Emissions trading requires immediate focus

Simon Watt, Partner | Friday 7 December 2007

New Zealand's much-awaited Climate Change Bill landed in Parliament this week. This signals the start of an intensive legislative process that will culminate in the imposition of a new cost of carbon, impacting across the economy.

The Climate Change (Emissions Trading and Renewable Preference) Bill enables the New Zealand Emissions Trading Scheme (NZ ETS) to be introduced along with amendments to relevant tax and personal property legislation.

It also introduces a 10-year moratorium on new baseload fossil-fuelled thermal electricity generation, except to the extent required to ensure the security of New Zealand's electricity supply - a measure to complement the emissions trading scheme.

Tight timeframes

The Government has set relatively tight timeframes for legislation to be passed. When enacted the legislation will apply retrospectively from 1 January 2008. It is expected to have its first reading as early as next week. It will then be referred to the Finance and Expenditure Committee, with a call for submissions by the end of February 2008. The committee will have the standard six month period to report back to Parliament, but it is expected that its report and the second reading will be completed well within this time. On that basis the Bill should be enacted in July or August 2008.

Basics of the Bill

In brief, the Bill sets out the mechanics of the NZ ETS, including:

• clarification as to which activities give rise to mandatory obligations or the right to participate under the scheme;

• who, in terms of a particular activity, will or could be the participant;

• details of a participant's obligations, and the penalties for failing to comply with them;

• the manner in which liabilities or benefits will be calculated and how units are to be issued or surrendered; and

• the basis on which units will be either freely allocated or sold to participants by public tender.

Notable features

Mandatory obligations
Obligations arise under the scheme as a result of a business carrying out a specified activity, subject in some cases to materiality thresholds. The Bill specifies at least 24 greenhouse gas-emitting activities that give rise to a mandatory obligation to participate in the NZ ETS.

Opting-in
Owners of post-1989 forests, producers of carbon-embedded products, and a small number of other entities have the right (and are not bound) to opt-in to the scheme. In the latter case this entails taking on the responsibility for emissions from that activity or portion of that activity from the primary market participant.

Industrial producers who embed carbon in their products, for example methanol, have a right to opt-in to the scheme and account for their emissions and removals (emission reductions from sequestering or embedding carbon), with the right to receive units for any net removals verified in a particular compliance period.

Getting together
Corporate groups that carry out an activity, or a number of activities, that give rise to obligations under the NZ ETS, could opt to report and account for those activities on a collective basis, through a nominated entity. This provides them with greater flexibility to manage participation in the scheme at the least cost to the group as a whole, while still acting consistently with the purpose of the scheme. The ability for a group to report and manage its activities, and associated benefits and liabilities, on a collective basis is important and a positive initiative. It is bound to cause entities to consider whether they have the most appropriate corporate structure to maximise any opportunities and minimise their liabilities under the NZ ETS.

Associated persons and relationships resulting in joint and several liability
Entities are also likely to consider closely the activities carried out by "associated persons" and any unincorporated joint ventures, partnerships, trusts etc in which they are involved. These relationships may have consequences as to whether entities are caught by the scheme or are jointly and severally liable with other persons under the scheme. Part of the purpose of these provisions is to ensure businesses do not avoid inclusion in the scheme when their activities should otherwise be captured. Again entities will be looking closely at their corporate structures and commercial and contractual relationships with other parties to maximise any opportunity to benefit, and minimise liabilities under the scheme.

Allocating units
Units will be allocated freely to those businesses who are unable to pass on costs, and will otherwise be sold by public tender. The Government has explicitly retained the right to restrict the people who may wish to buy units offered, aiming to reduce the risk that entities outside a sector with "deep pockets" and no obligations under the NZ ETS could buy units for more speculative trading, making units unaffordable for entities needing to buy units to stay in business. The Bill leaves open how and where the Government might impose restrictions on who can buy units, and we expect this to be an area for active lobbying.

Trade protections
There is a degree of protection for trade exposed entities (those who will be unable to pass on the cost of carbon and still compete with international firms), through the provision of free units. The Minister has discretion to determine who may fall within the criteria specified for trade exposure. Businesses who consider themselves to be trade exposed will no doubt be lobbying the Minister to ensure they are afforded some protection.

Forestry assistance
For the forestry sector, the manner in which units will be allocated for assistance to owners of pre-1990 forests is still being confirmed, so it is not certain that units will be allocated pro rata based on forest size. The Government's proposal to provide limited assistance to owners and foresters has been heavily criticised by elements of the forestry industry. The Government is also considering alternative options, such as targeting assistance on the basis of land-use capability or on key characteristics.

