The great climate change rort

by Rebecca Macfie / 16 May, 2016
The Government’s main climate policy is under attack by those who say it has been a vehicle for dodgy dealing and has done nothing to reduce carbon emissions.
Warrick James: “Forests suck up a lot of carbon dioxide. It’s pretty simple.” Photo/Joseph Johnson
Warrick James: “Forests suck up a lot of carbon dioxide. It’s pretty simple.” Photo/Joseph Johnson


Canterbury farmer Warrick James is not your stereotypical climate activist. You won’t see him abseiling in protest off the side of an oil rig or waving a ­placard in front of a coal-fired milk-drying plant. But he’s rightly proud of the contribution he is making to combating what many consider humanity’s greatest challenge.

Bouncing along a rough track in his ute through the radiata pine and douglas fir forest that cloaks the steep hillsides of his Selwyn Gorge property, he pauses briefly to reflect on the work his trees are doing.

“They’re really sucking it up.” Carbon dioxide, that is. Just how much they are sucking up has been worked out with a fair amount of precision by experts who can assess how fast the trees are growing. Averaged over 50 years, his pines are absorbing 40 tonnes of CO2 per hectare per year, and the slower-growing douglas fir about 21 tonnes.

Put another way, every hectare of his pines is soaking up about as much CO2 as is spewed out by 13 petrol-powered cars over the course of an average year’s driving, while each hectare of the douglas fir is sequestering enough to offset the emissions of about seven cars.

Read more:

Special Climate Report: Rebecca Macfie looks at how our lives will change as the world heats up and we move to limit greenhouse gas emissions.

And James has a large estate of these ­carbon-gobbling trees – 430ha of fast-­growing pines and 70ha of douglas fir. They won’t be cut down for timber – he’s growing them purely as a carbon crop. The trees were already planted when he and his wife, Cece, bought their 1300ha property in 2010. He’d been a pastoral farmer all his life, and the couple wanted to diversify so they were less reliant on returns from sheep and cattle for their income.

Under the Government’s emissions trading scheme (ETS), they are given carbon units for each tonne of CO2 sequestered by the trees. They can then sell them to a New Zealand carbon emitter – for example, an oil company or a coal-powered electricity generator – that is required under the ETS to hand over carbon units for the CO2 it emits into the atmosphere.

“You’ve got to have a price on carbon,” says James. “The beauty of it is that it makes the emitters look at their systems and work out how to cut their emissions to reduce their carbon cost. On the other side of the coin, you have farmers like me saying, ‘There’s money to be made in growing trees.’ And as we know, forests suck up a lot of carbon dioxide. It’s pretty simple.”

Demonstrators at the 2009 Copenhagen climate summit. Photo/Getty Images
Demonstrators at the 2009 Copenhagen climate summit. Photo/Getty Images

CARBON PRICE PLUMMETS


Or rather, it was supposed to be simple, but it didn’t turn out that way.

In the James’ first year on the farm, they sold their carbon units to a New Zealand emitter for about $20 apiece. But by the end of the second year, 2011, the price started going off a cliff . For three years, the values offered for their units were so derisory that they didn’t even bother trading. They just paid the insurance on the forests – a core business cost, because if the trees burnt or blew down they would have to pay back all the carbon units they’d been given – and focused on the sheep and beef side of the farm.

At the same time as the Jameses were watching their forestry cash-flow evaporate, Lizzie Chambers was sitting in Wellington wondering if the investment she had made in developing a transparent online carbon trading portal for ETS participants had been such a good idea after all. Chambers had returned to New Zealand after several years working in environmental markets in Europe, and set up Carbon Match, a website where companies with liabilities for their CO2 emissions could buy units from forest growers like James.

The first trade on her site was in May 2011, at a price of $20.30. But within a matter of weeks, it was clear that disruptive forces were at work in New Zealand’s carbon market. The prices that emitters were willing to pay for units was sliding fast, and she quickly realised that many were choosing to buy cheaper offshore units. By late 2011, she was hearing that local emitters were being phoned and door-knocked by European brokers peddling ultra-cheap Ukrainian and Russian units.

