Initially bilateral or regional agreements will allow exchange of units. Wider-scale carbon markets will potentially reduce the cost of carbon offsets as projects that have the lowest cost will be the first to be implemented. There is also potential to speed up reducing greenhouse gas (GHG) emissions if funds earned from the scheme are then invested into additional projects to reduce emissions.
"The Government is able to create and supply New Zealand Units, and units already in circulation can also be traded.”
How does NZ’s carbon market work?
There are actually several carbon markets that operate in New Zealand. Firstly, there is the market where New Zealand Units (NZUs) released by the Government are sold at quarterly auctions. Then there is the secondary market where NZUs in circulation are traded bilaterally – often aided by platforms matching buyers and sellers. These trades provide timely information about what’s most commonly referred to as the ‘carbon price’.
There is also a voluntary carbon market which exists outside of the government-regulated carbon market. In the voluntary market there is a range of standards and credits available. Companies that participate in this market tend to do so as they typically see it as an opportunity to market their ‘green’ credentials.
The voluntary market provides an opportunity for businesses to offset their emissions by investing in projects that reduce GHG emissions, such as planting trees. Deals are typically facilitated by a broker or a company that offers a certifiable standard. Pricing of credits in the voluntary market tends to be privately negotiated, so can vary from project to project.
Market for New Zealand Units
NZUs can be purchased directly from the Government auctions or on the secondary market. Any individual or organisation is able to own NZUs. There is no requirement to be part of the Emissions Trading Scheme (ETS) to own units.
There are several factors that affect the demand for NZUs. These include:
- Offsetting current emissions - companies from industries included in the ETS are required to submit an emissions return every year and must relinquish sufficient units to offset their GHG emissions.
- Changes in emissions by participating companies - some companies may find their emissions are lower than expected and may have excess units available that they may choose to sell. This may occur due to improvements in technology that reduce their emissions or a reduction in production which means emissions are lower than previously expected.
- Offsetting future emissions - companies who expect to emit CO2 in the future may look to purchase units today to offset their future emissions. This is known as ‘banking’ units.
- Free allocation - certain industries such as growers and manufacturers of products that are considered to be ‘emission intensive and trade exposed’ are currently eligible for a free allocation of units. Any changes to free allocations will potentially influence the NZU market.
- Speculation - anyone can buy or sell NZUs. Like any other asset, demand to buy units will increase if there is an expectation amongst investors that the price will rise.
The Government is able to create and supply NZUs and units already in circulation can also be traded.
Government emissions budgets should determine the number of units made available at the quarterly auctions. The Government currently has a provisional budget for the period 2021-2025 which was to be finalised before the end of 2021 but this date has now been pushed out to the end of May 2022. The government provides forward guidance on the number of units it plans to release over the next five-years. It is not able to make changes to the units being sold in the current year and can only change offer volumes for the following two years in exceptional circumstances. This provides a degree of certainty to the market as to the volume of units offered in the primary market.
There are two main factors to consider for units offered to the secondary market. Firstly, companies that can prove they have sequestered CO2, typically through planting trees, are entitled to receive NZUs. Some of these units may be offered to the market, increasing the supply of available units, but there is no guarantee that additional units earned will be made available for sale. NZUs may be held onto by the owner to offset future emissions or because they expect to be able to realise a higher return at a later date.
Previously, forestry owners typically earned units while forests were growing but were then faced with repaying these units when forests were harvested. Therefore forest owners often held onto units to offset future emissions. But forestry rules have now changed to ‘averaging’ which means forest owners now earn less units but are not liable to repay any units so long as they replant any areas of land where trees are harvested. This generally means planting land in pine trees provides an income stream for approximately 16 years.
Secondly, changes to units in circulation will potentially impact prices. The Government has acknowledged there is a large number of units in circulation and this stockpile provides elasticity in the market and could dampen the carbon price. It was previously proposed the stockpile of units be reduced by 5.4 million units per year via reducing auction volumes but this was to be dependent on price movements.
Given the full volume of the cost containment reserve (CCR) has been released to the market in 2021, there is not yet any immediate reduction in units in circulation, so the excess supply issue remains a risk that may impact prices at a later date.
Other factors that will influence supply of NZUs
Agriculture inclusions in ETS - from 2025 onwards a price will be put on methane emissions from livestock and fertiliser. He Waka Eke Noa – the partnership between The Ministry for Primary Industries (MPI) and primary industries – is trying to develop a scheme that is separate from the ETS. If agreement cannot be reached on how to implement such a scheme then the fall-back position is agriculture will join the ETS.
Under the scheme proposed by He Waka Eke Noa, the methane emissions from agriculture would be priced separately to carbon emissions, so if this scheme is adopted then it is unlikely this will have a direct impact on the carbon price. It is also possible there will be some offsets for soil carbon and offsets for natives (and other plantings) introduced at a later date that don’t currently match the ETS criteria. Further details about how agricultural emissions may be priced are expected to be released in early 2022.
Financial returns from alternative land uses - including the price of logs which will impact the harvesting of forests.
Forestry registrations - it is voluntary to register post-1989 forests. At present 54 per cent, or 400,000 hectares of post-1989 forest, is not in the ETS. If more existing forests are registered or more land is converted to forestry, then this could potentially double the units in circulation.
Existing stock of units - at present there is a large number of NZUs in circulation relative to the annual imbalance of demand and supply. As at 30 June 2021 there were a total of 138.4 million NZUs held whereas current demand is less than 40 million units. Total holdings have generally increased over the past five years and are forecast to continue to increase before peaking in 2022. It shows there is a massive buffer of supply of units which is forecast to only gradually reduce. This means the relatively small annual imbalances in supply and demand may have a muted impact on the price of NZUs.