NZ ETS unit limits and price control settings for 2024-2028

Overview

As part of the Climate Change Commission’s (the Commission) responsibilities under the Climate Change Response Act 2002 (The Act), we are required to provide the Government with annual advice on the unit limits and price control settings for the New Zealand Emissions Trading Scheme (NZ ETS) across a five-year window.

This year’s advice reflects new data that has emerged, updates to our approach, and the impacts of the Government’s decisions on the NZ ETS settings in 2022. Our recommended adjustments to settings are designed to help bring the NZ ETS back on the path to meeting national emissions reduction targets. Without such action, Aotearoa New Zealand risks failing to meet its climate goals or potentially facing higher emissions-related costs in the future.

The NZ ETS settings are currently at risk of being out of step with Aotearoa New Zealand’s emissions budgets, 2050 target, and Nationally Determined Contribution (NDC) to lowering global emissions reductions under the Paris Agreement. In an emissions trading scheme, it is not possible to keep in line with an emissions reduction target while also maintaining tight control of prices. The Government’s 2022 NZ ETS settings decisions increased the likelihood that extra New Zealand Unit (NZU) volumes will come to market and add to the existing surplus. Each of these units will be surrendered in place of emission reductions in the future, taking Aotearoa New Zealand further from its emissions targets.

In its first emissions reduction plan, the Government committed to aligning the NZ ETS settings with emissions budgets. If the Government sets price controls that keep emissions prices at lower levels, it will need to impose other regulations or policies to compensate for an NZ ETS that does not play a substantial role in lowering emissions.

The Commission acknowledges that we are providing this advice in the aftermath of Cyclone Gabrielle, which brought devastation to many communities across Aotearoa New Zealand, and tragically caused the death of 11 people. It is still too early to fully understand the impacts this event will have on the NZ ETS, in terms of emissions or its operation, but it has created uncertainties. The immediate priority for government agencies and responders is to support the lives and wellbeing of impacted communities. Consistent with our mandate, we will continue to monitor the situation as it unfolds and reflect any new information or lessons from Cyclone Gabrielle in our future advice to the Government, including on the NZ ETS.

What happens next

Providing this advice is one step within a wider process for updating the NZ ETS regulations. The Government will consider our advice and run a public consultation on proposals, which we understand will be led by the Ministry for the Environment on behalf of the Minister of Climate Change in the second quarter of 2023.

The Government must make decisions on NZ ETS unit limits and price control settings in time for the regulations to be updated by 30 September. The new settings will come into force on 1 January 2024. We expect to provide our next advice on this topic, relating to 2025-2029, in the first quarter of 2024.

The current role and operation of the NZ ETS

The NZ ETS is an important tool in the Government’s strategy to reduce emissions. Putting a price on emissions, which in turn raises the price of emissions-intensive activities and goods, encourages participants to make different choices and innovate to find low emissions alternatives.

Our recommendations on unit volumes and price control settings are based on analysis of what is required to meet emissions reduction goals and on the matters we are required to consider under the Act.

To remain in line with emissions reduction targets, it is important to consider the NZ ETS as a system, with each limit or setting contributing to a broader market environment. This is especially true with price controls – changing either the auction reserve or cost containment reserve price triggers materially shifts the nature of the price corridor and impacts the appropriate associated unit volumes. We have therefore developed our advice as a cohesive package and have noted in this report how conclusions and recommendations correspond with one another to help the Government avoid unintended consequences as it makes its decisions.

Government needs to make decisions on the long-term objectives of the NZ ETS

As with our 2022 NZ ETS settings advice, this advice reflects that the Government has not yet clarified some of its goals for the NZ ETS.

Our advice is informed by the Government’s statements in its emissions reduction plan that it seeks gross emissions reductions as well as forestry removals to meet targets. However, the NZ ETS is not currently set up to deliver that outcome, as it does not distinguish between the two. This is a major source of uncertainty and confusion for the market and will make reducing gross emissions more risky and likely more costly.

Government needs to clarify its intentions for meeting emission budgets, specifically whether it wants gross emissions reductions or to deliver them mostly through removals by driving afforestation. If Government wants to ensure gross emissions reductions occur, the NZ ETS must be amended to ensure forestry removals do not displace them.

Any amendment should involve partnership with Iwi/Māori to ensure decisions uphold the principles of Te Tiriti o Waitangi/The Treaty of Waitangi, avoid exacerbating historic grievances, and do not unintentionally disadvantage Iwi/Māori.

