How does the market determine the price of carbon?
Although the New Zealand Emissions Trading Scheme (ETS) has been around in some form since 2008, it’s only been in the past few years that we have seen the development of a competitive marketplace for carbon, with the price reflecting the underlying supply and demand of carbon credits.
Some companies in certain industries are legally required to surrender carbon credits each May to meet their emissions obligations for the year. Not all industries are legally obligated to participate in the NZ ETS, notably agriculture.
For participants, there are two avenues to purchase credits. A combination of these determines the price of NZUs (Carbon Credits):
a. Quarterly government auctions – each quarter (March/June/September/December) the government holds an auction to sell carbon credits to the market. The number of credits auctioned is determined by how much New Zealand can emit to still meet our climate targets.
Credits are sold in a ‘Dutch Auction’ style where all participants place price bids for specific unit amounts, when all the units are ordered they all sell at the lowest successful bid price, called the clearing price. However, if the cost containment reserve (CCR) is triggered, then the clearing price is set by the last bid above the trigger.
b. Secondary carbon marketplace – carbon credits can then be traded between firms and investors on the secondary marketplace. This gives year-round trading with the price fluctuating as a result of how many people are willing to buy and sell.
When trees are planted, whether that be through major plantation forestry or smaller scale regenerative forests like we support here at MyNativeForest, additional carbon credits are allocated to these sequestration projects. Forestry participants can either surrender their units directly to the government (to offset emissions), sell them on the secondary market, or hold to surrender or sell in the future.
Generally, the price that carbon credits are sold for in the quarterly auctions is expected to align with the price in the secondary marketplace. If the price at auction is expected to be high then companies will go to the secondary market before the auction to try and buy the credits needed at a cheaper price, whereas if the price at auction is lower than the market price then you can make a quick profit by buying at auction and then turning around and selling on the secondary market.
Auctions are currently where large numbers of credits are bought in bulk, so it’s not unexpected that the auctions may “reveal” that major emitters' willingness to pay is higher or lower than the secondary market price.
For further background on the NZ emissions trading scheme read our blog about New Zealand's Carbon Market.
Price trends in the carbon market
Below is how the carbon price has changed over the last couple of years. There are two types of carbon credits we track prices for:
a. Standard New Zealand Unit (NZU) carbon credits (yellow line) - equivalent to one tonne of emissions within the ETS. The price of which is determined by brokers in the secondary market, such as Comm Trade, and Carbon Match.
b. Verified NZ native forest carbon credits (blueline) – these are credits within the ETS that MyNativeForest has verified as coming from permanent native forests. These carbon credits are of the highest quality and therefore command a premium price, usually 15-20% above the NZU spot price. This price premium is determined by matching buyers and sellers, but the price movements tend to track the price of standard carbon credits very closely.
As you can see the price of carbon rose over the past year, jumping first in September 2021 before again rising throughout December and January and then again in July.
What’s causing these price changes?
Up until 2020, companies did not have to buy credits on the open market and could instead pay the government a fixed price of $35/tonne for carbon emissions. Although this provided an incentive for companies to reduce emissions, it wasn’t effective enough at curtailing emissions to reach our climate goals as there was effectively no limit to how much could be offset in this way.
Auctions were introduced from 2021 onwards, with strict limits on the amount of carbon available, with less and less on offer overtime. The price rises last September/December and this February coincide with the auctions in those months, with companies either buying up in the auctions to meet their emissions obligations in May or stockpiling some for future years to surrender or sell back to the market in anticipation of further price increases.
The softening in price from February onwards reflected less interest from buyers, this is not unusual as this pattern has been seen in previous years at this time after the May surrender deadline. Less interest may also partly result from greater economic uncertainty in the wider market with higher inflation, as well as regulatory uncertainty around potential upcoming changes to the Emissions Trading Scheme itself.
Most recently, in July 2022, the Climate Change Commission(CCC) released advice on the ETS unit limits and price control settings for 2023-2027. The Commission recommended that the 2023 auction reserve price be set at $60 and the Cost Containment Reserve price at $171. Ultimately the government has to decide by December this year whether to accept these recommendations, but they are likely to do. The recent uptick in the carbon credit price shows the market is responding to the Commissions indication that prices could be significantly higher in future years.
Although one might expect the price of carbon to increase in the future as the supply of carbon credits at the auctions is reduced, this isn’t a guarantee. Companies may already have a stockpile of credits that they are saving for the future or contracts in place already to meet some of their future obligations. Continued forestry planting adds new credits to the market, therefore increasing supply.
Our crystal ball to predict the future certainly isn’t perfect, but we expect there is room for the price to move upwards before it is so high that there is a significant incentive for businesses and individuals to invest in low emission technologies, rather than just pay for credits.
Coming up over the rest of this year
1. Further government auctions – there are two further government auctions this year on the 7th of September and the 7th of December. At the auctions each year the government has a reserve of credits, called the Cost Containment Reserve (CCR), that are added to the auction if a certain price point is reached, this is try to increase supply and cool the final clearing price. These are not magical credits that appear from thin air, instead, they are credits that would have been sold in future years but have been brought forward to meet present demand. This means there will be even fewer credits available in future years to balance things out.
For 2022, the year's reserve of credits has already been used up in the first two auctions, This will likely put additional pressure on the price in the latter two auctions this year. Keep a look out for how the price changes around September and December. It will be interesting to see if we get large movements in price as we saw in previous auctions, or whether the price is now settling down.
2. Changes to the emissions trading scheme permanent exotic forest eligibility – the government continues to make tweaks to the set-up of the emissions trading scheme to make it operate better and to meet our emissions targets more efficiently. Most recently the government has limited the free allocation of credits to companies.
In a potentially more significant change, from next year there will be a permanent forest category within the emissions trading scheme but the government is deciding on whether exotic forests, e.g. pine, should be allowed as a permanent forest or whether only native forests would count (pine forestry would still be allowed in the ETS, just not as a permanent forest). This has been driven by the concern about the negative downsides of permanent exotic forests such as fire risk, limited biodiversity, and a relatively short lifespan compared to well-managed mixed native/indigenous forests. Recent indications are that permanent exotic forests will still be allowed in the scheme in 2023, but that does not rule out changes for future years.
The Emissions Trading Scheme is New Zealand's key tool for reducing harmful atmospheric gas levels to meet international climate change response goals. Find out how and why.
Learn about carbon sequestration rates under the Emissions Trading Scheme (ETS) and their Carbon Credit earning potential, per hectare.
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.