The market price for a tonne of carbon in the Emissions Trading Scheme has exploded in recent weeks, raising questions about what to do if it reaches its cap, Marc Daalder reports

June 9 was the day the Climate Change Commission’s final advice to the Government was revealed, but it also saw another important milestone – the first time the market price for a carbon credit in the Emissions Trading Scheme (ETS) rose above $40.

Since then, the carbon price has veritably exploded, crossing the $45 threshold on July 7 and sitting at $47.80 as of 10am on July 12.

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As the price nears $50, the trigger level for opening up access to a flood of new units, the Government says its hands are tied about raising the cap this year.

Climate Change Minister James Shaw told Newsroom he’d been advised that he couldn’t raise that $50 cap until the end of the calendar year. Given the speed at which prices are rising, the threshold is likely to be breached well before then – possibly in the next government auction, scheduled for September 1.

"I'm not allowed to change those unit supply settings in the calendar year in which that would take effect," he said.

The Climate Change Commission had previously recommended that the ETS settings be adjusted as soon as possible to allow for a much higher carbon price. The cap would rise to $70 from 2022, in the commission's outline, and then jump "at least" 10 percent plus inflation each year thereafter.

"The NZ ETS cost containment reserve trigger price should be set well above expected market prices. An initial step up in value, to mitigate risks that it will be triggered and add to the NZU stockpile, should be followed by annual increases to give a trajectory that allows for prices of at least $140 in 2030," the commission wrote in its final advice. In sectors like process heat, mitigation options only started to become cost effective with a carbon price above $50.

Shaw said the Government has not yet made any decisions on the commission's advice.

The effective cap is not based on the market or spot price, but only on the clearing price in the quarterly ETS auctions. That means there's still some time before the new units are released into the market even if the spot price rises above $50 in the next few weeks.

Those units would come from the cost containment reserve (CCR), which holds enough units to allow seven million more tonnes of emissions this year. However, not all of these units would be released in an auction if the price cap was breached - only enough to fulfil all bids above $50.

Of the NZUs in the CCR, 5.4 million are units that have been intentionally held back by the Government to encourage polluters to use up massive stockpiles of carbon credits purchased at a cheaper price years ago. The remaining 1.6 million units are held specifically for the purposes of reducing prices if the trigger threshold is crossed.

At this stage, these units don't represent any "real" emissions reductions. If they're released, the Government will have until the end of 2025 to fund additional removals or reductions in order to make up for that gap. Exactly what that might look like is unclear.

"We are working on potential ways to provide equivalent emissions reductions or removals to back any reserve units released above the cap. No options are off the table at this point, but the units used for this purpose must have high environmental integrity," a Ministry for the Environment spokesperson told Newsroom.

In the past, commentators have theorised that the difference could be made up through funding the planting of trees or purchasing European carbon credits. This latter method, however, could expose the Government to fiscal risk. The EU carbon price is about double New Zealand's, meaning that for every dollar the Government makes from selling the additional 1.6 million units, it would have to spend two dollars in the European market.

While the ministry spokesperson emphasised that the market price and the auction clearing price are not necessarily the same, the two have been close for the first two auctions. In March, 4.75 million units were auctioned for $36 per unit, when the spot price was $38.75. The market price fell $1.50 the next day. In the June auction, the opposite happened - the auction cleared at $41.70, just above the market price of $40.90. The next day, the spot price jumped $2.35.

This indicates the cost containment reserve is likely to be opened up, if not completely emptied, in September's auction. This situation raises questions that go beyond the details of the settings as outlined by the commission and could pose a threat to New Zealand's ability to meet its carbon budgets: Namely, what to do about the enormous, existing stockpile of carbon credits.

Much of this stockpile was obtained by taking advantage of the Government's $25 fixed price offer. Until recently, ETS participants could satisfy the requirement to surrender NZUs by paying $25 a tonne to the Government, while building up stockpiles of NZUs for use later.

The Government also still gives out a number of free NZUs to big emitters. In the early 2010s, these big emitters surrendered cheap bunk credits from overseas to the Government to cover their emissions while banking the NZUs for later. Those overseas credits - which often didn't represent any real emissions removals or reductions - are no longer usable, but the big NZU stockpile is.

The ETS cap will be set in line with the commission's emissions budgets. But units representing emissions reductions from prior to 2021 can be surrendered without breaking that cap. In other words, a polluter could emit far more than it has new NZUs to account for and simply cancel some of its stockpile of older credits. From the ETS' perspective, everything is in order. But any emissions which aren't covered by post-2020 NZUs could exceed the Government's carbon budgets.

"Although stockpiled NZUs in the secondary market are still available for use by businesses in the NZ ETS, their use does not contribute towards meeting New Zealand's emissions reduction targets because they represent emissions reductions that occurred prior to 2021," the Ministry for the Environment website states.

The current stockpile of new and older NZUs sits at 134 million, as of March. These aren't all held by big emitters - about 71 million tonnes' worth is held by foresters, many of whom are planning to turn in credits to cover the emissions released when they harvest their trees.

But the total stockpile is nearly double what the commission's draft emissions budgets would allow the entire country to emit in each year from 2022 to 2025. In fact, once you take out agricultural emissions (which isn't in the ETS), the stockpile could cover 88 percent of emissions allowed over the entire first budget period.

This is why the commission urged the Government to alter the ETS settings.

"Not increasing them from current levels would risk triggering the cost containment reserve to release more units at auction in particular," the commission wrote in its evidence report.

"This would flow through to increasing the stockpile of surplus units in the market and depressing the NZU price, which in turn would make it very difficult to meet emissions budgets as the NZ ETS would not be able to drive the necessary emissions reductions."

Marc Daalder is a senior political reporter based in Wellington who covers climate change, health, energy and violent extremism. Twitter/Bluesky: @marcdaalder

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