In its emissions reduction plan, the Government also stated that significant offshore mitigation is likely required to meet the NDC. However, it has not yet approved any overseas units (units from another country’s ETS or other foreign mechanism) and has provided no clarity as to when or how it will access offshore mitigation. The absence of this information has created significant uncertainty for market participants and for the Commission as we have prepared this advice. Once this information is available, our future advice could materially change.

Engagement

Engagement is an important component of quality advice on the NZ ETS. Our 2023 advice has been informed by engagement with Iwi/Māori-collectives, companies and individuals from different sectors including compliance participants, intermediaries, members of bodies with an interest in the NZ ETS, and environmental organisations. This enabled us to hear insights, test ideas and enhance our understanding of the NZ ETS market and of market participants’ and other stakeholders’ concerns.

Several key themes emerged from our engagement, including that:

• we are on the right track with our work, with several stakeholders telling us they felt the Commission’s approach to analysis and the methodology used to inform our 2022 advice was robust
• forestry is responding strongly to NZ ETS incentives but is a key source of uncertainty in the market
• an approach to engagement that is better aligned with tikanga Māori will strengthen the Commission’s ability to reflect the diversity of Iwi/Māori perspectives, needs, and aspirations in relation to the role and operation of the NZ ETS.

Some of what we heard about the NZ ETS, for example views on the role of emissions pricing in achieving a balance between reducing gross emissions while increasing long-term carbon sinks, sits outside of the scope of this advice. We expect to address these concerns in our upcoming advice to the Government on the policy direction of its second emissions reduction plan.

Moving towards a fair, inclusive and equitable NZ ETS

Our analysis from Ināia tonu nei showed that the transition to a low emissions society can be economically achievable and socially acceptable. To achieve this, the transition must be well-paced, well-planned, well-signalled, and co-designed.

In this advice we consider how the NZ ETS can align with achieving the emissions budgets, the NDC and the 2050 target while supporting a fair, equitable, and inclusive transition. This includes considering the scale and distribution of potential impacts from a changing emissions price and the Government’s responsibility to give effect to the principles of Te Tiriti o Waitangi/The Treaty of Waitangi.

Iwi/Māori relationships to the NZ ETS

The Commission has emphasised that the Government needs to ensure an equitable transition for Iwi/Māori. Through our engagement with Iwi/Māori we heard that there is currently no Treaty analysis underpinning the NZ ETS, a gap which needs to be addressed. We have also heard that historic disruptions to Māori land ownership and assets impact the way different Iwi/Māori-collectives can participate in the NZ ETS.

Government needs to work with Iwi/Māori to better understand and address how the design of the NZ ETS compounds historic issues. The Government should also support Māori-led approaches to better understand and address any negative NZ ETS impacts on the Māori economy, and to identify options that better enable Māori to participate in the NZ ETS equitably and in a way consistent with their aspirations and values.

As part of this the Government must ensure, in a manner consistent with Te Tiriti o Waitangi/The Treaty of Waitangi principles, that it partners with Iwi/Māori in shaping the role the NZ ETS plays in Aotearoa New Zealand’s climate change mitigation strategy.

Addressing inequitable impacts

The NZ ETS has an important role to play in encouraging and incentivising low emissions investments and innovation. In many cases, low emissions investments made now will more than pay for themselves in the medium to long-term.

For the NZ ETS to be effective in reducing emissions, the relative price of emissions-intensive activities, products, and services must increase in a manner that encourages innovation and behaviour change. This will reward producers, consumers, and investors making choices that reduce emissions and make high emissions activities less and less profitable. Most costs related to the NZ ETS will fall as individuals and businesses transition towards lower emitting choices and are no longer noticeably impacted by emissions prices. However, in the short-term, there may be some who have less access to lower-emissions alternatives.

The Commission recognises that increases in emissions prices are experienced differently by different households, businesses, and communities. It is therefore important that Government implement policies designed to address any potentially inequitable impacts of emissions prices, for example through its anticipated Equitable Transition Strategy.

While that strategy remains in development, there are multiple options for how such targeted support could be provided using levers and funding sources already available to Government. Recent initiatives like the COVID-19 support payments and half-price public transport show that Government can act fast to counter cost of living impacts. These types of targeted, responsive initiatives can serve as a bridge leading to a long-term approach.

