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On Wednesday, The Government lost control of the ETS to speculators. This has big implications and challenges for the path ahead

On Wednesday, The Government lost control of the ETS to speculators. This has big implications and challenges for the path ahead

The September 1 auction of carbon credits within the Government’s Emission Trading System (ETS) has brought considerable embarrassment to the Government. Quite simply, the Government was outgunned by institutional investors and could not cap the price to the supposedly guaranteed maximum of $50 per New Zealand Unit (NZU).   

The ETS is a Government construct, within which the Government supposedly holds all the cards. The Government makes the rules and it also plays the game.

At this latest quarterly auction, there were supposed to be 4.75 million NZUs up for sale, with these available for purchase by companies needing to meet their carbon liabilities. However, there was also nothing to stop other companies that had no carbon liabilities from purchasing the units as a financial hedge.

Prior to the start of the year, the Government set the rules for 2021. These included that units at the four quarterly auctions would be available for sale at no less than $20 each and no more than $50.

The Government had two weapons to defend its stated rules. If all units could not be sold for at least $20 each, then some would be withheld. Conversely, if the price threatened to go above $50, then the Government had a war chest of another seven million units, euphemistically called a ‘cost containment reserve’ available to be used across the four auctions.

What the Government had never identified was that if institutional investors wanted to play the game in a big way, then the seven-million-unit war chest might not be enough. And hence they were badly caught out.  In essence, the war chest was a shield, but one which they hoped would not have to be used.

The reality is that the Government had to use all of its war chest, thereby auctioning 11.75 million units rather than the 4.75 million that it intended. Even then it was only able to hold the price to $53.85 instead of the supposedly guaranteed $50.

The fundamental principle of the ETS is that the supply of units is meant to decrease over time, with this causing the price to gradually rise and thereby influence emission behaviour.  Having to put another seven million units into the market has blown that strategy, at least for the meantime.

Somehow the Government will need to claw those units back over coming years, or else its Paris commitments will start to look very sick. And how is it going to now manage the next auction on 1 December?

Minister Shaw has previously stated that he cannot by law increase the $50 maximum within this current calendar year. Does that mean that something similar will occur at the next auction?

One thing for sure is that under current settings the institutional investors will be back for another go. Will Minister Shaw have to replenish the war chest and release even more units?

According to economic theory, hedge funds can serve a purpose by providing liquidity to a market and thereby dampen volatility. But the game changes when speculators, typically comprising institutional investors but also individuals, sense an opportunity to make a financial killing and thereby reshape the overall market.

There is no suggestion that the institutional investors in this case acted as an organised collective. Rather, they each saw an opportunity created the Government’s actions to play a game of buy, hold and then sell some time in the future.

The key event setting up the opportunity to make some big money occurred on 18 August when James Shaw in his role as Climate Change Minister advised that the minimum auction price for a NZU would rise to $39.32 by 2026, and the maximum price would rise to $110.15 $115.10

These announcements removed much of the speculative risk and increased the potential for windfall profits. Also, the underlying message was clear that the Government was going to use the ETS to drive behaviours. It was all on!

The institutional investors would have quickly realised that as long as they could afford to hold the units for several years, then it was a low-risk operation. At worst, they would lose around 20 percent of their investment, with this being highly unlikely, and there were very good prospects of doubling their money.

NZUs can be bought and sold on the secondary market at any time. By close of business on Wednesday, 1 September, the day of the auction, the price had already risen on that market to $59. The futures price for 2026 had risen to $67.62. So any speculator could immediately guarantee a profit of almost $14 pr unit by now taking out a contract to sell today’s purchased units in 2026.  

A realistic estimate is that genuine buyers needing units to cancel their emission liabilities would have soaked up most of the proposed 4.6 million units.  That suggests that the speculators have probably purchased about seven million units, which eventually they will put back into the market.

In cash terms, the Government has also done rather well. Purchasers will have to pay around $625 million to the Government in coming days for those purchases. But from the Government’s perspective, that was not the fundamental purpose of the ETS. In contrast, what the Government has accidentally created is an emission trading scheme where prices are fundamentally determined by speculators.

Minister Shaw must now be squirming at the way he has lost control of the ETS steering levers. There will be serious discussions in coming weeks between the Minister and his officials as to how the Government can get back control of the levers.

The importance of these matters is that the ETS has the potential to bring about the greatest land-use changes, both intended and unintended, that New Zealand has seen in the last 100 years. Let there be no doubt, carbon forestry based on current prices is much more profitable than sheep and beef. It is also highly likely that permanent forests will be more profitable than production forests.

