Part 8: Implications for public entities

8.1 General implications

Most, if not all, public entities will be affected by increased input costs because of the ETS.

Implementing the ETS in the stationary energy and liquid fossil fuels sectors from 1 July 2010 was expected to cause electricity price increases of 5% and petrol and diesel price increases of 3.5 cents per litre during the transition phase (from 1 July 2010 to the end of 2012).³⁸ After that, the increases are expected to double as the full obligation starts (compared with one NZU for every two tonnes of emissions in the transition phase).

In practice, the actual effect of the ETS has not been clear. Fuel prices are influenced by many factors, particularly exchange rates and international oil prices, and electricity prices are determined by the complexities of the electricity market.

In its 2010 annual report, Mighty River Power stated:³⁹

Like all energy producers, Mighty River Power is now affected by the Emissions Trading Scheme (ETS). The ETS has a whole-of-market effect, as there is no means of distinguishing “green” electricity from electricity generated from fossil fuels. Forward-looking wholesale prices have therefore increased under the scheme, resulting in greater costs for electricity retailers. Mercury Energy has chosen to be transparent about passing this cost on to the consumer and implemented an average 3.3 percent price increase for all customers from 1 July 2010, when the ETS came into effect.

Other input cost increases may occur from the effect of the ETS in other sectors (for example, the industrial process sector will add a carbon price to steel production), or the flow-on effects of the ETS on other industries (for example, energy-intensive products such as clay bricks). Although at first mitigated through the industrial allocation, the cost increases will grow as the transition help is phased out.

Few public entities will be eligible for the allocation to industry that is intended to compensate for ETS-driven cost increases. Therefore, public entities will need to manage these input cost increases in a period of public sector financial constraint.

Mandatory or voluntary participants in the ETS will incur further costs in terms of the direct cost of emissions and the compliance costs to meet their ETS obligations.

Cost increases, responses to them, and specific ETS transactions for participants, will need to be factored into public entity planning documents, particularly those that extend over the full implementation period, such as local authority long-term plans.

Additionally, public entities will need to consider the cost implications of the ETS for their communities and whether this will affect the demand for, or affordability of, their services. The ETS has been estimated to have increased national average household expenditure on fuel and electricity by $133 per year,⁴⁰ with further increases to come after the end of the transitional phase.

8.2 Implications for foresters (or potential foresters)

The ETS is already operating in the forestry sector. The many public entities that have forestry activities should already be considering and responding to the ETS, as should public entities that have land with trees planted for other reasons, such as recreational purposes (for example, reserves, botanic gardens, parks, town belts) or environmental reasons (for example, soil stabilisation).

The large Crown-owned forests (managed by MAF and the Department of Conservation) will not participate in the ETS as post-1989 forests and will not apply for pre-1990 forestry allocations. Therefore, the local authority sector may be the main public entity grouping affected by the forestry ETS.

The first step for public entities considering the implications of the forestry ETS, is to understand what forests they own, when they were established, and their size and type. This will enable entities to determine whether their forests are pre-1990 or post-1989 and whether they qualify for the ETS (for example, whether they meet area, width, and tree crown requirements), or are eligible for exemption (because of tree weeds, or the total size of their forests being less than 50 hectares – see section 6.2).

Once the forest holdings are understood, there are important decisions for public entities to make, including:

• for post-1989 forests, whether to opt into the ETS to receive NZUs for sequestered carbon as well as obligations to return NZUs for emissions on harvest; and
• for pre-1990 forests, whether to apply for free NZUs under the forestry allocation, or, where eligible, to apply for an exemption from the ETS.

Some of these decisions have deadlines that are fast approaching and need to be considered urgently, if opportunities are not to be missed.

If a public entity has more than 50 hectares of pre-1990 forest land, then it is already captured within the ETS. The forestry allocation provides some compensation for this, but will only be received if applied for before the close-off date.

