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NZU investors are now driving the price of carbon as they play the market

Rural News / opinion
NZU investors are now driving the price of carbon as they play the market
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Image sourced from Shutterstock.com

As I write this in late January 2022, the carbon price in the open market is $75, with this measured per tonne of carbon dioxide equivalent (CO2e). That is an increase of just over 10 percent since the last auction of units by the Government less than two months ago in December 2021. It is also 95 percent higher than the price of carbon this time last year.

The most recent 10 percent increase may not sound much. But the fact that the market price has now breached $70 is significant. It means that there is a developing consensus among players in the carbon market that, at the next auction on 16 March, the Government’s seven million NZU cost-containment reserve for all of 2022 will be exhausted.

If the reserve is exhausted in March, it is likely to be onwards and upwards from there for the carbon price, with three further auctions in 2022 unconstrained by any cost-containment reserve.

To understand what is likely to happen and the implications thereof, it is necessary to understand something about the Emission Trading Scheme (ETS). It is also necessary to understand something about new direct investors in New Zealand Units (NZUs) and the effects these people are having.

The ETS is where demand and supply for NZUs come together to determine the price of carbon.

Within the ETS, the demand for NZUs has, at least until recently, been determined primarily by the greenhouse gas emissions (GHGs) of commercial entities.  All commercial emitters of carbon dioxide, including farmers, are caught by the ETS. However, agriculture emissions for methane and nitrous oxide are currently excluded.

There is also a very generous supply of free units given by the Government to those industries assessed to be trade exposed. The four big entities in this category are the aluminium smelter, NZ Steel, Methanex and Fletchers.

There are also more than 80 smaller companies who get these benefits. Even rose growers can claim they are trade exposed and get some free units.

On the supply side, in addition to approximately eight million free units of carbon, there will be four auctions in 2022, each of 4.825 million units, plus an overall seven million units initially held back in the cost-containment reserve. This cost containment reserve will be triggered if and when the auction price reaches $70.   This supply of auction units come from the Government, with the auction earnings becoming Government revenue.

The potential supply of units is also increased by allocations, both current and historical, for carbon sequestration activities. The store of these units in private hands is now more than 150 million units with a market value of more than $11 billion. 

The Government has stopped publishing the proportion of these units that are held by foresters. This is probably because the distinction between forest companies and the new category of investors has become blurred. 

Some of the genuine foresters are holding units because they will have a carbon liability if they harvest their forests, rather than converting to permanent forests. The rest of the units are held by financial people who sit at computers in their offices.

Nearly all unit owners, both foresters and investors, are holding on tight to their units. This is because they think the carbon price is going to increase further.  And as long as they think that way, then they will continue to hold the units and the price will indeed increase.  

But that is not the full story. As well as holding their existing units, the investors are buying additional units.

At the start of this article, I used the term ‘players in the carbon market’.  This was purposeful, and reflects the emergence during 2021 of these finance professionals who are now ‘playing the market’. 

What caused the change?

Prior to 2021, there was essentially a fixed price at which emitters could buy NZUs from the Government. That all changed with the fixed price system being replaced in 2021 by an auction system, with the price quickly taking off.

The Government thought they could control the price with a cost-containment reserve of units. The flaw in that thinking was that the Government and its officials did not figure out that investors would buy the units as a new form of currency that was much better than a term deposit at the bank and with much less risk than bitcoin.

This was why I wrote an article last September where I said that the Government had lost control of the ETS. 

Currently, the number of units that the Government plans to supply at auction over the next few years is based on the premise that the stockpile of units will decrease as investors cash in on the price. But as long as the ‘players’ think the price will increase, then these investors will continue to suck units out of the market and into the storehouse.

The number of players has been increasing rapidly. Anyone can buy these units through entities listed on the NZX. 

I am also aware that some of New Zealand’s biggest companies are playing the game. Indeed, they increasingly have analysts whose primary role is to figure out how to play the game on behalf of their corporate owners.

I know about these people because some of them have contacted me to see whether I know something they don’t know. These are smart people, and apart from knowing a little more about the forestry aspect than most of them do, there is nothing much that I know that they don’t know. The only difference is that I am talking in public and they are not.

Quite simply, with the NZ dollar reducing in value with inflation, with housing prices topping out, and with share prices slipping, carbon looks an attractive investment. Hence, it is investor behaviours, either investing directly in carbon farming or more simply just buying up NZUs, that are driving the price of carbon.

So what about that forestry aspect?

Last September I was doing some forestry versus sheep and beef calculations using a carbon price of $50.  Even at those prices, a permanent (non-harvested) exotic forest stacked up as superior to sheep and beef in most situations.  At current prices of $75, the forestry option looks even better.

