Climate Change Policy: Measures to address - Agriculture Sector GHG Emissions
1. Executive summary
In December 2005 the Government rolled back its climate change policy framework and commissioned further work ahead of re-visiting the subject later this year. This paper contributes to a work programme on agriculture sector GHG emissions. The focus is on policy instruments that could be implemented for or during CP1, but also with a view to possible longer-term strategies.
1.1 Broad classes of policy instrument
There is a number of alternative general approaches that can be drawn on to address agriculture sector emissions. The main ‘economic’ instruments are:
• Government pricing of emissions (and emission reductions), that is, applying a charge on emissions and/or paying a credit for emission-reducing activities. Central to whether pricing should take the form of a charge (tax) or credit (subsidy) is whether or not emitters are regarded as having an ‘existing use right’ (to emit). Either approach results in emitters facing a price; either a charge, or the opportunity cost of a compensation payment forgone. Pricing emissions results in efficient outcomes as it tends to equalize the marginal cost of abatement across all emitters: each emitter faces an incentive to reduce emissions up to the point where the marginal cost (of emission reduction) is less than or equal to the emission price.
• Cap-and-trade arrangements, under which tradable emission rights are allocated by the Government. Under this approach a cap is set on the amount of emissions permitted, and the price is determined in a market. If emission rights can be traded internationally, then the local cap is no longer binding, and price converges on the world price. An internationally ‘open’ cap-and-trade arrangement corresponds, in economic substance, with a pricing regime in which the government charges for emissions above a threshold level (corresponding with the cap) and compensates emission reductions below that threshold, in both cases at the world price. The main difference is that under a government pricing regime, the government plays a central intermediary role, whereas under a cap-and-trade arrangement, the government steps back and transactions occur directly amongst those who emit and who reduce emissions.
• Offset schemes. These are essentially a constrained form of a cap-and-trade arrangement. They may involve an ‘internal exchange’ whereby an emitter offsets the emissions of one activity by undertaking another which has emission-reducing properties. Or there may be an ‘external’ exchange, in which an emitter contracts another party to reduce emissions, and may fund that other party to undertake an emission-reducing activity, or pay a sum of money equivalent to the value of the emission reduction.
• Mandatory emission standards or emission-reducing practices. Embedded in these also are prices and costs, but these are implicit rather than explicit.
• Voluntary emission reduction and reporting programmes, extension and advisory services, and publicly funded research on emission-reducing technologies, also have roles to play. These elements of policy are most effective when they are aligned with and complement the framework of economic incentives facing emitters, rather than when used as substitutes for economic incentives.
1.2 New Zealand’s agriculture sector emissions
Key points to note are:
To Represent those of the author a policy. That 65 per cent of agriculture sector greenhouse gas (GHG) emissions comprise Enteric mthane (CH4) emissions, and 35 per cent nitrous oxide (N2O) emissions.
• That of the N2O emissions, a little less than 20 per cent are directly attributable to nitrogen fertilizer, with the remainder (over 80 per cent) stemming from livestock excrement. “Directly attributable” means stemming from the fertilizer itself, and not including the additional livestock excrement that results from the additional pasture growth that the fertilizer promotes. The latter is included in the 80 per cent figure. Emissions attributable to nitrogen fertilizer, therefore, can be thought of as those that would result from applying nitrogen fertilizer to pasture that does not carry livestock.
• The three points of intervention identified: reduced application of nitrogen fertilizer, reduced livestock numbers, and the use of nitrification inhibitors. Latest central projections for Commitment Period One (CP1) are that N2O and CH4 emissions, combined, will be in the vicinity of 38 million tonnes (CO2 equivalent), which would contribute to Crown’s Kyoto liability over that five-year period of between $570 million (assuming a price of $15 per tonne) and $955 million (assuming a price of $25 per tonne.1
1.3 Specific instruments: possible candidates
Some specific possibilities for addressing agriculture emissions in CP1 are outlined below. These are intended to be illustrative only. Some go beyond current government policy but are included for comparative purposes, and to enable near-term measures to be considered in the light of what may be longer-term (post-CP1) possibilities.
A nitrogen fertilizer ‘Kyoto’ charge:
• This would be a specific (excise-like) charge on nitrogen fertilizer, calibrated to cover its N2O emissions (as included in New Zealand’s GHG inventory, and at the world price for emissions).
• Indicatively the rate of charge would be about 10 per cent on the existing price of urea, assuming a world price for emissions of $15 per tonne. This would raise revenue of about $38 million per annum during CP1, or $190 million over the five-year period.
