The Kyoto Protocol: issues for New Zealand s participation

Transcription

1 The Kyoto Protocol: issues for New s participation Trade realities and New s role in the international response to the threat of global warming REPORT TO THE CLIMATE CHANGE PAN INDUSTRY GROUP February 2002 The Climate Change Pan Industry Group includes: THE GREENHOUSE POLICY COALITION (for further information see NEW ZEALAND FOREST INDUSTRIES COUNCIL ROAD AND TRANSPORT FORUM OF NEW ZEALAND TODD ENERGY BUSINESS NEW ZEALAND PETROLEUM EXPLORATION ASSOCIATION NEW ZEALAND MEAT INDUSTRY ASSOCIATION CARTER HOLT HARVEY WELLINGTON REGIONAL CHAMBER OF COMMERCE BUILDING INDUSTRY ASSOCIATION NZIER Kyoto Protocol: issues for New s participation

2 The New Institute of Economic Research (NZIER), based in Wellington, was founded in 1958 as a non-profit making trust to provide economic research and consultancy services. Best known for its long-established Quarterly Survey of Business Opinion and forecasting publications, Quarterly Predictions and the annual Industry Outlook with five-yearly projections for 22 sectors, the Institute also undertakes a wide range of consultancy activities for government and private organisations. It obtains most of its income from research contracts obtained in a competitive market and trades on its reputation for delivering quality analysis in the right form, and at the right time, for its clients. Quality assurance is provided on the Institute s work : by the interaction of team members on individual projects; by exposure of the team s work to the critical review of a broader range of Institute staff members at internal seminars; by providing for peer review at various stages through a project by a senior staff member otherwise disinterested in the project; and sometimes by external peer reviewers at the request of a client, although this usually entails additional cost. Authorship This report has been prepared at NZIER by Alex Sundakov, Jean-Pierre de Raad and John Ballingall. NZ INSTITUTE OF ECONOMIC RESEARCH (INC.) 8 Halswell St. Thorndon P O BOX 3479 WELLINGTON NEW ZEALAND Telephone: Fax: Website: The Institute, its contributors, employees and Board shall not be liable for any loss or damage sustained by any person relying on this report, whatever the cause of such loss or damage.

3 EXECUTIVE SUMMARY This report provides an assessment of the economic impact of Kyoto Protocol policies on New, with a focus on international competitiveness issues. The report also considers the likely evolution of climate change policies internationally, and what that means for policy options open to New. We conclude that early ratification does not represent the best means for New to achieve a balance of what we assume to be Government s policy objectives, namely: 1. Encourage the creation of a global policy regime that would help mitigate the risks of global warming. Since New s own emissions are within the margin of error of global levels, this policy objective is primarily satisfied by actions that encourage the main emitting nations to take action. The key question is what specific actions, promises and threats by New would best contribute to inducing the desired global behaviour. 2. Ensure that New does not bear a disproportionate burden of global adjustment. This relates to emission reduction targets for New, other negotiated rules and domestic policy options. We assume that New s interest is best served by doing the minimum to achieve the first objective. 3. Protect New from the risk of treaty failure. Irreversible changes should only be made against secure expectations of action by the rest of the world. As long as uncertainty remains about the actions of other global players, New should aim to keep its options open. 4. The cost of the global regime to reduce the rate of climate change must not exceed the cost of mitigating the consequences of such climate change. The main reason why early ratification is not the preferred option is that the formulation of global climate change policies is not a one-off step. Rather, these policies remain uncertain and the environment is dynamic. Hence, it is in New s interests to retain as much leverage as possible over the future development of global policies. An unconditional commitment now reduces such leverage, making it less, rather than more, likely that a viable global regime will emerge. 1 We recommend that New would be more likely to achieve an overall balance of the objectives set out above if our ratification of the Kyoto Protocol was conditional on: Ratification and a credible commitment to implementation by those key countries by whom a decision not to participate in the first commitment period would sharply deepen the costs of that period for New. This would be particularly true of Australia and Japan. Successful completion of negotiations for the second commitment period, which would ensure that the main emitting developing countries, such as China and India, accept nontrivial binding targets from The negotiations would also need to ensure that the former communist countries accept binding targets once their hot air is depleted, and that New is not disadvantaged by the targets negotiated for the remaining Annex I countries. 1 Because New s influence on the world economy and environment is relatively small, it is assumed that New has some, but minimal influence over the behaviour of other countries. This applies equally to the analysis of moral persuasion and of negotiated positions. NZIER Kyoto Protocol: issues for New s participation i

