Domestic action towards New Zealand’s second NDC (2031-2035)

A significant domestic contribution towards New Zealand's second NDC is possible, but requires the Government to grapple with structural limitations in New Zealand's current policy framework

Nov 17, 2024

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Overview

With New Zealand's second Nationally Determined Contribution (NDC-2) due by February 2025 (UNFCCC Secretariat, 2024), the pressure for increased ambition is now on.

Recent NDC announcements by Brazil targeting 59-67% below 2005 emissions by 2035 (Presidencia da República, 2024), up from 53% in 2030, and an 81% reduction below 1990 emissions by the UK (Miliband and Department for Energy Security and Net Zero, 2024), up from 68% in 2030, exemplify the rising global ambition expected of countries. The Paris Agreement itself is likewise clear that each new NDC should "represent a progression beyond the Party's then current [NDC] and reflect its highest possible ambition" (2015, p. 4)

Countries can meet their NDCs through two broad approaches: reducing emissions within their own borders, or purchasing international units through carbon markets and cooperation mechanisms (Leining et al., 2024).

New Zealand's first NDC of 50% below 2005 emissions by 2030 (NDC-1) relies on both domestic efforts and a sizable portion of international units. Currently the gap between projected domestic emissions and NDC-1 sits at an estimated 93-97 million tonnes (equivalent to 1.5 years of allowed emissions under the target) (MfE, 2024a). Hence with six years left in NDC-1, significant international unit purchases are now largely locked in for NDC-1 even with further inroads on domestic emissions.

Though the Government has sent mixed signals about its willingness to use international units (Wannan, 2023; Hurrell, 2024; Kivi, 2024; Gibson, 2024a), the alternatives of walking away from NDC-1 or using creative accounting approaches (Daalder, 2024a) would risk serious reputational damage – a dire prospect for a small export-oriented country like New Zealand. Particularly given implementation of NDCs is now embedded in New Zealand’s free trade agreement with the European Union (2024).

This context raises critical questions about New Zealand's approach to setting and meeting its NDC-2 covering the period 2031-2035. This article thus examines how New Zealand's domestic policy framework and ambition will affect its ability to set an NDC-2 target that represents ‘progression’ on NDC-1, as well as any subsequent ongoing reliance on international units.

Drawing on emissions pathways from the Climate Change Commission's (the Commission's) (2024c) recent advice to the Government on the potential contribution of domestic efforts towards NDC-2, the article focuses on whether these domestic pathways are achievable within New Zealand's current policy framework.

Specifically, this article asks:

What does the Government's draft second Emissions Reduction Plan (ERP2) mean for emissions during NDC-2?
If domestic efforts aren't lifted, how many international units are needed for NDC-2 to achieve a progression beyond NDC-1?
Can the New Zealand Emissions Trading Scheme (NZ ETS) achieve the Commission's pathways in its current form?
What are the impacts of failing to act on agricultural emissions ahead of NDC-2?

For technical readers, notes on assumptions related to forestry accounting and methods used to relate the headline target number for NDC-2 to an emissions budget are also provided at the bottom of the article.

Key takeaways:

The Government's current domestic policy settings in its ERP2 would require 79 million international units during 2031-2035 to achieve a minimal progression target of 60% below 2005 levels - about 70% more per year than currently forecast for NDC-1.
While the Commission's modelled pathways show stronger domestic emissions reductions are technically feasible, these cannot be achieved within New Zealand's current policy framework due to structural limitations in the NZ ETS and delayed action on agricultural emissions.
The NZ ETS in its current form cannot deliver the net-zero or negative emissions seen in the Commission’s pathways in sectors covered by the scheme during NDC-2, as the Government would lose its ability to manage market outcomes once auction volumes approach zero.
Deferral of agricultural emissions pricing can reduce the domestic ambition possible by 3-7 percentage points when compared to the Commission's pathways, necessitating an additional 8-18 million international units during NDC-2.
Reforms to New Zealand's climate policy architecture are needed if the Government wishes to achieve greater domestic reductions and reduce reliance on international units. These could include NZ ETS structural changes, industrial allocation reforms, new funding mechanisms for removals, and earlier agricultural action.

