Climate Change Commission recommends removal of excess ETS units as soon as possible

Under the Climate Change Response Act 2002 (CCRA), the Commission provides annual advice to the Government on the New Zealand Emissions Trading Scheme (NZ ETS) unit and price control settings in light of New Zealand’s emissions budgets, the Nationally Determined Contribution (NDC) under the Paris Agreement and the 2050 target.¹ This is the third time the Commission has provided such a report. This year’s advice, covering settings for 2025-2029, was provided to the Minister of Climate Change on 29 February 2024 and made public this week. 

This year’s report came against a backdrop of significant volatility in the price of NZUs. In all four auctions of New Zealand Units (NZUs) held in 2023, bids did not meet minimum requirements, meaning that no units were sold.² In the Commission’s view, these auction outcomes reflect low market confidence and the large numbers of NZUs already in the market.³ It has therefore made recommendations which seek to address these issues. In this article, we consider the Commission’s advice and what this might mean for the NZ ETS going forward.

There is a surplus of units which should be addressed

A key finding of the Commission’s analysis is that the surplus of NZUs already in the market is larger than previously assessed at 68 million units at the end of September 2023, up from a surplus of 49 million units in mid-2022.⁴ This surplus has built up over time from various sources, including increased units being allocated to registered forests.

The Commission considers that these excess units present “a high risk to the achievement of the emissions budgets”.⁵ To correct the excess, the Commission recommends “a significant reduction” to the volume of NZUs made available at future government auctions.⁶ The table below shows the Commission’s recommended limits as against the current limits set out in regulations, in millions of units:⁷

As is apparent from the above table, if adopted by the Government, the Commission’s recommendations would amount to significant reductions as against the current trajectory, amounting to between a 25% and 35% reduction in NZUs available at auction, with an approximately 25% reduction to the overall limit on NZUs. While the impact of these changes would depend on whether the NZUs available at auction were utilised as well as other climate change-related policies, our expectation is that such reductions will likely result in price increases, as part of incentivising emissions reductions.  However, the magnitude of those price increases, and the resulting economic/social impacts, are as yet unclear.

It is also important to note that the Commission has proposed amendments to auction volumes from 2025. Under the CCRA, the Commission recommends changes to NZ ETS settings for years three to five of a reporting cycle (i.e. 2027 to 2029 for the current report), and may only recommend earlier changes if one of a small number of conditions is met. Here, the Commission has concluded that there has been a significant change affecting the proper functioning of the NZ ETS as a result of the surplus of NZUs, which justifies earlier amendment to the unit limits.⁸ In the Commission’s view, “[i]t is critical that the Government adjust the NZ ETS unit volume limits as soon as possible to draw the surplus down”.⁹ Acting sooner will also reduce the need for more drastic reductions in later years,¹⁰ with the Commission aiming to reduce the surplus of NZUs to zero by 2030.¹¹

No substantive change to price controls

In addition to unit limits, the Commission also advises on the price controls applicable when the Government either sells reserve units (i.e. the cost containment reserve which can be used when auction prices are very high) or withholds units from sale at auction (i.e. the auction reserve price). The Commission considers that these settings remain fit-for-purpose and require only minor changes to reflect inflation.¹² That is, it considers there is scope to amend unit volume limits while keeping price control settings essentially the same.¹³ The Commission further noted that, in its assessment, “price control settings are not the appropriate tool for addressing domestic distributional impacts or other equity considerations in the transition”, with the Government able to manage impacts on households and businesses through policies beyond the NZ ETS.¹⁴

Commission calls on the Government to clarify its approach

While not its focus, the Commission further identifies “ongoing gaps in Government policy” which it considers affects the NZ ETS and creates uncertainty for participants in the market.¹⁵ Following on from its advice on the second emissions reduction plan (which was provided in December 2023), it considers that two important issues remain unresolved, being:¹⁶

• • the relative role and levels of gross emissions reductions (i.e. reductions in emissions at their source) versus removing carbon dioxide from the atmosphere (i.e. through forestry) in achieving New Zealand’s emissions reductions targets. In addition, there remain questions as to what role the NZ ETS should play in achieving gross emissions and/or forestry targets, with structural issues potentially needing to be addressed; and
  • how New Zealand will achieve its NDC under the Paris Agreement. In particular, the Commission notes that offshore units will be needed to achieve the NDC, and there are questions as to how this will be done (for example, whether these will be Government funded, whether the NZ ETS will be re-opened to overseas units etc.).

In addition, the Commission has sought to identify opportunities to bring unit limits down to support further emissions reductions, for example by reducing limits to lock in emissions reductions achieved by changes to industrial processes. However, it has deferred recommending to tighten the NZ ETS cap for this year to reflect changes in demand resulting from other emissions reductions policies, instead flagging this as an “urgent policy issue” for Government.¹⁷

What happens next?

Having received the Commission’s advice, the Government will now consider it and determine what changes to the NZ ETS to propose. From there:

• • The Ministry for the Environment will then undertake a public consultation on those proposals in the second quarter of 2024.
  • The Government will then consider that feedback and make a decision on NZ ETS unit limits and price control settings so that the regulations can be updated by 30 September 2024.
  • The new settings will come into force on 1 January 2025.

In addition, the Commission is scheduled to deliver a range of reports on a variety of topics, including progress towards meeting the 2050 target and advice to inform New Zealand’s second NDC, before the end of 2024. We will continue to keep you up to date on key changes arising from these processes as they occur.

If you have any questions about the matters raised in this article please get in touch with the contacts listed or your usual Bell Gully adviser.

^[1] CCRA, s 5ZOA.  The 2050 target refers to the target set in s 5Q of the CCRA, which provides for net accounting of greenhouse gases to be zero by 1 January 2050, with different targets for biogenic methane.^[2] He Pou a Rangi Climate Change Commission | Advice on NZ ETS unit limits and price control settings for 2025-2029 at 30.^[3] At 12.^[4] At 16.^[5] At 16.^[6] At 10.^[7] The Climate Change (Auctions, Limits, and Price Controls for Units) Regulations 2020 Sch 3 set out the current limits, which were set by the Government following the Commission’s advice issued in 2023 (and a subsequent judicial review of the Government’s approach).^[8] At 25.^[9] He Pou a Rangi Climate Change Commission | Advice on NZ ETS unit limits and price control settings for 2025-2029 at 3.^[10] At 17.^[11] At 49.^[12] At 15.^[13] At 3.^[14] At 56.^[15] At 19.^[16] At 19 and 29.^[17] At 18.

Disclaimer: This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.