Part 2 - Further background for the ETS review

1. What gross emissions reductions and forestry CO2 removals are needed to meet current and future domestic targets?

New Zealand's first three domestic emissions budgets (out to 2035) were set based on the Climate Change Commission's Demonstration Path scenario. This scenario separately models:

• a path for reduction of gross energy/industrial/transport emissions, and the associated emissions price needed to achieve these reductions (which would be high and rising: the newly updated ETS price controls are based on allowing the market to reach such levels if needed)
• a forestry scenario based on supplying sufficient removals not only to reach net-zero in the ETS, but also to be able to cover agricultural nitrous oxide (outside the ETS but part of the net-zero target) and international aviation and shipping when these are brought into the net-zero target.
• agricultural emissions.

The Demonstration Path forestry scenario is NOT, and was not intended to be, a projection of the level of forestry removals that would occur on a market-driven basis under the ETS alone. The Demonstration Path is not a self-consistent price-driven model of gross reductions and forestry removals: on the contrary, it effectively assumes different treatment of gross ETS-sector reductions and forestry. The levels of forestry removals in the Demonstration Path is of similar scale to previous government projections with ETS prices in the $35 to $50/tonne range, while achieving the level of gross reductions in this scenario requires much higher prices. It reflects a value judgement by the Commission, accepted by the government, that gross reductions of long-lived gases are important even though they come at higher short-term cost than forestry removals.

The figure below shows the Demonstration Path for long-lived gas emissions and forestry removals. The amount of forestry removals is by design sufficent to achieve and mantain net-zero for all long-lived gases including ETS emissions (light grey), international aviation and shipping (dark grey, which I have arbitrarily shown entering in 2030) and agricultural nitrous oxide (orange), with a small buffer left over.

2. What might the status-quo ETS deliver?

To support the current consultation, the government has released preliminary results from an ETS spreadsheet market model, which balances gross emissions and forestry removals within the ETS, as well as NZUs moving in and out of the very large stockpile of banked units. With perfect foresight of ETS demand, forestry planting (and hence future supply of forestry removals) adjusts downwards over time to match falling ETS emissions. The model is very much a work in progress, but the initial results show a falling ETS price over time, and

• higher gross emissions than the Demonstration Path (i.e. higher than is consistent with achieving the emissions budgets that have been set), and
• less forestry removals than in the Demonstration Path (i.e. less than is consistent with meeting the emissions budgets that have been set).

Putting this another way, achieving the emissions budgets that have been set requires more gross reductions than the status-quo ETS will deliver (because the price won't rise sufficiently high), and more forestry removals (because the ETS won't incentivise removals to offset emissions that are not in the ETS). There is therefore a mismatch between the way the ETS is currently set up and the targets that have been set.

Could the Budgets still be met on a "net" basis without any particular focus on gross reductions? At least for the first two budgets to 2030, the answer is no, because any additional forestry planting today would not generate significant quantities of removals until after 2030 (because trees take time to grow). The only way in the short term to close the gap between projected emissions and the emissions budgets is through gross emissions reductions.

3. What is the contribution of gross reductions and forestry removals toward NZ's 2030 Paris Agreement NDC (and future NDCs)?

The discussion so far has only considered New Zealand's domestic targets. New Zealand also has an international target under the Paris Agreement which is more ambitious than the domestic budgets. Because the NDC is expressed as an all-gases target (as per UNFCCC expectations) the "net" emissions here are now for all gases.In the graph below I have shown biogenic methane meeting the targets that are in NZ legislation: a 10% reduction in 2030 and a 24-47% reduction in 2050 (I plot the midpoint of this range).

The NDC is shown in blue, and should be compared to the net emissions pathway (dashed black line). To the extent that domestic net emissions are higher than the NDC path, we will need to fund an equivalent quantity of emissions reductions in other countries, as allowed for under the Paris Agreement.

Any additional domestic emissions reductions that can be made will bring us closer to the NDC target and reduce the quantity of international cooperation required. This could be achieved both through action on fossil fuel emissions (e.g. moving closer to the IEA net-zero energy scenario, as discussed in Part 1), and by any over-achievement of the 2030 target for biogenic methane. As the domestic budgets and NDC were been set on the basis that the 2030 biogenic methane target will be met, any failure to do so results not only in failure to meet the domestic emissions budgets, but an increased need for offshore purchase to meet the NDC.

The figure below shows how New Zealand's net emissions could shift if gross fossil fuel emissions were to drop in line with the IEA NZE scenario (left = demonstration path, right = IEA NZE), and if forestry removals are kept at the level of the Demonstration Path in both cases. The additional gross reductions bend the net emissions curve downward and close the gap to the NDC, saving the majority of the need for offshore cooperation. This also means that future NDCs after 2030, as a continuation of the blue curve, could more easily follow domestic emissions without the same reliance on international cooperation.

The critical point here is that even if gross emissions reduce more quickly in the ETS, that does NOT mean that forestry removals should be scaled back: the freed-up forestry removals contribute to New Zealand's current and future NDCs, directly displacing the need for use of international markets.

Looking out to 2050, the scenario shown above has significant net-negative emissions for long-lived gases in 2050, however as discussed in Part 1, this can be seen as New Zealand's share of draw-down of global overshoot of the carbon budget for 1.5C. It would also provide a source of removals that would be available to offset agricultural emissions as markets demand this.

4. Conclusion: the government has not been clear on what the right questions are.

The consultation document is focused on action within the ETS: what is the right balance of gross reductions and removals. Some have argued not to worry because the ETS will self correct by reducing forestry supply (as in 2. above), however that status-quo outcome is inconsistent with achieving the targets that have been set. To me, the key questions should be

• What is the best way to provide a clear constraint on fossil fuel emissions that drives rapid gross emissions reductions, and
• What is the best way to provide investors in removals (forestry, but also other types of removals) with enough certainty to be able to invest now for what will be uncertain demand in future that will come from multiple sources (residual ETS, international aviation and shipping, agricultural nitrous oxide, NDCs, voluntary market, potentially agricultural methane, international buyers).

My view is that these are separate questions, so the policy framework needs separate levers to address them. The government has not provided enough detail in the consultation document to properly asses the pros and cons of different approaches, but it is clear that the status-quo ETS is not the answer.