What does the Government’s ERP2 mean for emissions during NDC-2?

The Government's recent draft ERP2 has attracted attention for falling short of New Zealand's domestic 2050 targets - a 24-47% reduction in biogenic methane and net-zero for other gases (Coughlan, 2024; Daalder, 2024b; Smith, 2024).

Yet looking ahead to NDC-2, a more immediate concern emerges: ERP2 projects a markedly slower pace of emissions reductions than pathways modelled by the Commission. As shown in Figure 1, emissions at the end of ERP2 (2035) lag behind even the Commission's least ambitious scenario that assumes both low technology availability and low pursuit of systems change (Commission: LTLS).

The gap between ERP2 and the Commission’s pathways also widens over time. The Commission's pathway featuring high technology adoption and high systems change (Commission: HTHS) for example sees emissions 12 million tonnes lower than ERP2 by 2030, but by 2035 - the target year for NDC-2 - this gap grows to 22 million tonnes.

When expressed relative to the 2005 gross emissions baseline used for NDC-1, ERP2 achieves a 40% reduction in domestic net emissions by 2035, representing modest progress beyond reductions under NDC-1, which are projected to reach 34.5% below 2005 by 2030. Yet as noted by former Climate Ambassador Kay Harrison at the 2024 Climate Change and Business Conference, living up to international expectations mean New Zealand's NDC-2 target would need to start with a 6, "at least" (Gibson, 2024b).

This growing divergence appears to stem from key structural aspects of New Zealand's current policy framework. While the Commission's pathways decouple price signals for gross emissions and forestry removals, pursuing ambitious action on both fronts, ERP2 relies primarily on the NZ ETS to drive both removals and gross emissions reductions at ‘least cost’ (MfE, 2024c). When combined with the Government’s choice to delay pricing of agricultural emissions until late this decade, these policy choices look set to constrain the emissions reductions achievable during NDC-2. These limitations are explored further in the following sections.

How many international units are needed to achieve progression for NDC-2?

Given New Zealand's current settings under ERP2, we can estimate the volume of international units needed to achieve a target representing progression beyond NDC-1. For this analysis, we'll use a 60% reduction below 2005 emissions as a minimum benchmark - though this should not be read as advocacy for that particular level of ambition, given the Paris Agreement's calls for NDCs that represent the highest possible ambition.

Figure 2 below illustrates the levels of international units needed during 2031-2035 across the Government and Commission pathways to achieve a 60% target.1

Under ERP2, New Zealand would need to purchase 79 million units over this period - equating to annual purchasing volumes approximately 70% greater than that currently forecast for NDC-1. In contrast, the Commission's pathways see progressively lower reliance on international units, with their high technology adoption and high systems change scenario (Commission: HTHS) even enabling a more ambitious target through domestic action alone (exceeding the 60% target by 19 million tonnes).

These results highlight a critical tension with the Government's stated positioning that it is "absolutely categorically focused" on minimising the gap between domestic emissions and New Zealand's NDCs (Kivi, 2024). To achieve this aim, the Government must address the structural policy settings that are driving higher emissions in ERP2 compared to the Commission's pathways, not just adopt the Commission’s proposals for NZ ETS auction volumes.

The timing of policy action is also crucial. As emphasised by the Commission (2024c), decisions and actions well ahead of 2030 will largely determine both New Zealand's ability to set an ambitious NDC-2, and its ongoing reliance on international units. This reflects the path-dependent nature of economic transitions (Aghion et al., 2019), where early policy choices can lock in sustained higher or lower emissions trajectories due to factors such as the slow turnover of capital assets.

Can the NZ ETS achieve the Commission’s pathways in its current form?

A key climate-related focus of the Government in its first year has been to bring certainty and stability to the NZ ETS. This has been pursued through cancellation of the prior Government's NZ ETS Review (Watts, 2023) and adoption of the Commission's proposed auction volumes for 2025-2029 (Watts, 2024).

While these actions appear to have achieved their intended effect of calming market conditions in the short-term, they leave key structural challenges that will constrain the NZ ETS's ability to deliver emissions reductions needed in the 2030s unaddressed.

