Friday 30 September 2022

Survey says! NZAE on the ETS

I've argued for some time that:

  1. Tightening the ETS cap makes more sense than layering stuff on top of the covered sector;
  2. Tinbergen means that you should use additional policies if you're dealing with additional market failures - so don't do additional policies unless you have an additional market failure, and don't force the ETS to try to solve things other than carbon;
  3. Use a carbon dividend to deal with distributional consequences of carbon prices. This is just first and second welfare theorem stuff. 
The New Zealand Association of Economists survey shows I'm not an outlier here. On these points, the vast majority of New Zealand's economists agree. Support for the carbon dividend over other ways of trying to deal with distributional issues is over 90%, with most of the remaining ones just uncertain. On the other questions, support is north or well north of 80%, with very few disagreeing.

Dave Heatley, in writing up the results, asks a good question:
Firm support for the NZ ETS is, in my view, consistent with mainstream economic theory and practice. I’ll attempt — no doubt imperfectly — to summarise this perspective as:
  • NZ now has an efficient and effective mechanism to reach the country’s stated emissions goal (i.e. a staged reduction to zero net emissions by 2050).9
  • Having got a capped ETS in place, it's now best to let it work. If there are specific roadblocks, then deal with those directly, rather than taking steps that might undermine the ETS, or skew emissions reduction towards costly actions.
  • Cost-effectiveness matters, because the public’s support for the goal may erode should they bear unnecessarily high costs.
  • Changed ambition (e.g. a quicker rate of emissions reduction) is best dealt with within the ETS framework, not outside it using regulatory tools that favour particular technologies or groups of emitters.
  • Equity concerns are best dealt with via cash transfers.
If, as I expect, many — perhaps most — respondents agree with this summary, and the survey’s results are representative of views of NZ economists, then there is an interesting quandary. These views are substantially at odds with those of the New Zealand Climate Change Commission (CCC) and the Ministry for the Environment (MfE)— the organisations responsible for running the NZ ETS. Does the CCC and MfE know something that NZ economists don’t? Or is it they that are out of touch? A topic worthy of further exploration.
It's a good question. I think a lot of them just use the term 'market failure' to refer to anything they don't particularly like, rather than having it firmly grounded in how economists use the term. I also think that, when they identify a potential market failure, they miss the difference between necessary and sufficient conditions for policy to improve outcomes. A hefty dose of Demsetz-style comparative institutional analysis could be warranted, as well as deeper appreciation for how markets respond to things. 

Supporters of additional measures targeting the covered sector raise a few justifications for those measures. You've likely come across them before. 

There’s a stockpile of outstanding emission permits so there isn’t really a cap.

This really misunderstands what the cap is. The cap is the current quantum of outstanding emission permits, plus the currently issued ones. The annual amount released takes into account the number of units in the stockpile. It’s an explicit part of how they think about the cost containment reserve: the first tranche of units in the CCR are held back in hope that price increases getting up to the price cap encourage people to sell units from their stockpiles. That doesn’t make the cap ‘soft’. It just means that you’ve mis-specified what the cap is.

The ability to hold units serves as a hedge for those particularly exposed. It isn’t purely speculation. And speculation wouldn’t be bad either: it’s price discovery. It’s helping to bring prices to where they should be, which encourages appropriate investment in abatement tech.

People can plant trees so there isn’t really a cap. 

We have a cap on net emissions and a net zero target. Not gross emissions. This was deliberate, and good. A lot of people seem determined to set regulation as though we have a gross emissions target, critiquing removals whenever they can as somehow being cheating. 

Any perceived problems from excess planting are going to be local rather than national, so leave it as a matter for local land use planning if Councils need to do something.

[Rod Carr has been arguing strongly against trees, claiming they'll break the ETS. I think he's deliberately pushing for a gross emissions target, over the net emissions legislated.]

We rely on buying credits from abroad to meet obligations and that’s cheating
There's a good case for being extra diligent to make sure that foreign-sourced credits are sound. The accounting has to be solid. But if you can abate two tons of emissions overseas for the cost of abating one here, we’d be stupid not to. Unless we don’t actually care about emissions.

But there is a good case around fiscal risk at the price cap when the Cost Containment Reserve runs out and govt has to issue new backed credits. 

The price cap has a nominal anchor and that introduces risk: who knows what it will cost the government to back those units. It’s why I've argued, for some time, that the price cap shouldn’t have a nominal anchor: it should be anchored in the weighted average of carbon prices in schemes that the Climate Commission considers to be credible, with a commitment to backing units through purchases in the market with the lowest price. 

Then, it isn’t a fiscal risk for the government. Every unit released at the cap earns a bit of money for the government and helps push the world toward a law of one price in carbon. 

There isn’t an intertemporal cap: we can’t guarantee that future governments won’t just release a lot more credits.

This absolutely isn't crazy. But the solution is to have Parliament set a quantum of unbacked credits that can be released between now and 2050, drawing from that pool whenever it auctions or allocates units, and remembering when it sets that pool that the quantum of unbacked credits that might be used also includes already-issued credits that haven't yet been used. 

That makes it explicit if Parliament exceeds the intertemporal constraint. 

Plus, if you run the price cap mechanism properly, there’s a lot less political pressure to break the intertemporal cap. Prices here would just track prices abroad. Less risk of leakage. 

We can’t guarantee when a stockpiled credit will be used so that puts our emission budgets at risk

So much the worse for the short-term emission budgets. You’d break a beautiful system so that you can meet specific and rather silly short-term constraints on a path to 2050? That’s just dumb. Set the quantum of unbacked credits that can be issued or allocated between now and 2050 and then just stop caring about the path. The path largely sorts itself out. 

Like government could announce the annual releases between now and 2050, but the actual path taken will depend on tech progress (in abatement and in sequestration), expectations of tech progress, interest rates, and international prices (where we reset the price cap to track international prices). 

There are Hotelling-style processes running here. If govt issues more this year than the market would want to use this year, they get held; if it issues too few, they draw from stockpile or we hit the cap and track international prices. 

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