The Climate Commission has said that the carbon price needs to be around $140 by 2030 and $250 by 2050.  This is supposedly what is required to drag the rest of New Zealand away from fossil fuels. At those prices, there is nothing other than dairy on the very best land and kiwifruit on specific land types that can compete with long-term forests.

As for harvested timber, I consider it doubtful as to whether New Zealand needs new forests for that purpose. There are already about 1.3 million hectares of pre-1990 forests that are on their second and third rotations.  If simple economics is what counts, then permanent exotic forestry is where the money now lies. 

There are of course caveats on everything. The ETS has been constructed by Government and it is the Government that sets the rules. There are rumours that the rules will indeed change in the coming months to put a dampener on conversion of pastoral land to carbon farming.

However, changing the rules could still leave carbon farming as very profitable and that is what many of the investors are betting on. Right now, there is no doubt that it is carbon farming that is driving North Island hill-country land prices in particular.

Carbon farming ‘rules of the game’ have to be long term given that forestry investments are long term. Accordingly, all political parties need to quickly get on with the job of sorting out their own long-term policies.

In the meantime, big decisions have to be made by those owners of post-1989 forests who are not enrolled in the ETS.  There are about 350,000 hectares of forest, much of it farm forestry, in this category.

Anyone considering doing this needs to get everything in place before the end of 2022 so as to obtain credits for the period of 2018-2022. There are delays in the registration process and it cannot be left any longer.

I have been an advocate that owners of these forests should register them, claim the credits, and hang on to them until the dust settles.  Obtaining and holding the 2018-2022 credits is fundamental to retaining the option to never harvest these forests. However, not everyone is tuned into this new way of thinking.

My one overarching conclusion is that everything to do with climate-change issues is going to be tumultuous. There will be no smooth sailing.


*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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39 Comments

Carbon credits are to the environment as Bitcoin is to currency; both achieve little with regards to their purported objectives, but do succeed in making a few people very rich.

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Nailed it. The yawning gulf between the theory and the reality of carbon markets with their bubbles, hot air, and complete disregard for human nature, makes the Grand Canyon look small.

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ETS is NZ's version of a digital currency aided by the tail winds of popular climate change culture.

It's not hard to ride the prosperity wave when the availability of credits are limited and that it would be politically unpopular to issue more.

It doesn't matter if the grocery bills goes up another 20% if we can make another 40% on the same unit of accounting.

Perhaps dual listing onto NASDAQ would greatly benefit traders with its accompanied efficiencies.

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What a train smash this ETS nonsense is.  Its now a speculative investment opportunity thanks to a nieve govt and in particular James Shaw. Do the govt make any money out of this?

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As Keith says: "This supply of auction units come from the Government, with the auction earnings becoming Government revenue."

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thanks missed that in my skimming the article

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NZ is going to be in deep trouble when the time comes to buy carbon offsets offshore to offset emissions here , they will be very expensive maybe unaffordable. It may make the more expensive native forest establishment economical .

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Most of the above comments are ignoring 2 key points. "Emitters" need to buy ETS units, and "farmers" produce them . Its more like the futures market for any product , than a digital currency. 

I think the government should limit bidders to emitters , and in proportion to how many they need to offset their emissions.

The other point to remember is a higher auction price means more revenue for the govt, albeit for units it has to "account" for.  

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How much money do they want to pour into setting up a regulatory outfit that certifies who or what is an emitter?

I mean I'm breathing out CO2 with every breath. I might have split some wood from the tree I dropped in the garden and will be burning it this winter in the woodburner. So although I may be paying for emissions through some channels like petrol in the car, electricity through the wires, food I bought at the supermarket....I might feel obliged to buy some offsets for other activities not yet caught through any other means.

And whoops, I bought way too many credits.

And I only just figured this out after some period of time. Who can blame me if now I release my surplus carbon credits back into the market they've shot up in price?

 

Regarding the price going up for carbon credits = more revenue for the government, isn't the sad joke being that they were forced to release a whole bunch of credits at their lowest target price and now they can't sell them in future auctions where they have already set target price(s)? So in fact, lost revenue for the government.

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the emitters who have to pay are obviously already in the system . Your breath is tax free. Don't waste it . 

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I think the government should limit bidders to emitters

Effectively just having a user-pays approach to the cost of pollution. And those who clean up being rewarded - albeit we clearly need to adjust to respond to what's happening with forestry.

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Fascinating. I'd like to get some exposure to this. 

