World news – Emissions Trading System: The New Zealand Carbon Market Explained

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James Shaw rang the NZX bell to mark the start of the first ETS auction in New Zealand. Photo: Lynn Grieveson

Marc Daalder is a senior Wellington political reporter specializing in Covid-19, climate change, energy, primary industry, technology and the rights. Twitter: @marcdaalder.

The Minister for Climate Change, James Shaw, rang the NZX bell in Wellington to mark the start of the first emissions trading scheme auction.

By noon that day had around Forty participants bid for 11 million credits, and a total of 4.75 million were auctioned at $ 36 per unit.

That may have sounded like a bunch of gibberish to almost anyone outside those 40 participants . While the Emissions Trading Scheme (ETS) is one of New Zealand’s most important tools for reducing emissions, it is terribly complex and poorly understood.

Given that it is likely to play an increasingly important role in combating climate change – which is expected to be solely for will be responsible for a 15 percent drop in emissions by 2035 – and will face correspondingly greater public attention, Newsroom wrote this Explainer to help our readers understand what the ETS is and how it works.

In some countries, emissions trading schemes are called cap-and-trade systems and that could be a better name. The rough idea is that a certain number of emission certificates – in our ETS they are called New Zealand Units (NZUs) – are available for trade between polluters. For every ton of emissions a polluter releases in a year, he has to return a carbon credit to the government.

By limiting the total number of credits in the system, the amount of emissions allowed in a given year is limited. When there is too little credit for the expected emissions, the price of each credit rises according to the basic rules of supply and demand, and the polluters decide whether to spend the money on a loan or whether it would be more economical to stop emitting (through decarbonization pollutants, who have to give NZUs for their emissions, are as high up the production chain as possible. For example, while you and I who drive our cars are responsible for the greenhouse gas emissions, you don’t have to buy carbon credits or give them to the government. Instead, the companies that import gasoline into New Zealand are responsible under the ETS – even though they pass the costs on to consumers.

Under current regulations, every industry except agriculture is counted in the ETS. Agriculture is expected to join the system (or face some other form of carbon price) by 2025 at the latest, and a review of the sector’s progress on pricing is planned for next year.

However, this has not always been the case. Initially, only forestry was part of the ETS. The rest of the economy was supposed to come in gradually, but this was delayed when National neutered the system in 2009. Eventually the waste, energy (including transportation) and industrial sectors entered the ETS, but the agriculture entry date was postponed indefinitely by National.

There are five ways a particular participant can acquire NZUs. The first is via the auction mechanism that debuted last Wednesday, March 17th.

In quarterly auctions, the government will put a set number of units up for sale – currently 4.75 million per auction. There is a lower price limit (currently $ 20) and an effective upper limit where an additional million credits are released during an auction if the threshold (currently $ 50) is exceeded to bring the price down. Within three hours on an auction day, participants submit online bids, which are then sorted from highest to lowest. The first bids worth 4.75 million units are successful and all successful bids are paid at the final clearing price, the price of the lowest successful bid.

Just a few days before the first auction, the government also changed the law so that Shaw could establish a method of determining a secret reserve price without which the market could be manipulated.

At the auction on Wednesday, 408 bids were submitted by 40 participants looking for a total of 11,626,500 NZU. Since the clearing price of USD 36 fell well below the effective maximum price (known as the cost containment reserve), only 4.75 million units were actually auctioned to 30 successful bidders.

The second way in which issuers can receive NZUs is the free assignment. Certain ETS participants receive a free allotment from the government of up to 90 percent of their expected emissions in NZUs. This is to ensure that these participants are not placed at a disadvantage when exporting products and competing with companies in countries without a CO2 price. In the worst case, emitters exposed to the full load of the ETS could close their businesses in New Zealand and create a new, dirtier emitter somewhere without a carbon price.

These selected companies, which are classified as emission-intensive and trade-exposed companies (EITE) are known to receive millions of free units from the government every year. A 2019 stuff analysis found that only four companies – Tiwai Point aluminum smelter, Glenbrook steel mill, Methanex, and Fletcher Building’s cement arm – received three-quarters of the free allocation. Reforms to the ETS in 2020 that introduced auctioning also began phasing out these free units, but with an ice rate of 1 percent per year for the next decade, then 2 percent per year through 2030, and 3 percent per year through 2050 .

If agriculture is included in the ETS, it will also likely get a free allotment of up to 95 percent.

The third way to buy units is to buy them on the secondary market. Any company that owns NZUs can sell them to another participant at an agreed price. This is supposed to be the main mechanism of the ETS, as the prices for supply and demand in the secondary market are unlikely to lead to a price increase. In fact, the price of carbon has risen dramatically since the 2020 reforms, from around USD 25 per NZU to just under USD 40 today.

Fourth, anyone can receive NZUs if they can demonstrate they have a corresponding amount of CO2 from the atmosphere has bound. This is mainly true of large forest operators who can « create » NZUs when their trees soak up carbon and then sell those NZUs for a profit in the secondary market. However, when they cut their plantation forests, these companies have to give some units back to the government to get the carbon released by the decaying trees. However, forest companies aren’t the only companies that can get NZUs through sequestration. It is a role for other landowners that significant forest resources such as farmers receive some NZUs for their seizure. This could help offset the cost of adding agriculture to the ETS.