 It would be nice to think that the Government did at least have control over the levers.


*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. You can contact him directly here.

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48 Comments

I'm not sure Shaw is surprised, nor upset,  that the carbon price is been bumped up . I always thought the onlythnig stopping them form increasing it before , Was NZ First .

As far as Green Party objectives go, i would have thought the higher the carbon price the better. That is as an incentive to cut carbon emissions.  

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A key issue for James Shaw is that there are now another 7 million cost containment units that have been released into the NZU system.  And he is going to need a lot more for the next auction if he wants to manage the price.  But all of these extra NZUs in the system are not consistent with the Government's Paris-related emission budget. Currently the units are held by investors (speculators) but these units will at some time have to come across into the real emission trading system. Unless James Shaw creates new regulations as to who can participate, then the speculators can keep buying. It reminds me a little of George Soros and the Bank of England some thirty years ago. 

What we are now seeing is a carbon price sufficient to transform New Zealand land-use but insufficient to change consumer behaviours. Even at $50 it is sufficient to transform land-use, but it only adds about 12c to a litre of petrol. And that is not enough to change consumer petrol-buying behaviour in a significant way.
KeithW

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Great article, Keith. Can you take it just a bit further? Society is running what it calls its 'economy'  on draw-down of its Natural Account. That is having globally-forcing repercussions. Those have to be addressed physically. But we didn't do that; we stuck with the remnant of a stupid concept which I call Neoliberal Ignoromics. Meaning we allowed betting to continue; using tokens which haven't been pegged to anything for decades, far too many of which exist. Those who have been finding it increasingly harder to 'make' tokens by having tokens, were always going to bet in this arena.

Spatially, we are already 'full'. Land-uses are already competing, increasingly. Pressures are on farm from city, biodiverse land from farm. Desertification, top-soil loss, aquifer depletion, off-site acreage-demand (PKE displacing rainforest, for instance) all add to that. Then carbon-farming comes along, but it has to displace something. Not surprising; the added carbon is the result of us digging up many, many acres of fossilised sunlight. For a brief period we had, via those fossilised acres, a bigger planet. Now we increasingly don't, and we will increasingly see competition for the acres that ARE here.

Apportioning those by money and/or credits, is socially stupid. We need to define our desired outcomes, and regulate. I always de-rated Shaw because of the 'business' tendency; Fitzsimons would have been better. That said, there is no perfect way out of this; only a best way. Stop the fossil energy, we stop our economy. Stop our economy, globally, half the planet is dead shortly afterwards. Keep pretending we can sequester, so we can keep fooling ourselves, so we can keep on kicking the can....... and we deplete (and fry). The only way for NZ is to repel boarders at the borders, and to attempt full sustainability. And hope the rest of them don't fry the planet or start a war which ends with nukes. Interesting time to be alive......

https://www.youtube.com/watch?v=MSZgoFyuHC8

 

 

 

 

 

 

 

 

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Yes, I agree a great article - I copied a link to my students, Keith.

Hope they are reading this to get your comment too, Murray.

Check out what James Shaw had to say about it in this article;

https://www.newsroom.co.nz/climate-emergency/govt-must-reduce-emissions…

Neoliberal Ignoromics - yup.

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Great article Keith.

It does sound like there is no way to avoid change of land-use, in particular if we want to see behavioural change of consumers (much much higher carbon price).

Once we look past our diary addiction, we quickly realise that exporting milk solids around the world for a handful of dollars is ecologically unsustainable.

When we start pricing in the real costs of the current business model (fossil inputs like fertilisers & energy, emissions of livestock, processing, shipping), it becomes just inviable. NZs agricultural lobby is still trying to slow this down but it is inevitable and just a matter of time.

Personally, I don't agree that transforming land use from pasture to forrest (ideally native forrest) is a bad thing. Ultimately, NZs landscape may look closer to what it used to be, before colonisation and the capitalistic leviathan ravaged most of its biomass.

(Native) forrests are some of the most productive sustainable habitats that can be (measured in biomass per sqm). Unfortunately, our monadic measure of productivity (units of milk solids) does not allow us to recognise the real productivity of such land.

I think we need to start getting our heads around things like agroforestry. This enables us to see the productivity we would like to see (units of xyz produced) but also allows to produce things we need to have more of on the very same land (increased biodiversity, carbon storage, climate change resilience).

