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Climate Change Leadership Forum reports

Minutes CCLF Cluster B Meeting 4

1pm, February 15 2008
Deloitte, Wellington/Auckland

Meeting 4 addressed the following topics:

1. Adjustment costs
1.1. Computable General Equilibrium (CGE) Model (Adolf Stroombergen)
1.2. Summary of research on related issues (ETG)
1.3. Future modelling
2. Leakage stories
3. Potential changes to phase-out (ETG)
4. Voluntary reporting
5. Where do we go from here?

1. Adjustment costs

1.1 Computable General Equilibrium (CGE) Model (Adolf Stroombergen)

Adolf Stroombergen (AS) presented results from an analysis, commissioned by the ETG, that aims to explore the size of adjustments in response to the ETS using his CGE model. He opened the discussion with some background on the caveats of using this type of model, primarily its limitations in modelling transitions.

To model the short term shock he assumed that real wages and costs of capital are fixed. The scenario assumes a price of $25 per tonne of CO2-e, is carried out in 2025, the ETS covers all sectors and gases, and has no free allocation.

Stroombergen noted that estimate of 52,000 job losses (Table X) is an indicator of the overnight pressure of an ETS. This employment pressure could manifest as changes in real wages rather than job losses and that those jobs that are lost would return over time, though not necessarily in the same industries.

These results by sector that are given in Table X are compared to to historical changes in employment. Net changes in employment across three recent five year periods are much larger and more uneven that those predicted to follow the ETS.

The sectoral results were also spread across regions and occupational class to see if there are likely to be heavily affected groups. In general the effects seem to be relatively evenly spread and much smaller than net employment changes experienced in the past. This is partly due to the methodology for spreading which assumes employment changes by industry are spread proportionately across all current employment by sector.

Caveats noted by group members include the following:

A number of assumptions in the CGE model have the potential to over- or underestimate actual costs of the ETS. Those noted at the meeting are summarised in the following tables:

Potential to OVERESTIMATE costs – actual costs could be lower
  • The model assumes no legislative or regulatory attention to leakage, and no corresponding cost of carbon offshore.
  • It assumes no mitigation, for example no reduction of nitrogen per unit of production on farms or increase in energy efficiency. It does allow fuel switching.
  • It does not include the gifting and phase out of allocation.
  • The model shows an overnight effect, whereas the actual system is implemented over several years.
  • The economy may adjust faster than assumed – real wages may be flexible in the short term.

Potential to UNDERESTIMATE costs – actual costs could be higher
  • It assumes – at least in the scenario discussed at the meeting – a potentially low cost of carbon at $25
  • The exchange rate is assumed to immediately depreciate – this may be true in the long run but short run effects can be different. The exchange rate shift is critical in the model and creates a smoother overall effect.
  • It assumes that industries can expand/scale back through continuous adjustment. This is potentially unrealistic for steel and aluminium, dairy processing, and pulp and paper. The following perspectives are from industry representatives:
    • For pulp and paper the tipping point between scaling back production and plant closure is reportedly very early: there are just two large processing plants in NZ. Continuous adjustment is more realistic for sawmilling where there are a number of small plants, however sawmills work as part of a processing chain (including mdf and pulp processors) so would be affected by closures in other parts of the chain
    • In Dairy, while there are a number of smaller plants, continuous adjustment is restricted because processing needs to be available close to farms.
    • Cement, aluminiumm and steel have 2, 1 and 1 plants respectively and while they can change production incrementally a certain amount, scale is critical so adjustment is unlikely to be continuous.
  • The model does not show regional effects and consequently underestimates any concentrated social costs of the ETS.
  • Fuel switching may not be as simple as the model assumes.
  • It assumes that total investment will be unchanged. While this may be the case for new investment, existing investment in industry cannot move faster than the rate of depreciation. New investment will be affected if there is sufficient economic uncertainty – the model does not address this. Because the current scenario is run in 2025, capital stocks have adjusted to the ETS to a large extent – clearly they will not do this in the short term. The scenario needs to be respecified.
  • The model treats jobs as roughly equivalent, however new jobs may pay less than jobs lost through the ETS due to a lack of transferable skills and lack of opportunities.

There are still many unknown inputs for this type of modelling, including whether there is potential for output-based allocation in the future.