4 Ratification should also be predicated on the development of viable domestic policies, which would carry New over the first commitment period without undue damage. We arrive at this conclusion in part through the analysis of the likely changes in New s competitiveness during the first commitment period the time when our main competitors face no binding targets. Impact on New The official view is that, whilst the costs of climate change are potentially large because much of our economy is weather-dependent, overall the economic costs to New of implementing the Kyoto Protocol are likely to be small and, with an ability to claim credits from forestry, might actually produce a net benefit to New. (New climate change programme p17) The precise impact will depend very much on the policy implemented domestically. But there are a number of reasons why the burden on New looks to be higher than expected, and disproportionately high compared to other Annex I countries: Energy is a key input in New, and the possibilities to switch to lower emission energy sources or other inputs at reasonable cost are limited. Increasing the cost of emissions will reduce our economic growth prospects more than other, less energy intensive economies. This will do little for our aim to climb up the OECD s GDP per capita rankings. The choice of 1990 as a benchmark is particularly disadvantageous to New. In contrast to all other Annex I countries, New s energy intensity has been increasing due to the significant structural changes of the late 1980s. Over the period emissions (including land use change and forestry) had risen by about 5%, compared to a 0% target for Our industries are particularly vulnerable to competition from countries outside the Protocol. More so than other Annex I countries, our primary commodity-based exports tend to compete with those from non-annex I countries. A rise in production costs due to Kyoto will threaten our competitiveness. Our geography puts us at a disadvantage. Apart from high transport emissions per unit of GDP, energy intensive industries (such as wood processing) are at risk of relocation to the non-annex countries en-route to our main markets. This will particularly impact on the low-skilled labour predominant in these sectors. Forest sinks offer only limited potential to offset the abatement costs. Prospects of an effective global policy We also consider current international trends with respect to climate change policy. Developing countries are exempt from emission targets during The idea is that they would take on binding targets after But they have few incentives to accept any meaningful targets, as that would constrain economic development objectives, and the loss of the competitive advantage gained over Annex I countries during the first period. Annex I countries are already starting to question the wisdom of a policy that puts the competitiveness of their economies at risk, without achieving environmental objectives. The US was first out of the starting blocks. That sentiment will be fuelled by a rising awareness that given the lack of progress to date most Annex I countries are unlikely to be able to meet their Kyoto targets at reasonable cost. As 2008 closes in, and the costs of meeting emissions targets become real, domestic debates on who should pay what will heat up. The fuel price protests throughout Europe in 2000 gave a NZIER Kyoto Protocol: issues for New s participation ii

5 taste of the level of public tolerance for increased taxes now in return for long-term environmental benefits. The subsequent retreat on eco-taxes in key EU countries illustrates the lack of appetite to incur the political costs. It seems likely others will follow the US, either explicitly by quitting Kyoto, or, more likely, implicitly by watering down the domestic impact through exemptions to industries most exposed to international competition, and missing and then re-negotiating down the targets. NZIER Kyoto Protocol: issues for New s participation iii

6 CONTENTS 1. Introduction Emissions and energy use in NZ Sources of greenhouse gasses Energy and the economy Transport Electricity generation Conclusion Threats to NZ trade performance The trade in energy-intensive goods Threats to New 's exports Dairy products Cattle meat products Chemicals Paper products Wool products Machinery products Non-ferrous metals products Wood products Competition within New Labour market Conclusion A fair share for New? The additional burden of using 1990 as benchmark year Land use change and forestry Conclusion A comparison with Australia Australian emissions profile Substitution to lower emission energy sources Impact of Kyoto on Australia s economy Energy exports Australian prospects in meeting its Kyoto emission target Conclusion Kyoto and the developing countries The impact of phased negotiations What incentives to join? Conclusion...36 NZIER Kyoto Protocol: issues for New s participation iv

7 7. Progress by the Annex I Countries Emission trends and the Kyoto gap The evolution of climate policies European Union Japan, US, Canada, and Australia Transitional economies Conclusion What are our options? Early ratification Domestic policies Conclusion References APPENDICES Appendix A: Emission tables FIGURES Figure 1 Trends in New 's emissions of GHGs... 4 Figure 2 Contribution to total New emissions by sector... 4 Figure 3 Emissions as a proportion of Gross Domestic Product... 5 Figure 4 Value of energy input per $ of GDP in NZ and the OECD... 6 Figure 5 Energy consumption by sector... 7 Figure 6 Transport emissions per unit of GDP... 8 Figure 7 Threats to New 's exports: a schematic representation Figure 8 New 's dairy exports by destination Figure 9 New 's meat product exports by destination Figure 10 Share of New 's chemicals products exports by destination Figure 11 Share of New 's paper products exports by destination Figure 12 Share of New 's wool exports by destination Figure 13 Share of New 's machinery exports by destination Figure 14 Share of New 's non-ferrous metals exports by destination Figure 15 Share of New 's wood exports by destination NZIER Kyoto Protocol: issues for New s participation v

8 Figure 16 NZ capacity utilisation Figure 17 Australian exports Figure 18 Historic and projected CO 2 emissions Figure 19 CO 2 emissions in key Annex I regions: Figure 20 CO 2 emissions by the top 6 European emitters: Figure 21 Emissions per $1000 GDP Figure 22 Canadian Exports TABLES Table 1 New 's greenhouse gas emissions... 3 Table 2 Sector contributions to GDP key Annex I countries... 5 Table 3 Energy related CO 2 equivalent fossil fuel emissions Table 4 New 's export markets by distance... 8 Table 5 Trade in energy intensive products for OECD regions (1994) Table 6 Export profile: selected Annex One countries Table 7 Competitors to New 's dairy exports Table 8 Competitors to New 's meat products exports Table 9 Competitors to New 's chemicals exports Table 10 Competitors to New 's paper products exports Table 11 Competitors to New 's wool exports Table 12 Competitors to New 's machinery exports Table 13 Competitors to New 's non-ferrous metals exports Table 14 Competitors to New 's wood exports Table 15 Manufacturing employment Table 16 Emission trends summary Table 17 Australian CO 2 emissions and removals Table 18 Top ten sources of CO 2 emissions Table 19 Emissions and targets for Annex I countries Table 20 Comparison of Annex I emissions Table 21 Emissions by region NZIER Kyoto Protocol: issues for New s participation vi

