On Wednesday September 1, The Government lost control of the ETS to speculators. This has big implications and challenges for the path ahead.
The September 1 2021 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 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 supposed maximum of $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.
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 1September, 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 per 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 4.75 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.
Posts from Keith Woodford 
Keith, so what are the consequences of the cap price breach? Is someone going to jail?
Seems to me that there’ll be a lot of see-sawing as this very new and volatile market settles down to a bit of order, based on genuine demand for settling C debts and surpluses.
If Shaw wants to drop the price , then all he has to do is sell mega units. We saw what happened when mega Ukrainian units were deliberately employed to drop the price by the Key Govt. That worked wonders in the opposite direction!!
Cheers for revealing these actuals Keith, no other media has had the balls to expose this faux -pas of Shaws. Keep it up.
Alan,
I don’t think anyone will go to jail.
But the possibility of a civil case is interesting.
At the 1 Sept auction the cap was breached by just under $4 and this is probably insufficient to make a case worthwhile.
But that could change if the cap is breached more seriously in December.
Civil cases are expensive to prosecute. The big emitters are protected by their free credits. So it would need to be a class action by the smaller companies.
Keith
This was not a CAP! This was a Cost Containment Reserve and there was clear guidance about how this worked and the volume triggers in play. There was no guarantee that the price would stay below $50, there was only a contingency plan to assist in keeping it below. It was always very clear that if the CCR was emptied then the top pricing control was gone.
Calling it a cap is false information.
Jack,
Technically you are correct in that the $50 was the ‘trigger price’ to release the cost containment reserve. But no one in Government ever foresaw a possibility that the the cost containment reserve would be blown away by the action of the speculators. So the $50 which is a legal trigger price that can not be increased within a calendar year was widely described as a maximum. The term ‘cap’ strictly speaking relates to the total number of emissions to be allowed within the economy. The exhaustion of the cost containment reserve leaves the Government in a challenging position as to how they will now manage the next auction in relation to the cost containment reserve and that cap.
Keith
Oh dear.
Fancy that, a socialist Labour/Greens construct being torn apart by those who actually understand markets!
By the way, I’m not saying that while pretending here that I understand markets but this is seen so often when governments create these artificial incentives.
100% right. Its a legislated market and worse it has a controlled unit release so was always going to be milked. Is there a public ledger of who purchased these units?
How many current or former politicians ( in their Trusts no doubt) traded units
But regardless, how dare all recent governments endorse such a fraudulent concept and create the massive land use distortion occurring again.
The lesson should have been learned incentives for clearing marginal land in the 1960/70’s.
Unsubsidized products trading in untainted markets is the only fair exchange.
The ETS will never fit that.
The sanctity of Property Rights is key to a prosperous society, but I cannot endorse a legislatively created C unit system failing having any rights to compensation from taxapayers.
It’s not to do with markets – that was the kind of thinking that got us in our compound messes (CC being only the exhaust gasses of our energy frenzy; Catton called us Homo Colossus in his 1980 book Overshoot).
You cannot trade this stuff, you have to have absolute limits – and that is easier at the pump than at the exhaust-pipe; we needed rationing, with ever-tighter limits.
But nobody will accept that, so it won’t happen. On markets, ask yourself this: If money is digitally keystroked into existence as debt (it is) and only fractionally-backed by bits of paper and hope/trust (it is) and it takes $3.50 of debt to ‘create’ $1 of GDP, what is ‘ money’ worth anymore? The debt cannot be repaid (planetary Limits to Growth – as per Gaya Herrington, KPMG Director: https://www.clubofrome.org/blog-post/herrington-world-model/ ) . Thus the need for physical rationing. Shaw dropped the baton. Maybe he was outvoted, who knows?
Murray,
You have said yourself that physical rationing will not happen. So what is the solution?
In my mind I foresee a system whereby every adult gets an annual ration of petrol and an associated smart card to access that ration. Rations can also be traded electronically, just like a bank transfer. That would give every adult the same fundamental access to petrol regardless of economic status, but those who think they need more would have the right to purchase more from those who don’t want to use their ration, or prefer to sell their ration for cash.
KeithW
Wah wah wah. Looks like its now more expensive to create emissions. Who cares who is buying the units. If it results in less emissions then its a good thing…. Unless your a supporter of the emitters Keith?
Jack,
I don’t think it is that simple.
At some time the units purchased as a hedge have to come back into the market.
The Govt has to work out a way to manage that.
Until now, the Govt thought it was in control of the carbon market by making the rules and then also playing the game itself.
But the speculators, acting individually but with a collective effect have shown that right now they are running the game.
