Pricing Agricultural Emissions Climate Change Commissions Report

The Climate Change Commission (Commission)[1]: has recently released its Report “Progress towards meeting agricultural emissions pricing, June 2022”[2] (Report).  The Report was required to be provided to the Ministers for Climate Change and Minister of Agriculture by 30 June 2022, and   reports on progress made and readiness for the Agricultural sector to adopt an emissions pricing scheme.^[3] It also contains the Commission’s analysis and feedback on He Waka Eke Noa, the Primary Sector Climate Action Partnership’s (HWEN or Partnership) recommended Farm-Level pricing system to regulate agricultural emissions, as an alternative to inclusion within the Emissions Trading Scheme (ETS).[4]    In our first article, we took a deep dive into HWEN’s proposal[5].  In this article, we provide a summary of the Commission’s key recommendations to the Ministers and its assessment of HWEN’s proposed Farm-Level pricing system.

Who is this for?

This article is relevant for:

• Any farming or primary industry business which may be directly affected by the emissions pricing system to regulate Agricultural emissions by 2025.
• Landowners;
• Forestry companies;
• Agritech and rural professionals who may have a significant role in assisting farmers to meet their reporting obligations under a Farm-Level System; and
• Funds, investors and third-party financers investing in the primary sector, or looking at investment opportunities or risks created by changes in NZ’s climate policy.

Background: What is required by the Climate Change Response Act 2002 (CCRA) and where are things headed?

In our earlier article[6], we summarised the statutory requirements relating to agricultural emissions.  The Climate Change Minister and Minister of Agriculture are required by the CCRA to report on a system for pricing agricultural emissions as an alternative to the ETS by 31 December 2022.  The report needs to address the matters stated in the Act.

As part of that process, HWEN released its recommendations for a Farm-Level pricing system to regulate agricultural emissions.  The Commission, in line with its statutory requirements under s220 CCRA, has now provided its advice to the Government and, as noted above, a decision will be made by Central Government by the end of the year.

It is important to note that the CCRA provides a statutory obligation for a system for pricing agricultural emissions to be in place by 1 January 2025.  So agricultural emissions pricing is not a case of ‘if’ but ‘how’. 

Commission’s Assessment of Readiness - Are Farmers Ready?

A core component of the Commission’s report was to assess the readiness of the Agricultural sector for agricultural emissions pricing by 2025. Specifically, the Commission assessed readiness to commence three agricultural emission pricing options:[7]

1. a simplified Farm-Level system (as proposed by HWEN);
2. farm level pricing within the ETS; and
3. processor level pricing within the ETS.

 In assessing readiness, the Commission specifically looked at the following:[8]

1. How ready is the system to be implemented?;
2. How ready are farmers and the sector to participate?; and
3. Will farmers be able to identify emission reduction actions in response to the system?

HWEN Farm-Level System

The Commission’s assessment was that with significant effort, implementing a streamlined version of the HWEN Farm-Level System would be possible by 2025. Key factors identified as being crucial to the ability to commence were:[9]

1. Designing and building the necessary IT systems;
2. Establishing administrative, compliance and enforcement actions; and
3. Putting regulations in place.

The Commission however concluded with high confidence that the Agricultural sector will not be ready for the detailed Farm-Level System by 2025 as proposed by HWEN, and that a basic Farm-Level System using elements of HWEN’s proposal should be used as an interim step.[10] Current barriers to implementing the full Farm-level system as proposed by HWEN include:

• passing legislation and drafting regulations;
• IT and data management system cost and build time;
• challenges with registering more than 20,000 farms into the system; and
• establishing and administering a compliance function and developing and delivering enforcement mechanisms.[11]

The Commission noted that at the time of its engagement, the Government had yet to define a responsible administrative agency/s and had not secured budget appropriations for implementing a farm level system in 2025. Decisions on these matters will be needed by the Government by the end of December 2022, and it sets a very challenging timeframe to be ready by January 2025.[12]

While the Commission concluded that it may be possible to implement the simplified HWEN Farm-Level system by 2025, it was unable to assess the Government’s readiness to implement due to a lack of evidence.[13]

In assessing farmer readiness, the Commission noted that while there was high confidence that almost all eligible farmers can be ready to participate in a basic farm-level pricing system by January 2025, many farmers were still unsupportive of emissions pricing and that there was consistent disagreement across the sector, and a lack of consensus on emissions pricing.[14]

Other Systems Assessed

Farm level pricing under the ETS

The Commission also assessed the readiness for farm level pricing within the ETS where 20,000+ farmers would be brought into the ETS and required to submit farm level data to the regulator and pay for their emissions through purchasing and surrendering NZUs.  The Commission had high confidence that implementation of a farm level pricing system within the ETS would not be feasible by 1 Jan 2025.  It also expressed concerns about the potential for over-allocation if farmers received 95% free allocation reducing 1% per annum (as currently set out under the CCRA).[15]