If a public entity has less than 50 hectares of pre-1990 forest land, then there is a choice to be made between applying for an exemption from the ETS or applying for free NZUs under the forestry allocation. If the intention is that the land will continue as forest land indefinitely (allowing for possible harvest and replanting), then the forestry allocation is likely to provide more value than the exemption. If a change in land use is possible in the future, then applying for an exemption may be more beneficial. Not applying for either the free allocation or the exemption would appear to be an opportunity lost.

Public entities with forests should consider the implications of the ETS before entering into transactions such as sale or purchase of a forest or being a party to a forestry right or lease. Guidance on issues that can arise is provided in MAF’s May 2011 publication Forest Land Transactions in the Emissions Trading Scheme.

Those public entities that have land (for example, town belts or reserves) that may be suitable for new forests (indigenous or exotic) may want to consider whether the NZUs earned by the potential forest – under the ETS or the Permanent Forest Sink Initiative – make new forests a more economic proposition.

All public entities with pre-1990 forests (not subject to exemption) will be captured by the deforestation rules and will need to consider the implications, particularly in terms of emissions liabilities, of any activities or public works (such as roading and power infrastructure) that may require removal of trees. This could be in terms of direct ETS liability for the public entity or possible compensation to a third party.

8.3 Implications for waste disposal facility operators

Many councils operate waste disposal facilities and will be required to report and pay for emissions under the ETS. Mandatory reporting obligations start in 2012 and emission obligations will start on 1 January 2013.

The main implication for waste disposal operators will be the cost of emissions. The ETS is expected to cost landfill operators about $27.50 per tonne of waste, based on a carbon price of $25 per tonne and the use of the default emissions factor.⁴¹

These costs are likely to be passed on to customers through increased charges for refuse collection and using landfills, and will be additional to the cost of the existing waste levy ($10 per tonne as at July 2011).

Councils will need to accurately forecast the ETS cost implications to determine the required increase in user charges. They will need to consider the appropriate mechanism to increase the charges. These financial implications should be included in their 2012 long-term plans.

Councils will also need to decide whether they will determine their emissions and obligations using the default emissions factors, or whether it will be to their advantage to apply for unique emissions factors in relation to:

• site-specific analysis of waste composition (for which a unique emissions factor will be advantageous for those landfills that have a lower proportion of organic material in either their total waste or certain classes or sources of waste); and
• landfill gas collection (for which a unique emissions factor will be advantageous to those operators that collect their landfill gas).

When considering whether to apply for a unique emissions factor based on sitespecific analysis, councils will need to consider the costs of the required analysis, which may be significant. The Regulatory Impact Statement for the Climate Change Response (Disposal Facilities) Regulations 2010 suggests an amount of $50,000 per test for the costs of sampling and weighing. It also states that at least two tests will be required for a unique emissions factor application.

Compliance costs in relation to reporting emissions are unlikely to be a major factor, as councils already have reporting obligations in relation to their landfill under the Waste Minimisation Act 2008.

The ETS provides a further incentive for councils to consider landfill gas capture or diversion of organic waste in order to reduce methane emissions and the resulting ETS liabilities.

8.4 Implications for participants in other sectors

Only a few public entities will be directly affected by implementing the ETS in the other sectors.

In the stationary energy sector, Solid Energy has registered as a coal miner (mandatory participant), Genesis Power has registered as a natural gas miner (mandatory), a coal importer (mandatory) and a coal purchaser (voluntary), and Mighty River Power has registered as a user of geothermal fluid (mandatory) and a natural gas purchaser (voluntary). Meridian Energy does not own coal- or gas-powered power stations and so is not a direct participant in the ETS. In the liquid fossil fuels sector, Air New Zealand has registered as a jet fuel purchaser (voluntary participant).