If we get really technical, some experts say that only NZUs earned through sequestration are real « carbon credits » because they are one represent real compensation or a reduction in emissions. NZUs obtained using other methods are acceptable emissions, but not greenhouse gas reductions.

Finally, emitters can buy units from the government at a fixed price that has long been $ 25. The availability of an unlimited supply of units at a given price has resulted in the secondary market price dropping to $ 25 for most of a decade. However, the reforms for 2020 indicated that the fixed price option would be abolished in May this year. It was also increased to $ 35, which in part led to the recent spike in the price of carbon.

The New Zealand ETS has been a cap-and-trade system with no upper limit for most of its existence. The fixed price option allowed unlimited units to enter the market, which meant that emissions were never capped. In essence, the ETS was a complex and piecemeal carbon tax of $ 25 per tonne on certain emissions activities.

However, the reforms for 2020 set a stricter cap. The number of eligible NZUs is now based on emissions budgets for consecutive five-year periods. These budgets are recommended by the Climate Change Commission, which presented its first draft recommendations in January, and approved by the government.

For example, the Commission’s draft budget for the period 2026-2030 is 290.2 million tons. This means that under the ETS, 58.04 million tonnes would be available in each year of this period. Some of these would be given to issuers in the form of free allotments. Others could be completely deleted for sectors not subject to the ETS. For example, just over half of the current provisional budget for 2021 will not be taken into account as agriculture is not yet included in the ETS.

The rest will be auctioned at the quarterly ETS auctions. Thereafter, the system is a closed market, where new units are introduced only through carbon removal activities such as planted trees.

A 2019 New Zealand emissions report found that the ETS had the greatest impact on emissions of all to date announced measures would have. However, policymakers, experts and officials (outside the Treasury) largely agree that the ETS alone will not get us to our goals.

While in theory it could achieve our various goals on its own, the non-tax implications could be significant if the price cap were lifted and the price of carbon skyrocketed. It would mean replacing almost all New Zealand sheep and beef farms with plantation forestry.

Furthermore, such a solution would not be sustainable – after all, forest ecosystems become saturated with carbon and offer declining returns. This means that a strategy that is based solely on forestry compensation payments and not on emissions reductions will plant hectare by hectare until we run out of land.

« There is no chance. No chance – zilch – that you just go along with it Do the ETS, « Shaw told Newsroom last year.

 » What was previously described by the Treasury Department as ‘complementary action’ is actually – you have to do everything. You have to pull every single lever you have.  »
– James Shaw, Minister for Climate Change

« And I think that’s a significant change in thinking. If you were to honestly go back to the last administration, if you went back to the 2000s, the market purists would say: ‘All you have to do is get the price right and change the will. In any country that has actually changed, the carbon price – whether it was an ETS or a carbon tax – was part of the solution, but often on the sidelines. In the UK they think the ETS is a 10 percent role, « he said.

 » What was previously described by the Treasury as ‘complementary action’ is actually – you have to do everything. You have to pull every single lever you have. « 

 » The emissions trading system alone does not get us where we need to be. Action is required in all sectors of the economy, « wrote the Commission in its draft draft.

« In the current political framework, the amount of afforestation that is likely to occur would depend in large part on the emissions price of the emissions trading system. Wholesaling or large-scale conversion of sheep and beef land to forestry would impact communities and reduce employment in the U.S. The immediate area as forest-related work is likely to be more focused on larger rural cities, especially those involved in processing . « 

The ETS will now continue with a few more changes, the government said. The next big change will be the government’s decision on emissions budgets, which will then aim to set the cap on the ETS.

Next year the Climate Change Commission will also review progress on agricultural emissions pricing, and livestock emissions could then be forced into the ETS if enough progress has not been made to independently reduce emissions, or if more details on pricing are available in the year 2025.

The Commission’s draft advisory proposal also contained proposals for further changes to the carbon market, including a higher price floor and a higher threshold for the containment reserve. Currently, both the minimum amount and the reserve will increase by 2 percent per year However, the Commission would like the Mind The estimated amount is immediately set to USD 30 and increased by 5 percent per year plus inflation, while the effective upper limit is raised to USD 70 and increased by 10 percent per year plus inflation.

« The price corridor you signal should be sufficiently wide to allow for market pricing and account for inflation to prevent real price levels from falling, « the commission wrote.

The draft opinion also raised concerns that the ETS is overly forestry highly stimulating and insufficient to make gross emissions reductions worthwhile.

« The current ETS settings in New Zealand could incentivize more large-scale pine plantations than is desired to meet the 2050 targets, and lead to forestry is displacing gross emissions reductions « , stated the Commission.

 » This approach would not make any sense of decarbonisation and instead consume land resources to offset avoidable emissions. This is unsustainable and would leave the next generation with the task of reducing gross emissions at the same time as they need to be. « Adapting to the escalating effects of climate change. »

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Ref: https://www.newsroom.co.nz

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