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Dairy could benefit from agroforestry practices (more commonly referred to as farm forestry in NZ). Increasing the 10 or 20 metre Riparian strips to 30 metres wide would allow them to claim carbon credits on the existing strips planted after 1990. Maybe not economic on prime dairy land , but on the more marginal land , (which probably should not have gone dairy in the first place). Trees nearest the grass also providing fodder potential in a drought . 

 

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But he's lost the opportunity to weigh a higher cost on emitters that will need to buy those 7 million units in the future. Or if they do have to pay more, then many of those $$ are going to private investors and the government just lost out. This needs more media attention.

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As opposed to the opportunity lost over the last decade or so, the $$ of which went to private investors?

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Lost control of the housing market too.  And homelessness.  And Delta. 

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Eh? There are more houses being built, than there ever were per time. What they lost control of was exponential growth. Beats you every time. It's the reason for all three - don't blame the Government, blame a stupid society which chose Growth within a Bounded System.

And chose to ignore those who warned....

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I've been waiting for the comments to come back on so that I could say what a great article this was Keith!

This is one of the most important stories of the year, yet radio silence in the media?!? How could anyone design an ETS that is so wide open to time arbitrage? 

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Thanks Jfoe

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Agree, a great article. My only annoyance is that I was late to the party and am now paying a premium on NTA to buy the CO2 ETF. 

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Exactly, I think this is the agriculture issue of the year. 

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It has begun. Without exaggeration the greatest land use change in NZ since Muldoon's livestock incentive and SMP schemes shoved sheep across our hills this government's carbon policy (and their management of it)  will see the sheep and cows gone, replaced by pine trees.. 

Want proof? Ask your local rural agent who made the top 3-5 offers on their last farm tender.. 

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A great article. Unbelievable this isnt all over our news media. Disgraceful really. Looking forward to the next one though Keith. And wondering what on earth Shaw will do now. I have family looking to sell their block to forestry. What will this do to the value of their farm? 

I would like to hear again what help the government is giving overseas buyers of our land to plant in pines? 

 

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The government is brainless.  One policy stuff up after another.

With an ETS the government sets the quota and the market sets the price.  Is it any wonder its open day for speculators when the carbon price is a one way ride.  All the estimates are circa NZD250 per ton (real 2021 NZD) by 2050.

With a direct carbon tax the government has to set the tax where it thinks is needed to get the desired emissions outcome.  This removes the speculators from the ring, but brings other issues.

Alternatively with the ETS the primary auction market could be removed completely with the government selling directly and continuously into the secondary market only and managing the maximum price only considering the 12 month rolling quota it has released ( this wont remove the speculators but may smooth the price trajectory)

 

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Here was my recommendation back then - and still is now. 

For the simplest form of climate policy, we would count only carbon dioxide emissions; put a tax on carbon emitters (with no concessions for the Emissions Intensive, Trade Exposed (EITE) industries) and scrap the ETS.  Additionally, we would cost-recover public transport based on its emissions profile only. 

Provided we kept increasing capacity on PT to meet increased demand, with the above framework AND a ban on synthetic nitrogen, we’d likely meet our Paris commitments without the need for any other policy initiatives.

 

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"All the estimates are circa NZD250 per ton (real 2021 NZD) by 2050".

Sorry, but that's nonsense. We're dead if we're still trading carbon past 2030. Which we won't be, the Limits to Growth decline is too well advanced.

Do some homework, K O  - there's been enough put up hereabouts....

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I wonder if anyone will be living in NYC in 2030?

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Those below street level apartments aren't looking too flash going forward, that is for sure.

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Just saw a news item on Al Jazzera this morning about a couple who drowned in their ground floor apartment in New Jersey.  They contacted the neighbours on the second floor for help but the stairwell was totally flooded and so the neighbours could not reach them.  The entire apartment complex (of three story units) has been evacuated.  Toxic mud/silt covers the ground and cars are strewn around one on top of the other. 

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Hi PD

I've seen your comments before.

Suggest you see

https://www.rethinkx.com

We're going to stretch those growth limits for quite awhile yet.

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I looked.

And filed it under techno-optimism; tried to follow the money (will investigate further).

Anyone who talks of replacement energy being 'cheaper', has to be discounted. Sorry, but they just don't get it.

You can't create energy, nor - without it - can you technologise. It's a bit like reporters who do a wide-eyed article on meat-replacement - in a lab petrie-dish. Or RNZ and 3D printing. Then, forgetting that these need feedstock, they assume volumetric replacement of something existing.

