Wednesday, 21 September 2022

Gross or net?

The Climate Commission keeps trying to push us from having a Net Zero target to having a Gross Zero target. 

Carbon News reports:

Climate Change Commission chair Rod Carr says, if left alone, the planting of pine trees purely for carbon credits will prevent the ETS from playing the part it should in reducing carbon emissions.

Speaking at the Climate Change and Business Conference in Auckland, yesterday, Carr said the government needed to address the problem urgently but in consultation with those most affected by any changes: foresters and landowners.

...

Climate change minister James Shaw acknowledged the commission’s concern that a glut of forestry offsets in the 2030s “could lead to a crash in the ETS price and a return to the bad old days of companies just using cheap offsets rather than actually reducing their emissions.”

The ETS's job is to limit net emissions on a path to Net Zero in 2050. Forest sequestration can be an important part of that. If it is cheaper to sequester a tonne of carbon than to prevent a tonne of emissions, then do the former. 

There can be all kinds of potential problems. If there are biodiversity benefits from native planting over pine, and those are substantial enough to warrant policy involvement, then set a subsidy for the production and maintenance of those habitats. 

Here's Shaw, from the same piece:

“Aotearoa is the only country in the world with an ETS that allows companies to offset 100% of their pollution with forestry.”

He said including forestry in the ETS had meant the cap was a very soft one. 

“That’s because anytime anyone plants enough trees to sequester a tonne of carbon, we automatically generate an NZU, which is a permit to pollute a tonne of carbon into the atmosphere.

“Which means, technically, that unlimited forestry allows unlimited pollution,” Shaw said. 

We don't have a soft cap, or at least not in this way. We have a cap on net emissions. The point of having a net emissions cap is to be flexible. Climate doesn't care about gross, it cares about net. But politicians and, seemingly, the Commission, want to force gross reductions even if that's less cost-effective. 

Caps on net emissions are great because they're agnostic about how net emissions come down, so long as they come down. If carbon capture tech aiming at USD$100/ton pans out, that sets a natural limit on ETS prices. If it doesn't, the ETS encourages finding other options instead. But if we wind up flipping to a gross target, it can't help us. 

One might start to get the impression that none of them actually care about net zero, but instead mainly care about the behavioural changes required for gross emissions targeting, for reasons other than climate change. 

Changes that would make a tonne of sense, if all of this were actually about reducing net emissions through 2050:

  • Setting a cap on the number of unbacked ETS credits that can be issued by the Crown between now and 2050, requiring that annual auction and allocation draw from that pool;
  • Considering the number of outstanding units when setting that cap to 2050;
  • Rejigging the ETS price cap to track a weighted bundle of carbon prices in credible ETS markets rather than just being some nominal amount - this would have us more easily following without exceeding prices elsewhere;
  • Using international credits to back units issued at the price cap, unless the government has immediate access to cheaper ways of backing those units - and note that government would earn money at the price cap under this mechanism rather than facing fiscal risk;
  • Taking ETS revenues and redistributing them to households as a carbon dividend rather than a slush fund for political favourites.

Tuesday, 20 September 2022

GIDI and the Emissions Reduction Plan

The Environment Select Committee invited me to provide a supplemental submission on the Emissions Reduction Plan. My initial submission had taken EECA at its word that they had received no advice about the additionality of projects funded under GIDI. More the fool me.

Recall that GIDI is the funding line to subsidise investment in lower carbon tech. Some $600m in new funding for it was announced at the last budget. And this kind of approach is all over in the Emissions Reduction Plan. 


One particularly fun bit: the consultant noted that applicants for GIDI were all over the map in their assumptions about future carbon prices and future fuel prices. That'll matter in assessing whether funding for a project was additional or whether it was something that the company would have done on its own without funding. See 3.6, below.

From my submission:
ASSESSING GIDI ADDITIONALITY 

3.1 Evaluation of the documents released by EECA suggest that GIDI projects do not reduce national net emissions. EECA’s conception of additionality relates to whether a project would have been undertaken as quickly in the absence of funding, not whether net emission reductions then obtain. 

