On Wednesday 26 July, the New Zealand government announced the long awaited outcome of the second stage of the New Zealand Emissions Trading Scheme (NZ ETS) review. The two-stage NZ ETS review began in 2015, and stage one has already resulted in policy changes, with the 1-for-2 transitional measure to be phased out by 2019. Stage two of the review had a broader scope, aimed at addressing fundamental design elements of the NZ ETS to make it fit for purpose – in particular, supporting New Zealand to reach the ambitious targets of the Paris Agreement and beyond.

Minister for Climate Change Issues, Paula Bennett, has tabled a cabinet paper outlining the rationale for the package of decisions made on the basis of the review. The proposed changes will provide the government with the tools to align the supply of units in the NZ ETS with their climate change targets, while giving participants greater certainty over market developments. Such changes would also make the NZ ETS more similar to other carbon markets around the world, making it more compatible for international linking.

Although the in-principle decisions are still subject to further consultation and engagement, advice on the proposals is expected to be provided to the Minister by the end of 2018. The four proposals are:

1.       Introduce auctioning

The government aims to establish an auctioning mechanism by 2020. While an auctioning provision already exists in the Climate Change Response Act 2002, it has yet to be implemented. The government has proposed stakeholder outreach to develop a regulatory framework on the timing, participants, penalties and scope of auctioning. An overall limit on the number of NZUs that would be auctioned also needs to be set.  As indicated in the cabinet paper, auctioning could generate public revenue from the sale of units, potentially in the range of NZD 0.73-2.15 billion (EUR 0.47-1.37 billion) over the period 2021 to 2030.

2.       Limit the use of international credits once the NZ ETS reopens to international markets.

The NZ ETS is currently closed to international markets. However, international units are expected to play an important role in meeting New Zealand’s targets. Therefore, the government has decided to limit participants’ access and use of international units when the market reopens to international markets. The level of the limit and how it will be implemented is now being considered. Concurrently, the government is actively exploring options to access international markets in the future. They are also working together with international and domestic experts on environmental integrity criteria for international credits.

3.       Develop a different price ceiling

The current price ceiling allows participants to purchase an unlimited number of allowances at the fixed price of NZD 25.00 (EUR 15.90). The government will consider alternatives, including a volume-limited price ceiling that can be incorporated into the auctioning mechanism. In the meantime, the fixed price option will remain at least until auctioning is in place or international links are established.

4.       Coordinate supply settings

Currently, the Climate Change Response Act (section 30GA) mandates a five year rolling period for setting allocation volumes. To determine the volume of units that can be sold at auctions each year, the government will be required to set NZU limits five years into the future with a one year extension annually.

The government proposes extending this approach to account for other unit supply settings, such as international unit limits, price controls and levels of free allocation. This approach will provide a forward view of supply settings that aim to balance predictability for market participants with flexibility for the government to adapt settings as needed. Forestry units will not, however, be subject to supply constraints under the proposed system, although decisions on auctioning volumes would take the overall supply of units into account. No decision was taken specifically on levels of free allocation.

Further decisions require consultation

Several decisions relating to the review are still to be made, with further consultation needed on free allocation and forestry. Free allocation rates will continue as planned until at least the end of 2020, though advice on this is also expected in 2018. The government will also consider competitiveness concerns, including international carbon prices. Secondly, changes to the forestry sector are still being examined, and an announcement on a forestry package is expected in mid-2018. This will address a possible change in the NZ ETS accounting methodology to a system of averaging, aligning it with New Zealand’s national accounting under the Paris Agreement. The forestry package will be developed alongside options to increase administrative and operational efficiency, as many of the potential gains are to be made in this sector.