Sunday, December 3, 2023

Carbon market beset by chaos and confusion

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Lack of certainty may cut forest planting and emissions mitigation.
Ministry for Primary Industries officials told ministers that current policies heavily incentivise planting forests of exotics and walking away from them.
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The fall in carbon prices is due to chaotic policy and confusion in the market that will cut forest planting and emissions reductions, say market participants.

The decline in New Zealand units (NZUs – the equivalent of one tonne of carbon) continued last week, all driven by government policy decisions or the lack thereof.

The fall from the peak of $88.50 in November began with the cabinet declining to follow Climate Change Commission advice on tightening Emissions Trading Scheme (ETS) settings.

The announcement that a review was coming helped push secondary market prices lower. The lack of certainty led to two government auctions of NZUs failing to clear as bids were below the confidential reserve price, with the second auction of the year not even attracting enough bids to cover the volume on offer.

Then the government released its consultation review. The effect was dramatic as prices first fell from $60 to $50 and then last week to $40, with some trades as low as $39 on public secondary market platforms.

One broker said he had even settled an off-market trade at nearly $35 with a forester who needed to raise some cash quickly by selling a small holding of NZUs.

Many market participants had similar stories, with very low volumes, very little interest in buying, and confusion – particularly from forest owners and those holding forestry-created NZUs.

Eligible forests get an NZU for every tonne of carbon their trees absorb.

Until now, there was, for all intents and purposes, no difference between the NZUs created by the government and those created by forests.

However, the government has become concerned about the amount of tree planting that was being driven by the carbon price, particularly over “carbon forests”. This is where trees, mainly pine, are planted solely for carbon credits, with no intention of harvesting the logs.

One concern was that it was cheaper and more lucrative to plant trees than it was for emitters to cut emissions. Another concern was swamping the market with forestry NZUs that the government had no control over – creating a boom and bust cycle in carbon prices. Yet another worry was the loss of land to monoculture pine forests.

The options put forward by the government to change the ETS range from tweaking the rules to some form of separation of forestry NZUs and government NZUs. This could mean emitters not being allowed to use forestry NZUs to settle all or part of their ETS obligations. Another option is to have two ETS systems, one using government-issued NZUs to settle their obligations and another where the government, and presumably others, would buy forestry NZUs.

One broker said the situation is “chaotic and it is causing confusion”. The problem is, with so many options on the table, no one knows what their NZUs are worth now or what they might be worth in the future.

Another broker said he is pleased that the law does not allow him to give financial advice, as he has absolutely no idea what advice could be given.

“Those with NZUs now have no idea whether they should sell now while they are worth something or risk holding on to them to see if they have greater value in the future,” said the broker, who specialises in selling foresters’ NZUs to emitters and others.

Another said foresters who had been looking to plant trees have also put those plans on hold.

“It’s a bit of a perfect storm for them,” a broker said. Low log prices, less demand from China and bad weather are all hitting hard. Now the carbon price collapse and uncertainty about the future are adding further weight to the sector.

Forest Industry Contractors Association chief executive Prue Younger said the sector faces a dire situation. “This policy will add to their burden, and we’ll see lots of businesses cease to exist and therefore lots of the workforce out of jobs. 

“Not many can survive in this ongoing uncertainty, with dire market conditions. A substantial number of jobs are at stake, threatening the livelihoods of 20-40% of the workforce.”

NZ Institute of Forestry president James Treadwell said tree planting is the only way the country will meet its international climate change obligations.

Salt Carbon Fund managers agreed: “Some commentators believed that NZ was already on track to miss its Paris commitments for the 2020 to 2030 period by over 100 million tonnes of emissions. At a nominal $50 per tonne, to make good on our commitment equates to a cost to the taxpayer of $5 billion,” the fund said in a note to clients.

The fund is one way for investors to get exposure to carbon markets, but its units have been hit hard by the fall in carbon prices.

Fund units peaked at $2.45 last year and fell last week to $1.18, though they have since bounced back a bit to $1.38.

So great is the uncertainty on what forestry NZUs will be worth that the fund has “moved to protect the interests of unit holders from this potential price dislocation and the fund no longer holds any forest-removal NZUs having switched entirely into other NZUs”. 

Salt said it expects any future decisions about the ETS would include some form of “grandparenting” of existing NZUs, but there is potential that removals by forestry will not be able to be used after 2024.

“We expect there will be minimal trees planted until the uncertainty is resolved, which isn’t good for encouraging emissions removals and will potentially require a higher carbon price in the future to suppress NZ’s gross emissions.”

Salt said it has heard about offtake agreement – where someone agrees to buy NZUs off a forester in the future – negotiations being put on hold and “we would expect the lawyers for emitters will be dusting off the existing offtake agreements looking for ways to get out of them (force majeure). All of this will have a significant negative impact on further forestry planting.”

Brokers said there will be no pressure on emitters to buy in the auctions for the next two years as they will likely be able to source and surrender forestry-removal NZUs at a discounted price.

“Consequently, there is now a high probability that the September 2023 and December 2023 auctions will also not see any NZUs sold by the government, resulting in a reduction of 17.9 million tonnes of NZUs that were forecast to be available in 2023,” Salt said.

This would also mean the government would have little or no revenue from the auctions to fund its decarbonisation policy, such as the recently announced deal with NZ Steel.

Asked where carbon prices would go next, one broker said: “I was going to ask you the same question.” The consensus was that buyers would remain cautious until they knew NZUs had some value.

Only one market participant could see a way for prices to rise or stabilise. In that scenario, a buyer could take a gamble that prices had troughed and swoop in at the next auction to scoop up a large volume at what they would hope would be a bargain price in hindsight.

It would be a risky play.

Others are bullish on the long-term price potential, once the current uncertainty has been sorted out.

The cabinet is considering CCC advice to tighten ETS settings and could this time agree to follow it. This, combined with the lack of buyer interest at the moment, the slow reduction of the NZU stockpile and a lower supply, would point to a higher carbon price in the years to come.

But for the moment, confusion and uncertainty rule.

Government officials have been inundated with questions at a series of webinars on the review consultation and have been unable to give any certainty about crucial questions.

They have been clear there will be no chance of decisions until the end of the year and that could mean a whole new set of ministers and almost certainly another round of consultation on narrowed-down options.

This only adds to the uncertainty, as a National/ACT government would probably head in a very different direction than a Labour/Green one.

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