Alarm bells were going off throughout New Zealand’s nascent carbon industry. Ollie Belton, who with his father, Mark, pioneered forestry carbon trading, watched in despair as the price of units plunged to as low as 10-15c, and the purpose of the ETS – to create an economic incentive to reduce climate-altering CO2 emissions – seemed to be suddenly subverted into a game of financial arbitrage.

“There had been a lot of players entering the market up until this time,” recalls Belton. “Forestry consultants had been throwing their weight behind carbon, and we were dealing with international carbon companies out of the UK and US that were actively looking at setting up offices in New Zealand. There was a huge amount of interest, but all of that just came to an abrupt halt.”

Motu's Lizzie Chambers, who developed a transparent online carbon trading portal.
Motu's Lizzie Chambers, who developed a transparent online carbon trading portal.

SURPLUS OF UNITS


What was going on? As Belton explains, several things had contributed to a loss of impetus in the ETS. Almost as soon as it was elected in 2008, the new National Government started a review of the Labour-designed scheme (which had been passed into law eight weeks before the election). The following year the Government softened the scheme by subsidising emitters to the tune of half the cost of their carbon pollution. Instead of having to give the Government one carbon unit for every tonne of CO2 emitted, they now had to do this for every two tonnes. The planned entry of agriculture into the ETS was also delayed, and the Government capped the price of carbon at $25 a tonne.

The global financial crisis had also contributed to a big surplus of carbon units in the European Union Emissions Trading System, as manufacturers and energy ­generators scaled back production (therefore producing less CO2) in response to the deep recession.

Critically, the failure of the 2009 Copenhagen climate summit to deliver a new agreement to take over from the Kyoto Protocol left a cloud of uncertainty over future global demand for carbon units.

But something else was going on, too. Right from the outset, the ETS had been designed to allow New Zealand companies to buy overseas carbon units to meet their obligations under the scheme. In principle, this made good sense, because the goal of carbon trading is to reduce emissions at the lowest economic cost.

If, for instance, a Chinese coal-fired power station was replaced with a solar array and this was done more cheaply than, say, turning a New Zealand coal-fired electricity generator into a wind generator, it was rational that the New Zealand outfit ought to be able to buy the benefit of the cheaper Chinese emission reductions.

It was well known, however, that not all carbon units were created equal. One of the early carbon-trading rorts centred on Chinese factories that produced a highly potent greenhouse gas known as HFC-23 (commonly used in air conditioning), which deliberately ramped up production so that they could then reduce it and claim the reductions in carbon units.

Both New Zealand and the EU announced bans on the use of these bogus credits in their respective emissions trading schemes in 2011.

But the general principle of “open ­borders” remained in place in the New Zealand ETS. And that’s where critics say the scheme lost not only its way, but also its integrity as the country’s primary climate policy.

In a new report, Geoff Simmons and Paul Young of the Morgan Foundation have pulled together the complex threads of New Zealand’s carbon trading history, alleging that the Government allowed the system to be debased by fraudulent Ukrainian and Russian units, from which some companies profiteered while the environment suffered.

Geoff Simmons (left) and Paul Young allege that the Government allowed the ETS to be debased. Photo/Martin Hunter
Geoff Simmons (left) and Paul Young allege that the Government allowed the ETS to be debased. Photo/Martin Hunter

‘HOT AIR’ OF UKRAINE AND RUSSIA


To understand all this, it’s necessary to absorb a short history of international climate negotiations. Under the Kyoto Protocol, participating countries were given emissions targets, and received official carbon units (called Assigned Amount Units, or AAUs) equal to the emissions they were allowed between 2008 and 2012 (the Kyoto Protocol’s first commitment period).

As it turned out, Russia and Ukraine got far more credits than they needed because their economies had collapsed and their smoke-stack industries were producing much less CO2. From very early on, Russian and Ukrainian AAUs were tagged as “hot air”, and they were banned from trading.