9 1. INTRODUCTION The New Government intends to ratify the Kyoto Protocol in This international agreement seeks to manage the impact of human activity induced global warming by first limiting, and eventually reducing, global emissions of greenhouse gasses (GHG). The response to climate change is one of the most complex risk management issues facing New and the world. Nothing is straightforward. The effects of climate change are uncertain: The potential costs and benefits are spread unevenly across the globe and across economic sectors. There is also considerable uncertainty about the degree to which viable changes in greenhouse gas emissions associated with human activities will alter the direction of climate change. The effects of the Kyoto Protocol on global emission levels are themselves uncertain. It is generally recognised that the implementation of the first commitment period ( ) by developed countries will do very little to change the trend in greenhouse gas emission growth. Rather, the initial implementation of the Protocol is intended to generate a political and economic environment in which the developing nations will be willing to sign up to an emission reduction regime. There is clearly a risk that the actions by Annex I 1 countries will not generate the desired buy-in from the rest of the world. There is also a significant risk that some Annex I countries will not fulfil their obligations, while many former communist countries may withdraw from the agreement once they no longer enjoy the benefits of hot air. 2 The key problem from New s national interest perspective is that the economic costs of implementing the Protocol are highly concentrated on the first commitment period. This is because during this period if New were to ratify we would be imposing on ourselves significant economic costs which would not be faced by our main competitors both in the imports and exports markets. New s relative position in world markets would deteriorate until all countries around the world face the same marginal cost of greenhouse gas emissions. This will not happen until the second commitment period at the earliest. There are no easy answers to how New should best manage these risks. If New uses policy instruments during the first commitment period which affect our competitiveness, New would be incurring significant immediate economic costs. In return, it will be buying some improvement in the probability that human generated greenhouse gas emissions will eventually be contained, which will increase the probability that the effects of climate change will be mitigated, which may reduce the future costs on New and the rest of the world of dealing with the negative effects of climate change. It 1 Annex I to the Kyoto Protocol lists the countries which, by ratifying, accept the responsibility for limiting greenhouse gas emissions. This includes most industrialised countries, South Korea, Singapore, Israel and Taiwan, and the European former communist countries (i.e. it does not include the Asian republics of the former Soviet Union). 2 Hot air is the term used to describe actual reductions in emissions already achieved by these countries due to the collapse of heavy industry in the post-soviet period. Hot air makes these countries net creditors during the first commitment period. This gives them a strong incentive to participate during as they can sell their excess credits. In subsequent periods, these countries would no longer enjoy such benefits, and may not be willing to constrain their economic growth. NZIER Kyoto Protocol: issues for New s participation 1

10 is very difficult to assess any of these probabilities. There is a non-trivial risk that New may incur the immediate costs under the Protocol, and then still be faced with the cost of dealing with the effects of ongoing climate change. There may also be some risks to New from not ratifying the Protocol. If the Kyoto-type regime does become a global standard eventually, there may be some benefits from being an early adopter. There may also be some risk that other developed countries which ratify the Protocol could eventually seek to impose some trade restrictions on countries that are outside the regime. Hence, the key issues facing New s policy-makers are: Do the expected benefits, given their magnitudes and probabilities, justify the expected costs, particularly of the first commitment period? How do the benefits and costs of immediate ratification compare to the benefits and costs of delayed action, such as ratifying at the same time as our major competitors? What are the tools available to New to manage various risks? Against this background, this report investigates: The structural and sectoral differences between New and other developed economies (in particular, and in most detail, Europe and Australia) to understand the differential impacts. The likely development of global climate policy. The policy options open to New in the context of an evolving climate policy stance in Europe, Australia, Canada and the US. We conclude by developing a recommended policy approach to manage various complex risks faced by New. NZIER Kyoto Protocol: issues for New s participation 2