• The effect on rates of nitrogen fertilizer application and hence GHG emissions would likely be small. N2O emissions attributable directly to nitrogen fertilizer account for no more than about 5 percent of New Zealand’s agriculture sector GHG emissions. Also, the available evidence indicates that, at the rate of charge envisaged, paying the charge would be a lower cost option in most situations than curtailing nitrogen fertilizer application.
1 All emissions prices in this paper are quoted in terms of an equivalent tonne of carbon dioxide, that is, as a ‘carbon price’.
• Confining a Kyoto charge on nitrogen fertilizer to its direct emissions only would be largely consistent with maintaining a stance of not wishing to implement policies aimed at penalizing farm production. (Any reduction in application rates, and hence ‘collateral’ reductions in pasture growth and production, could be expected to be small.)
A broad-based ‘Kyoto’ charge on livestock numbers/production
• This would be a charge per head of livestock, or unit of livestock production (at the dairy/meat processing company level), calibrated according to the emission factors used in calculating the agriculture N2O and CH4 emissions in New Zealand’s GHG inventory, and at the world price for emissions.
• The charge could be zero-rated for up-to-1990, or existing (2006), levels of emission. Each point of obligation would be allocated a base level of throughput that would be free of charge, determined according to by how much aggregate livestock numbers/production have increased since the reference year.
• Revenue estimates for the five-year CP1 period, assuming a price of $15 per tonne, are $570 million if emissions above 1990 levels were charged (this would cover the full amount of the Kyoto liability attributable to agriculture emissions), and $115 million if charging commenced for emissions in excess of 2006 levels. These revenue estimates assume that the charge mainly would raise revenue rather than curtail production, at least in the short term. Over the longer run, the charge could act as a more significant counter-weight to production growth.
A compensation payment for use of a nitrification inhibitor
• This would involve payment by the government of a credit, calibrated according to qualifying nitrification inhibitors’ properties in reducing N2O emissions, at the world price of emissions.
• Nitrification inhibitors initially were developed to boost the production efficiency of nitrogen, but more recently there has been an additional focus on how inhibiting the nitrification process can also reduce N2O emissions. Inhibitors come in at least two forms; as a coating to nitrogen fertilizer, and in a fine-suspension form that is applied separately from nitrogen fertilizer. The later, manufactured by the Ravensdown Fertilizer Co-op Ltd, and marketed as eco-nTM , has been the subject of most research in the GHG context. Research to date suggests it can reduce N2O emissions from animal excrement and nitrogen fertilizer by 50 per cent to 70 per cent (depending on conditions), and nitrate leaching into water bodies by 35 per cent to 50 per cent. However these results are not (yet) taken into account in New Zealand’s GHG inventory calculations.
• Payment of a Kyoto credit would increase uptake of inhibitors, possibly significantly given that they already are marginally economic as a nitrogen efficiency booster alone.
• If (or when) inhibitors are recognized in the GHG inventory, each dollar of credit paid would be offset by a corresponding diminution in the Crown’s Kyoto liability. In effect, paying a Kyoto credit would amount to buying emission credits locally rather than abroad under the Kyoto Protocol's flexibility mechanisms.
Mandatory use of nitrification inhibitor
• This would involve mandatory use of nitrification inhibitor, either in conjunction with nitrogen fertilizer, or on prescribed (dairy) pasture. Under the latter approach, the requirement to treat pasture could extend beyond that to which nitrogen fertilizer is applied, and include any pasture subject to intensive stocking. (Although limitations would apply in the case of the eco-nTM product, which has to be sprayed from a vehicle, little hill-country is intensively stocked.)
• A nitrogen fertilizer and inhibitor co-use requirement could apply at the wholesale level, by making it a requirement that nitrogen fertilizer be sold only jointly with the inhibitor. In this case, compliance monitoring would be straightforward. If the requirement, however, was to apply an inhibitor to prescribed pasture, compliance monitoring would need to be at the farm level, and could be more difficult.
• Compulsion may result in less efficient outcomes than if the emission reduction value of the product was priced, bearing in mind that their effectiveness varies with conditions. For example, compulsion could result in inhibitor having to be applied in situations where there would be little boost to nitrogen efficiency, thus making the treatment a high cost means of mitigating emissions. Conversely, in other situations, the mandated level of application may fall short of that which would have occurred if the full, including emission mitigation, benefit of the product had been factored into farmers’ cost-benefit assessments.
• Making use of inhibitors compulsory could give suppliers pricing power and hence a possible need for price regulation.