But as Simmons and Young explain, they could turn their hot air into tradable carbon units by attaching them to projects that were ostensibly reducing emissions. These units were called, prosaically, Emission Reduction Units (ERUs). An example of the type of projects that got ERUs is the prevention of spontaneous ignition of piles of coal (achieved by digging out the coal pile or putting out the fire). Another is the expansion of natural gas pipelines and plugging leaky old pipes so that more people could use gas instead of coal (thus producing less CO2).

Under the Kyoto rules, Ukraine and Russia were able to run these ERU projects without international oversight.

Around the same time as these units started flooding into the New Zealand ETS market, international carbon ­observers were publishing warnings about the emission-reduction projects to which they were attached. In May 2012, Europe’s Carbon Market Watch wrote that they were “notorious for their lack of transparency, accountability and environmental integrity”.

The volume of ERUs from Ukraine and Russia surged further from late 2012, when the EU moved to block units from countries that had not committed to a second emissions target under the Kyoto Protocol, unless the projects were subject to independent oversight. Realising that their surplus units would soon be worthless, Ukraine and Russia started pumping them into the market in huge volumes.

“Junk” climate credits from Russia ravaged the New Zealand carbon price. Photo/Getty Images
“Junk” climate credits from Russia ravaged the New Zealand carbon price. Photo/Getty Images


It was these units that were pouring into New Zealand, helping to ravage the price that people like Warrick James could earn for their forestry units.

Ollie Belton says there were grave suspicions in the New Zealand market about the integrity of the ERUs that were causing such havoc. He and others were beating a path to the Government’s door, seeking limits on the volume of overseas units.

“Everyone was saying, ‘Lock out this junk,’” says Belton. “New Zealand had become the dumping ground … We were taking anything and everything.”

Then-climate change minister Tim Groser announced in early 2012 that he was likely to restrict the flow of overseas units into New Zealand, warning of a “serious danger of New Zealand essentially exporting capital for no good reason resulting in a loss of economic welfare.” But that plan was scuttled in a deal with Act, which claimed the continued unrestricted import of overseas carbon units was beneficial for “Kiwi households”.

Simmons and Young report that by this time New Zealand was the only country allowing the unlimited import of these cheap Ukrainian and Russian units.

Each year the Environmental Protection Agency tallies up the type of carbon units that have been handed in by emitters under the ETS. These reports show just how dramatically the cheap imported units displaced those of local forest growers. In 2010, the majority of units handed over were from forestry; by 2013, more than 90% were ERUs and, in 2014, 74%. The majority of these units were from Ukraine. At the same time, trading in forestry credits had slowed to a trickle.

Simmons and Young have also analysed the final reconciliation reports submitted by all countries in the Kyoto Protocol’s first commitment period (which finished in 2012), and found that proportionally New Zealand has been the biggest user of ERUs. Some 11% of all ERUs issued ended up here, even though this country accounts for less than 1% of global carbon emissions.

Forestry carbon trading pioneer Ollie Belton.
Forestry carbon trading pioneer Ollie Belton.

INCENTIVES DESTROYED


As the tide of ERUs was turning into a deluge in late 2012, Lizzie Chambers warned publicly that the Government’s refusal to limit the number of overseas units was depriving New Zealand of precious capital that could instead have been directed into carbon-reducing projects.

“An ETS that does nothing but drive cash offshore is not consistent with that, and will ultimately represent a terrible loss of what could have been really dynamic capital.”

According to Simmons and Young, $200 million has been spent offshore by emitters on foreign credits.

With the price of carbon at just a few cents a tonne, the incentive for land­owners to plant forests was destroyed. According to ­modelling done for the Government’s ­current review of the ETS, a price of about $15 a tonne is needed to make substantial areas of new forestry plantings stack up.

At the same time, the rock bottom price of carbon eliminated any disincentive that might otherwise have existed for landowners to clear forests and convert to emissions-intensive dairy farming.

But one of the more perverse outcomes of the flood of cheap carbon currency was that foresters themselves were able to game the system. It worked like this: forest owners who were given legitimate units when they joined the ETS could then withdraw from the scheme, use cheap Ukrainian units to repay the Government and pocket the government-issued units (in the expectation that they would increase in price in the long run, which they subsequently have). Some then repeated the cycle, re-entering the ETS, pulling out with cheap Ukrainian units and hanging onto the good ones.

