number: 13
Briefing for the Climate Change Leadership Forum
Prepared by the Emissions Trading Group
Date: 8 April 2008

Section 1: Introduction

This paper provides:

• a summary of the independent analysis, undertaken by the University of Waikato and Covec, of several alternative proposals for including pre 1990 forests in the ETS (submitted by Ngai Tahu and PF Olsen and the Flexible Land Use Alliance)
• details and rationale for the government’s revised proposals for the free allocation of NZUs to pre 1990 forest owners

Section 2: Independent Analysis of Alternative Proposals for the Inclusion of Forestry in the ETS

The Leadership Forum has previously received and discussed alternative proposals (developed by Ngai Tahu and PF Olsen¹) for including forestry in the ETS.  At the Forum’s request, these proposals have now been independently reviewed by the University of Waikato (Professor Frank Scrimgeour) and Covec (Dr Tim Denne).

At the time of writing this note, the University of Waikato / Covec report was still only a final draft.  It had been provided to a range of key stakeholders for comment, including representatives of Ngai Tahu, PF Olsen and the Flexible Land Use Coalition.  In turn, PF Olsen had sought an independent review of it. Those comments had not been provided at the time of writing.  A summary of them, along with the finalised University of Waikato / Covec report and any independent analysis of it, will be provided at a later date. 

Summary of Options

PF Olsen

PF Olsen recommends an alternative solution for the treatment of deforestation of pre-1990 forests. There are two elements that apply to land owners of these forests:

• a requirement for all deforestation to be offset by planting, either on the same piece of land or elsewhere;
• a requirement to surrender NZ Deforestation Units (NZDUs). NZDUs would be placed on the market through auction and the number put up for auction would be determined by a survey of deforestation intentions; and

• NZDUs would be non-tradable and land owner-specific. Eligibility for participation in the auction will be limited to “forest landowners who were prepared to establish new forest on non-forest land.”

Flexible Land Use Alliance

The Flexible Land Use Alliance (FLUA) proposal is substantially similar to that of PF Olsen. It proposes an offset scheme that requires planting of land to compensate for any deforestation. This proposal has not been analysed separately.   But the University of Waikato / Covec report expects the results of the analysis of the PF Olsen proposal to apply to the FLUA proposal also.

Ngai Tahu

Ngai Tahu provided two alternative solutions, relating both to the treatment of pre-1990 and post-1989 forests.

Option 1 is focussed on promoting afforestation. It includes the following elements:

• a requirement for all forest owners that deforest to hold “contestable deforestation permits” (CDPs). To obtain CDPs (land) owners would need to apply to the government to obtain a permit to deforest a specific site. The government would assess all sites against a set of criteria, which might be (or include) a cost-benefit test; the highest ranked sites would be granted CDPs. The number of CDPs would be limited to 21 million tonnes in CP1, consistent with the ETS proposals.
• those that afforest would receive 100 NZUs/ha and those that deforested or harvested after receiving 100NZUs/ha would face an obligation to surrender 100NZUs/ha.

Option 2 introduces a wider set of obligations on deforestation. The components of this option include:

• Obligations on deforestation of pre-1990 forests to hold CDPs (with a process as described above) and/or surrender NZ Deforestation Permits (NZDPs). A limited number of NZDPs would be made available each year (5-6,000 pa is suggested in the proposal); they would be placed on the market through auction.
  
• NZUs would be awarded to forest owners for absorption. This would apply equally to pre-1990 and post-1989 forests, despite the fact that New Zealand does not obtain additional Kyoto units for additional absorption by pre-1990 forests. However, the amount awarded to forest owners would be based on the total number of RMUs awarded to New Zealand under the Kyoto Protocol, divided by the quantity of CO₂ absorbed by both pre-1990 and post-1989 forests. This results in an award ratio estimated by Ngai Tahu as approximately 0.4 NZUs per tonne of CO₂ absorbed.
• Deforestation or harvest of post-1989 forests would result in a requirement to surrender NZUs, but this would be limited to the number already earned for that area of land. Thus it is limited in the short run to an approximate 0.4:1 ratio.²

Assessment

The report’s overall conclusion is that:

“… the emissions trading system (ETS) as currently specified has greater net benefits than the other options. This result occurs because the ETS ensures that deforestation occurs only when the net benefits are greater than the costs of the emission units that need to be surrendered as a result of the deforestation. Surrendering emission units is a real cost to the nation that the other proposals do not pass on to landowners. The other options result in a greater level of deforestation, and the additional area deforested has higher costs than benefits.”

