The first carbon auction of the year takes place on Wednesday amid a stagnating secondary market with speculation that it might fail to clear for the first time with no New Zealand Units sold.
NZUs were trading at $88.50 last November on the secondary market. They are now trading at below $67.
The collapse in price followed the cabinet declining a critical part of the Climate Change Commission (CCC) advice that would have tightened up the supply of units to the Emissions Trading Scheme (ETS).
Cabinet papers show that ministers were more concerned about the cost pressures from a rising carbon price than they were in sending stronger price signals to reduce greenhouse gas emissions.
The resulting drop in carbon prices was dramatic, as those who need NZUs to settle their emissions and those trading for other reasons suddenly lost all confidence that carbon prices would track upwards.
Since then, the major secondary market operators have been reporting low volumes and little interest from buyers and sellers.
Another indicator of falling confidence in the market is the fall in Salt’s Carbon Fund units. It is a managed investment scheme that provides investors with exposure to carbon prices.
Units were trading at about $2.40 before the government’s ETS setting’s decision and fell as low as $1.87 recently.
Interestingly the unit price perked up a bit last Friday to $1.97, perhaps on speculation this week’s auction might change the recent narrative over carbon prices.
However, this could also be due to the Carbon Fund saying it may provide exposure to the price of carbon offshore.
International carbon prices have not been following the NZ market.
The large European Union market recently broke through the €100 ($170) barrier for the first time after plummeting in the wake of Russia’s invasion of Ukraine.
The question in NZ now is what will happen at the auction.
There are 4.475 million NZUs on offer on Wednesday out of the 17.9 million being auctioned this year. There is also a cost containment reserve of 8 million NZUs available if the trigger price is met.
This trigger price is currently set at $80.64.
This is below the price NZUs were trading at before the cabinet’s decision was announced last December, but well above what they are trading now.
With the secondary market so low, there is a chance that those with an interest in buying NZUs may lowball the auction.
However, complicating this is that the auction is also subject to a confidential reserve price. How this is calculated is not public, but its original intention was that it would ensure the auction price did not fall below the secondary market price.
If there are not enough offers above the confidential reserve price to clear all the offered volume then none will be sold.
“Most of the market chatter last week centred around the upcoming auction on March 15 and whether it could fail due to lack of demand or interest,” Jarden’s Carbon Report said last week.
Secondary market rival Carbon Match also reported stagnant interest in the run-up to the auction, which it said was not unexpected before an auction, but it had been a quiet quarter overall.
Both pointed to the fact that the market is a creation of regulation and subject to it with the risks of political and regulatory uncertainty high.
The question is whether anyone believes there will be any appetite in the major political parties for higher carbon prices when their current preoccupation is the cost of living.
Carbon Match said the “fear of over-paying appears to have taken hold” and “increasingly there has been a sense that price risk to the upside is somewhat limited”.
If the NZUs on offer do not sell they roll on to the next one.
Jarden pointed out that there is a possibility that the failure to clear could cascade into the three remaining auctions.
“You could see an outcome where all auctions fail, and if that happened on the last auction of the year all that volume is effectively cancelled and not pushed into the following year.
Failure to clear at this auction or the following ones this year would be a double-edged sword for the government.
The last auction in December (just before cabinet’s decisions made in November were made public) cleared at $79 and reaped $381 million.
This is another factor that has angered many involved in the market – ministers made decisions they knew would tank the price and sat on the information until after the last auction and earned the government more money.
If the latest auction clears lower it will mean less revenue; not clearing at all would mean no revenue. This, in turn, would mean less or no money for the government to spend on its climate change policies.
On the other hand, fewer units in the market means less supply, which in theory would push up the price and reduce the NZUs stockpiled by various parties.
Some think it is unlikely the auctions will not clear, though it may be at a low price.
This is because emitters need NZUs to settle their emissions under the ETS. Failure to do so results in heavy penalties. Not buying them at auction means relying on the secondary market and finding a willing seller for the volume needed. This will be a risk many will not take.
However, the pressure of necessity will be low at this auction.
Those who have to settle emissions must file accounts in March and hand over NZUs in May.
It is unlikely any liable parties would have left themselves exposed at this point and probably have a stockpile already. Many would also have taken forward cover fearing higher prices and will be sitting on a loss-making position now.
As a result, traders may be willing to take a risk and test the market and the confidential reserve price at this week’s auction and even the following, even if just to push the price lower.
However, they could be unlikely to do so for the entire year.
In the longer term, the Ministry for the Environment’s recent forecasts of NZU supply predict decreasing supply and increasing demand over the coming years.
Much of this is based on assumptions around forestry and more trees being harvested. There will also be fewer free industrial NZUs allocated and liquid fossil fuels demand is expected to fall.