May 29, 2022
The New Zealand carbon market is a big and relatively new space. This blog will cover the NZ ETS, market functions, carbon credits, and the different participant interactions in the NZ carbon market.
New Zealand's Carbon Market has developed as part of the NZ Emissions Trading Scheme (ETS), the second oldest scheme of this type in the world. The ETS is New Zealand's key tool for meeting domestic and international climate change obligations.
The ETS is a market-based approach to reducing Greenhouse Gas (GHG) emissions.
It puts a price on each Tonne of CO2 equivalent, forming a kind of currency, known as a ‘New Zealand Emissions Unit’ (NZU), or more commonly, a ‘Carbon Credit’.
By commodifying GHG emissions, the intended effect is to create a financial incentive for businesses to prioritise innovation and low emissions technology to reduce their carbon footprint.
The NZ ETS helps to reduce emissions by requiring businesses to measure and report their GHG emissions and forces them to surrender 1 carbon credit back to the government for each tonne of GHG emitted. The government then in turn allocates these carbon credits to GHG absorbing participants, such as forest owners.
All sectors of the New Zealand economy, apart from agriculture, are required to participate in the NZ ETS and do so through their carbon credit surrender obligations. The government is working with the primary sector to reduce emissions through the He Waka Eke Noa: Primary Sector Climate Action Partnership.
On the flipside, trees are the only source of carbon sequestration currently included in the ETS. Forestry participants are rewarded with carbon credits to sell as the trees grow, this reflects the role forests play in removing CO2 from the atmosphere.
Although all sectors are affected at the producer level, this cost is almost always passed onto the end consumer, i.e. the price of petrol at the pump has the emissions cost built into the price.
Over recent years New Zealand has seen an increasing number of businesses and individuals voluntarily commit to environmental governance and carbon offsetting. This trend is predicted to continue increasing into the future.
Many institutions, businesses, and individuals are also turning to carbon credits as an investment vehicle. Carbon has become established as an asset class of its own, with a secondary market developing that is dedicated to the trading and offsetting of New Zealand carbon credits.
The NZ ETS functions as a ‘cap and trade’ system, but there is unit supply, and price control settings in place to act as safeguards. These safeguards help keep the NZU price in line with what is considered necessary to meet New Zealand's emissions budgets.
The government is required to set an overall limit on carbon credit supply, known as a cap, for the number of units supplied to the market for each 5-year rolling period. To help meet New Zealand's climate change targets, there is an ever decreasing number of units for sale at government auctions with fewer and fewer being released each year.
Units are initially allocated to the market by the government, either through its auction mechanism, industrial allocation, or to forestry participants. Units are then able to be surrendered, or traded in the secondary market.
The price is set by supply and demand, although the NZ ETS has price control settings that act as safety guards. These safeguards only apply to government auctions and not to the secondary market where most of the trading occurs.
The upper price control is the ‘cost containment reserve’, which when met, releases more units into the market to increase supply. The lower price control is the ‘auction reserve price’, which stops excess units from being sold, keeping unit supply in check.
The current settings for the cost containment reserve are $70.00 for 2022, tracking to $110.15 in 2026.
Mandatory vs Voluntary
Mandatory participants in the ETS are those required by law to purchase carbon credits and cancel/retire/surrender them to offset emissions created from their business. This is the main market the ETS was created for. Over time the government intends to further include major emitting industries as mandatory participants in the ETS
Voluntary participants are those individuals or businesses not required by law to be involved in the NZ ETS but choose to do so anyway. Voluntary offsetting participants choose to purchase Carbon Credits to surrender/retire them. Doing this offsets their emissions impact, either in part or in its entirety. This in turn removes the credits from the scheme, ensuring they cannot be double-counted or used again
Voluntary Offsetting providers exist to help businesses and individuals fully understand and reduce their impact on the environment. They provide the recognised certification that allows for the marketing and advertising of climate-friendly actions outside of the mandatory ETS participants.
Carbon Calculators enable business undertakings to be expressed in terms of their effect on emissions. For example, using 400L of petrol creates 0.97 Tonnes of CO2 emissions.
Once a business’s emission impacts are fully understood, offsetting providers enable access to different types of ‘offsetting projects’. These projects will either store, avoid, or reduce GHG emissions.
Not all offsetting projects are created equal; some are international, and some are not from forests at all:
Offsetting certification often uses a mix of many project types, 1 Tonne of GHG emissions offset through a voluntary scheme often costs significantly less than 1 Tonne offset through the NZ ETS with Carbon Credits.
Participating voluntarily will offset the required amount of GHG emissions, but it may not be from a local or desired source.
Businesses and individuals should be aware of which projects they offset with and consider supporting projects that benefit New Zealand.
As a result of the business marketing component associated with voluntary offsetting, a premium price has developed for those projects seen as ‘website worthy’. For example, New Zealand native forest sequestration projects are the ‘top tier’ in carbon offsetting, therefore carbon credits from these projects command a higher price; usually 10%-40% above the spot price for a normal NZU.
Investors participating in the carbon market are doing so by using carbon credits in the same way as any other asset class. Investors do not retire/surrender carbon credits, they buy them to hold and trade, getting exposure to the market and its price fluctuations.
To simply understand the differences that can occur in price, there are only two types of carbon credits; those from native forest sequestration projects, or those from any other source.
Native forest carbon credits have a premium price that reflects the local impact and the marketing aspect of supporting New Zealand's natural landscape.
Carbon credits from native forest sequestration projects command a higher price that reflects the associated business marketing, but also a local impact perspective when aligning investments with personal values.