The reports’ estimates of the overall benefit of the pre 1990 forestry components of the ETS (relative to a base case scenario where no policies are introduced to manage New Zealand’s deforestation emissions) are shown in Table 1 below.  Those benefits stem from a reduction in deforestation levels, and a resulting reduction in the costs New Zealand is expected to face in order to meet its commitments under the Kyoto Protocol. 

Table 1 Estimated Benefit of the ETS

Unit price	ETS ($m)
$15/t	$100 – 219
$30/t	$480 – 623
$50/t	$1,184 – 1,361

In turn, the reports’ estimates of the cost of the different options relative to the ETS are shown in Table 2.

Table 2 Net Costs of Policy Options Relative to Current ETS Design

Unit price	PF Olsen/FLUA ($m)	Ngai Tahu 1 ($m)	Ngai Tahu 2 ($m)
$15/t	$76 – 167	$60 – 132	$60 – 132
$30/t	$384 – 499	$320 – 416	$320 – 416
$50/t	$832 – 956	$704 – 809	$704 – 809

The report goes on to note that there is an irreconcilable trade-off when designing the ETS between minimising costs to landowners, and costs to the economy as a whole:

• “The landowners’ costs are only reduced by increasing land use flexibility, and allowing more deforestation.
• The nation’s costs are minimised when deforestation is restricted to that area for which the net benefits of switching are greater than the emission unit costs.”

It concludes that “it is this trade-off that leads to the ETS approach of passing on the full cost so that the national benefit is greatest but designing a compensation package to offset landowner costs”.

With regard to the adequacy of the approach the government has previously proposed for compensation, the report concludes that: 

“If there is a desire to compensate, then the ideal approach is to provide lump sum compensation to those that are most likely to face costs, and for the level of compensation to any individual landowner to be independent of the decision to deforest. This ensures that it does not reduce the effective emission price faced by landowners.

The difficulty faced by the government is to identify these participants. It is easy to identify deforesters, after they have deforested. But ex-post compensation of those that do deforest (and presuming that they know compensation is coming) is equivalent to these landowners not facing the full price of emissions—rates of deforestation would rise and the nation would face higher net costs. The compensation needs to be lump-sum and this is what the proposed regime seeks to achieve.

The problem is, it is poorly targeted. But the targeting problem is not easily resolved. The only way to be sure of providing adequate compensation is to increase total compensation levels. However, in the absence of a clear way to target compensation, this would need to be spread widely thus increasing total costs to the government substantially.

The government is left with a clear policy dilemma: an efficient outcome that results in high costs being passed on that cannot easily be compensated, or not without high costs; or less efficient outcomes that pass lower costs on to landowners but result in increased deforestation and greater national costs.”

Section 3: Government’s Revised Proposals for Allocation to Pre 1990 Forest Owners           

For the reasons discussed in the University of Waikato / Covec report, Ministers do not favour changing the way that forestry is included in the ETS.  However, after considerable discussion with a broad range of stakeholders, Ministers are now proposing a revised approach to freely allocating NZUs to Pre 1990 forest owners.  That revised approach, and the rationale behind it, is discussed below.

Context

The Emissions Trading and Renewable Preference Bill (the Bill) provides for an allocation of New Zealand units free of charge to owners of pre 1990 forest (with the exception of those whose land has been declared exempt under the 50ha participation threshold).  The total number of units freely allocated will be equal to 55m NZUs, less the number required to meet the cost of the 50ha threshold and the ongoing 2ha deforestation exemption. 

In the ETS engagement material put out by the government in September 2007, the government proposed that this total number of units be apportioned on an equal pro rata basis across all landowners.  No differential was proposed to take account of whether landowners purchased their land before or after the date when the government first announced its intention to introduce deforestation controls (October 2002).  It was estimated that this approach would provide each landowner with an allocation of 39 units per hectare (it is not possible to calculate this figure with certainty until applications for the 50ha participation exemption have been received). 

In that engagement material, units allocated in respect of Crown Forest Licence (CFL) land not yet passed to successful Treaty claimants were to be received by the government.  The approach set out in the engagement material therefore was expected to lead to the allocation shown in Table 2.

Table 2:  Allocation Approach Proposed in the 2007 Engagement Material

Owners of Pre 1990 Land Purchased Prior to October 2002	39 NZUs per ha
Owners of Pre 1990 Land Purchased After October 2002	39 NZUs per ha
The Crown (for CFL lands)	39 NZUs per ha
Future successful Treaty claimants	Nil (but could be part of a negotiated settlement quantum)

This approach has received considerable criticism from stakeholders in the forestry sector.  The key argument has been that the approach does not adequately target assistance to the parties that are likely to face the greatest costs under the ETS, and does not provide sufficient compensation to those parties that have real opportunities to introduce alternative land uses. 