11 2. EMISSIONS AND ENERGY USE IN NZ This section of the report compares the sources of greenhouse gas emissions in New and in other Annex I countries. The differences are important, because they lead to different burdens of adjustment and impose different dynamic constraints on economic growth. 2.1 Sources of greenhouse gasses In New, carbon dioxide from energy and methane from agriculture are the two main sources of greenhouse gas emissions (Table 1). This mix is unusual among OECD countries, where carbon dioxide predominates. This reflects the relative importance of the agricultural sector to the New economy. Table 1 New 's greenhouse gas emissions CO 2 equivalent (Gg) 1 Carbon dioxide ,399 25,882 27,763 27,136 27,199 27,206 28,223 30,210 28,824 30,523 Methane 35,211 34,478 33,857 33,896 34,105 34,144 34,103 33,494 33,558 33,594 Nitrous oxide 11,849 11,725 11,738 11,887 12,048 12,097 12,041 12,062 12,231 12,397 Other Total 73,064 72,737 74,004 73,166 73,651 73,757 74,782 76,151 75,010 76,831 Source: Ministry for the Environment (2001). Notes: 1. 1 Gg ( Gigagram) equals 1 kiloton The data refers to gross emissions Other refers to the sum of hydrofluorocarbons, perfluorocarbons, and sulphur hexafluoride. In 1999, carbon dioxide accounted for around 39% of gross emissions. This share has been growing since 1990, reflecting growth in the transport and energy generation industries in particular, as well as the manufacturing & construction industries. Methane accounts for around 44% of New 's gross greenhouse gas emissions, down from 48% in 1990, mainly due to changes in the levels and mix of livestock (see Figure 1). Nitrous oxide represents around 16% of total GHG emissions. By contrast, CO 2 is the main greenhouse gas in the rest of the developed world, primarily from fossil fuel combustion. In 1996, 84% of US emissions came from fossil fuel combustion, while methane accounted for 10% (EIA 2000). These compositional differences are significant because at present there are no economically or technologically viable means of reducing methane emissions from ruminant animals. Hence, any emission constraints in this area would more likely be associated with output declines. NZIER Kyoto Protocol: issues for New s participation 3

12 Figure 1 Trends in New 's emissions of GHGs Percent of total gross emissions Carbon Dioxide Methane Nitrous Oxide Other Source: Ministry for the Environment (2001). When expressed by economic sector, emissions from agriculture accounted for 55% of gross emissions in 1998, and emissions from fuel combustion and industrial processes 41% (Ministry of Economic Development 2000). The vast majority of New 's methane emissions come from pastoral agriculture, with 88% stemming from ruminants. Of this ruminant methane, 51% was from sheep, 23% from beef cattle and 23% from dairy cattle (Joblin, 2001). These proportions have changed over the 1990s, with sheep now accounting for relatively less of the methane emissions, and dairy cattle more. This reflects the continued conversion of sheep farms into dairy farms. Non-agricultural sources of methane in New include landfills and energy. Figure 2 Contribution to total New emissions by sector Mt CO 2 equivalent All energy Industrial Processes Agriculture Land Use Change and Forestry Waste Source: Ministry of Economic Development Energy and the economy New is the only OECD country where energy-related greenhouse gas emissions relative to GDP have increased since While there has been some decline from the peak in NZIER Kyoto Protocol: issues for New s participation 4

13 1991, the emissions ratio has been relatively stable since the mid-1990s. This appears to be a characteristic of commodity dependent economies, such as New, Canada and Australia, compared to ongoing declines in other industrial countries. Japan is unusual in this regard. Figure 3 Emissions as a proportion of Gross Domestic Product Million metric tons CO 2 equivalents per US$1000 GDP Canada United Australia Japan New United Kingdom Germany Source: Energy Information Administration 2001 Table 2 shows that, as in many other OECD countries, the service sector has become more important. But compared to other OECD countries: The share of the more energy intensive industries, such as those in the primary sector, has in fact increased over time, although it has fallen back since the mid-1990s due to the decline of the petrochemicals sector. The contribution of agriculture to New GDP is 2-6 times larger than in other Annex I countries. The contribution of services to New 's GDP increased by 2.0% during the period. Other Annex I countries increased their share of GDP due to services by up to 8.5%. The size of the service sector in New is smaller relative to others once the energy intensive transport industry is excluded. The service sector (excluding transport industries) in the US and Australia, for example, accounted for about 65% of total GDP in 2000, compared to less than 50% in New. Growth in the relative share of the service sector came at the expense of light manufacturing. Table 2 Sector contributions to GDP key Annex I countries Country Agriculture Industry (total) Services New Australia Japan United Canada France Germany United Kingdom Source: OECD 2001 Another way of illustrating the same point is that, compared to the rest of the OECD, New had the 2 nd highest value of energy inputs per dollar of GDP in NZIER Kyoto Protocol: issues for New s participation 5

14 Figure 4 Value of energy input per $ of GDP in NZ and the OECD Dollar of energy input per $ of GDP in OECD and European countries (NZ$, 1998) Japan European Union OECD Pacific OECD Europe UK OECD Australia OECD North America US NZ Canada Source: NZIER Using more energy per dollar of output than other countries does not mean energy is used inefficiently. Rather, it reflects the availability of energy inputs relative to other inputs. It also reflects the overall comparative advantage: New is relatively good at producing commodities that are energy intensive, in particular dairy and meat, forestry and wood products, petrochemicals and aluminium. A closer look at New s CO 2 emissions from energy consumption (fuel combustion) shows that transport accounts for 42% of emissions in 1999, thermal electricity generation 20%, and the manufacturing industry 21%. 3 In 1999 diesel, petrol and other liquid fuels accounted for 51% of emissions; gas 35.5%, and coal 11.1% (MED 2000). Table 3 provides an international perspective on these 1999 data. Table 3 Energy related CO 2 equivalent fossil fuel emissions 1999 Emission source NZ 1 Industrialised World 2 US 2 Australia 3 Oil 51% 49% 42% 30.1 Gas 35% 20% 22% 13.3 Coal 11% 30% 36% 56.6 Source: MED 2000 (1), Energy Information Administration (2), Australian Greenhouse Office (3) In terms of emissions, the thermal electricity generation and the transport sector have also been the fastest growing over the last decade (up by 4.9% and 3.2% respectively), in line with increased energy consumption. This is not surprising. Since New was an early adopter of large-scale hydro generation, thermal generation represents the main marginal source of energy. Transport sector growth has been largely driven by the rapid growth of commodity sectors and tourism, as well as the number of cars on the road. The above differences between New and other Annex I countries are significant in terms of the relative costs of containing emissions: As the only agricultural economy among the Annex I countries, New will be largely on its own in having to develop technologies for containing agricultural greenhouse gas emissions during the first commitment period. This is a relatively heavy burden for a 3 In 2000, transport accounted for 45% of emissions, electricity generation 18.2%, and the manufacturing industry 23.1%. NZIER Kyoto Protocol: issues for New s participation 6