The Government passed a law to stop foresters from taking advantage of this arbitrage opportunity in May 2014. But it didn’t stop other ETS participants from using cheap overseas units until May 2015.

Simmons and Young argue there were enough warnings in the international carbon markets about the Ukrainian and Russian units for the Government to have known they were dodgy. Some carbon watchers think that criticism is unreasonable, saying the units brought into New Zealand were legal carbon currency. Either way, it is now beyond dispute that the ERUs were of dubious merit and that most of them did not represent genuine carbon reduction efforts.

A major study by the respected Stockholm Environment Institute last year found that 80% of ERUs created (most of which came from Ukraine and Russia) had “low or questionable environmental integrity”. In many cases, they were attached to projects that were already happening (therefore didn’t represent additional carbon reduction effort) or they substantially overstated the amount of emission reduction. One of the report authors, Ukrainian Vladyslav Zhezherin, was reported as saying many were probably “fake”.

A UN official interviewed by the Guardian after the Stockholm report was published supported the conclusions, saying the projects had been beset by “significant criminal energy”.

Motu’s Suzi Kerr.
Motu’s Suzi Kerr.

‘WE ARE ALL GUILTY’


Paula Bennett, who took over from Groser as Climate Change Minister late last year, defends the Government’s decision to continue allowing unrestricted flows of foreign units into the New Zealand ETS and says at the time it was the right decision.

Suzi Kerr, of economic think tank Motu, says the price of carbon should not have been allowed to drop so low, but the decision to maintain an open door on foreign units has to be seen in light of the Government’s own objectives.

“If they just wanted New Zealand to comply with Kyoto at a low cost, then getting cheap units into New Zealand was a way of doing that.”

Kerr also points out New Zealand was a “huge supporter of international trading, and we didn’t want to look like we were putting random restrictions on. The problem was we didn’t change our mindset when the price went extremely low and it became apparent that this was unravelling.”

And while New Zealand’s carbon prices plunged, “no one’s prices were beautiful during that period either … We are all guilty. None of us has done enough so far, including New Zealand. But it’s not because we bought international units and others were virtuous and didn’t buy international units.”

When the Government eventually blocked trading in foreign credits in May 2015, it wasn’t for the reasons that people such as Belton started lobbying for way back in 2012. The trigger was that New Zealand had not signed up to the Kyoto Protocol’s second commitment period, which meant this country could no longer trade in international units.

The upshot is that for almost a year, the ETS has been a domestic-only trading scheme, and the price of carbon has been recovering. This week it was $13 for the first time since late 2011 – although that’s still not high enough to make large-scale planting of carbon-sequestering forests stack up.

A key reason for the price recovery is Bennett’s well-signalled intention to remove the subsidy that allows emitters to hand over only one unit for every two tonnes of carbon. She told the Listener she will be confirming her decision within the next two months because it has Budget implications.

Source: Ministry for the Environment
Source: Ministry for the Environment

STOCKPILE SUPPRESSES PRICES


So does New Zealand’s history of – as Young and Simmons put it – “gorging” on cheap foreign carbon units matter now? After all, they’ve finally been blocked from the system and the ETS itself is under intense scrutiny as part of a wide-ranging Government review. Can’t we just put it behind us and move on?

It’s not quite that straightforward. As a result of the flood of cheap ERUs, New Zealand now has a huge stockpile of 140 million carbon units that is expected to suppress the price (and therefore the incentive to reduce emissions and plant forests) for several years yet. Bennett confirmed to the Listener that one of her reasons for wanting rid of the two-for-one subsidy is to help clear some of that backlog by boosting market demand for units.

As for the dubious Ukrainian and Russian units themselves, in its final reconciliation for the first Kyoto commitment period, the Government is using them to pay for New Zealand’s international climate obligations. But that still leaves a huge overhang of legitimate Government-issued units (NZUs).

