To set appropriate unit limits, we need to estimate how many of the units currently in the NZ ETS market are ‘surplus’, and how to address them over time. Surplus units are units in private accounts that are not held for future surrender or other compliance purposes, and therefore may be sold freely into the market. Determining how many units are surplus is important as, by enabling additional emissions, surplus units create the risk that emissions budgets will not be met.
However, the size of the surplus stockpile is inherently uncertain. Estimating the surplus requires making assumptions about future behaviour of market participants such as unit holders, emitters and foresters. This uncertainty can be partially managed by the adaptive management approach the Government takes to setting unit limits.
This year, as well as including the latest data, the Commission has made substantial changes to its surplus estimate methodology. Some changes came from its consideration of a 2024 Ernst & Young (EY) report (commissioned by the Ministry for the Environment – see step 5a of the seven steps methodology), which reviewed the methodology.19 Other changes resulted from the Commission’s own analysis.
The Commission’s changes this year include incorporating two additional categories of units into its estimate of the surplus:
Based on our preliminary assessment, we consider these methodological changes are conceptually valid and likely to improve the accuracy of the surplus estimate. They have been developed using quantitative evidence (where available) and refined through industry engagement conducted by the Commission and EY.
However, the changes have large impacts on the surplus estimate. Even relatively small refinements to some of them could have a material impact on the number of units that are assessed to align with emissions reduction targets.
The inclusion of holding volumes alone reduces the estimated surplus by 34 million units. The Commission has recommended that we consult on this change in particular, and whether holding volume may partially overlap with units held for hedging.
Table 6 sets out the impact on the surplus estimate of each individual methodological change.
| Category |
Approximate impact on surplus (millions) |
| Inclusion of non-surplus holding volumes |
–34 m |
| Units estimated to become surplus from MERP4 |
+10 m |
| Adjusting the base year of the price hedge to 2030 |
+8 m |
| Updated assumptions about harvest ages of post-1989 forestry |
+7 m |
| Updated assumption about liquid fossil fuel hedging |
+4 m |
| Updated assumption of pre-1990 transfer rate |
–2 m |
| Approximate overall impact |
–7 m (±1 m) |
Key aspects of the surplus estimation methodology for feedback
We detail these changes at step 5a of the seven steps methodology in appendix 1.
We would like your feedback on the following areas.
Units held for surrender for past emissions (holding volume)
This year, the Commission has incorporated a new category of non-surplus units, referred to as ‘holding volume’. The report distinguishes between units held for future emissions (hedging volume) and units held for surrender for emissions that have already occurred (holding volume).
Emitters will accumulate units over the year for emissions that have occurred, increasing to a peak in May when units are due to be surrendered. Following the surrender period in May, the holding volume falls to a minimum, before growing again.
Including this new non-surplus category has the effect of reducing the central surplus estimate by about 34 million units.
Assumption that holding and hedging volumes are separate
The EY report recommended accounting for the holding volume separately from the hedging volume when estimating the unit surplus. This is the approach the Commission has taken.
However, it may be that some emitters use this holding volume as a partial hedge for future price risk. If this behaviour was prevalent, it could mean we are double-counting the number of units held by firms to manage future obligations. This would result in an underestimate of the surplus size.
We would like to hear from you on:
- whether this assumption reflects participant behaviour
- whether the estimated total scale is appropriate.
If your response is no to either or both points above, what adjustments to the approach may be needed?
Units held for hedging by emitters
It is common for NZ ETS participants to hold NZUs to cover a proportion of their emissions compliance obligations over a certain period in advance (hedging). Hedging involves emitters pre-purchasing NZUs when they fix prices with customers or suppliers, to manage their exposure to NZU forward price risk.
The estimate of units held in this way has reduced from 28.3 million to 17.4 million units. This is mainly due to two adjustments to the methodology:
- an adjusted base year of the estimate of units held for hedging – using the volume forecast for 2030, instead of the volume from the most recently completed calendar year (2024)
- a reduced estimate of hedging by the liquid fossil fuels sector, as EY recommend in its report.
Estimating hedging requirements for 2030, rather than the current year
The Commission has changed the base year for its hedging estimate. This is to account for the fact that, as emissions reduce, the required units for hedging will also reduce. It means that some of the units currently held for hedging will become surplus by 2030, unless we factor in future changes to hedging volumes now. Factoring in those changes aligns with the Government’s target of reducing the surplus to zero by 2030.
