Annual updates to the NZ ETS limits and price control settings for units 2023

After the Government’s announcement of the ETS unit settings in December 2022, the price of NZUs on the secondary market decreased significantly (about a $10 decrease). The consultation document acknowledges this on page 31 in the Price Control Settings section:

When the Government announced in December 2022 that status quo price control settings would largely be retained, the secondary market price of NZUs immediately slumped from $86 to around $70. NZUs have this year largely traded in a range between $55 and $65. These responses further highlight the unintended role that price control settings have played in secondary market prices for NZUs.

Since the Government did not follow the Commission’s advice, market confidence has been shaken, demonstrated by the continued falling of NZUs prices on the secondary market. We do not think that the current prices represent the long term price even in the presence of the existing price control settings, but rather are an indicator of a loss of market confidence in the Government’s governance of the ETS unit supply caps and the questionable commitment to climate change targets the governance decision indicated. We are confident that the price (and associated incentive effects) will recover as clearer signals and material commitments to deliver emissions reduction targets via the ETS are made.

Yes, more forestry removals are now in the ETS than was expected, changing the unit volumes available. With the end of the recent Mandatory Emissions Return Period in 2022, forestry areas registered in the ETS are now receiving unit entitlements, adding to the number of units available to be traded on the secondary market. The auction volumes should be adjusted to reflect this increase in the removals volume captured within the ETS, to preserve overall climate accounting integrity within/without the ETS, and ensure the unit volumes auctioned into the ETS are consistent with achieving emissions budgets. Our view is that forest removals within the ETS will be significantly greater than is indicated even in the revised targets, especially due to the retrospective forestry removal entitlements for the 2018-2022 period. We feel that the Government's assessment that these removals would remain outside the ETS is essentially a forecasting error, and their change in scope to be included within the ETS must be addressed by a corresponding reduction in auctioned NZUs to account for both the future and past shift in budgeted issuances.

Yes, we believe there are two additional special circumstances:
1. Our view is that the Government has an overly optimistic assessment of the fraction of the privately held NZU stockpile that is ‘available’, and that the true ‘available’ fraction is higher than currently assessed. We think that this should be acknowledged, and that the revised assessment will constitute special circumstances necessitating a reduction in the 2024/2025 auctioned volume (and especially the CCR price settings) to align with the available unit volumes necessary to deliver appropriate decarbonisation incentives to achieve New Zealand's emission reduction targets and budgets through 2030 and beyond.

2. Our view is that the market response to the Government’s price control decisions in the December 2022 review was unexpected by the Government and has resulted in a change in short term market incentives to decarbonise. This has significantly increased the short term risk to achieving the emissions budget through to 2030. This constitutes special circumstances requiring corrective action in the form of revised and updated 2024/2025 unit availability and cost setting signals to the market, to restore confidence and a NZU price which incentivises decarbonisation and removals appropriate for our national mitigation targets.

Yes, we think that the ETS unit settings should be updated for 2024 and 2025. This would provide signals to the market which will better enable NZ to meet its first emissions reduction target in 2025, and especially to deliver overall supply and price signals better aligned with emissions reduction targets through to 2030.

There has already been much uncertainty in the ETS market, and updates to the unit settings would not increase this uncertainty. Rather, it would signal the Government’s commitment to emissions reductions and using the ETS as an important climate change tool, which would actually reduce uncertainty.

This is especially true considering the increased volume of total forestry removals recognised within the ETS. A failure to adjust auctioned unit volumes proportionally would increase uncertainty as it would suggest that the Government will not manage ETS supply and caps in a manner consistent with New Zealand’s overall national emissions budgets. Any such failure to consistently manage supply would be harmful for market confidence and decarbonisation targets.

We strongly agree with the Climate Change Commission’s advice that units from the cost containment reserve should be rarely released to market. The poorly considered cost containment reserve settings from 2021 and 2022 have already resulted in a significant unit surplus which must be addressed through reduced future auction volumes to preserve integrity. If the 2023 cost containment reserve is triggered, this will only increase the urgency of adjusting future auction volumes to realign total available unit volumes with budgeted emissions.

