NZETS evolving differently from EU

Wednesday 15 Sep 2021

For anyone who has followed New Zealand and European carbon prices over the last couple of years, it has been easy to draw parallels between them - Both markets have experienced strong and nearly identical price gains since the beginning of 2019 on the back of policy reform. However, when looking into the stockpile volumes in the two markets, there are clear differences between them. For any NZ ETS market participants who have expectations that “where Europe goes, New Zealand will follow” the contrasts in stockpile volumes should be a cautionary tale.

Price trajectory and policy reform: a shared history
Both the NZ ETS and the EU ETS have experienced a rapid growth in prices over the last couple of years and this invites an easy comparison between these two markets. The price rises are very well aligned with each other:
• European prices have risen from $NZ42 at the start of 2019 to exceed more than $NZ100 in most recent trading – a price rise of 137%.
• New Zealand prices have risen from $NZ25 at the start of 2019 to reach $NZ60 at the end of last week – a price rise of 139%.

The strongest driver of these substantial price rallies has been policy reform in both markets. However, while policy reform is common to both markets, the focus of each reform package has been quite different. The European reform package has specifically focussed on addressing its oversupply/stockpile issues, whereas reform in New Zealand has been needed to fix a much broader range of structural issues.

European carbon market reform: a focus on oversupply ~ The most recent round of European carbon market reform was initiated in response to the oversupply of units that built up in the years following the Global Financial Crisis (GFC) of 2008/9. The EU ETS quickly became oversupplied after the GFC because the demand for units dropped sharply as economic activity fell and the supply of units into the market was rigidly fixed. European prices dropped away from their pre-GFC price peak above $NZ45 to a low of $NZ5 in early 2013. The five years of trading from the beginning of 2013 to the end of 2017 saw low and rangebound prices. Brexit wasn’t helpful either.

The solution for oversupply that European policymakers arrived at was to auction fewer units. By auctioning fewer units this would force market participants to consume units from the stockpile. The units which were withheld from the auctions would be placed in a reserve and would not be available for market participants to access.

This reduction in auction volume was carried out in two phases. As a short-term measure, auction volumes were reduced by about a third over the 2014-16 period. As a long-term measure, a mechanism was put in place to reduce auction volumes whenever the unit stockpile was larger than a pre-determined target stockpile volume. This mechanism, called the Market Stability Reserve (MSR) started operating in January 2019.

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