Processor level pricing under the ETS

The third option the Commission assessed was the readiness for processor level pricing within the ETS.  Milk and meat processors and synthetic nitrogen fertilizer producers are already required to report on emissions associated with their processing through the ETS.  If a processor level pricing option was adopted, they would also face reporting and surrender obligations for the  downstream emissions resulting from the products they process.[16]  Although the Commission found there were few barriers to implementing processor level emissions pricing and no barriers for farmers participating, this option was not recommended.  This was because processors would likely just pass costs on to farmers and it would not recognize or reward actions taken by farmers to reduce their individual emissions and would create little incentive to reduce on farm emissions.[17]

The Commission’s Assessment of the HWEN proposed Farm-Level System

Summary

For a detailed summary of the key details of HWEN’s proposed Farm-level system, please see our earlier article here https://www.cooneyleesmorgan.co.nz/pricing_agricultural_emissions

Overall the Commission has agreed with the Partnership’s farm-level approach, that a split-gas detailed farm-level pricing system outside the ETS is the best approach to pricing agricultural emissions in the long term.[18] However there are some significant divergences in relation to key aspects of the Farm-Level System and how it should be implemented.  We provide a more detailed breakdown of the Commission’s analysis below.   

Commission-HWEN Consensus

There is agreement that a farmer-focused and cost effective pricing system is the best way to deliver agricultural emission reductions to contribute to NZ’s climate change reduction targets.[19] The Commission agrees that long-term a detailed farm-level system utilising a split-gas levy outside the ETS is best, however in the short-term the government will need to implement a basic farm-level system in the time it has, and then rapidly scale up.[20] The Commission stresses that a pricing system for agriculture must be in place by 2025.[21]

Commission-HWEN Disagreement

The Commission considers that several critical changes are necessary to HWEN’s recommended Farm-Level System to improve its alignment with key principles for evaluating an agricultural emissions pricing system.  The 9 key principles described by the Commission are[22]:

• practical (i.e. able to start pricing from 1 January 2025 in a way that encourages active participation and can be enforced);
• broadly supported (i.e. sufficient buy-in);
• efficient (avoids unnecessary admin and aligns with existing process and systems as much as possible);
• equitable (acknowledges varied circumstances and implications for the economy and future generations.  This includes specific challenges faced by Māori owned land and broader impacts on iwi/Māori);
• effective (clear, long-term incentives to support investments and deliver changes to meet statutory targets);
• comprehensive (recognises and encourages emissions reduction from changes to farm management practices, production and land use);
• well-aligned (with other climate and non-climate environmental policies, social and economic policies and sits well with the ETS);
• adaptable (monitoring and evaluation of performance so policy can be adjusted to meet its objectives); and
• transparent (clear and predictable process for how decision to adjust policy will be made).

The Commission recommends the following four substantive changes to the HWEN proposal should the Government consider adopting it:[23]

1. Excluding Synthetic Nitrogen and pricing it in the ETS ASAP

Synthetic Nitrogen should be priced at the manufacturer and importer level in the ETS, not at the farm level as soon as practicable. The Commission concludes that there is no emission reduction benefit to pricing synthetic nitrogen fertilizer emissions at the farm level compared to the manufacturer and processor level.[24] In addition, currently the HWEN threshold definition of farm would exclude many horticulture and arable farms that are significant users of synthetic fertilizer.[25]  No Horticulture operations would be included, whereas pricing at the manufacturer and processor level would capture all synthetic nitrogen fertiliser users. In addition there are few barriers to enacting this right away, as fertiliser manufacturers already report emissions.  The Commission also notes that the government should reconsider revising the free allocation of NZUs to synthetic nitrogen fertilizer manufacturers and importers if they are brought under the ETS.[26]

2. Reliance on mitigation technology to reduce Methane difficult in short-term

The Commission identifies three potential pathways for reducing agricultural emissions:[27]

1. Reducing the emissions intensity of production;
2. Reducing production / output; and
3. Changing land use.

The Commission considers that a combination of these will likely be needed to meet emission targets.[28]

A key observation by the Commission is that the HWEN modelling relies heavily on incentive payments for currently unavailable technologies such as methane reducing feed additives and vaccines to reduce emissions.  However, HWEN concludes with high confidence that these technologies will not be widely available for NZ farmers by 2025.[29]  It therefore has concerns about placing reliance on such technologies.  There is also concern that some of the other currently available technologies, such as use of low protein or methane forages and effluent methane capture, will not be able to be incorporated into the national greenhouse gas inventory by 2025 and therefore such reductions will not be able to contribute towards NZ’s emissions budgets.[30]   

Although not expressly stated, the logical conclusion from the Commissions’ observations is that it probably considers that reducing production and/or land use change (i.e. farmers converting land from livestock to vegetation) will, in the short term, be the main vehicles for the agricultural sector to meet its emission reduction targets.  This is likely to be a bitter pill to swallow for farmers.