15 small country. Other countries, which share common emission problems, will be able to spread the costs and risks of research. The high share of transport in New s energy emissions makes economic incentives relatively less effective in New. Fuel demand in transport is relatively insensitive to price. Hence, New will find it relatively difficult to align its policy instruments with other developed countries. This again imposes an additional adjustment burden on a small country. New s greenhouse gas emissions are largely produced by the sectors which are the key drivers of this economy. By contrast, in most other Annex I countries, the bulk of emissions comes from mature, low growth sectors. Hence, the dynamic effects of imposing emission constraints are likely to differ. Unlike most other Annex I countries, the marginal sources of energy in New are more greenhouse gas emission intensive than the existing sources. In other words, average emissions will keep rising as we add more gas and then coal-fired electricity generation. By contrast, most other Annex I countries, at the margin, are shifting from coal to gas, reducing their average emission intensity. This is being done for economic, rather than environmental, reasons Transport Data from the US Energy Information Administration allows an international comparison of how energy consumption is distributed by sector. The main observation is the large share of energy consumed in New s transport sector, compared to other OECD countries. Figure 5 Energy consumption by sector Share of total energy consumption 1998 Transportation Residential Industrial and commercial 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% New Australia Canada United Japan France Germany United Kingdom Source: Source: EIA Country Briefs, Ministry of Commerce for New Transport-related greenhouse gas emissions per unit of GDP closely follow this pattern: the OECD (1999) found that for New these were amongst the highest in the OECD (see Figure 6). NZIER Kyoto Protocol: issues for New s participation 7

16 Figure 6 Transport emissions per unit of GDP 1996 data. Tonnes of carbon dioxide per $US million OECD average Luxembourg Canada USA N. Australia Mexico Iceland Greece Korea Spain UK Germany France Japan Source: OECD (1999) Notes: OECD GDP data at 1991 prices and purchasing power parities New 's economic structure and geography generates a greater than average dependence on road transport. The key export industries of dairy, meat products and wood all involve extensive transportation, from farms and forestry plantations spread across New to processing plants to international gateways 4 and markets. This contributes to our greater emission intensity per unit of GDP. The relatively small population spread out over a relatively large land mass also contributes to our high reliance on road transport. In all, New ers travel 503 vehicle kms for each $US 1000 of GDP. This is similar to the Australians and Americans, but compares to an average of 408 in the EU-15 countries (OECD 1999). Since New s per capita GDP is substantially lower than either in the US or in Australia, this highlights our relatively high mobility needs. The problem with transport related emissions is that there are currently few feasible options to reduce these, without significant changes to the structure of the economy, car and truck use, or fuel conversion. In other words, the marginal abatement costs would be high in this sector. Table 4 New 's export markets by distance Distance, km No of countries % of total NZ exports d<7, ,000<d<11, ,000<d<13, ,000<d<15, ,000<d<17, ,000<d<20, Source: NZIER Most external trade is carried by sea: almost 85% of New exports by value, and over 99% by volume (Statistics New ). However, initially international transport itself will not be subject to the Kyoto Protocol restrictions. NZIER Kyoto Protocol: issues for New s participation 8

