Climate minister takes hands-off approach to carbon market

Analysis: Concerns the Government could artificially deflate the price of carbon have eased after Climate Change Minister Simon Watts announced new price controls and unit limits for the Emissions Trading Scheme that largely followed the advice of the Climate Change Commission on Tuesday.
In March, the commission recommended the Government drastically cut down on the number of units auctioned over the coming years in New Zealand’s carbon market, to help empty out a stockpile of banked credits polluters have assembled. Price controls should simply be adjusted for inflation, the independent climate watchdog also said.
The Government’s consultation on ETS settings largely suggested following the commission’s advice, but it did also offer up the possibility of reducing the price floor for carbon in quarterly auctions. This came after months of the secondary market price lying below the price floor, preventing auctions from clearing.
Lowering the floor might allow more auctions to clear – and thus bring in revenue the Government has earmarked for its tax cuts – but it would also further deflate the already depressed carbon price.
On Tuesday, Watts confirmed the Government wouldn’t be messing with the price controls.
“Our assessment in terms of the feedback we received indicated that the auction process was operating as it should be and there was no requirement for us to consider making any change in that space,” he told Newsroom.
When an auction fails to clear, the remaining units roll over to the next auction that year. At the end of the year, any leftover units are cancelled.
This means the Government has two tools for reducing the carbon unit stockpile at its disposal now. The primary one is still offering fewer units for auction. But the secondary benefit of auctions failing to clear (because the price floor has not been touched) is that this too could similarly draw down the stockpile through reducing unit supply.
The reason auctions are failing to clear in the first place is (at least in part) due to this oversupply. That leads to lower prices which leads to auctions failing.
The lower prices also jeopardise a key element of the Government’s climate strategy. While the ETS has for both sides of the aisle been the primary tool for reducing emissions, the coalition Government plans to rely much more heavily on it than Labour did.
This means the price needs to rise to incentivise decarbonisation. Otherwise, the Government’s much slimmer roster of complementary pollution-cutting policies won’t be able to meet New Zealand’s climate targets.
That is a large part of what motivates Watts’ hands-off approach, especially after Labour’s politically motivated tinkering with the market in 2022 led to a collapse in the carbon price and the current era of depressed prices.
However, there is one area where a heavier hand may be needed. That’s in industrial allocation – better known as free allocation – in which large emitters that are exposed to global trade receive some units for free to ensure they can fairly compete with overseas companies that don’t face a carbon price.
Under the new settings, from 2026 more units will be distributed for free than will be available for auction. By 2029, the Government is scheduled to auction just 2.4 million units while giving 5.5 million away free.
While the number of units allocated free may be reduced after a review of emissions baselines this year, there is still a longer-term problem for the scheme, which could continue to subsidise pollution long after the rest of the economy is meant to reach net zero emissions.
More structural reform of industrial allocation, however, is not on the table.
“We aren’t signalling to the market that we’re going to do a fundamental reform of … how that market works,” Watts said.
“I think the broader conversation is the discussions that I and my colleagues are going to and continue to have with the high emitter grouping of entities across the country. It is our expectation that those entities, and actually all entities, are playing their part in terms of emission reduction.”
In other words, the Government hopes the decarbonisation of big emitters will reduce that free allocation burden, rather than any market reform.
“The question is what is the role of Government in that. What we’re signalling very clearly to those entities and all entities is: Play your part,” he said.
“When you look at the big players, they’re a big driver of our emissions profile. We can do a whole lot of stuff to really turn the dial but some of those big players are the ones that are going to help us to ensure that we get to our targets at the pace which is required.”