Then there's lead-times, already-scarcity, inertia, entropy. And overshoot. Good luck believing - we are actually heading for a much simpler world.

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i dont disagree with you, its only a question of how long.

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Finance is belief. Prick that belief and it could cascade in hours/days (as per 2008, darned near, and all parameters (population, depletion, debt) are orders of magnitude worse since then. And they've played all their cards (they were economists; they came to a Bridge game trained in Euchre). (there's gotta be a Trump analogy in there somewhere).

So it could be sudden. Longer, we're seeing the reversal of Globalism (read The End of Globalism - Saul) which high-water-marked socially about 1995. Structurally it's still partly a dead man walking - but note it wasn't corporations 'which stepped up to Covid; technocrats are empty vessels (vassals?) when the chips are really down. No useful skills at all, despite the self-importance.

So more of the Nation State, probably paralleling more inter-State friction. So wars...... Wars would be longer than a finance-led collapse; damned if I know which would be easier to live beyond. Depends if the Nuke button got pushed, presumably. Yet it will even if the collapse is just financial; will all those nuclear technicians turn up to work ? Will the grids still supply power?

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Will this bill allow OECD investors to pile into carbon forestry and amp up farm prices even more? https://www.parliament.nz/en/pb/bills-and-laws/bills-proposed-laws/docu…

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This bill has come from ACT. It won't get far in Parliament. But yes, if it was enacted then it would remove all restrictions on foreign investors including carbon forestry.

KeithW

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So if I read all this aright, the sequence goes like this:

  1. Gubmint announces certain price trajectory for carbon prior to the recent auction.
  2. Supplementary supply of units is there but intended as a last resort.
  3. Auction happens, price exceeds the legislated trajectory (see #1), last resort units tipped in and promptly hoovered up by buyers.
  4. Gubmint cannot raise price trajectory quickly so cannot influence the auction price or volume speedily.

Are we right in thinking that:

  • None of the Giant Brains in the Gubmint apparatus predicted this or at least spotted the massive ARB opportunity that this configuration presented to those with deep pockets and quick reflexes?
  • None of the units can be clawed back nor the certain future gain unwound?
  • The next auction is going be another fustercluck?

Someone's got some 'splainin' to do.......

 

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National are probably secretly impressed with the mechanism by which private investors have just been handed a gift.

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I seems to me that we are on the verge of shifting  the burden on future generations from the effects of greenhouse gas emissions to one of a land covered in permanent carbon forests.  If future generations are really unlucky they will get both. 

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Let's be honest here. Would you have James Shaw manage your business?

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Yes , i would . do you even have any idea of his qualifications and experience?. 

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... ETS .... Bitcoin .... NFT's ... it feels like I been transported 250 years into the future ...

And I'm standing in the middle of a field , like a stunned mullet trying to figure out what the bicycle is for  ....

WTF ??? ....

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It seems the problem is the price cap, without it, the market would find the correct value taking into account reduced future issuance by the government. I wonder who we have to blame for the cap?

A potential alternative would be to make these government issued units expire, say after a year or two, which would reduce the incentive to but them as a speculative vehicle. As you mention there are only so many we actually consume

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No. There is that much QE'd debt, and that much need to lever by hedge (and other - think Kiwisaver) funds, that money is no longer a measure with which to achieve physical ends. The variable of carbon, is best dealt with at source, by rationing. Then you screw down the ration. The variable of investment, has lost track of any 'price discovery' of the very tokens it is 'measured' in. Best left to die a natural death.

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That's what the ETS purports to do, i.e. limit emissions to x tonnes per year. The cap is where that falls down as we're saying above this price we'll just allow you to pollute as much as you want, and due in part to QE the price cap got hit pretty easily

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I believe the price cap , and other watering down , were to appease National and NZ First , As Shaw wanted ( and achieved with National at least ) cross party support , to ensure the scheme would continue after an election.  

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The way out for the government , is to use the $ 685 million to plant trees on state owned land . If its a money maker for investors , it must also be self funding for the government, the higher the price , the more it earns.

Alternately , the government could use the money to reduce its own emissions , achieving the same end. 

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In line with the new religion and although it doesn't quite precisely fit, the objective is similar.