Suggestions were to:

1.2 Summary of research on related issues

An official in the ETG tabled a summary of Stroombergen’s findings alongside two papers which provide relevant context. One is a discussion of recent labour market changes in New Zealand and the second describes changes in the labour market following the introduction of manufacturing tariffs in the two decades to 2001.

The official also noted a potentially relevant Treasury working paper on the biggest influences on NZ’s economy in recent years. It is available for download here: http://www.treasury.govt.nz/publications/research-policy/wp/2006/06-08/

As more context, it was noted that the predicted cost of the ETS is much smaller than that from the recent oil price shock. As a brief indication based on the Infometrics model, offshore permits – the primary cost of an ETS – are likely to cost around 0.1% of GDP. ACC levies were also predicted to cause major issues for industry, a threat which failed to eventuate.

The labour market paper tells us that New Zealanders frequently change jobs. It is not clear whether they also frequently change industry or location.

In summary, it was noted that the modelling does not indicate a short run crisis from the ETS at a macroeconomic level. This is reassuring.

1.3 Future modelling

What are the opportunities from the ETS? This was a question tabled at the first CCLF meeting but not addressed further.

Modelling leakage: it will be a political issue if leakage occurs and production goes offshore. This has little effect on a macroeconomic model such as that discussed here.

Actions

Members to provide more modelling requests by Monday.

2. Leakage stories

Members had difficulty finding concrete stories of leakage. BusinessNZ has no direct members so cannot collect stories. There are significant confidentiality and competition issues for all. (Though the Wood Processors Association is currently preparing a document for submission to select committee.)

We want stories that present the ‘essence’ of the leakage issue for political use. Fewer stories carefully written would be best, around 2-5 stories in total.

A potential strategy for collecting stories is as follows:

Initial contact has been made and both MEUG and GPC have expressed interest in discussing the option further.

It would also be possible to ask participants in the SEIP TAG whether they would like to provide stories. The invitation can be open, but we only want 2-5 stories. The TAG will have a more detailed role.

We need to be very clear on our purpose here. The CCLF can look cross-sectorally and will be able to consider issues such as phase out. Our engagement needs to stay at this high level. We are aiming to bring government and business together.

Actions

The Environment Manager at Fletcher Building is to provide a leakage story for Fletcher Building (as long as it is clear what it will be used for).

The wider CCLF to discuss and comment on plans to approach MEUG and GPC.

3. Potential changes to phase-out (ETG)

Options for the phase out of free allocation in the ETS remain open in its current form.

Much of the conversation surrounding free allocation has taken place in previous meetings. In summary:

Allocation to address leakage should be tied to what happens in the rest of the world. This requires regular reviews.

One way to add certainty (which related to relative rather than absolute costs) is to legislate that phase out will be responsive to overseas developments. Retaining a fixed phase out provides uncertainty since there is no way to know how the level of allocation will correspond to those in overseas markets. A fixed phase out is therefore a disincentive to invest.

Some level of fixed phase out can be justified by mitigation options that will expand over time.

A counter argument is that it could take many years for overseas developments to take place and protecting firms in the long run is very expensive to the taxpayers and NZ Inc. Some felt that a long period of uncertainty on the regulation our competitors face and on border tax adjustment options is unlikely given current diplomatic efforts.

The group proposes something similar to Option 2 in the ETG paper (distributed with agenda). Progress on this issue is important: the SEIP TAG are having difficulty discussing allocation without clear direction on the rate of phase out.

Actions

The Emissions Trading Group and Environment Manager at Fletcher Building to write a more detailed paper on phase out based on this discussion.

4. Voluntary reporting

Firms are at risk of large fines if they mis-report their emissions once the ETS is in place. One way to prepare for the reporting process would be to introduce voluntary reporting.

MED and the SEIP TAG are also looking at this issue.

Since this is not a clearly a cross-sectoral issue it is not appropriate for our group to cover it also. It is also difficult to ask for voluntary reporting without knowing about points of obligation and what a methodology for reporting will be.

Actions

Recommend that mechanisms for voluntary reporting are made available once a methodology for reporting has been developed.

5. Where do we go from here?

The CCLF needs to provide direction for this subgroup. The primary focus is on legislation – TAGs provide advice for regulation.

Potential topics for future meetings build on present issues: