Dairy Companies Association of New Zealand (DCANZ) Submission to Emissions Trading Scheme Review Select Committee

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1 PO BOX 3413 Shortland street Auckland New Zealand ~ h ns. z7a szs7 Dairy Companies Association of New Zealand (DCANZ) Submission to Emissions Trading Scheme Review Select Committee FEBRUARY 2009 INTRODUCTION DCANZ welcomes the opportunity to submit to the Emissions Trading Review select committee. We consider the development of enduring climate change policy architecture in New Zealand, which strikes an appropriate balance between economic and environmental drivers to be of high importance. DCANZ does not believe the current Emissions Trading Legislation appropriately responds to the challenges presented by differing levels of international action in this area. By not doing so the scheme is unsustainable on the grounds that it is heavily slanted towards both economic and environmental leakage DCANZ proposes that the Emissions Trading Legislation be amended to address leakage risks through the provision of an output (intensity) based allocation regime, linked to best practice; to provide greater business confidence in the stability of the scheme, via establishment of an independent regulator authority; and to provide a more supportive environment for investment in the development and adoption of lower emissions technologies. BACKGROUND DCANZ represents the collective views of the dairy industry on trade policy matters, as well as relevant domestic regulation and general public policy. DCANZ members currently include Fonterra Co-operative Group, Westland Milk Products, Tatua Co-operative Dairy Company, Goodman Fielder, NZ Dairies, Fonterra Brands NZ, Open Country Cheese and Synlait. This DCANZ submission supports submissions made by the individual dairy companies. Dairy exports generated 10.2 Billion dollars last year, comprising 24 percent of New Zealand's merchandise trade exports. Downstream activities such as transport, rural financing and retailing mean that dairy production plays an even greater role in the national economy. Over the last 15 years growth from the agriculture sector has more than doubled that of other manufacturing industries. Dairy has in turn been a key driver of the growth within the pastoral sector. Depending on its specific design, New Zealand's climate change response has significant potential to either impact both on the economic contribution of the dairy industry, or to contribute to an overall policy environment that supports the on-going success of the industry. TERMS OF REFERENCE ADDRESSED BY THIS SUBMISSION:

2 3.1 This submissions responds to the following Terms of Reference for the Emissions Trading Scheme Review: (d) Consider the impact on the New Zealand economy and New Zealand households of any climate change policies, having regard to the weak state of the economy, the need to safeguard New Zealand's international competitiveness, the position of trade-exposed industries, and the actions of competing countries; Examine the relative merits of an emissions trading scheme or a tax on carbon or energy as a New Zealand response to climate change; Consider the timing of introduction of any New Zealand measures with particular reference to the outcome of the December 2009 Copenhagen meeting, the position of the United States, and the timetable for decisions and their implementation by the Australian Government; Identify the centrallbenchmark projections which are being used as motivation for international agreements to combat climate change; and consider the uncertainties and risks surrounding these projections. 3.2 The related nature of many of the terms of reference items result in a number of the submissions points made below are relevant to more than one. 4 GENERAL POSITION Principles 4.1 Long-term climate stabilisation requires a comprehensive international response. The purpose of a New Zealand' climate change response should be to support and encourage global efforts to reduce and stabilise greenhouse gas emissions over the long-term. DCANZ supports New Zealand's active contribution to a global response. We consider the following to be important considerations in determining the exact design of the domestic policy that should be implemented to drive that contribution to global emissions reduction: (d) (e) The uneven international playing field which currently exists due to differing levels of commitment under the international climate change framework and the leakage risks this creates; The importance of a supportive environment for development and deployment of lower emissions technologies. Achieving globally significant emissions reductions without compromise to wellbeing will require technological step-change; The increasing global demand for food and New Zealand's competitive strength in the production and supply of relatively low emissions dairy products; The consumer led response to climate change. Ultimately reduction in global emissions will be driven by consumption responses. Consumers will be informed in their response by the carbon footprint of their products (emissions intensity per unit of output); The evolving nature of climate change related science and its application to the policy context.

3 Evaluation of current emissions tradina scheme desian DCANZ generally supports a market based approach to climate change policy in New Zealand. However, we consider that the current emissions trading scheme falls short of what is required for an enduring policy response, on the basis of poor performance against the following fundamental criteria: Economic and Political Sustainability; Scientific integrity; Fiscal neutrality; (d) Regulatory Independence. The current Emissions Trading Scheme is slanted towards both economic and environmental leakage from New Zealand. An emissions leakage case study on Fonterra indicated the potential leakage in the form of reduced exports would total $650 million (based on long-term average dairy prices)-. When the exporting activity of other dairy companies is taken into account this number increases. Where New Zealand dairy production reduces as a result of the imposition of carbon costs on the dairy supply chain ahead of our competitors, the supply gap in the international market will be filled by production from less greenhouse gas efficient production systems. This risks both a substantial cost to New Zealand as a country and increases in global greenhouse gas emissions. New Zealand's international competitors within the dairy markets do not yet have any fixed commitment to bring agriculture into an emission trading scheme within the timeframes set by the New Zealand emissions trading legislation. Furthermore, those competitors most likely to fill any international supply gap left by New Zealand do not have emissions reduction commitments under the Kyoto Protocol, as a result of their developing country status. The current emissions trading scheme is neither low-cost nor fiscally neutral. A 2008 NZIER study' concluded that the cost to the New Zealand economy of implementing the proposed ETS (which they estimated at $5.9 billion) would be four times greater in 2025 than meeting New Zealand's international obligations without a scheme. Treasury indications are that the scheme will result in a net fiscal benefit to the Government from Despite its cost to the New Zealand economy, the current emissions trading scheme is constrained in its ability to support behaviour change and meaningful emissions reductions. The scheme risks exposing efficient producers to a price on carbon well beyond the margin and in excess of current abatement potential; this will constrain the growth environment for these businesses and therefore their ability to invest in development and deployment of lower emissions technology. At the same time setting the point of obligation for agricultural emissions at the processor level (the current default point in the legislation) will restrict the ability to recognise individual farmer's use of lower emissions farm tools and techniques. Proposed alternative 1 The case-study was undertaken by NZIER in accordance with TOR agreed by MfE The impact of the proposed Emissions Trading Scheme on New Zealand's economy. NZIER, April 2008