A cap-and-trade approach – an allocation of N2O emission rights to the dairy sector
The idea here would be to make a free allocation of N2O emission rights to the dairy sector, specifically to dairy processing companies (Fonterra and the ‘independent’ dairy companies). Those entities then would be able to sell emission credits if emissions were reduced below the level allocated, and correspondingly be responsible for emissions above that level.
In this way dairy companies would be incentivised to work with their shareholder-suppliers to minimize emissions, for example, through more efficient use of nitrogen fertilizer and nitrification inhibitors (leveraging of Fonterra’s existing promotion of nutrient budgeting), and adoption of on-farm practices that reduce N2O emissions, eg, use of feed-pads, and optimal spreading of cow-shed effluent. The dairy companies would assume the compliance-monitoring role, in which they could leverage off their supply relationships. They would also face incentives to promote the research and extension activities required to maximize mitigation potential, including with respect to promoting the research required for emission- reducing on-farm practices to be recognized in the GHG inventory calculations.
1.4 An illustrative package
The above kinds of intervention could be ‘mixed and matched’ in a number of ways, including to achieve different combinations of ‘sticks’ and ‘carrots’. Desirably, extension, voluntary and research programmes would be integrated and aligned with a framework of economic incentives so as to be mutually reinforcing – such that the ‘whole’ might come to more than the sum of the parts.
A packaged, mutually reinforcing, approach comprising elements of give and take, might comprise:
• A ‘Kyoto’ charge on nitrogen fertilizer to cover its direct emissions; combined with Payment of a ‘Kyoto’ credit on nitrification inhibitors (subject to the inhibitor being recognized for GHG nventory calculation purposes);
• Some co-financing of the research required for use of inhibitors, and on-farm practices such as he use of feed lot pads, to be taken into account in the GHG inventory; Co-funding of extension and demonstration farm programmes that promote adoption of emission-reducing practices and technologies on-farm, as well as to provide a base for applied research.
A package along these lines would:
• Represent a significant step toward pricing N2O emissions, but with only a handful (perhaps three or four fertilizer company) points of obligation/entitlement;
• Offset the Crown’s Kyoto liability by about $190 million during CP1, that is, by about one third of that attributable to agriculture. Some of this financial benefit could be recycled to fund targeted research, extension and demonstration farm programmes;
• Leave the way open to introduce pricing of livestock-attributed (N2O and CH4) emissions at a later stage; and For the meantime, at least, preserve a stance of not wishing to introduce policy measures aimed at penalizing farm production. Such a package for agriculture would be broadly consistent with an (assumed) forestry sector package involving payment of a Kyoto credit for new afforestation, and a charge (or corresponding cap-and-trade arrangement) for deforestation in excess of a 21 million tonne CO2 e cap. The fiscal cost of such an approach for forestry would be up to $315 million (assuming deforestation reaches the 21 million tonne cap, and a CO2 price of $15 per tonne), compared with, say, about $400 for agriculture.2 The package outlined would also overlap with policies directed to achieving water quality goals in 2 The $400 million figure is a ‘round figure’ derived as $573 million - $190 million, plus an allowance for outlays on research, extension and demonstration farm programmes. Sensitive catchments. Soil nitrates are a common source of both N2O emissions and nitrate contamination of water bodies; hence GHG measures focused on nitrogen would have co-benefits or water quality. However, the overlap is far from complete. There is a material difference in focus as between climate change and water quality policy. For example, climate change policy has a global context, whereas water quality is a local issue. Hence, while an ‘open economy’ approach is preferred in designing price, or cap-and-trade, regimes for addressing GHG emissions, a local or ‘closed economy’ approach needs to be adopted if water quality goals are to be met. (Buying emission credits abroad to meet the Crown’s Kyoto obligation, for example, does nothing to help improve water quality in the Taupo catchment.) The present direction of water quality policy has been to adopt a cap-and-trade model for managing nutrient inputs in sensitive catchments (notably the Taupo catchment). By contrast, a more incremental approach to pricing and mitigating agriculture GHG emissions is envisaged, with comprehensive pricing or a cap-and-trade arrangement seen as a possibility only in the longer-term. There would appear to be scope to bring these two areas of policy on to more parallel, though not necessarily identical, tracks, and in a way that would enable each to more effectively leverage the other. For example, the research, extension and voluntary programmes envisaged for addressing GHG emissions could also strengthen the foundations for introducing nutrient cap-and-trade arrangements in sensitive catchments. Conversely, local initiatives to achieve water quality objectives could pave the way for more broad-based measures directed to reducing GHG emissions.
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