Although the effect of the ETS on the above entities will be complex and significant, they are well placed to respond to the challenges because they are large SOEs. Mostly, it is expected that ETS costs will be passed on to their domestic customers (noting that coal exports and fuel for international air travel are exempt from the ETS). However, the effect of the ETS is significant and is likely to have significant implications for business cases (for example, thermal versus renewable electricity generation) and business strategies. For example, Solid Energy states in its 2010 annual report:⁴²

From 1 July 2010, under the Emissions Trading Scheme (ETS), Solid Energy is liable for greenhouse gas emissions associated with coal sold in New Zealand and for fugitive emissions of methane from all coal mined in New Zealand regardless of where it is sold. Our emissions liability must be calculated for each tonne of coal sold depending on the type of coal, its source (opencast or underground mine), whether it is blended with other types of coal, and who it will be sold to. Until 31 December 2012 the cost of an emissions unit (tonne of CO₂) in New Zealand is capped by the Government at $25, and only one credit must be surrendered for two tonnes of emissions, so that the effective emissions cost is $12.50 per tonne of CO2. The average cost of coal to those of our New Zealand customers who continue to use coal will increase by 17 to 40%. We cannot pass these ETS costs to international customers. The fugitive emissions of methane charge will have a significant financial impact on Spring Creek Underground Mine and this remains under review.

In the synthetic gases sector, it is possible that some public sector entities could be required to register as participants through importing the gases within other goods. Entities in the electricity sector are most likely to fit this situation because gases are used as insulators in high-voltage electrical equipment. However, it is possible that other public entities could be subject to the ETS, when importing other goods such as motor vehicles, ships, or aircraft that may contain the gases. Given the exemptions for the first 100 tonnes of emissions from importing each of these, it is likely that very few public entities could become subject to the ETS in this way. However, public entities that do import such goods need to ensure that they consider the implications of the ETS.

In the agriculture sector, few public entities are expected to be participants because the point of obligation lies at the processor level. However, those public entities in the wider agriculture sector will be subject to further increased costs because of the ETS from the date that agriculture comes into the scheme (currently 1 January 2015). It is not yet clear whether the sector will be able to pass on these increased costs to their customers.

8.5 Taxation implications

Public entities will also need to consider the taxation implications of their ETS involvement. Public entities that are exempt from income tax will still need to consider the goods and services tax (GST) consequences and obligations arising from their ETS involvement.

Transactions in NZUs will generally be zero-rated for GST purposes (that is, GST applies at 0%). Therefore, GST input tax incurred in supplying associated goods and services is fully claimable. However, GST will apply at 15% to the total value of barter transactions, for example when an energy supplier charges its customers a dollar price plus a number of NZUs.

In relation to income tax, for ETS sectors other than forestry, the broad concepts are:

• all transactions are on the revenue account;
• accrual accounting applies;
• purchase of NZUs is deductible (stock on hand at year end to be adjusted for as an asset at cost);
• sale of NZUs (bought or allocated for free) is taxable;
• emissions liabilities are deductible on an accruals basis; and
• income from allocation of free NZUs is recognised as the associated costs are incurred (generally, as emissions liabilities are recognised).

The income tax rules for the forestry sector are different from those applying in the other ETS sectors. The rules vary depending on the type of ETS forest (post-1989 or pre-1990) and whether the forest land is held on capital account or revenue account.

In most cases, pre-1990 forests will be held on capital account and there will be no tax implications for receiving a pre-1990 forestry allocation or selling the allocated NZUs. Similarly, surrendering NZUs to the Crown and any purchase of NZUs to meet deforestation liabilities will not be tax deductible.

For post-1989 forests, income tax generally applies on a cash transaction basis. The allocation of NZUs has no tax consequences, but the sale of allocated NZUs leads to assessable income. Any NZUs bought to meet a surrender obligation for a post-1989 forest will be tax deductible.

38: Ministry for the Environment (September 2009, updated November 2009), Emissions trading bulletin No 11: Summary of the proposed changes to the NZ ETS, available at www.mfe.govt.nz/publications/climate/emissions-trading-bulletin-11/index.html.

39: Mighty River Power Limited (2010), Annual Report, page 7.

40: Ministry for the Environment (2011), Emissions Trading Scheme Review 2011: Issues statement and call for written submissions, March 2011, Emissions Trading Scheme Review Panel, Wellington, page 17.

41: Ministry for the Environment (2011), Emissions Trading Scheme Review 2011: Issues statement and call for written submissions, March 2011, Emissions Trading Scheme Review Panel, Wellington.

42: Solid Energy New Zealand Limited (2010), Annual Report 2010, pages 9-10.