A new form of indulgences? Couldn't quite get it to fit but you'll get the gist.

an indulgence is "a way to reduce the amount of punishment  one has to undergo for sins". (reduction of carbon emissions) The Catechism of the Catholic Church describes an indulgence as "a remission before God ( Minister of Climate Change, James Shaw although I'd put him the realms of a bishop at best) of the temporal punishment (pay for carbon now to reduce future punishment)  due to sins (carbon emissions) whose guilt has already been forgiven, which the faithful Christian (carbon emitter) who is duly disposed gains under certain prescribed conditions through the action of the Church  (govt) which, as the minister of redemption (govt and james Shaw), dispenses and applies with authority the treasury of the satisfactions of Christ (govt) and all of the saints" (none fit  this bill)

The recipient of an indulgence must perform an action to receive it. This is most often the saying (once, or many times) of a specified prayer (repeat the mantra Climate change after any adverse weather event), but may also include the visiting of a particular place, or the performance of specific good works.(flying overseas to attend a CC conference or buying an EV)

 

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My 2 cents worth

1. We do not know who bought in the auction yet but rest assured there will be traders, banks, funds etc.

2. They will restrict non emitters in the auctions next year - still allow some non emitters as all markets have traders- currency, pork belly etc etc.

3. There is an overhang but by just reducing action volume the traders will come to market at some stage to book profit. The price may fall then!!

4. Price will move thoughts - Coal is first to go - the rush for biomas for fuel is becoming a 50 metre sprint to the finish now rather than a marathon. As a side note Fonterra joined the NZ Forest Owners Association a few weeks ago - not because they suddenly like trees, they need them to operate. Prediction - in 10 years Fonterra could be the biggest single buyer of NZ radiata logs.

5. Transport will take time but car companies are doing that one. Prediction - in 10 years pure ICE cars will be in the minority of sales.

6. The biggest dial move here is landuse - the economics for forestry is overwhelming now. Prediction - there will be controls on permanent radiata forest very soon. New Radiata planting for timber (averaging) and permenant allowed into the ETS will be capped at 380,000 ha. It will be crude but first in first served - Farmers note.

7. Note in Stuff today - native seedling nurseries can't keep up with demand as exotic ones can't - trees are being planted now.

8. My green friends and even my right of Atilla the Hun business friends, who are green ACT types, think the price rise is fantastic as it will change behaviour.

9. This administration is very serious about decarbonising the economy (compared to any other). They will try to limit collateral damage but there will be some as in any change process.

10. Our markets/supply chains now and more so will require zero carbon, environment, animal welfare etc etc (rightly or wrongly its the market). Ignore or dismiss at your peril.

An article this week in the Herald re Hawkes Bay dry

"Some farmers who have had a couple rough years will be keen for the next generation to take over, some who have just taken over the reins will be wondering what the hell they've done and some will be contemplating selling to forestry."

McGillivray said with carbon forest companies paying above market value for land, the region was already starting to look different.

"Traditionally wonderful lamb and cattle finishing properties, that's gone into forestry. It's not the seller's fault, it's the kind of situation we've got with carbon at over $50 a tonne."

Its not forestry fault - the last one should read  .. its the kind of situation we've got to with no rain and the climate heating up. They are very grateful they have an exit option".

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They could also put their worst land into permament forest,and keep the best for farming, thus making the whole farm economic overall. 

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I think we have been lucky to date re forest fires. The worm will turn if that luck runs out. 

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That's an oxymoron, Belle.

If we keep pumping carbon, we will indeed see more forest fires. But planting forests cannot compensate for burning pre-buried carbon - they can only redress prior deforestation.

So our bigger need is to stop burning the fossilised sunlight - but that means a society unlike anything you and I have experienced.

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Hmm, small picture here PDK, I have native on 3 boundaries, pines on 1. I know where the problem will be if anything lights up. Your dream of a reforested NZ is all well and good, but at what they pay for pine....your forest is going to be all pine. Thats not NZ how it was. 

 

 

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$625 million sucked out of the economy which could have been spent on modern cancer drugs and saved lives today. Instead we see the landed gentry and carbon bludgers enriched, young farmers shut out of the industry and zero change to the climate. What a farce.

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Young farmers already shut out from buying farms. At least some carbon farming could give them some numbers to take to the bank

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One thing I agree with 'Jack Lumber' is that the crude way that the NZ carbon emissions market was established (remember $2.00 per tonne pretend credits) and now being exploited by big business (both overseas and locally) will be reflected in the crude way limits will be put in place to stop unintended consequences. Those lucky enough or smart enough to get in now will reap the financial benefits regardless of a genuine interest in saving our planet.

Mitigating is much less inconvenient than amending or fixing. 

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