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Gubmint naivety about markets , behavioral economics, investor calculations is baked in.  They have few to no clues about such basic concepts as arbitrage, opportunity cost, time value of money to name only three.  Hence the emerging fustercluck which is the ETS. There isn't a big enough carpet to sweep this one under.......

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So...

How do I as a retail "investor" speculate on these carbon-coins?

NZX:CO2 or is there something better?

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Unless you're an overseas investor buying up big tracts of NZ land, sight unseen, to plant up in wilding pine, the answer is ETFs, which are listed on the NZX but carry counterparty risk.

In other words, like most investors who think they're buying gold, you don't actually own any of the underlying asset.

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In other words, like most investors who think they're buying gold, you don't actually own any of the underlying asset.

I wonder if they're allowed to manipulate the price like JP Morgan does with gold. 

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Seems to be the only thing I can find. I'm getting some. Looks like a doozy. 

 

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YOLO :)

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rogerdickie.co.nz

Own the land, the trees and the carbon.

There's a new offer coming available late Feb. Minimum inv $20K, then in multiples of $1K for any more shares.

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It's slightly amusing to me that agricultural, after lobbying to get a hard won exemption from ETS, still ended up directly downwind of the fallout. Either way it sounds like the tightness in supply will make this a strong buy.

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The Climate Commission has said that the carbon price needs to be around $140 by 2030 and $250 by 2050.  This is supposedly what is required to drag the rest of New Zealand away from fossil fuels. 

Total hubris from the CC.  Not a thought for the far greater likelihood that scarcity will overtake price as the determinate of where we get dragged to.

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This is the best thing ever for all those unsustainable hard hill country farms that need to be retired anyway. There are other trees such as redwoods and eucalypts that sequester carbon at good rates. Only other option is natural regeneration which takes generations to happen. Good opportunity for farmers to increase production on their better country using carbon money.

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Keith, what is the situation for forestry  planted in winter 2019 that is yet to be registered in the ETS? I think I have read elsewhere that no income from carbon credits is available until six years after planting, or is it after registration? Could such a planting be deemed to have an accrued unrealised value?

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As far as I can work out , Already planted trees,not registered, have a carbon value. While you cannot claim for cycles past , the trees will enter the ETS , with a value based on their average age. So a block of trees that average 5 years old , will enter the ETS at the 5 year rate , rather than starting at the one year rate per Ha.  

For pine in auckland, that is 59 units per Ha, vs 0.5 for year 1. multiple by $ 75  atm. 

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Had a reread , and am not sure I'm quite correct. The pines would enter the ETS, having 59 units under their belt , but not claimable. However year 6 is 98 units - 59 units in year 5 , so still  39 units earned in first year in , vs 0.5 for 1 year old planting. The time the seedling is grown in a nursery is not counted either. 

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Couple of points.

  1. If you have existing P89 trees not registered, after 31 Dec 2022 you will only have permeant forest as an option to earn carbon if more than around 10 years old (first rotation) or any second rotation forest that was clear land at 1990, if not REGISTERED by this years end.
  2. Keith is right in that if you have P89 forest planted in the 1990s and is not registered – get it in NOW – I would say if you have not applied in the next 2 to 3 months you will miss out.
  3. Carbon is going up all over the world – Australia is up over 100% and its not even a legal requirement. Other markets the same. NZ is not unusual or leading anything.

Heres a link to look at goings on around the world.

https://carboncredits.com/?sl=carbon-credits-home-ad&gclid=CjwKCAiA3L6PBhBvEiwAINlJ9Ic163vEDCFNH2JUhh-hX397z7xKGankQ3HDD4mAkO1ABi6c515YJhoCv58QAvD_BwE

Voluntary markets are roaring ahead of regulatory markets – IMHO these will be the ones to watch as they could end up driving the regulatory ones ie they will cannibalise the regulatory markets like the NZETS.

NFTs are coming/here for carbon – watch that space – we ain’t seen nothing yet.

The Cost Containment Reserve  - extra put in at auctions if required is the only carbon the Crown needs to actually back. Look for changes to the auctions soon.

A lot of the volume sold has gone to large financial institutions who are forward selling to large emitters – they hold the carbon and sell with a carry cost (interest) in the future. Everyone expects carbon to rise and interest rates to rise so in effect they are locking in a forward mortgage rate while rates are lower and start prices are lower as well. This effectively allows emitters to lock in future costs.

As such a lot of the volume out there now is committed forward – at some point the market will correct if volume keeps being added.