Taking the hedging estimate at 2030, rather than the most recent year (ie, 2024), has the effect of increasing the surplus estimate by about 8 million units. This reflects the additional units that may become surplus over this period, as hedging requirements decrease.
- To estimate the 2030 forward hedging volumes, an assumption has to be made about the NZ ETS emissions cap over EB3.
We discuss this issue and seek your views on this under Provisional NZ ETS cap for EB3.
- We would like to hear from you about the proposal to take the hedging estimate at 2030, rather than the current calendar year.
Reduction in assumptions about liquid fossil fuel hedging requirements
The EY report advised on lower hedging volumes for the liquid fossil fuel sector. The Commission tested this information through its targeted engagement with participants, and has revised its assumption about liquid fossil fuel accordingly. Other hedging assumptions are unchanged.
This assumption has the effect of increasing the surplus estimate by about 4 million units. This reflects that liquid fossil fuel participants are holding fewer units for hedging than previously assumed.
Surplus units from MERP4
This year the Commission identified a need to anticipate the impact of forestry units expected to be allocated after MERP4 ends. This will help avoid an unexpected surplus increase in 2027 after final unit allocations are completed for MERP4 (2023–25).
A proportion of the post-1989 forestry units earned over MERP4 will only be allocated into the market after participants submit their end-of-MERP final returns in June 2026. This means that the removals will have occurred during the EB1 period, but the NZUs issued for them could allow emissions during the EB2 period.
The Commission has estimated that, of the forecast post-1989 forestry units still to be issued up to the end of MERP4, 10 million are likely to add to the surplus. This has been estimated by considering the modelled low-risk carbon units still to be allocated, and comparing this volume with the projected demand in the NZ ETS, above the net emissions cap over 2023–25 (MERP4).
We would like to hear your views on including these new surplus units, and the approach to estimating them.
Updated assumptions about units held for post-1989 harvest obligations
Owners of forests planted after 1989 receive NZUs for the carbon stored in their forests. However, if the forest is harvested and not replanted, they must surrender a large proportion of these units back to the Government. This means that forestry participants need to hold many units in advance of harvesting their forests.
Estimates of the number of units held for future liabilities are based on a model of forestry allocations and surrenders developed by the Commission.21 This model is underpinned by several inputs and assumptions, such as the rate of sequestration and the proportion of permanent forests that are harvested annually.
This year, the Commission has updated two sets of assumptions, relating to:
- the distribution of ages at which post-1989 forests are harvested
- the low-risk carbon level.22
Together, these updated assumptions have the effect of increasing the surplus estimate by about 7 million units.
Updated distribution of harvest age for post-1989 forests
A key assumption affecting the estimated volume of units held for future harvest liability is the rotation age of post-1989 forests (ie, the age at which forests are harvested). This year, the Commission has used a weighted average of harvest age by area in its modelling of units held for harvest. This better reflects the spread of harvest age.
This change shifts the distribution of harvest age lower than previously assumed. It has the effect of lowering the estimate of units held for future harvest liabilities, and increasing the size of the surplus. This is because, all else equal, a younger harvest age will require fewer units to be held, as fewer NZUs have been allocated for the forest.
Updated assumptions about low-risk carbon units
The carbon stock of forests does not return to zero immediately on harvest, due to residual carbon stored in roots underground. Some units earned by production forests on their first rotation can be considered low risk as they will never have to be surrendered if the forest is replanted. Additional units may also be considered low risk if a forester can manage liabilities across a portfolio of forests of different ages (effectively smoothing their harvest liabilities).
This year, the Commission has made a minor reduction in its assumptions about the proportion of low-risk units that foresters can achieve. This has the effect of increasing the number of units foresters need to hold for future liabilities and reducing the size of the surplus.
To support these updated assumptions, the Commission analysed the range of possible levels of low-risk units available to owners of post-1989 forestry, identifying the minimum and theoretical maximum low-risk units that could be achieved.
It then compared these against a breakdown of NZ ETS forestry by forest estate size, to derive the final assumptions. This is because foresters’ ability to obtain low-risk units depends on the size of their forestry portfolio. For example, large forest estates are more likely to be made up of diverse portfolios of multiple age classes, allowing increased low-risk units.
21 For a copy of the Commission’s 2024 forestry model, go to its website: ETS Forestry Model version 2.0.
22 Low-risk carbon (or ‘safe’ carbon) refers to units earned by a forest that are considered low risk to sell, as they will likely never have to be surrendered if the forest is replanted due to carbon stored in roots that remain post-harvest.
