In response to readers' questions around last month's carbon feature, Element asked Ben Coleman, director, commodities, carbon and energy at Westpac to comment on the past, and the future, of New Zealand's carbon market.
1: What have we seen in the first two years of the NZ ETS?
Westpac played a critical role in the establishment and commencement of the New Zealand Emissions Trading Scheme (NZ ETS), as the first financial institution to make a market and facilitate transparent price discovery. Trading in the NZETS began in April 2010, with Westpac publishing a two-way price for buying or selling New Zealand Units (NZUs). Over the first six months activity involved parcels of spot New Zealand Units (NZUs). As participants gained more experience in carbon markets, international units such as Assigned Amount Units (AAUs), Certified Emission Reductions (CERs), Emission Reduction Units (ERUs) and Removal Units (RMUs) were all traded.
Today, market activity includes spot and forward transactions of all eligible units, spot and forward swap agreements and repurchase agreements. Considering its size, the market is reasonably efficient and liquid. Participants have good indications of where carbon units are trading and the market has linked well with the international market.
2. Why has the carbon price fallen so far?
Participants who have liabilities under the NZETS have the choice to either purchase and surrender NZ domestic units such as NZUs or international offset units such as CERs, ERUs and RMUs. As such NZUs are 100% substitutable with international units and emitters will usually purchase the lowest cost unit to surrender for their annual emission liabilities.
The price of international units trade as a function of supply and demand and the international market is currently massively oversupplied and hence the price of carbon has fallen to record lows. There are several reasons for the lower international price including sluggish European economic growth, new energy efficiency standards to drive lower emissions throughout Europe, more CERs produced through United Nations schemes than the market expected and a massive supply of ERUs coming from countries such as Ukraine and Russia which has flooded the market.
As a result the international price has fallen and NZUs have been dragged lower at the same time. NZUs however are trading at a premium to these international units as the local supply of NZUs remains tight due to foresters holding their units. In addition NZUs remain the unit with the least risk of ongoing regulatory change within the NZETS.
3. Crystal ball: what will happen to international carbon markets in 5, 10, 20 years?
Climate change is of increasing importance to governments around the world due to the impact of rising temperatures. To reduce the impacts of climate change the world needs to reduce the amount of greenhouse gases that are released into the atmosphere. The most effective way of reducing greenhouse gases is to put a price on them thereby ensuring people factor the externality into their decision making.
On this basis it is reasonable to assume that 1) the volume of carbon traded will significantly increase over the next 20 years as more of the world prices the greenhouse gas externality; and 2) the price of carbon will increase thereby encouraging emitters to reduce the amount of greenhouse gas released from their operation by changing the way they do things.