3.2 Recall that cost-effective additionality of GIDI subsidies requires that emissions are mitigated relative to the counterfactual, that those emissions are mitigated at lower cost per tonne than going ETS prices, and that government is able to reduce the number of carbon credits issued because of the measure. If the cost of abatement is lower than the going ETS price, then companies already have strong incentive to pursue mitigation without subsidy; if the cost of abatement is higher than the going ETS price, government could do better by buying back and retiring outstanding ETS credits. 

3.3 Comparison to ETS prices introduces something of a knife-edge. If a company’s investment, proposed for subsidy, mitigates emissions at lower cost than current and expected ETS prices, why is the company not already doing it? If it mitigates emissions at higher cost than the current and expected ETS price, why is the government subsidising something that is not cost-effective? The subsidy has to help the company or industry overcome some other market failure to be cost-effective. And it has to consequently allow the government to reduce the number of issued ETS credits. 

EVALUATION OF GIDI 1.0: DISCUSSION WITH EECA 24 MARCH 2022 

3.4 Concept Consulting’s presentation was developed to help improve the application process for future rounds of GIDI funding. The additionality of funded projects is first assessed at point of funding application; if a project is not considered likely to result in investments that otherwise would not have taken place as quickly, the project will be less likely to be funded. Concept evaluated five applications for GIDI funding. 

3.5 The presentation noted deficiencies in GIDI 1.0 that could and should be improved in future rounds, including insistence that every application use standard assumptions about future changes in fuel costs, in inflation, and in ETS prices. Applications used 2030 ETS prices that varied from $40/tonne to $140/tonne, and 2040 prices that varied from $40/tonne to $180/tonne. Gas prices in 2040 ranged from just over $10/GJ to over $20/GJ. 

3.6 It is somewhat surprising that GIDI 1.0 allowed applicants to set their own assumptions on ETS prices, fuel prices, and inflation. Treasury’s guidelines for cost-benefit assessment and its CBAx tool, for example, are set to provide a consistent approach. Projects should be assessed using the same ruler. If one project is funded, and another is not, because the projects made different assumptions about ETS prices and future inflation rates, the right decision will have been made only by chance. Worse, if applicants know that they can manipulate the process by setting assumptions painting a rosier picture of their project’s suitability for funding, it would be foolish to expect that they would not do so. 

3.7 The section on additionality says, “It appears that four of the five projects evaluated may not be additional.” Concept considered that, on the applicants’ assumptions, every proposed project would have paid itself off in less than four years, without a subsidy. And three of the four projects would pay themselves off within four years even if carbon were not priced. In other words, most of the projects Concept evaluated could and should have been undertaken by the companies on their own, even if the ETS price were zero. 3.8 Concept noted that, in some cases, small projects with high internal rates of return may not be undertaken without government support. They provided examples where resource constraints or financing constraints mean the project with an attractive-seeming internal rate of return may not make it to the top of a company’s priority list. 

3.8.1 As simple example (provided by us rather than by Concept, by way of illustration), a $10,000 project with a 200% internal rate of return might not be worthwhile if it sucks up a lot of internal administrative resources that are not appropriately costed in determining the rate of return. The real internal rate of return could be strongly negative if undertaking the $10,000 project meant diverting the attention of a project manager responsible for a $10,000,000 project with a 10% internal rate of return. 

3.9 In other words, if a project seems to make sense but is sufficiently small that a company does not find it to be worth prioritising, government support for the project may be necessary. But if that is the case, it seems quite unlikely that the project can do much to affect national net emissions. 

3.10 In other cases, debt constraints were considered as potential hindrance against taking up projects with a promising internal rate of return. If covenants on existing debt set hurdles on taking on further debt, then some projects might not be pursued. 

3.11 But other alternatives might be available in such cases if the potential returns were substantial. A company might lease equipment rather than purchase it. Or it might seek an equity contribution from shareholders, if those shareholders could be convinced that the rate of return were high enough to warrant the investment. In general, should it be the role of government to provide grants to companies that have found themselves credit-constrained? If it is, might we expect more companies to find themselves to be credit-constrained? 

3.12 In both cases, EECA subsidy might encourage a company to change its priority ordering of projects, perhaps bringing forward a low carbon project while pushing back another project. There could be some reduction in that company’s emissions over the period in which the investment is in place thanks to GIDI funding before the company would have made the investment on its own. In that case, any benefits of the funding should only be assessed over that short interval of time, rather than over the lifetime of the equipment. And any wider cost-benefit assessment would need to consider the costs of deferring the projects that were pushed back in the priority ordering. 