17 2.2.2 Electricity generation The bulk of New s electricity generation (about 65% in 1998) comes from hydro-plant. While hydro-generation has environmental impacts, particularly on establishment, it does not emit greenhouse gases in contrast to coal, gas, and to a lesser extent geothermal generation. In 1998, coal accounted for about 5% of capacity, and gas for 20%. The remaining capacity comes from geothermal and wind. Coal is currently used to meet peak demand, but the Ministry of Economic Development predicts that coal will provide a growing share of marginal base-load capacity. MED analysis (2000) shows that demand for electricity has grown largely in line with GDP over the last 30 years; to fuel future economic growth, 2200 MW new capacity is being commissioned. As New has already developed a major hydro capacity, only a limited amount (18%) of that new capacity will come from hydro, with over 30% to come from coal (other main sources are 13.5% from gas and 12% from geothermal generation). As a result, coal s share is estimated to grow to 14% in 2020, while the shares of gas and hydro generation drop to 15% and 52% respectively. As a consequence, the business-as-usual scenario is that carbon intensity of electricity and overall energy consumption in New will grow, notwithstanding any abatement technologies or fuel efficiency improvements. Combined with a forecast growth in electricity demand, emissions from this sector are set to grow. This contrasts sharply with the situation in Europe and Australia. Europe has traditionally relied on coal for much of its base-load capacity. Since the early 1990s, most European countries have been switching to gas as a result of electricity market and coal subsidy reforms. This development has been underpinned by access to substantial gas reserves in the North Sea, and an increasing reliance on gas delivered from Russia. In other words, in Europe the switch from more emission intensive electricity generation to less emission intensive practices has been occurring for economic reasons, with incidental environmental benefits. In contrast, New is, in effect, being penalised for its early adoption of hydro-power generation, with only limited development potential left under the existing non-emitting technologies. MED estimates that a carbon charge to reduce emissions by 13% would raise electricity prices by 12-13%, while coal prices would increase by 34%. 2.3 Conclusion The above international comparisons of the sources of emission indicate that the costs for New of adjusting to the Kyoto Protocol emission restrictions are likely to be higher than for most other countries likely to participate in the first commitment period. In fact, New s economic structure, its per capita GDP and the structure of its emissions is more in line with many of the developing countries, which are not part of Annex I. This creates significant risks for New in being an early adopter of the emission reduction targets. NZIER Kyoto Protocol: issues for New s participation 9

18 3. THREATS TO NZ TRADE PERFORMANCE In principle, all emission-intensive industries in Annex I countries are vulnerable to competition from the developing world. But some Annex I economies are more exposed than others. We analyse the competition faced in key New export markets. In particular we check: The relative importance of trade in emission-intensive commodities. What proportion of our external trade is in emission-intensive goods, compared to other Annex I countries? Competition in our main export markets. Do New exports compete mainly with other Annex I countries or with developing countries? We will also look at exposure of domestic producers who compete with imports from developing countries, and the potential of industries shifting part of their production process to developing countries. 3.1 The trade in energy-intensive goods Table 5 shows that the Pacific and North American regions are more exposed to energyintensive trade with non-annex 1 countries than Europe. In turn, the Pacific region is more exposed than North America (Baron et al. 1997). Table 5 Trade in energy-intensive products for OECD regions (1994) OECD Region Europe North America Pacific Exports of energy-intensive products to non-annex 1 countries over total exports Imports of energy-intensive products from non-annex 1 countries over total imports 3.2% 4.9% 7.5% 1.0% 1.8% 3.7% Share of exports (imports) of energy-intensive products to (from) Annex I countries Net exports of energy-intensive products to non-annex I countries (Billion) 80.7% (88.9%) 66.6% (79.1%) 33.3% (67.2%) US $39.8 US $16.1 US $21.3 Net exports of energy-intensive products to other regions (Billion) US $53.0 US $2.7 US $8.0 Contribution of trade to GDP (Imports+Exports)/2*GDP 27.3% 13.4% 9.8% Notes: Source: (1) Energy-intensive goods are defined as: iron and steel, non ferrous metals, paper and pulp, chemical products Baron et al p27 New is particularly exposed, because of its different export profile to those of other major Annex I nations. Table 6 ranks the ten highest export earning industries in New, Australia and other key Annex I countries. It shows that: After the trade and transport grouping, 5 New 's highest export earner is the dairy products manufacturing sector. This sector is both energy and methane intensive. It does not appear in the top ten export earners for the other Annex I countries in the table. Exports of cattle meat 6 products are also vital to New 's export receipts. But its competitiveness is at risk from rising costs of cattle methane and transport emissions. This is also a major export earner for Australia. 5 Trade and transport includes tourism (hotels and restaurants), retail trade and air, water and land transport. 6 Cattle meat includes beef, sheep, goat and horse meat. NZIER Kyoto Protocol: issues for New s participation 10

19 Other emission-intensive export sectors that are prominent in New are wool, paper products, and manufactured wood products, which are less significant for other Annex I nations. The low emission exports of machinery, vehicles, financial and business services are far more important to the other Annex I countries. Table 6 Export profile: selected Annex 1 countries Ten highest export earning sectors, 1995 NZ Australia United Canada United Kingdom Germany Japan 1 Trade and transport Trade and transport Machinery Vehicles Machinery Machinery Machinery 2 Dairy products Coal Financial and business services Machinery Chemicals Vehicles Vehicles 3 Cattle meat products Minerals 4 Chemicals Non-ferrous metals Trade and transport 5 Other food Chemicals Electronic equipment Paper products Trade and transport Chemicals Chemicals Electronic equipment Chemicals Trade and transport Wood products Vehicles Public administration Electronic equipment Trade and transport Chemicals 6 Paper products Public administration Vehicles Trade and transport Financial and business services Electronic equipment Ferrous metals 7 Wool Machinery Transport equipment Electronic equipment Public administration Ferrous metals Other manufacturing 8 Machinery Cattle meat products Public administration Non-ferrous metals Oil Paper products Financial and business services 9 Non-ferrous metals 10 Wood products Financial and business services Source: GTAP version 4 database Wool Paper products Oil Ferrous metals Metal products Transport equipment Other manufacturing Financial and business services Paper products Textiles Textiles 3.2 Threats to New 's exports An increase in the cost of producing emission/energy intensive commodities and bringing them to export markets will affect the competitiveness of New exports. New export competitiveness is affected in two areas: Compared to other Annex I countries. Greater emission-intensity due to greater transport costs and greater reliance on energy-intensive processes to get our key export commodities ready for export would make New commodities more expensive compared to the same goods from other Annex I countries. This will affect New s competitiveness both in Annex I and in developing countries. Compared to non-annex I countries. A carbon charge or similar will make production of a commodity in New more expensive relative to production in a non-annex I country. This will make imports of these commodities from non-annex I countries rather than NZ more attractive to both Annex I and non-annex I countries. An increase in relative production costs is equivalent in its effect to a price decline. In essence, New s imposition on itself of the Kyoto Protocol restrictions during the first commitment period is equivalent to us suffering a negative world price shock. Our terms of trade (that is, the ratio of export to import prices) worsen. This is important, since as will be NZIER Kyoto Protocol: issues for New s participation 11