A fair, inclusive, and equitable transition means that issues of social and economic equity and tackling climate change must be pursued in parallel. One set of issues cannot be used to justify inaction in the other. In line with our previous NZ ETS settings advice, we conclude the price control settings are not the appropriate tool for addressing domestic distributional impacts or other equity considerations in the transition, as the Government can act on climate change and manage impacts to households or businesses through policies outside the NZ ETS.

Unit limits

The Commission is required to advise the Government on three categories of unit limits for the NZ ETS: a limit on units available by auction; a limit on approved overseas units available for use; and an overall limit on units. The purpose of these limits is to cap the emissions allowed by the NZ ETS in accordance with Aotearoa New Zealand’s emissions budgets, 2050 target, and NDC.

Each year we extend our recommended settings out a further year and review the existing regulated settings. To ensure participants have reliable forward information, the Act only allows for the first two years of settings to be changed under specific conditions, like the triggering of price controls or a force majeure event. As these conditions have not occurred, we have only advised changes to existing regulations from 2026.

Proposed auction volumes

Our application of this seven-step process and the restriction from advising changes in 2024 and 2025 results in the following proposed annual auction volumes:

These proposed annual auction volumes are part of what informs the Commission’s recommendation for the limit on NZUs available by auction (the annual auction volume plus the CCR volume) and the overall unit limit (the annual auction volume plus the CCR volume, projected free allocation, and approved overseas units).

Price control settings

The price controls in the NZ ETS are the cost containment reserve and the auction reserve price. The purpose of these controls is to manage the risk of the NZU price at auction being out of line with what is necessary to meet emissions budgets. They are not intended to guide or set the price of units at auction.

Cost containment reserve

The cost containment reserve (CCR) is a supply of NZUs that become available for sale if the auction clearing price meets or exceeds a specified trigger price or prices. While the cost containment reserve is intended to be used only rarely, it has been triggered in three out of the last seven auctions.

The Commission has considered concerns that the CCR could anchor price expectations or create a ‘magnet effect’ that would drive prices up to the CCR price triggers. We are unable to determine conclusively whether the CCR trigger price is having an anchoring effect on NZU prices.

However, since the Government’s last decisions on the NZ ETS setting in 2022, the Commission has continued our engagement with market participants. Based on this engagement and market research, it is the Commission’s view that the combined influences of signals from the Government about its commitment to climate action, additional information about the costs of decarbonisation, regulatory uncertainty, and price increases in international emissions trading schemes are what led to the shift in market expectations about future prices, rather than a significant price anchoring or ‘magnet effect’ by itself.

Our advice has also been informed by new information from the market, which was not available when Government made it 2022 decisions. Since December 2022, the market has weakened considerably. This trend has continued through to the 15 March auction which was declined due to bids not meeting the confidential reserve price, which ensures the Government does not sell units below their price on the secondary market.  

Our advice is that significantly higher trigger prices are justified to put them well outside where the market may need to operate to be consistent with meeting emission budgets. We judge it unlikely that any potential magnet effect would be sufficiently strong to cause prices to rise to that level. However, we will continue to actively monitor NZU prices as part of our annual NZ ETS settings advice and to build our insights regarding market behaviour, including market expectations and the potential impact of price anchoring.

We also continue to propose that the CCR has two tiers of trigger prices. With two trigger price tiers, the risk of any potential magnet effect will be further reduced as will the risk of adding significantly to the existing surplus, as any release of reserve units will be staggered. The two tiers of trigger prices and reserve volumes will therefore help manage both the risk of prices going above what is considered necessary to meet emissions budgets and the risk to meeting emissions budgets should additional units be released.

Auction reserve price

The auction reserve price (ARP) is the price below which the Government will not sell units at auction. It is closely interrelated with the cost containment reserve (CCR) trigger price, and we advise against making decisions on either setting in isolation.

The ARP has never been triggered. Prices at auction have been well above the ARP since its introduction, and the only auctions declined to date have been due to the confidential reserve price not being met. While the current settings are not known to have caused any issues to the functioning of the NZ ETS, it is likely the ARP is currently set too low to adequately address risks around potential market oversupply. We therefore recommend the price be increased to align with the minimum NZU price path compatible with achieving emissions budgets in line with the Government’s sector sub-targets.

Recommendations

Our recommendations for the unit limits and price control settings, reflecting the restriction from advising changes in 2024 and 2025, are:

Unit volume figures are rounded to one decimal place and columns may not sum due to rounding.