Farmers – DON’T SELL YOUR LAND – just had a farmer client ring – he’s just realized he has $1.5 million in carbon in acct now and growing – tried to explain this many times over the past 2 years. Very excited and animated discussion. As he said this is the only option he has to ever pay debt off on the farm plus he can retire and convert more land to trees  - native and exotic – while farming less stock better and more profitably. He said hes now going to vote Labour or Greens!!! Not sure if he was serious on that one!!

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Jack

"A lot of the volume sold has gone to large financial institutions who are forward selling to large emitters – they hold the carbon and sell with a carry cost (interest) in the future. Everyone expects carbon to rise and interest rates to rise so in effect they are locking in a forward mortgage rate while rates are lower and start prices are lower as well. This effectively allows emitters to lock in future costs."

That is a very insightful comment. I don't personally have the evidence to verify it, but it is totally logical. I doubt very much whether the Government saw that coming!
KeithW

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I think it is what they wanted. I have meet a couple of the people who designed and setup the auction system and they wanted liquidity in the secondary market so things such as forward options, contracts etc can be provided. These people are very experienced market operators. I don’t think James Shaw is worried about price – its going to drive the change they want. I see comments today from James Shaw

Shaw told Carbon News he was committed to balancing out the additional 7 million units released last year when the then $50 trigger price was breached.

“My officials are currently looking at the best way to achieve this. One option is an amendment to the volume of units available to purchase at future auctions.

“The changes we have made to the ETS in recent years mean it is, at last, functioning as it should be – with a cap on emissions that has put a genuine price on carbon. I am determined to keep it that way,” Shaw said.

Also comments today on radiata for permeant use – its highly likely this will change – in fact I would almost put a bet on it – I don’t gamble. Shame in some ways as if used properly has a lot of benefits for NZ and many land owners.

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Jack,
I think that the units available this year in the auction are fixed and the Minister does not have the power to change that.  Is that also your understanding?
But next year could be very different.
I can see a scenario where the price of carbon rises very rapidly.
A key issue is whether any changes re the rules for permanent radiata forests are aimed at control or prevention of these forests. 
Right now the Minister has a tiger by the tail. Maybe more than one tiger by the tail.
KeithW

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To be honest Keith I don’t know enough detail to comment on the auction volume side. Im sure they can alter if they wish as noted with the comments from James Shaw above – time will tell I suppose. Im going to ask a few other contacts tomorrow and if I find anything reliable I will let you know.

I think your right he’s got a tiger but I’m not sure he’s trying to hold it back to hard!! I think we all underestimate the intent to drive change.

Permeant radiata forest – well who knows – it will be out well before year end as the option to elect to go permanent opens then.

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It seems they can change the volumes this year. Not sure how or what they may do.

The limits and price control settings for the next 2 years (Y+1 and Y+2) can be changed only if certain conditions are met. These conditions include the cost control reserve being released, units being sold at the minimum price, a change to the emissions budget or our Paris Agreement target, or a significant change in one of the factors the settings were based on. 

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It's the old story: riding the tiger is easy. The dismount  however, is quite another matter....

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Jack,
I think you are correct re the intent of the original scheme designers. Economists are taught that emission trading schemes are better than emission taxes. They are using a criterion of 'economic efficiency'. One of the things they almost always fail to consider is asymmetry of information.   And that is one of the things that we have right now!   When playing the game, there  are huge advantages to those who have the best information as to how the Government is thinking.

Economists also understand the importance of liquidity in the market, and the design reflects that.
KeithW

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Agree – it works well when all the market is well educated with the same information at the same time.

Carbon was a side show until recently so not many people showed a lot of interest and the rules keep changing and are very complex.

Some big winners out there now.

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Very interesting. Thanks

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Buying land to plant exotic forests just on the strength of receiving carbon credits makes no financial sense. Option 1 is receive the carbon credits and then surrender them all on harvest. Carbon credits then are only a loan. Option 2 is adopt the averaging scheme and you have to maintain a perpetual forest. This liability will discount the land value. Either way planting exotic forests just on the strength of carbon credits makes no sense. Planting exotics for timber value makes economic and environmental sense – particularly when planting on marginal hill country. What would also make sense is incentivising permanent native forest. As a forest owner I have surrendered all my carbon credits in disgust – a poorly designed and run scheme

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Option 3, 

Option 2 but taking gamble that in 20 years time the scheme will be a write-off, literally, and you go ahead and harvest.

Fair bet?

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You can mill a sustainable amount (5% per year ???)   from a permanent forest , as long as you maintain the 30 % canopy cover. Hopefully we will have some nice exotic and native timbers available in 30 -50 years time. 

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Stu Smith

I hope you have assessed any liabilities you might have at harvest

Keith 

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