There are concerns the latest review of the Emissions Trading Scheme could further subdue carbon prices in the short term, but in the long term, it could drive them up.
There are also concerns that government decision-making and how it is announcing those decisions is increasing uncertainty in carbon markets.
The Ministry for the Environment confirmed on Wednesday evening that it is reviewing the Emissions Trading Scheme (ETS) following concerns, including those of the Climate Change Commission (CCC).
It comes at a time when the prices of New Zealand Units (NZUs) have fallen from a high of $88.50 last November to below $65 this week.
Cabinet papers released about the review show decisions to hold it were made last September when carbon prices were high.
One of the main concerns in the papers and of the CCC was about the impact of forestry. There were fears that the high prices of carbon would incentivise the planting of pine plantations solely to reap NZUs.
This would have land-use implications, encouraging the planting of monocultural exotic forests on sheep and beef farms that would never be harvested. There would also be implications for the ETS as it would increase the supply of NZUs and make planting trees more profitable than reducing emissions.
While carbon offsetting is an integral part of the government’s emissions reduction plan, the cabinet papers indicate concerns the balance could swing too far.
Secondary carbon market platform Carbon Match said the review “underscores how serious this government is about true decarbonisation”, but said, “it’s yet another source of regulatory uncertainty in the run-up to October’s election”.
ANZ economists said the review will be welcomed by many who feel the current system simply incentivises land to be planted in exotic trees rather than tackling the underlying issue of pollution.
“The review is likely to deliver some significant policy changes. Whilst the review is being undertaken we are likely to see significant disruption in the existing carbon markets and markets for real estate that may have been destined for afforestation,” ANZ said in a note.
Attempts last year to prevent permanent carbon forests from accessing the ETS and suggesting ways to decouple forestry from the ETS were dropped after pushback from forestry owners who had made investments based on the current rules.
Māori forestry owners threatened to take a claim to the Waitangi tribunal. One of the reasons for this is that a lot of Māori-owned land is very marginal in terms of productive use and carbon forestry is one way to earn some money.
Government officials currently have another work stream going on the issue of plantation and exotic carbon forestry as well as looking at ways to encourage the planting of more permanent native forests.
Carbon Match said the move would raise the “hackles of forestry owners” who already face the prospect of increased costs for participating in the ETS.
On the other hand, farming groups have lamented the possible economic, environmental and social impacts of land-use change.
ANZ said that, under the current ETS setting, it is expected that between 410,000-670,000ha of land would be converted to forestry by 2035 resulting in a 20-30% increase in the area currently planted in exotic forests.
The cabinet paper accentuates the need for certainty and stability around ETS settings, although some with an interest in the market said these priorities seem to have become lost in the past six months.
The decision to ignore crucial parts of the CCC’s advice on ETS settings came as a surprise last year. This was followed by the government’s policy reprioritisation, which resulted in some climate change policies being scrapped.
Looking forward, there is also the uncertainty of the upcoming election. When National was last in office, it set the carbon price lower than it is even now, and Labour has recently shown its priority is getting cost-of-living pressures under control.
There is also concern about how announcements have been handled and timed.
For instance, the cabinet decision to reject parts of the CCC’s advice was made last November. The decision was publicly announced after the last carbon auction in December. That auction cleared at $79 and reaped the government $381 million. Hours after the announcement, the carbon price crashed.
The decision to hold the review was made last September. While it was not unexpected, it was not formally announced until this week. There has been no explanation for why it was only announced now after the first-ever failure of a carbon auction.
The cabinet papers also suggest that ministers were to make broad-brush decisions about the review’s direction in the first quarter of this year. That is, by March.
The Environment ministry’s two-paragraph announcement of the review on its website made no mention of what those broad-brush decisions might be or if they had been made.
The paper suggested public consultation on the review would begin this year.
The review of the ETS will consider unit supply settings, including industrial allocation, the current stockpile of units, rates of afforestation and deforestation, and the number of units being auctioned.
This would be with the intent of driving an “appropriate balance of net and gross emission reductions over time, including additional sources of emission removals”.
It will seek to support indigenous biodiversity and achieve emissions reduction targets.
The paper said some reductions in emissions might be achieved via complementary measures to the ETS, enabling some of the transformations to a low-carbon economy to be made without a high carbon price.
“However, these other measures may not be sufficient or optimal. The NZ ETS forms the backbone of the mitigation policy response for good reasons.
“A price on all sources of emissions provides incentives for reductions wherever they occur and for emissions to be reduced via changes in behaviour or activity that cannot be identified in advance,” the paper said.