We believe that the Commission’s updated estimates are an improvement, and result in an adjustment in the right direction, but that they remain overly ‘optimistic’ regarding the fraction of (especially historic) ‘outside ETS’ removals. We believe the total volume of forestry removals within the ETS and shift of removals from outside->inside the ETS will exceed those indicated by the Commission (especially considering retrospective entitlements for the 2018-2022 period).

We support the Commission using the updated figures from MPI for how much post-89 forest land is now registered in the ETS, as well as whether this land was established before or after 2019 (since the Commission thought that most new registrations would be for forests which were planted after 2019). We believe that regular and accurate data-sharing in relation to the extent and precise nature of net forestry unit flows is important and should be readily achievable with low cost extensions to existing reporting frameworks.

The Commission assumed that most forest areas which are removing carbon, established before 2019, and could be contributing to New Zealand’s NDC are already appropriately accounted for in NZ’s inventory accounting (i.e., forestry emissions were correctly estimated inside and outside the ETS. However, at CarbonCrop we have found that there are still substantial areas of post-89 forest land (particularly native forests) which are not registered in the ETS, and we suspect that this is not well accounted for. We would like to see the Commission obtain better estimates of the area of post-89 forest that is unregistered. Then the Commission could use these estimates to better predict future forestry removals and adjust auction volumes. This is also the case for the ongoing removals in regenerating pre-1990 indigenous forest. However because removals in these forests are presently not accounted for either inside or outside the ETS, we do not expect them to contribute negatively to New Zealand's progress towards emissions reduction targets.

Yes, we think that the auction volumes should be adjusted to reflect updated forecasts (and empirical results) of the total volumes of forestry removals within -vs- without the ETS. In a very real sense, we believe the Government is in effect auctioning into the ETS (to its own benefit) the removals delivered by eligible forest not registered in the ETS, and is failing to adjust these auctioned volumes when the eligible forest is moved within the ETS (with the associated NZU’s then being issued to the forest owner). Failure to appropriately adjust auction volumes in response to forestry ETS registrations would then, in effect, result in ‘double counting’ and ‘double selling’ of those removals, and would be:

-Inconsistent with emissions accounting integrity, and
-Harm New Zealand's progress towards emission reduction targets, through creation of an oversupply of NZUs, deflating the NZU price and disincentivising emission reductions.

The ETS ultimately exists to achieve targeted outcomes with regard to New Zealand’s Greenhouse Gas Inventory. Discrepancies are to be expected despite best efforts - the nature of the system means that perfect accuracy is unrealistic - but discrepancies should be addressed when identified to deliver the best ongoing alignment from a cumulative emissions/removals perspective. Failure to make appropriate adjustments will otherwise effectively incentivise further discrepancies.

We believe that the estimates of the ‘available’ fraction of the stockpile are overly optimistic, and that consequently the stockpile represents a bigger threat to achieving reduction targets than is presently acknowledged. We believe that auction unit supply volumes should be revised to deliver a more rapid reduction in the stockpile, and that this (and not changes to the forestry eligibility settings, which are inherently independent of our net emissions budgets) will be the primary factor in delivering price incentives consistent with our net emissions budget targets.

We believe that the stockpile available surplus:
-Is greater than is currently acknowledged
-Is primarily the result of past supply decisions (auction volumes, cost containment reserve, fixed price option settings)
-Is a threat to achieving emissions budgets and net emissions reduction goals

We believe that addressing this excessive available surplus should be prioritised to align unit supply with net emissions reduction goals.

The triggering of the 2021 and 2022 cost containment reserves has resulted in a surplus of units within the ETS beyond budgets, and if unaddressed is a threat to achieving net emissions reduction targets. Any approach other than future adjustments to address these historic excesses would endanger net emission reduction targets and reduce ETS emissions accounting integrity.