4 DCANZ considers that a modified emissions trading scheme which focuses on the emissions efficiency of output, particularly where there is a risk of leakage for no environmental gain, is the best way to achieve a balance between environmental and economic drivers in the absence of a level international playing field. A full cap and trade scheme is in appropriate until such time as there is a global price on carbon We consider it both feasible and desirable to amended the Emissions Trading Legislation to: (d) Adopt an output intensity based approach to allocation that is referenced to best practice targets; Place the point of obligation at the individual farm level; Provide greater flexibility in responding to evolving emissions related science, and new emissions management tools and technologies. Establish an independent regulatory authority to set allocation provisions and undertake reviews. DCANZ views it as appropriate that a modified ETS be accompanied by an on-going commitment by the New Zealand Government to emissions reduction research, focused on those areas where New Zealand has a particular competitive advantage as a country. Alongside the establishment of an economic sustainable and scientifically sound domestic policy response, New Zealand should place a high priority in seeking quality outcomes from the current negotiations. DCANZ considers the outcomes of the current international framework negotiations to be highly uncertain at this time. But notes that they provide an important opportunity to address weaknesses in the current Kyoto framework, particularly in relation to treatment of food production. Related to this we note that there are questions being raised regarding the current treatment of biological methane and encourage the New Zealand Government to commit resources into ensuring that these are addressed. OUTPUT INTENSITY BASED ALLOCATION Basing allocation on the intensity of output, referenced to best practice, and without a cap, is necessary to achieve the appropriate balance between encouraging emissions reductions within New Zealand and avoiding leakage for no environmental gain. Under an output intensity based approach to allocation, participants in sectors at risk of leakage (agriculture and stationary energy) would receive allocations equal to a best practice target level of emissions per unit of output for their total production volume. The objective of this would be to fully compensate participants at risk of leakage, who are operating on an emissions efficient basis, for the additional costs arising throughout their supply chains as a result of New Zealand adopting a cost on carbon ahead of competitor countries. DCANZ considers that this approach to allocation would: Avoid punitive penalty to efficient producers; Drive reductions in NZ emissions from business as usual without risking increases to global emissions via leakage to less efficient

5 competitors. This approach sets a requirement for New Zealand participants to operate on an emissions efficient basis, including by adoption of new cost effective technology. Best practice targets will phase-downwards to reflect advances in emissions efficiency technology and practices; Provide effective behaviour change signals. It will: (i) (ii) (iii) (iv) Maintain a price at the margin; Set clear commercial drivers for participants to optimise their investment in carbon efficient technology; Recognise and reward the use of lower emissions practices at an individual level; Create the right environment for investment in new technology. 5.4 We view an output intensity based approach to allocation as being practical. It aligns with consumer market responses to climate change by focusing on emissions intensity per unit of output. While some work would be required to determine the mechanisms for setting best practice targets the need for complex plans for allocating within a cap would be removed. 5.5 An output intensity approach to allocation for agriculture would necessitate an on-farm point of obligation. DCANZ considers an on-farm point of obligation to be a necessary element of a behaviour change focused scheme. The alternative - a processor level point of obligation - will in-practice work as an output levy and will be constrained in terms of its ability to recognise new technology or reward behaviour change. The tools to support an on-farm point of obligation (the OVERSEER model) are already being used by the dairy industry. 6 RESPONDING TO EVOLVING SCIENCE AND NEW EMISSIONS MANAGEMENT TECHNOLOGIES 6.1 To be most effective, an ETS must recognise and reward all techniques and technologies that are scientifically proven to reduce net emissions. If the scheme recognises only internationally agreed technologies, the motivation for participants, including farmers, to innovate and invest in emissions reduction will be weakened and the scheme will be far less effective. 6.2 DCANZ considers that a modified ETS should allow for recognition of land switching and sequestration of carbon by trees located in plantings of less than 1 hectare. It should also include provision for emerging management technologies to be credited at the time that New Zealand has confidence that they are scientifically robust. This recognises that the international recognition process for new technologies, such as nitrification inhibitors, could be lengthy. 6.3 Alongside the implementation of a modified emissions trading regime DCANZ considers it important that the Government continues to actively supports research and technology in areas where New Zealand can make significant contribution to global emissions solutions. In particular the success of the Government-Industry partnership for agriculture emissions mitigation research, via the Pastoral Greenhouse Gas Research Consortium should be built upon. 6.4 It is important that New Zealand recognises that the many of the tools required for long-term climate stabilisation on not yet available. An on-going

6 commitment to research and a support environment for business investment is critical to their development and adoption. 7 REGULATORY INDEPENDENCE 7.1 DCANZ considers that the operation of an emissions trading scheme, including setting and reviewing emissions targets and recognising new technologies, should be governed by an independent regulatory authority. This is important for business and markets as it will instil confidence the scheme will be stable and predictable over the long-term. 7.2 Both the Reserve Bank and Commerce Commission provide potential models for further consideration.