3.13 Concept notes that GIDI 1.0 evaluation placed 20% weighting on economic stimulus driving domestic employment and 10% weighting on speed of spending. Neither makes any sense in assessing projects for carbon reduction but may be important for make-work projects. Make-work projects might be ill-advised when Reserve Bank views employment rates as unsustainably high. 

3.14 Concept notes that GIDI 1.0 evaluation scoring placed 10% weighting on “level of innovation and co-benefits”. Concept noted that demonstration benefits can be valuable, but “should potentially come with a requirement that information is shared with the wider industry.” 

3.15 EECA Chief Executive Andrew Caseley noted, in his defence of his agency’s view that Concept’s advice constituted author opinion, that assessing additionality is complex and requires information on a range of factors that might not have been available to Concept, including companies’ “internal decision-making processes, their risk appetite, financial measures such as cost of capital, sector norms in decarbonisation decision-making etc.” 

3.16 Concept may not have had information on each of these in assessing the five applications, but its presentation and correspondence clearly suggested that it was thinking about these issues. Sector norms in decarbonisation would be a rather plausible reason for considering the benefits of demonstration projects. Concept had to point out to EECA that the value of demonstration projects is higher if the funded business has to share information with others that might benefit from it.

Even more innovative than I'd thought

In last week's Insights newsletter, I celebrated public sector innovation and entrepreneurship. But I'd underappreciated just how innovative folks have been!

I'd written:

Entrepreneurship is highly rated. My son’s school even renamed their NCEA Level 1 economics paper “Entrepreneurial economics” and their accounting paper “Entrepreneurial finance.”

But entrepreneurship remains underrated. Entrepreneurs’ alertness to opportunity, and determination to see it through, are a fundamental source of rising living standards. 

Public sector entrepreneurialism often goes unnoticed. Results may not always be as desirable as in the private sector, but who are we to judge?

So let us recognise some remarkable public sector entrepreneurship.

Public sector bodies traditionally did not get involved in electioneering. But that missed an opportunity! Supporting a candidate who supports the agency’s views could make both better off.

Local government candidates extolling the merits of new cycleways feature in NZTA advertisements. The ads will have to stop running during the regulated period, but name and face recognition count for a lot. Voter memories might be short, but they aren’t that short.

It’s an innovative move that, somehow, seems allowed by law. So why shouldn’t they?

Public funding of sympathetic documentaries about Members of Parliament who are sympathetic to public funding of documentaries? It’s obvious win-win in hindsight, but it took entrepreneurial alertness to spot the opportunity. Kudos to New Zealand On Air.

And let’s not forget EECA’s exceptional achievement earlier this year. Deeming a consultant’s presentation as mere opinion, and out-of-scope of my OIA request, rather than in-scope advice? A masterstroke!

The Wiri alcohol licensing trust has been promoting candidates for local body elections – including election to their own board.

Unlike some other licensing trusts, Wiri has no monopoly on local alcohol sales. But friendly councillors would be helpful when central government considers tighter alcohol restrictions.

Local campaigner Nick Smale complained Wiri’s actions were unethical. But should we blame the Trust? They discovered an opportunity. That kind of gumption should be celebrated rather than discouraged.

Monopoly licensing trusts able to earn cartel-like rents could follow Wiri’s entrepreneurial example. In 2014, the Auditor General said they were “probably the least scrutinised part of the public sector.”

Lack of oversight provides tremendous opportunity for entrepreneurial innovation. Why not recycle trust cartel profits directly into billboard and radio campaigns for friendly candidates? It’s an entrepreneurial opportunity ready to be taken up.

So stop complaining about a moribund public sector. Innovation is all around us. You need only be alert to see it.

If New Zealand’s high schools taught civics, they could even rename it “Entrepreneurial politics”.

That bit about NZTA not running ads featuring candidates during the regulated period? They've been more innovative than that. And why shouldn't they? Nobody will tell them that they shouldn't, not even the Public Service Commissioner who's presumably perfectly pleased with their conduct. [Important update below!]

