The Climate Change Commission is recommending more than halving the number of carbon credits auctioned off next year, in an effort to reduce oversupply.
Cutting the auction volumes could threaten the Government's plan to use revenue from the Emissions Trading Scheme (ETS) auctions to help fund income tax cuts.
Usually, policy settings are fixed two years in advance and are unable to be changed except in special circumstances which the Commission thinks have been met.
It said dysfunction in the scheme last year—prompted by an unlawful Cabinet decision and a review of forestry units—was significant enough to justify amending the unit limits next year.
This was made even more urgent by a revised estimate of the amount of units that have been stockpiled by emitters for use in the future.
New data suggests there may be 19 million, or 38%, more surplus units being held than had been previously thought, largely due to a sharp rise in forestry registered in the scheme.
The Commission said that surplus still needed to be used up by the end of 2030, or else New Zealand might blow its second emission budget, and therefore unit settings needed to be cut faster.
It has recommended more than halving the amount of units being offered in 2025 and in the following five years. The total number of units would drop from 49.5 million to 24.7 million.
Price control settings would remain unchanged in the next two years and rise gradually thereafter. The minimum reserve price would rise from $68 today to $88 in 2030.
Cost containment reserve trigger prices would rise from $194 to $250 and $243 to $313.
Rod Carr, Chairman of Climate Change Commision, said the four declined auctions in 2023 demonstrated there was an oversupply of units already in the market.
“The auction results highlight that the NZ ETS is not primarily a revenue generating mechanism and cannot be relied on as a steady source of funds,” he said.
“This unit surplus will not self-correct. It is critical that the Government adjust the NZ ETS unit volume limits as soon as possible to draw the surplus down and bring the settings back into alignment with targets”.
Government response
Minister of Climate Change, Simon Watts thanked the Commission for the advice but did not make any further comments.
The advice will go out for public consultation later in the year and the Government will make the final decision on ETS settings before September.
National and its coalition partners are relying on the scheme to deliver on Christopher Luxon’s personal promise to achieve net zero emissions by 2050.
It also plans to redirect its revenue into the Government’s general coffers to free up some funding for its income tax cuts. This was pitched as an indirect ‘carbon dividend’ of sorts.
Redistributing the proceeds of the scheme to income earners would help to ease the political pressure that could come with letting the carbon price climb.
While only emitters and market makers take part in the ETS scheme directly, consumers indirectly pay the carbon tax when they buy electricity, petrol, and other things.
The Climate Change Commission's recommendation—to halve the number of units sold over the next six years—could create a headache for the those trying to balance the Budget.
“Adjusting units in the scheme to align to targets … highlights the unreliability of income for the government from the NZ ETS,” it said in its advice.
Fiscal fallout
Auction volumes were already set to decline in line with emissions targets until they both reached zero in the mid-2030s, but this policy recommendation puts it on a fast-track.
“The current increase in the surplus, which leads us to recommend sharper adjustment to auction volumes, makes this unpredictability more acute,” it said.
It is hard to know for sure how much revenue the Crown might miss out on, as reducing the number of units available could push up prices and lessen the fiscal impact.
But Paul Harrison, a managing director at Salt Funds, said it wasn’t obvious that following this advice would cause the carbon price to spike significantly.
The advice was given in response to the higher stockpile estimate and was intended to keep emissions within the existing budget — which could mean prices stay on a similar track.
“I think what's apparent is that New Zealand has sold too many in the previous auctions and let emitters get off too easily,” he said.
The price was expected to rise in the coming years and would need to be higher if it was going to encourage companies to invest in renewables and consumers to change behavior.
In a press release, Labour’s climate change spokesperson Megan Woods said the advice “foreshadows lower than expected” auction revenue.
“Which is a problem for the Government if the intention is to use the money from auction proceeds for tax cuts,” she said.
Woods said the Coalition should “move quickly” to ensure the ETS is aligned with emissions budgets and also articulate its broader climate policy plans.
Comprehensive policy needed
Carr advised there was an opportunity to tighten the ETS cap and reduce the amount that would need to be spent on offshore offsets.
“We have deferred adopting this approach in this advice as we await the Government’s clarification of its approach to gross emissions reductions, removals from forestry and purchasing offshore mitigation, as well as its wider vision for climate policy in the second emissions reduction plan to be developed this year,” he wrote.
The Coalition needed to urgently set out the role it sees the ETS playing in a “coherent policy package” that would meet the country’s various emission reduction targets.
Current ETS settings are likely to drive lots of new forests, which sequester carbon, but not significant reductions in actual gross emissions.
This might be the fastest and cheapest option but has a negative effect on many rural communities and may not succeed at permanently reducing emissions.
The Commission wants the Government to quickly signal whether it wants to stick with a net emissions reduction strategy, or attempt to seek more gross emissions savings.
“Delay will undermine the confidence of investors, lead to disappointed expectations, delay action needed to meet targets and impose avoidable costs in the future,” Carr said.
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