New Zealand outlines cap on ETS and auctioning plans

On 2 June 2020, the New Zealand government announced proposed regulatory settings for the NZ ETS from 2021-2025, which will establish for the first time a cap on emissions under the NZ ETS. The proposals, outlined in a series of cabinet papers, further determine a provisional emissions budget for the period, establish new price control measures, and provide details for the introduction of auctioning, scheduled for 2021.

The  cabinet papers (here, here, and here) were finalized after a public consultation that closed in February 2020 and have carried through most of the government’s original proposals. The detailed settings will soon formally become regulations under the Climate Change Response (Emissions Trading Reform) Amendment Bill, enabling anticipated reforms to the NZ ETS to be implemented as early as 2021. The Bill cleared its second reading in parliament last week and is expected to pass into law after a third reading later this year.

The process of setting the cap and determining the supply of units is a key element of the NZ ETS reforms. The process is outlined in the first cabinet paper and consists of a series of steps. First, a provisional national emissions budget is set, based on which the NZ ETS cap can be determined. This then informs decisions on auctioning supply volumes. The coordinated process considers various other unit supply factors such as the rate of free allocation, projections of forestry removals, potential international units, and the stockpile of units still in circulation. Once the unit volumes are decided, the auctioning mechanism will become the key tool for managing the supply of units into the NZ ETS, and the new price-control mechanisms will operate via auctioning.

As a necessary first step, a provisional emissions budget of 354 Mt CO₂e has been set for 2021-2025, to be formalized in 2021 by the Climate Change Commission under the mandate of the Zero Carbon Amendment Bill of 2019 and in line with New Zealand’s new 2050 climate targets. The provisional budget avoids frontloading supply in the period, reflecting the short-term reduction in emissions caused by the COVID-19 crisis. It starts at 71.8 Mt CO₂e until 2024, when it decreases to 70.0 Mt, reaching 68.1 Mt in 2025. The total budget of 353.6 Mt over 2021-25 can be compared to New Zealand’s projected emissions of 368 Mt over the same period.

The provisional emissions budget includes net emissions from all sources. The NZ ETS, however, will cover less than half of these: of the 354 Mt budget, the share of emissions covered by the NZ ETS, and thereby the NZ ETS cap, will be 160 Mt over 2021-2025. Emissions not covered during this period make up around 194 Mt and are largely from the agricultural sector, for which other measures are planned.

As only a portion of the NZ ETS cap will be allocated via auctioning, a series of adjustments were made to calculate auctioning volumes, accounting for free allocation, forestry units, international units, and the current stockpile of units held in private accounts. Of the 160 Mt cap, 43 Mt will be freely allocated to industries deemed at risk of carbon leakage until 2025. Forestry sector trends and issues were assessed but did not result in changes to the cap, as the calculation methodology was revised to remove forestry emissions outside of the NZ ETS from the overall volume limit. Furthermore, international units are still disallowed from entering the NZ ETS during the period, as no decisions have yet been made about New Zealand’s access to high-integrity international carbon markets. The government may decide to introduce international units if advances are made, as part of the annual update to the NZ ETS settings.

There is also currently a large stockpile of over 130 million allowances (NZUs) in private accounts, which the government plans to reduce by 27 million NZUs by 2025. This volume is considered appropriate for reducing the stockpile in a managed and predictable manner, while still allowing forestry entities to retain enough units to protect against deforestation liability, and to allow other market participants to manage risk and compliance strategies. To achieve this reduction, fewer units will be auctioned such that total supply is less than the cap, encouraging some entities to meet their compliance obligations via the secondary market. Adjusting volumes further by these 27 Mt leaves a total of 89.6 million NZUs to be auctioned between 2021-2025.

Auctioning will start in 2021 with 19 million NZUs (approximately 59% of the NZ ETS emissions cap and 24% of annual emissions) and increase to 19.3 million in 2022, before falling to 18.6 million in 2023, 17.2 million in 2024, and 15.5 million in 2025.

Auctioning will be held quarterly beginning in 2021. Auction schedules will be published every September for the upcoming year, and overall supply volumes are subject to adjustment on a rolling basis. Annual volumes will be split evenly across all four auctions, and any unsold allowances will be added to the next scheduled auction in the same year.

For the duration of 2020 and until auctioning is established in 2021, the fixed price option (FPO) will remain in place but increase from NZD 25 (USD 16.3) to NZD 35 (USD 22.8). This transitional pricing mechanism serves essentially as a price ceiling, where entities can simply pay a fixed price per tonne of emissions instead of surrendering allowances. If auctioning is delayed, the FPO will remain for an additional full calendar year until the first auction. In addition, forestry participants in the NZ ETS will be able to use the NZD 25 FPO for activities before 1 January 2020 and the NZD 35 option for activities within 2020 on a pro-rata basis.

The FPO will be replaced by the cost containment reserve (CCR) once auctioning begins. The CCR will release additional NZUs into the market if the price trigger of NZD 50 (USD 32.6) is hit at auction, thereby relieving pressure on supply and pushing down the price. The price trigger will increase annually from 2021 by 2% alongside forecast inflation to reach NZD 54.12 in 2025.

Seven million NZUs will be held in the CCR from 2021 until 2024, decreasing to 6.9 million NZUs in 2025. These volumes are calculated as the annual units withheld from auction under the NZ ETS cap to reduce the stockpile plus 5% of the total NZ ETS cap. Units released by the CCR that exceed the NZ ETS cap will have to be ‘backed’ by an equivalent tonne of removals or reductions procured by the government to ensure environmental integrity.

A minimum sale price at auction of NZD 20 will be set from 2021, also increasing annually by 2% in line with forecast inflation to reach NZD 21.65 in 2025.

Although the COVID-19 pandemic has significantly impacted the New Zealand economy, the proposed NZ ETS reforms are set to move forward largely as planned, described by the Cabinet Environment, Energy and Climate Committee as still “broadly appropriate”. After five years of work, the reform process of the NZ ETS is on track to be largely completed by the end of this year, with the major changes taking effect from 2021. The Climate Change Minister, James Shaw, said that the changes will deliver a system that will begin to cut emissions as was originally intended, commenting that “until now the ETS has been a cap-and-trade system without a cap…I am delighted to say we are finally changing that.”