This becomes clear when examining the Commission's emissions pathways split between sectors covered by the NZ ETS and those outside it (agriculture and part of waste emissions). As shown in Figure 3, when split out, emissions from NZ ETS sectors must reach net-zero or even net-negative during NDC-2 to keep pace with the Commission's more ambitious modelled pathways.

These outcomes pose fundamental challenges for market stability under the NZ ETS's current framework.

First, the Government's current primary tools for managing price stability operate through the scheme’s auction system (through an auction price floor and a cost containment reserve). To achieve net-zero emissions in the scheme, the Government would need to cease all auctioning of units - removing any influence of its mechanisms for shaping market prices at a time when stable price signals would be crucial for driving investment in emissions reductions and removals.

Second, as the NZ ETS is currently the only large-scale funding mechanism for removals (with the vast bulk of carbon generated by post-1989 forests registered within the scheme), achieving net-negative emissions in NZ ETS sectors would require either substantial funding of removals outside the scheme (beyond what is possible through voluntary carbon markets), or novel changes to the NZ ETS such as modified obligations for gross emitters (e.g., requiring surrender of units above 100% of actual emissions).

These challenges are compounded by New Zealand's industrial allocation settings. Current phase-down rates mean around 20 million units will be allocated during 2031-2035 (Commission, 2024a), with highly trade-exposed sectors set to still receive a 30% allocation rate as far out as 2050. Figure 4 illustrates how these industrial allocation volumes severely constrain auctioned units when pursuing emissions reductions in line with the Commission’s pathways.

Under the Commission's EB4 demonstration pathway for example, only 4.6 million units could be auctioned during 2031-2035 while maintaining current industrial allocation settings. The Commission's HTHS pathway meanwhile requires net-negative emissions from NZ ETS sectors during 2031-2035, with an implied negative volume of auctioned units (-25.2 million) given current industrial allocation settings. This is simply not achievable within the NZ ETS under its current design, and would require fundamental reconsideration of both the design and volume of industrial allocations, as well as the broader role of the scheme.

What are the impacts of delayed action on agricultural emissions for NDC-2?

The Government's decision to defer previously planned pricing of agricultural GHG emissions until late this decade presents another structural constraint on domestic emissions reductions. To assess the impact of this delay on NDC-2 ambition, we can examine what happens when agricultural emissions from the Government's ERP2 pathway (reflecting delayed action) are substituted into the Commission's modelled pathways.

Figure 5 shows how this constraint on agricultural action reduces the target achievable through domestic action alone. For the Commission's EB4 demonstration pathway, the achievable target drops by 3 percentage points. For the more ambitious HTHS pathway, which assumes earlier adoption of agricultural mitigation technologies and practices, the impact is more severe at a 7 percentage point reduction in achievable ambition.

Constraining agricultural emissions to ERP2 levels also directly increases reliance on international units. Figure 6 shows the additional units needed to achieve a minimum progression 60% target - an extra 8 million units for the EB4 demonstration pathway during 2031-2035, and with the surplus ambition seen under the HTHS pathway largely eliminated due to constrained ambition on agriculture.

Experience with the NZ ETS suggests new pricing mechanisms take time to establish and drive behaviour change, and there is little grounds to suggest pricing agricultural emissions will be any different. Deferring agricultural emissions pricing till late this decade thus risks limiting achievable emissions reductions during NDC-2 and putting the Commission’s pathways out of reach.

Summing it up

The Commission's modelled pathways demonstrate that stronger domestic emissions reductions are technically feasible and could enable New Zealand to adopt an NDC-2 that both represents progression beyond NDC-1 and reduces reliance on international units.

However, achieving these pathways requires confrontation with the structural limitations of New Zealand's current policy framework, a framework that has remained largely unchanged in its core design since the introduction of the NZ ETS in 2008.

The Government has several options available should it wish to achieve domestic reductions in line with the Commission's pathways, for example:

Investigating reforms to the NZ ETS to achieve net-negative emissions in covered sectors.
Reforms to industrial allocation in the NZ ETS (both in terms of design and rates of allocation).
New funding mechanisms for removals outside the NZ ETS (e.g., a standalone removals market, or obligations on agricultural emitters for their N₂O emissions).
Earlier and more ambitious action on agricultural emissions (e.g., bringing forward pricing, and early support for adoption of mitigation measures such as low-methane breeding, and EcoPond).