3. Ring Fencing Revenue

The Commission also raises the issue of equity with the HWEN proposal to ring-fence levy revenue for use by the agricultural sector to reduce future emissions, which is not available or proposed for other sectors in the ETS. 

4. Sequestration

Probably the most contentious point of difference, the Commission does not agree that on-farm non-ETS eligible sequestration should be recognised as proposed by HWEN.  This recommendation comes despite the Commission noting that recognising non-ETS sequestration was consistently considered a key feature for an emissions pricing system, and received strong support from both farmers and Māori, in responses from Te Aukaha FOMA and in submissions from Māori agribusiness. It also noted that there is potential for Māori collectively owned land to benefit significantly from the proposed treatment of sequestration in the HWEN proposal.[31]

The Commission sets out the following reasons for excluding non-ETS eligible sequestration:  [32]

1.  It does not consider rewarding sequestration to be an essential feature of emission pricing, and that any reward for sequestration should also be aligned with international carbon accounting and regulatory standards; should satisfy internationally accepted principles such as additionality; and there should be commensurate liability for clearing.

2.  It disagrees with offsetting biogenic methane emissions by payments for carbon dioxide removals, as it sees this as inconsistent to a split gas target.

3.  Including non-ETS eligible sequestrations would add significant additional complexity and system cost, while providing little additional incentive given the financial cost of establishing and managing vegetation vs the reward; and therefore there would be little additional benefit for meeting emission reduction targets.

4.  From a practical perspective the Government does not have the capacity to accurately monitor all potential areas, particularly small vegetation blocks.

5.  Revenue provided for sequestration diverts revenue that could be used to advance options that will reduce emissions at source.

6.  It creates inequity between farmers and other sectors (as only farmers can claim benefits for non-ETS sequestration vegetation).

The Commission does however recommend that the Government progresses a system that recognises and rewards additional non-ETS carbon sequestration outside the ETS, which would particularly benefit Iwi / Māori and better recognises the wide range of benefits that on-farm vegetation provides.[33]  However, it doesn’t provide any detail or information as to what such a system would look like, or a time frame for its implementation.

Comment

The most contentious point in the Commission’s assessment of the HWEN proposal is likely to be its stance on non-ETS sequestration, given the wide support from both farmers and Māori for its inclusion; and in light of the Commission’s assessment that (at least in the short term) technological advances in methane reduction proposed by HWEN are highly unlikely to be available within the timeframe required.  This could lead to difficulties for some farmers if they are unable to utilise wider sequestration opportunities other than the currently limited ETS approved ones. 

The Commission’s concerns appear to relate primarily to the necessity of such an inclusion given the administrative cost (and difficulty) and potential inequity between farmers and non-farmers, without improving emissions reduction outcomes.  The Commission is careful to note that it would meet the principle of ‘broadly supported’ (including by Māori) but firmly takes the view that it is inconsistent with five of the other principles outlined earlier.  It refers to the ‘range of environmental benefits’ that non-ETS vegetation can provide and considers (relatively opaquely) it could provide a useful contribution to ongoing policy development ‘inside or outside the ETS’.  It was clearly concerned about the need for a robust evidence basis to understand and quantify the impact of land-use practices and choices on natural carbon stocks.  It also notes there would need to be changes to accounting for emission budgets and targets to incorporate additional sources of sequestration. 

Currently, as signalled by the Commission in the short term, agricultural reductions are likely to come from a reduction in agricultural output and land use change.  Reading between the lines, this could spell farmers exiting and conversion of active farms to ETS recognised sequestration.   It will be interesting to see if this exacerbates the current conversion of farmland into exotic pine plantations that are rewarded under the ETS.

Process and Next Steps.

The Ministers will consider both the Commission’s advice together with the Partnership’s recommendations before making its decision and providing its Report in December 2022 on pricing of agricultural emissions from 2025 onwards. [34]  All eyes are now firmly on the Government’s response.

Want to find out more?

If you’re interested in finding out more about changes in climate policy and how they may affect your business, please contact Rachael Zame or another member of the Climate Change and Sustainability team.

Article co-written by Mark Harding, Consultant to Cooney Lees Morgan

Latest Update:  25 August 2022