Source: Ministry for the Environment
Source: Ministry for the Environment


That surplus means New Zealand can easily comply with its international target of a 5% reduction in net carbon emissions by 2020, despite the fact our actual emissions are continuing to grow and New Zealand is among the developed world’s biggest ­emitters of ­greenhouse gases. Arguably, the ETS has created a mechanism for New Zealand to meet its international carbon targets without having to do much to reduce emissions.

As Motu’s Catherine Leining put it in a recent blog: “We are hitting the target but missing the point.” Mark Belton is more blunt in his appraisal: “We cheated,” he stated this week in a seminar with Government officials on the ETS review.

Simmons and Young argue the Government needs to put things right by cancelling a chunk of the assigned amount units it plans to use to meet its 2020 emissions target, in recognition that it has met its Kyoto obligations with the aid of dodgy currency. They note that Denmark, Germany, the UK, Sweden and the Netherlands announced at the Paris talks that they would cancel surplus units from the first Kyoto commitment period as a way of sending a strong signal of support for an ambitious global climate deal and highlighting the risk posed to the climate if countries used leftover units to comply with their future emissions obligations.

The Government hopes to once again trade in international carbon units to help meet its commitment under the Paris Agreement, but Simmons and Young say the ETS should remain shut to foreign units “until we can be certain the system has integrity”.

Motu’s Catherine Leining.
Motu’s Catherine Leining.

DITCH THE SCHEME?


In light of all this, it’s perhaps little wonder that some, including the Green Party, argue that a carbon tax would be a simpler, cleaner way of putting a price on carbon. The Greens’ Kennedy Graham says not only has the ETS “demonstrably failed” to reduce emissions, it is “politically odious and morally wrong” to trade in a pollutant. A carbon tax, while “blunt”, can be dialled up or down according to targets. The Greens argue for a carbon tax of $25 a tonne for all sectors except agriculture, which would be taxed at $12.50 a tonne.

Given that after eight years of operation the ETS has done nothing to push the economy in the direction it needs to go – towards net-zero carbon emissions by the second half of this century – might the Greens be right? Should the ETS just be ditched?

Suzi Kerr thinks not. Many of the same problems in an ETS are present in a carbon tax, she says, “and the biggest challenges are political and policy instability. Moving to a tax doesn’t resolve that.” The current overhang of units is “not good in terms of providing signals to the market, but it’s not a crisis”.

She says the underlying architecture of the ETS is sound, with important lessons having been learnt over the past eight years. Among the issues that need to be confronted, she and Leining say, are the removal of the subsidy, the inclusion of agriculture (although the Government has excluded it from the current review and Bennett says she won’t be bringing it into the scheme) and greater cross-party support for a rising carbon price “as part of a broader low-carbon development strategy”.

The role of the ETS as an emission-reduction tool also needs to be kept in perspective, Kerr says.

“The ETS is only part of the policy package needed. It is not going to be enough to induce the construction of a rapid [electric vehicle] charging network or the construction of bikeways or improvements in the public transport system. Other actions have to be taken. But if there is a higher price, then people may be more willing to accept some of these other actions. They all work together.”

Including giving farmers like James the confidence to go out and plant more trees.

CAPS, TRADES & DIRECT ACTION


When the ETS was established in 2009, the European Union Emissions Trading Scheme was the only other mandatory ETS in operation. There are now 17 trading schemes in four continents and 35 countries. This includes nine new trading schemes launched in Asia in the past three years, and China expects to have a national carbon market from 2017. South Korea launched an ETS in 2015, and Japan has established a cap-and-trade scheme in Tokyo. California and Quebec operate a bilateral ETS.

Some countries have moved away from emissions trading schemes, or implemented alternative approaches. Australia dropped the idea of a trading scheme and introduced a Direct Action policy, central to which is an Emissions Reduction Fund. British Columbia implemented a carbon tax in 2008.

Source: Ministry for the Environment

Read more:

Special Climate Report: Rebecca Macfie looks at how our lives will change as the world heats up and we move to limit greenhouse gas emissions.

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