Jem Traylen over at BusinessDesk has been all over this file, most recently on Monday. Jem writes:

Such are the slow machinations of the state at these lofty levels, particularly when it seems the public service has embarrassed its political masters for the third time on the same issue of political neutrality in government advertising. 

Meanwhile, we’ve had ads featuring local body politicians running as early as January in a local government election year, with some as recently as Sept 2. 

The formal election period commenced on July 8 – nearly three months after Hughes was first notified of the situation by the NZ Taxpayers’ Union's April 12 complaint.

And I'd left out all of the wonderful innovations by the Mahuta-Ormsby family, and by the bureaus very happy to accommodate New Zealand's shift away from the rule of law, and from impartial and impersonal institutions, back toward kin-based contracting norms that do wonders for development

Raise a toast to all of these spectacular innovators. They will lead the country into a new age. 


Update: The Public Service Commissioner has weighed in!

Thursday, 8 September 2022

Afternoon roundup

So many browser tabs before the rebooting can happen...

Water entity debt

This really doesn't seem like a good idea.

Central Government provided sweeteners for local councils to encourage them to participate in the Three Waters Reforms. Two rounds of contestable funding for local projects. 

The first round is funded by central government. The Waikato Times reported that it's being used for all kinds of projects far removed from water infrastructure: passenger rail business cases, improving the local pool, walkways, contemporary art and more. 

That part seems silly but perhaps less harmful. Far better if the funding were being used to get the local waterworks up to spec for whatever might come in water reform.

But the second tranche seems a really really bad idea.

The Waikato Times writes:

“As we already have project ideas worth more than the $16.46m in available funding, community feedback to help council make the final project decisions will be vital," he said.

Ideas that aren't included as part of the Tranche 1 application may be carried over to Tranche 2 or form part of the new long-term plan next year.

The council says Tranche 1 funding is expected to have no direct impact on rates, as it is a grant from central government.

Tranche 2 funding will be debt-funded, with the debt transferred to the new Water Services Entities.

“As such, this will be repaid by water users of the respective entities,” the council says in its consultation document.

“How the entity decides to recover this debt and any subsequent impact on rates is unknown at this time.”

So. Local councils pitch for Tranche 2 projects that could be every bit as water-related as community art projects. They get funded by debt that's loaded into new amalgamated water service entities. 

Local councils have a complicated relationship with those proposed amalgamated entities. But if a council winds up bearing something like 1/N of the cost of whatever projects they pitch, they'll have pretty strong incentive to make sure that every dollar that their council can get through the thing goes to their council - regardless of how weak the case for it might be. 

S&P had already found the water entities are going to be aggressively leveraged, and that the Crown's backstop guarantee really matters in getting a reasonable credit rating for the things. They might be even more leveraged than S&P had figured, if they're also going to be loaded up with piles of council pork-barrel projects in addition to having to fund necessary water infrastructure. 

It might not be crazy to have Tranche 2 funding available for water infrastructure upgrades in advance of amalgamation. It still seems a worse idea than having the new entities make whatever decisions make sense across their areas as a whole. But encouraging councils to run a pile of pork barrel projects that load into the debt burden of amalgamated water entities - I don't know what the heck they're thinking here. 

The background documents have the main difference between Tranche 1 & 2 being expectations around the extent of co-design and co-implementation of projects, not whether they have anything to do with water services. 

And they also confirm that the water service entities are taking on a billion and a half in debt out of this, while claiming that it's okay because water users will benefit from it, and because the value of the Crown backstop is bigger than the debt loading. 

Who will provide the funding?

The support package will be met by both the Crown and the new water services entities.

The Crown will provide $1 billion of funding towards the better off component of the package, as an investment into the future of local government and community wellbeing.

The Water Services entities will provide $1.5 billion of funding, comprising:

• An estimated $500 million towards the no worse off component of the package

• $1 billion towards the better off component of the package.

It is appropriate for water services entities to bear some of the costs associated with the support package given that future water customers stand to benefit most from reform. From the perspective of future water customers, the size of this benefit is significantly greater than the cost associated with providing some of the funding for the support package.

Moreover, given most future water customers are also ratepayers, they stand to benefit from the additional investment into community well-being. 