Yet each of these options requires a softening of the Government's current positioning that puts the NZ ETS at the forefront of efforts on both removals and gross emissions reductions. The Government's strong stated commitments for example to: 1) use the NZ ETS as the core lever guiding gross and net emissions outcomes; 2) constrain levels of afforestation; and 3) defer action on agricultural emissions, will in concert prevent New Zealand from keeping pace with the Commission's pathways in the 2030s.

Failure to wrestle with these structural questions will necessitate sustained use of high levels of international units if New Zealand is to achieve an NDC-2 that represents progression beyond existing commitments. This reliance can be reduced, but only if the key structural limitations inherent in New Zealand's domestic policy framework are grappled with.

Technical notes

These technical notes provide additional detail on key methodological choices and assumptions underlying the analysis.

Forestry and form of target

This article assumes continued use of averaging accounting for post-1989 forests rolled over from NDC-1 to NDC-2. It also assumes that as with NDC-1, New Zealand sets NDC-2 on a 'gross-net' basis, where net emissions in 2035 are framed as a reduction below 2005 gross emissions.

However, New Zealand is not restricted to these accounting choices, and could for example adopt an approach closer to that more common among other developed countries. For example, by expressing NDC-2 as a target to reduce net emissions in 2035 by X% below 2005 net emissions, and making use of inventory GHG accounting for both pre-1990 and post-1989 forests. This approach would carry benefits from a domestic policy perspective - something I may explore in a future article - but is difficult to analyse at this stage given the Government has not released projections of forestry using inventory accounting recently.

Approach to establishing emissions budget for NDC-2

The Commission's (2024c) advice to the Government on New Zealand's domestic efforts towards NDC-2 included three methods for establishing an emissions budget for NDC-2 based on the headline number chosen for the target. The merits and weaknesses of these approaches have been covered elsewhere (Hood, 2024), and require a fairly lengthy discussion to cover adequately, so are not explored here.

For reference, this article makes use of the Commission's 'method 2', where an emissions budget is established by drawing a straight line from NDC-1 (50% below 2005 emissions) in 2030 to the NDC-2 target in 2035. This method is selected given NDC-1 is primarily framed around New Zealand's headline target of '50% below 2005 emissions', and method 2 offers arguably the most intuitive approach of assessing whether NDC-2 represents progression above NDC-1.

Modelled scenarios

All scenarios make use of published results data from the Commission (2024b, 2024c) and Government (MfE, 2024c, 2024a) that use the Emissions in New Zealand (ENZ) model developed by Concept Consulting.

Simplified assumptions are taken in three areas to ensure that ballpark conclusions can be drawn about the challenges facing New Zealand given its current domestic policy architecture, and that the Government's ERP2 scenarios can be compared directly against the Commission's pathways:

Agricultural emissions in the Commission's dataset have been adjusted to align with the 2024 GHG inventory using the ratio of means per GHG species relative to New Zealand's 2024 GHG inventory (MfE, 2024b) for the years 1990-2021. This change ensures better alignment with the Government's ERP2 scenario, which is calibrated to the 2024 GHG inventory.
NZ ETS covered emissions have been calculated assuming half of waste emissions remain uncovered by the NZ ETS, and agricultural emissions remain excluded. Other minor differences (such as small volumes of forestry currently outside the NZ ETS) are not adjusted for. Other technical corrections employed by the Commission in their NZ ETS auction volumes advice are not applied, as these are assumed to be addressed by 2030 or will otherwise be negligible for NDC-2.
Industrial allocations are estimated drawing on the Commission's 2025-2029 NZ ETS auction settings report (2024a), where it is assumed allocations are consistent for each scenario examined in this report. In practice, industrial allocations may track lower in more ambitious pathways (e.g., the Commission's HTHS scenario), which mean that auction volumes stated in Figure 4 for the Commission's EB4 demo. path and HTHS scenarios may be slightly understated relative to when these effects are factored in.

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