20 explained in the concluding section the dynamics of the terms of trade is a critical determinant of New s economic performance. Below, we analyse these competitive threats to New 's key commodity exports, as listed in Table 6. We consider: 1. Where is each commodity exported to? 2. Who else exports these commodities to each destination? Let us consider the example of dairy products to explain how we sought to answer these questions (Figure 7). We first looked at which countries New exports dairy products to. Then, for each of the top 10 destination countries, we looked at who else exports dairy products into that country. Any non-annex 1 countries or the US (which does not intend to ratify the Kyoto Protocol) among the top 10 importers are then identified as threats to our dairy export market. If any other Annex I countries choose not to ratify, they will need to be added to the list. It is likely that if a country figures among the top 10 sources of imports, its producers would tend to have the necessary production capacity and market presence to expand market share relatively quickly. In addition, new market entrants may also pose risks. Figure 7 Threats to New 's exports: a schematic representation Export destinations Other sources of dairy imports for New 's export destinations A1 NA1 THREAT A1 New Dairy products A1 A1 NA1 THREAT A1 NA1 THREAT A1 Source: NZIER NZIER Kyoto Protocol: issues for New s participation 12

21 3.2.1 Dairy products a) Destinations for New 's dairy exports New 's dairy exports are primarily sent to the United Kingdom, Japan, Malaysia and the former Soviet Union (FSU). The top 10 destinations in the chart below account for around 67% of New 's dairy exports. Figure 8 New 's dairy exports by destination Percent of total exports United Kingdom Japan Malaysia Former Soviet Union Rest of the Middle East Taiwan Australia Philippines Central America and Cartibbean Rest of North Africa Source: GTAP version 4 database b) Potential threats to New 's dairy exports Table 7 Competitors to New 's dairy exports Source of imports UK Japan Malaysia FSU Middle East 1 REU Australia New 2 New New 3 Germany REU REU New 4 Denmark United Germany 5 Canada Denmark United Export destination Taiwan Australia Philippin es Germany REU Australia New Central America North Africa Australia REU REU Australia REU Denmark REU REU REU New United New New Denmark New Australia CEA EFT United CEA Germany United 6 EFT FSU UK Finland UK Denmark United UK Denmark United New Germany Germany Germany USA Canada UK Central America 7 Australia UK CEA Denmark CEA FSU CEA Singapore Germany CEA 8 United Germany Denmark Sweden United 9 Sweden EFT Canada Canada Finland Middle East 10 FSU Canada Finland EFT Canada South Africa Denmark Argentina UK CEA Canada Australia Canada Argentina Australia Finland Sweden India EFT Central America Notes: (1) FSU = Former Soviet Union. REU = Rest of Europe. I, N, S = Iceland, Norway and Switzerland. CEA = Central European Associates (incl. Bulgaria, Hungary, Poland, etc). EFT = Iceland, Norway, Switzerland, Liechtenstein. Source: GTAP version 4 database As the preceding chart shows, New 's dairy exporters compete mainly with Annex I countries in their main markets. The direct threat appears to come from the US, which is only now beginning to expand as a dairy exporter, and from the growing dairy industries in Latin America. This threat is significant, particularly in relation to future growth. Moreover, prices in many markets are increasingly being set at the margin by new competitors. NZIER Kyoto Protocol: issues for New s participation 13

22 The key risk to New dairy industry, however, is that European countries will protect their farmers from the effects of the Kyoto Protocol. International dairy prices are heavily influenced by the European subsidy levels. These subsidies are politically motivated, and are determined by the desire to provide an acceptable level of income to the incumbent farmer population in the European Union. It is highly unlikely that these political imperatives will be altered by the Kyoto Protocol. While the WTO rules would constrain overt new subsidies to compensate for production cost increases, it is very likely that other measures will be found to insulate European dairy producers from the effects of Kyoto polices. Since agriculture is a marginal activity in Europe, such political settlements can be sustained by European economies Cattle meat products This category includes products from sheep, bovine cattle, goats and horses. a) Destinations for New 's meat products exports North America (beef) and the European Union (sheepmeat) are the main destinations for New 's meat products exports. In 2001 each market was worth approximately $1.5 billion. North Asia and the Middle East are other key export markets for meat products. The countries in the chart account for around 85% of New 's meat products exports. Figure 9 New 's meat product exports by destination Percent of total United United Kingdom Rest of European Union Japan Canada Germany Korea Taiwan Rest of Middle East China Source: GTAP version 4 database b) Potential threats to New 's meat products exports New product mainly competes with meat from Australia, the US and South American beef producers (Argentina, Brazil, and Uruguay), as well as from European producers in their home markets. Beef and lamb trade in the US and EU is subject to quotas. For example, New has a 230,000MT beef quota to the US, whereas Argentina and Uruguay each have a quota of 20,000MT. Similarly, New s quota to the EU is many times greater than that of Argentina and Australia. These quotas limit the competitive threat from other exporters to our main destination markets. In this case, the increase in production costs from climate change policies is more likely to be borne in the form of reduced profit margins rather than through loss of market share. Overall, New s meat products exports appear highly vulnerable to the price distortions during the first commitment period of the Kyoto Protocol. NZIER Kyoto Protocol: issues for New s participation 14