We also note that the proposed support arrangements provided by the Crown to the water service entities (such as a liquidity support), are expected to reduce the borrowing costs. The net present value of the reduced borrowing capacity is expected to be greater than the $1.5 billion of funding provided by water service entities through the support package.

It seems mad.  

Tuesday, 6 September 2022

Morning roundup

The morning's worthies, on the closing of the tabs:

Stupid GE bans

One cost of regulation is the innovation you never get to see. 

We know about how New Zealand's stupid ban on genetic modification is causing problems for GHG reductions in agriculture. Even field trials of promising rye grasses have to be undertaken over in the US because the government bans them here.*

Michael Donaldson over at The Pursuit of Hoppiness points to another problem. Perhaps even more important than global warming and the climate response. This one's about beer.

Before I explain just how world-leading this product is, we first need to understand thiols.

Simply, thiols are organic compounds that contain sulphur. They are present in varying levels in different varieties hops as well as other plants.

Thiols come in all sorts of chemical configurations. Most create odours reminiscent of rotten eggs or garlic while others produce can pleasant flavours such as those found in coffee or grapefruit. The thiols that brewers most want deliver potent characteristics of tropical fruit, notably passionfruit and pineapple.

Popular hops such as Citra, Simcoe and Mosaic include plenty of thiol precursors, but New Zealand hop varieties such as Nelson Sauvin, Motueka and Southern Cross have overly high levels of thiol precursors, which is why they are so prized.

Ruffell has always been intrigued by these flavour compounds.

“I’ve been thinking about thiols since around 2013. We have high levels of thiols in New Zealand hops and we don’t really know why and that’s always interested me.”

He then learned that Marlborough-grown sauvignon blanc grapes are unique in the world for their high level of thiol precursors.

Ruffell says there are number of factors that make Marlborough Sauvignon Blanc grapes so high in thiol pre-cursors. Some of it has to do with terroir, some with specific UV light in that part of the world, and he understands there is also “a stress response from plant” so machine-harvested grapes have higher levels of thiol precursors than hand-harvested grapes.

“In 2018 I had this concept which eventually became Phantasm,” he explains.

...

In terms of flavour delivery, Ruffell says thiols are so potent the equivalent of “thimble-ful in a swimming pool” is enough to make an impact.

“I joke about it as MSG of beer — add a little bit and it just helps everything really pop.”

At the moment, the brewers getting the benefit of this flavour bomb are in America, and there’s a regulatory reason for that: genetically-modified yeasts.

To get the best out Phantasm, it helps if you can use one of the new genetically-modified yeasts on the market, known as thiolising yeasts.

New Zealand’s strict regulation on genetic modification (and ditto for Australia, Canada and many European nations) means those yeasts are not available here.

“At the moment Phantasm is almost entirely sold into the United States and that’s because they can use genetically-modified yeasts to unlock the best characters of Phantasm,” Ruffell says.

“We’ve kept Phantasm under the radar here and we sell exclusively to America because of those GMO yeasts. We can get pretty good results with non-GMO yeasts but it’s not quite the same.”

Ruffell expects that to change in the future, noting that Omega Yeast’s Cosmic Punch is an example of a yeast that could have been developed through breeding “but they just have a precise, elegant way of doing it” in the lab. (For geeks, what Omega have done is take the IRC7 gene in the Chico yeast strain, where it’s inactive, and inserted it into London III strain and “connected the pathways” to make it active).

Where ever it’s been used in America, the reaction to Phantasm has been incredible.

Brandon Capps, owner and head brewer at New Image Brewing in Colorado said it helps him create the “ultimate realisation of what hazy IPA could be”. 

“Does it taste like citrus? Does it taste like papaya? Maybe overripe nectarine or plum would be the closest description I can find. It’s just this really interesting flavor that tastes like biting into a piece of tropical fruit.”
Emphasis added. 

Hippies are a problem. 

HT: Glenn Boyle. I'd caught the article on Twitter, saw an interesting new Garage Project beer that I wanted to try, didn't get down to the important stuff below the fold. Glenn read the whole thing. 

* A set of regulations so intractable and impossible to comply with is identical to a ban, so pedants can go soak their heads.