We believe that an increased CCR trigger price will lead to increased NZU prices, though largely to the extent that NZU prices have not yet found their ‘natural balance’ between removals and decarbonisation. We do not believe that the CCR trigger price will act as an arbitrary attractor for the NZU price, and that to the extent that there has been the appearance of this in the past it is largely due to an artificially low NZU price resulting from lax supply-side constraints (including a low CCR price).

We strongly agree with the Commission’s position that the CCR threshold should be such that the CCR is rarely triggered.

We are wary of setting price controls that are highly opinionated regarding how New Zealand achieves climate change mitigation, and our view is that this could simultaneously increase the costs of New Zealand achieving its climate change mitigation goals and also reduce the probability of New Zealand achieving those goals. This would be harmful, and a poor strategy.

We are, however, strongly supportive of setting price controls that deliver targeted net emissions reductions, and are of the view that this will also deliver appropriate gross emissions reductions if and only if the qualifying removals activities are restricted to those which are aligned with New Zealand's long term land-use policy objectives (specifically, among others: the creation, restoration, and protection of biodiverse and native forest).

We are largely indifferent to the auction floor settings, and our view is that in a properly managed supply environment they will be largely irrelevant. However, to the extent that they provide confidence and signalling of intent and commitment to the ETS, we view the proposed settings as positive.

We expect that the primary impact will be representative of increased market confidence in the ETS, visible in the form of an NZU price increase.

We accept that some cost containment reserve is necessary to help stabilise possible market transient effects and give operational cost confidence and guard rails to emitters. We feel that the current market supply and stability issues are primarily a consequence of having a plainly inadequate cost containment reserve threshold, rather than an inherent issue with a cost containment reserve in general.

We believe that a progressive cost containment reserve will be both more predictable and more effective in achieving the joint goals of market stability and business operating certainty, and provide the Government more tools in achieving those outcomes.

The cost containment reserve volume should be set primarily with the expectation that:
-It will rarely be triggered, and
-Its primary purpose, when triggered, is to stabilise and constrain the NZU price.

We believe that the stockpile reduction should come primarily from changes in the planned auction volume, and that if and when the CCR is triggered that should be compensated for with reductions in future auctioned volume.

The volume of units should be based primarily on the Commission’s guidance to deliver the necessary market price stabilising effects while preserving the intent that the CCR be triggered rarely and, when triggered, not materially threaten overall net emission reduction goals.

We think the proposed trigger price settings (and associated thresholds) are generally reasonable and on adoption are likely to result in an increase in unit price sufficient to incentivise appropriate net emissions reductions as intended.

Our view is that sufficient prices to realise decarbonisation objectives are likely to result in small increases in the cost of living, and consideration should be given to the deployment of ETS revenue for general redistributive payments to the affected population of NZ at large, rather than entirely ring fenced for the Government’s climate initiatives, so as to offset these effects. This could be done in the form of a 100% redistributive mechanism for all proceeds above a certain unit price threshold, so as to ‘cap’ the effective cost-of-living impacts resulting from a sufficiently high decarbonisation incentive.

Price controls should, in particular, give businesses with surrender liabilities in their supply chain (who effectively pass costs onto households and consumers) planning confidence with regard to upper cost bounds, so as to constrain total costs to households.

Redistributive mechanisms above certain price thresholds - rather than price control settings alone - should be considered as a key mechanism by which to manage impacts.

We believe the Commission’s proposed settings (after the adjustments recommended above, in particular considering the larger than acknowledged available stockpile) are appropriate - subject to ongoing review and adjustment based on market and emitter/remover actions.

Like any rational economic actor, high prices combined with restored trust in the integrity of the ETS price setting governance will inform our operational and capital investments in emissions reduction and high quality carbon removal activities. We see myriad opportunities to dramatically reduce net emissions within the cost envelope of the proposed CCR trigger prices.

Please see our answer to question #23.

We welcome and appreciate the prudent reassessment of price control settings in this review, following the market response to the Dec 2022 price control setting update, and remain convinced of the critical role (and effectiveness) of the ETS in delivering on NZ’s climate change targets in an efficient and positive manner.