23 Table 8 Competitors to New 's meat products exports Source of imports United Export destination UK REU Japan Canada Germany Korea Taiwan Middle East 1 Australia REU REU United 2 New New United UK Australia New 3 Canada Brazil Germany New Australia REU United Argentina Australia United New New China Australia REU United New Australia New New Australia 4 Argentina Argentina Denmark Canada Argentina Denmark Canada Canada India Canada 5 Central America Southern Africa 6 Brazil Australia United 7 Mexico Uruguay New 8 Uruguay South Africa Argentina Argentina Brazil UK RAP Japan Uruguay REU China EFT Brazil Japan China Argentina RAP RAP REU CEA EFT RAP Germany Argentina Brazil Chile Uruguay Uruguay REU Chile United 9 Japan Denmark Uruguay REU UK South FSU REU Turkey Denmark Africa 10 REU EFT CEA Thailand Southern Africa Australia Taiwan Singapore UK Finland Notes: (1) FSU = Former Soviet Union. REU = Rest of European Union (incl. Austria, Belgium, France, Greece, Ireland, Netherlands, Portugal). CEA = Central European Associates (incl. Bulgaria, Hungary, Poland, etc). EFT = Iceland, Norway, Switzerland, Liechtenstein. RAP = Rest of Andean Pact (incl. Bolivia, Ecuador, Peru). Source: GTAP version 4 database Taiwan Chemicals This category includes products such as fertilisers, industrial chemicals, resins, paints, pharmaceuticals, cosmetics, tyres and tubes, and other rubber and plastic products not listed elsewhere. a) Destinations for New 's chemicals exports Australia is New 's largest export market for chemicals, accounting for 28% of the total market. Japan and the United are the other two key markets. The countries in the chart account for around 90% of New 's chemicals exports. Figure 10 Share of New 's chemicals products exports by destination Percent of total Australia Japan United Korea Rest of European Union Germany Rest of World Taiwan United Kingdom China Source: Note: GTAP version 4 database The Rest of World aggregation contains 45 very small countries. NZIER Kyoto Protocol: issues for New s participation 15

24 b) Potential threats to New 's chemicals exports Whilst exports of chemicals are important to the New economy, the New chemical industry is a relatively small player in all destination markets except Australia. There are many threats to New 's exporters of chemicals the US, China, Singapore, Korea, Taiwan, and Malaysia, none of which have emission targets in the first commitment period. The Middle East also poses a strong threat. The largest single export in this category is million tonnes of methanol per annum manufactured by Methanex from natural gas. As this manufacture involves significant process emissions, ongoing production in New may no longer be viable under climate change policies. As the world demand for methanol is not likely to be affected by such changes, and may increase in response to climate change policy - a significant amount of methanol is used to produce an additive in gasoline to make it clean burning - emissions are likely to shift to other countries. This could possibly include Australia, which has signalled that it is likely to indemnify the process emissions from the gas industry. Table 9 Competitors to New 's chemicals exports Source of imports 1 United Australia Japan United United 2 REU REU REU United Export destination Korea REU Germany Rest of World Taiwan UK China Canada Japan REU REU REU Japan REU Taiwan Germany EFT CEA United Germany 3 Japan Germany Japan REU UK UK Singapore REU United 4 UK China Germany Germany United United Japan Korea Germany Germany EFT United 5 Germany Korea UK China EFT CEA China Singapore Sweden FSU 6 New EFT China Middle East Japan Japan UK Korea Japan REU 7 China UK EFT UK FSU China Thailand China China Hong Kong 8 EFT Taiwan Mexico FSU CEA Sweden Japan Canada Denmark Germany 9 Singapore Middle East Middle East 10 Korea Sweden Central America Malaysia Middle East Denmark United UK FSU Middle East Indonesia Sweden FSU EFT EFT CEA Singapore Notes: (1) FSU = Former Soviet Union. REU = Rest of European Union (incl. Austria, Belgium, France, Greece, Ireland, Netherlands, Portugal). CEA = Central European Associates (incl. Bulgaria, Hungary, Poland, etc). EFT = Iceland, Norway, Switzerland, Liechtenstein. RAP = Rest of Andean Pact (incl. Bolivia, Ecuador, Peru). Source: GTAP version 4 database NZIER Kyoto Protocol: issues for New s participation 16