Guy Trafford explains how the New Zealand carbon pricing system works, how 'supply' influences the price, who has the big exemptions, and how it compares to the EU and China versions

With the New Zealand carbon price bouncing around the $48 per tonne mark post the June auction it is worth looking a bit closer at the market and how it is likely to impact upon New Zealand emissions and government liabilities.

The major issue looming for the next government auction of NZU’s credits, which is to be conducted in September, is whether or not the current $50 price cap is exceeded.

Currently government policy has a floor price of $20 per unit (1 unit equals the right to emit 1 tonne of CO2e) and a cap of $50. The cap is in place so that excessive volatile pricing does not occur and place undue pressure on sectors in the economy. However, with the NZU’s price already sitting at $48 it looks highly likely to threaten the cap price. If that happens then the government is able to draw on its reserves of “cost containment reserve units” to meet the extra demand and soften the NZU price.

Currently, the New Zealand government ETS auction system takes place four time a year (two have already taken place) in March, June, September and December. In normal circumstances 4.75 million NZU’s are put up for each auction (19 million in total) and in the two which have taken place so far all offered have been sold - in March for $36 and in June for $46 but the price is continuing to climb, currently at $48.60.

Source: Jarden Securities

The government (apparently) is not allowed to alter the auction settings within the calendar year and so the only way to control the price is to make more units available. So, the government has a fiscal budget for 7 million units which it is able to put onto the market in such, supposedly rare, situations. But still has to source the units from somewhere, likely to be from the EU trading scheme which trades internationally.

The problem is these are also experiencing rapid increases in value, currently worth around NZ$90 per unit. Both the Climate Change Commission (CCC) and other ‘experts’ have warned the government that they need to have a more relaxed policy around the cap and some have said it should be linked to the EU carbon price. This could avoid a budget blow-out in the upcoming auctions, presumably with the higher price it may also lead to reduce demand for credit.

The CCC recommended the Government raise the trigger for additional units from $50 to $70, with an annual increase of 10% plus inflation. To get to net zero, the carbon price could reach $140 per unit by 2030, the commission has said. Given the recent increases and with some sectors still to come into the ‘scheme’ there are plenty of upside pressures.

Source: Refinitiv

These select businesses, known as emissions intensive and trade exposed (EITE) entities, receive millions of free units from the Government every year. A 2019 Stuff analysis found just four companies - the Tiwai Point aluminium smelter, the Glenbrook steel mill, Methanex and Fletcher Building's cement arm - receive three quarters of free allocation.

Reforms to the ETS in 2020 that introduced auctioning also began to phase out these free units, but at a glacial rate of -1% a year for the next decade, then -2% a year through the 2030s and -3% a year until 2050. So, agriculture is not the only sector that has beneficial treatment in the ETS.

The New Zealand carbon price is showing a similar pattern to the EU’s and as the EU’s climbs the politicians there are looking to provide further protection to their own industries from imports from countries with ‘weaker’ carbon reduction policies and to help prevent ‘leakage’ from the EU itself to other developing countries.

A new Carbon Border Adjustment Mechanism, or CBAM, is likely to be the most likely tool to penalise those beyond the EU's borders.

The CBAM is aimed for non-EU companies exporting to Europe to pay the same price for their carbon footprint in Europe as European companies. The CBAM looking to be somewhat contentious especially to countries like China who while having a form of an ETS program is more limited than the EU’s and priced a lot lower at the moment.

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Currently the USA also does not favour the CBAM which provides developing countries some protection. China remains the world's larger greenhouse gas emitter, with 27% of total carbon emissions globally with coal still supplying more than 70% of China's electricity needs.

The EU is considering restricting the ‘border tax’ to cement, iron and steel, aluminium, fertilisers and electricity, and a lead in period of up to 2035 before it is implanted in full. So, at this stage New Zealand does not have to worry to much about meeting the EU criteria.

In reality by 2035 the New Zealand ETS is likely to be very close to the EU’s in value and coverage. Currently the EU ETS policy does not effectively include agricultural emissions of which make up about 10% of their total. Since 1990 their agricultural emissions have reduced by about 20% but have stagnated in the last 10 or so years.

If the EU does want to achieve its (new) policies of reducing its net emission target by 2030 by at least 55% compared to 1990 levels to achieve climate neutrality target by 2050, it is hard to not see their agriculture being included at some time in the future.

Back home, the impact of the ETS on reducing GHG emissions is predicted as having limited success with its influence only reducing emissions by 15%. Although, Treasury believe that it will still have a major impact. However, they seem to be standing alone with this view and most experts, the Minister for Climate Change Shaw and the CCC believe that all or at least more reduction policies are required to get the reductions required.

This is also consistent with international experience. Only when the ‘catch’ is broadened and the price of carbon goes up will any real progress be seen.