As noted in the University of Waikato / Covec report, the targeting problem is not easily resolved.  However, the government now believes that it is possible to improve the proposed approach to some degree, in a way that better targets those parties that are likely to be most heavily affected. 

New Proposed Approach

As noted, Ministers are now proposing a revised approach to freely allocating NZUs to Pre 1990 forest owners.  This revised approach differs from the previously proposed approach in three key ways:

• the allocation of NZUs to owners of pre 1990 land that was purchased prior to October 2002 will be increased to 60 units per hectare
• an allocation of 18 units per hectare will be introduced for future Maori owners of CFL lands (who receive the land as part of a future Treaty settlement)
• the Crown will choose to forgo receiving units for the CFL lands it currently holds.

 
This new option is summarised in the table below (with the original approach from the 2007 engagement material provided for comparison).

Table 3: Summary of Proposed Revised Approach to Forestry Sector Allocation

	Original Approach (in 2007 Engagement Material)	Suggested Revised Approach
Owners of Pre 1990 Land Purchased Prior to October 2002	39 NZUs per ha	60 NZUs per ha
Owners of Pre 1990 Land Purchased After October 2002	39 NZUs per ha	39 NZUs per ha
The Crown (for CFL lands)	39 NZUs per ha	Nil
Future successful Treaty claimants	Nil	18

Other key points to note about this new proposed approach are that:

• The total level of allocation to pre 1990 forest owners will remain within the 55m NZU envelope specified in the Bill  (the increases in allocation to owners who bought their land prior to 2002, and to iwi yet to settle, will be ‘paid for’ by the Crown opting to forgo receiving units for its CFL lands.
• No parties (other than the Crown) will receive a lower allocation than they would have under the original approach proposed in 2007.
• The allocation of 18 units to iwi yet to settle will be held in Trust in an approved Maori Development Entity and transferred (units or their equivalent value) to iwi on transfer of the relevant CFL land.  This allocation would be provided outside of whatever settlement quantum is agreed between the Crown and iwi in question. 
• Settled iwi, who own areas of pre 1990 forestland that was purchased prior to 2002 will receive the same 60 unit allocation as all other owners of similar land. 
• The government is exploring whether the key elements of this proposed approach could be included in the Climate Change (Emissions Trading and Renewable Preference) Bill 2007.  This would provide greater certainty for all stakeholders.

Reasons for New Proposed Approach

As noted, this new proposed allocation approach provides an increase in assistance to owners who bought their pre 1990 land prior to October 2002 (‘pre 2002 Owners’) and future Maori owners of CFL land (‘iwi yet to settle’). 

The government first announced its intention to introduce deforestation controls in October 2002.  Owners that bought their land after that date, or purchased a company which owned forest land, would/should have known about New Zealand’s Kyoto obligations and the government’s policy to limit its exposure to deforestation liabilities. They therefore had the ability to factor these commitments into their purchase price and other management arrangements so as to account for the increased limitations on alternative land uses.

On the other hand pre 2002 owners could not have anticipated Kyoto and the associated limitations of land use change. A number of these owners now have much more constrained options and opportunities than they had anticipated. This argues for the pre 2002 owners receiving a higher value allocation of NZUs than 39 units per hectare.

Turning to iwi yet to settle, officials’ previous analysis noted where iwi opt to take CFL land as part of a settlement, the ‘price’ they pay for that land will be reduced, where relevant, to reflect the fact that it is covered by the ETS and has restrictions on its future use.  This will clearly reduce the impact of the ETS on iwi yet to settle.  However, the Iwi Leadership Group has argued that it does not mean that they will not face any impact.  Had those settlements been completed earlier, claimants would have had the opportunity to take advantage of the recent rises in land values, and/or the opportunity to convert forest to farming operations in advance to the ETS coming into force.  In such cases the claimants may not have ‘paid’ a land value much different to forest only valuations – since these additional opportunities have only arisen fairly recently. 

The proposed allocation of 18 units per hectare for iwi yet to settle reflects this lower, but non-zero, impact. 

Next Steps

The government has not yet made an unconditional decision to introduce this new allocation approach.  Its final decision will be taken after:

• Ministers have had the opportunity to discuss it with a wide range of key stakeholders.
• The ability to include the approach in the Bill itself has been assessed (which will require liaison with the Finance and Expenditure Select Committee that is now considering the Bill).

A small number of operational issues have been analysed by officials.

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