Direct reductions
The Bill could be read as only enabling liabilities to be reduced through direct emission reductions in the particular activity covered, rather than allowing participants to use indirect off-sets to reduce their liabilities. This is an area where clarification is needed. We would expect to see submissions favouring a wide approach to incentivising the use of off-sets (such as building a wind farm to balance out industrial process emissions).

Global trading
International trading is recognised and permitted by the Bill, albeit the Minister retains the discretion to restrict the types of emission units that may be traded internationally and enter the scheme, such as certified emission reduction units (CERs) from nuclear projects. Future international linking with other emissions trading schemes is foreshadowed by the inclusion of "approved overseas units" as a type of unit that may be surrendered for compliance purposes.

Finance markets
Financial market players will be interested to note that the regime for taking security over emission units will mimic that for security interests over shares and other financial products. Adopting a regime familiar to the many participants in financial markets will promote liquidity and tradability of units.

Penalties
The NZ ETS adopts a self-assessment approach similar to that used for tax returns. However, participants should be aware that hefty penalties may arise for failing to enter the scheme or comply with obligations. Penalties include full compensation at market rates for any units that entities fail to surrender, plus heavy penalties which could double or triple an entity's liability.

Binding rulings
Entities may seek a binding emissions ruling, for instance as to whether their business activity is deemed to be giving rise to obligations, similar to the binding ruling process for tax and Commerce Act issues. The inclusion of this process indicates the potential for uncertainty as to whether an entity's business does or does not fall within a specified activity or whether it produces a product which is considered to embed carbon.

Moratorium exemptions
The Bill provides for exemptions from the 10-year moratorium on new baseload fossil-fuelled thermal electricity generation, and a process for seeking exemptions. Generators will be focusing on how they might fall within exemptions, and on influencing the Minister and the Electricity Commission on this.

Detail in regulations
A number of detailed matters have been left to regulations, which results in a level of uncertainty despite the number of issues dealt with by the Bill. It provides an opportunity for those who are likely to be affected to influence the development of these subsequent rules.

Where to from here for business?

New Zealand businesses are already mobilising to address the changes the Bill will bring. New teams are being formed combining regulatory and environmental specialists - the people who have primarily been driving the business' involvement in the climate change arena to date - with members of financial, operations, legal and tax teams, to ensure their business takes a holistic approach in identifying liabilities and benefits, and the strategic approach that the business may wish to take.

Checklist for business

From here we suggest that businesses may wish to:

• Review and make submissions on the proposed legislation, particularly those provisions that may have an unduly onerous or unintended effect.

• Develop or refine their strategy for dealing with impending liabilities or maximising opportunities under the NZ ETS, and determine whether that strategy is viable from a legal perspective.

• Businesses will also need to appreciate that the level of liquidity in the New Zealand market cannot be guaranteed. It is likely that the market in New Zealand will be short, in that there will potentially be more buyers of units than sellers (depending particularly on the willingness of foresters to enter the scheme and sell their units). Accordingly, some international trading of units is a reality and as assigned amount units or AAUs (the type of units issued to governments under the Kyoto Protocol) are not readily available, primary or secondary CERs will generally be the unit of trade purchased internationally for compliance and trading purposes. Businesses need to decide whether they wish to purchase more expensive CERs on the secondary market, or whether to buy primary CERs by participating directly in Clean Development Mechanism projects in developing countries at cheaper prices. If entities are interested in the latter option for compliance purposes prior to 2012, then they need to start focusing on the option now to ensure the project provides CERs in time.

Also this week

Bell Gully has received independent recognition by being named as one of just 12 law firms globally who are leaders in providing advice on climate change.

Climate change practice leader and partner Simon Watt has also been named one of the top 10 climate change lawyers in the world by UK-based researchers Chambers Global.

Chambers interviewed clients and lawyers in over 160 countries, before naming its list. Bell Gully is one of two non-European or North American firms listed as international leaders in advising clients on climate change issues.

Chambers researchers noted: "These firms have built up a huge depth of expertise and resources, which is increasingly important to corporate clients seeking assistance on climate change matters."

Bell Gully has "garnered a global reputation for environment work, and is rapidly distinguishing itself in the field of climate change".

Chambers says Simon Watt, who with fellow partner Andrew Abernethy recently travelled to Jakarta as guests of the Indonesian Government to discuss climate change issues, is considered by clients as "an intelligent and considered adviser who has credibility in both the private and public sectors".

 

For further information, please contact your usual Bell Gully adviser or:

Simon Watt
Partner

Kate Radka
Senior Associate

David Craig
Partner

Garry Downs
Partner

Ian Gault
Partner

Mark O'Brien
Partner

Willy Sussman
Partner

Clive Taylor
Partner

Marija Batistich
Senior Associate

Josh McBride
Senior Associate

Damian Stone
Senior Associate