Carbon Match market update

Wednesday 7 Aug 2019

NZUs have firmed again and finished up for July with a last trade of $23.85. As of writing, NZUs are best bid $23.50, best offered $24 - a wide spread which most probably reflects the fact that the market is still digesting last night's announcements. Third Tranche of ETS Fixes Announced – Yesterday the Government announced a third set of fixes to the ETS.

One aspect which will serve to tighten supply over time is that free allocations to entities that are both Emissions Intensive and Trade Exposed (EITE) will begin to be phased down by 1 per cent per year from 2021-2030, then at 2 per cent from 2030-2041, and at 3 per cent per year from 2041- 2050.

Changes to how forestry is treated in the ETS have also been announced in relation to the application of "averaging".

If eligible for averaging, post-89 forest owners will not need to surrender emissions units upon harvesting as they do under the current saw-tooth approach. Instead as a forest grows, NZUs will be received up to a forest's average level of long-term carbon storage, and there will be no harvest liabilities provided replanting takes place.

The Government had already announced that averaging will be an option available to forests registered into the ETS from the beginning of 2019, and mandatory for forests registered from 2021 onwards. But of course those new forests take time to grow, delivering a very small contribution to supply in the short to mid-term. The bigger question for the market had been how owners of existing "post-89" forests older than that would be treated.

Last night the Government announced that forests registered in the ETS before 2019 will not be able to transition to averaging accounting.

Keeping Control of Supply – One of the key reasons cited for this was "to maintain a stable price to drive emissions reductions". There was concern that "moving more than 2200 existing forests onto averaging could contribute to an oversupply of units (which, under stock carbon accounting, will be surrendered to the Crown upon harvest) into the carbon market."

There was also concern that offering averaging as an option to older existing forests would have created significant extra financial costs to Government due to units already credited no longer being required to be surrendered on harvest.

While the press release states that that decision may be revisited in 2021 (once more relevant data has been collected), we think the Government's concern over the risk of creating extra supply should be noted by emitters.

All About Trees One of the tricky things with the New Zealand ETS is that its supply is so heavily concentrated in the hands of forest owners, and hence strongly linked over time to what is happening in that sector.

History has made for a lack of diversity on the supply side. Indeed emitters wanting to meet their obligations are pretty much restricted to buying a forestry derived NZU or, if available, surplus NZUs allocated to EITE entities.

While the plan to auction into the private sector the unallocated portion of the Paris budget will somewhat alleviate this, it will by no means be enough without international purchases and further sequestration in new forests.

But Not Everyone is Happy - Unfortunately public opinion is increasingly mixed about the use of forests to meet our Paris targets and other future commitments. Recent opposition has surfaced from the likes of the 50 Shades of Green group - see our previous newsletter - farmers, conservationists and others.

See for example the recent criticism by Dame Anne Salmond of the Government's Billion Trees program, and the response thereto from Te Uru R?kau / Forestry New Zealand. Those wanting a podcast for the way home might be interested in ‘The Detail’ on Newsroom.

Our point? Our (approximate) overshoot of our Paris budget could be as much as 200 million tonnes and we have no credible plan to get there yet.

There are three ways in which New Zealand can try to address that: 1) afforest 2) buy international reductions (if possible) and 3) fundamentally tighten our belts to create genuine emissions reductions in the economy. As land-use gets ever more contentious, expect more focus on the latter, and the prices required to drive that.

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