Friday, April 26, 2024

‘Little chance’ of carbon auction clearing

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Several reasons for traders to be shy about taking part in this week’s auction.
Uncertainty about the government’s policy on forestry and land use is one of the many issues hanging over the carbon market.
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It’s likely that the government’s carbon auction this week will fail to sell the available units and there’s a chance the rest of the auctions this year will go the same way, Jarden’s head of commodities, Nigel Brunel, says.

This Wednesday, the second auction this year of New Zealand Units (NZUs, an equivalent to a tonne of carbon) will take place. 

On offer are 4.475 million NZUs. If they are sold, there will also be available the same amount carried over from the first auction that did not clear – the first time this happened.

In addition, there are 8 million NZUs in the cost containment reserve (CCR) should a trigger price of $80.64 be reached.

The CCR is unlikely to be triggered with NZUs trading last Friday at around the $56/57 mark on secondary platforms.

This is off the peak last year of more than $85 when a series of government actions and decisions shattered confidence in the market and sent prices plunging.

Brunel said there is little chance of the auction clearing, but he prefers not to call it a failure because the auctions were designed to be passed in if market conditions dictated. When an auction is passed in that means there were not enough bids above the confidential reserve price for all the units on sale.

The market “remains somewhat fragile given volumes are much lighter than usual”, he said.

The only chance he sees for an auction clearance is if there is a change to the way the Confidential Reserve Price (CRP) is set.

The CRP is set somewhere near the current secondary market price and the auction can only clear if there are enough bids above that price to clear the NZUs on offer.

Brunel’s view, and that of others involved in the market, is that this is unlikely to happen.

If this auction does not clear, it looks unlikely any auction will clear this year, Brunel said.

If this happens, it would be a double-edged sword for ministers. On one hand, they lose the cash the auctions would have raised.

The money is currently being used to fund emissions reduction projects and if there is no cash from the auctions that money dries up or has to be topped up from general taxes. 

This would somewhat weaken ministers’ arguments that taxpayers are not forking out for corporate welfare as the polluters themselves are paying for it.

It also means those that hope the proceeds could be used to give households a “carbon dividend” would be disappointed because there would be no money to hand out.  

The impact on the government’s books is already being felt with last week’s larger-than-expected deficit in the Crown accounts. The Treasury said this was partly due to Emissions Trading Scheme (ETS) revenue being lower by $0.7 billion.

The bright side for the government, if all four auctions do not clear this year, is that none of the carbon credits on offer in 2023 would be carried over into 2024.

This would result in the supply of units reducing and, in theory, less supply would increase the price of NZUs in the future.

Brunel calculates the knock-on effect on NZU supply would result in 169 million tonnes shrinking to under 100 million by this time next year.

This matters in the carbon market because companies involved have to surrender NZUs to meet their emissions obligations under the ETS. Unlike those who entered the market speculating on the future price, they have no choice but to hold and surrender NZUs.

As their banked units dry up, they will have to restock through auctions or the secondary market.

But for the moment others involved in the market say confidence remains low and there is deep suspicion about the direction policy is going.

One person involved in carbon trading for a major emitter said that even though they have one eye on the future requirements it would be “irresponsible” to spend company money until the future becomes clearer.

At one end of the spectrum of concerns is the risk that the ETS might not exist after the election or be seriously gutted. 

At the other end is the fear that the ETS in the future may face very different rules around the supply of NZUs – whether that be through the treatment of forestry in creating carbon credits, how agricultural emissions will be priced or other ETS settings.

There is also general distrust that the government will change the rules or withhold for its own benefit and to satisfy policy concerns other than setting a carbon price.

Exhibit A in this argument is the timing of decisions about the ETS last year.

Then carbon prices had been trading at their peak levels as the Climate Change Commission recommended tightening ETS settings.

Ministers baulked at those recommendations fearing their inflationary effect.

This was an entirely legitimate decision. However, cabinet made that decision before the last auction of the year but did not announce it until afterwards. 

This raised suspicions that the ministers had done so to maximise revenue.

Since then there have been a series of announcements about reviews of various aspects of the ETS which have carried on with those involved in the market having little public knowledge about what is being contemplated.

Chief among these is the role forestry will play. Ministers have worried about both the creation of NZUs over which they have no control and also the incentive they give to convert land to carbon forests, which are cheaper to plant than actually reducing emissions.

Decisions about holding a review on this were made months ago, but the promised discussion document covering the options is yet to be released.

A court case last week threw some light on this.

Te Taumata, which represents Māori trading interests including foresters, went to the high court seeking to delay the release of the discussion document on reforming the carbon market.

It sought an injunction on the release until there had been further engagement with Māori before wider consultation. 

It failed essentially because the court ruled there could be more engagement as wider consultation was yet to be held.

The case showed Te Taumata had been holding very brief discussions with officials about the paper and the options under a non-disclosure agreement.

Balancing treaty obligations with other interests is a precarious act for ministers and officials at the best of times, but some involved in the carbon market say once again this shows that some market participants have more information than others.

Apparently, the discussion document is set to be released, but not until after this week’s auction.

Another reason for traders to be shy about taking part.

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