Keith
So you want a communist type regime to overrule who can purchase commodities in this country. I guess we better start limiting how many share people can purchase of companies too because god forbid they were to make money from them. I understand your sentiment but a free market is such that. If private individuals/institutions want to invest in carbon then why shouldn’t they be allowed too? These transactions create future liquidity and remove the power from the EMITTERS who would be running the show in these auctions without the individuals/institutions.
All we need next is for agriculture to be included property so they can stop getting a get out of jail free card. Our current emissions reductions are pitiful and we need to change. There will certainly be a lot of complaining (like from yourself) about the fairness (or unfairness) of these settings. However, we need to inflict pain on the emitter if we are ever going to combat climate change and actually make a difference.
Jack,
At no time have I said as to how the Government should unscramble the egg. What I have done is point out that the egg is scrambled and how that creates particular challenges. The Government is now caught between a rock and a hard place and getting out of that situation will involve policy trade-offs that are going to upset some people.
KeithW
Love your work Keith! Putting aside the current pricing madness for a moment, if the expectation is that the ETS price will reach levels of around $150/tCO2e by 2030, and it is already more profitable to grow trees than sheep and beef at current ETS prices, then doesn’t that mean that a lot of our farming is bound to end up as forest if the ETS prices behaved as intended? Is there any alternative you see here?
Tony,
Unscrambling an egg is always challenging!
All of my recent forestry articles have focused on the financial and economic aspects because these are what drivee investment behaviours including land-use decisions. At some stage I want to look at some broader issues, recognising that the NZ-led economy is export-led and that primary industries currently comprise 83% of exports. Yes, that figure is correct! And carbon forests as currently set up do not earn foreign funds. There are also complex social and ethical issues around the appropriate social rate of discount – i.e. how much weight should we put on the long term future when those of us here now will no longer be here. But so far I am still building a foundation for those discussions as a prior need is for people to understand the financial incentives for permanent forests, as it is these financial issues that drive individual and hence collective behaviours.
KeithW
Hi Keith, I am close to Hastings and at present the best use of my land is in Forestry for credits, Im just having issues getting trees but once sorted this farm will start to disappear under a canopy of some sort. This includes my flats.
I talked to a Forestry manager last week, trying to plant 2000 hectares, for a German company I think. He told me in 23 years that forest will have 170,000 truck loads of logs. He thought our infrastructure wouldn’t cope. Up one valley there is 10,000 hectares going in, 1 million trucks that Napier or Gisborne ports, our roads and rail could never cope with, including any other port in the country.
I think Pine captures 32 tonnes a year pr hectare, thats $1800 a hectare, Tree nursery told me Eucalypts are the way to go capturing %50 more than pine or at present value $2832 a hectare but Nursery thought Gums could get to $3500 a hectare, goodbye sheep ,beef, cropping and dairy.
Andrew,
My current thinking is that most of those forests will not be harvested. I expect the current Chinese demand to taper off over the next ten or so years. And unlike some people, I am cautious about new markets emerging.
I agree that eucalyptus trees have lots of potential. I recall when I first went to Peru on mountaineering endeavours in the 1970s being fascinated by the fact that eucalypts from Oz had become the major tree species up on the Altiplano. I have also much more recently seen them become the dominant production tree in Uruguay and in Chile, also all from Oz, when I have been in South America on agricultural endeavours. An amazing genera of trees that flourish in widely differing environments. But I have more to learn about their NZ potential.
Keith
Hi Keith
Great article.
One solution to speculation would be for the govt to issue carbon credits with a 1 year expiry date. After the year has elapsed and the credits haven’t been used they are forfeited back to the govt at the market price they were purchase for hence eliminating any opportunity for speculation. The market would still function as only organisation’s needing to purchase carbon credits will do so.
The market would lose the ability to forward hedge but the ETS is setup to change behavior
Paul,
One of the points I have not made but perhaps should have made is that some of the people buying these units have been doing so as a risk management tool. They know they have liabilities coming up and are trying to cover that risk in advance.
Keith
keith great article and a good attempt to look at the future of logging /as well as carbon farming;
You mentioned that methane emissions were not as toxic as nitrous oxide ;
Question do you know whether there has been much progress with vaccines etc?
David,
The big challenge with vaccines is that they have to act within the stomach system rather than within internal organs. am not optimistic. In contrast, feed additives are promising within zero-grazing systems but so far are not successful in pasture systems.
Keith
Hi Keith,
Regarding the research focus on methane vaccines that target rumen methanogens: conversely, how much work is going into maximising the effect of methanotrophs, both in-situ in pasture soils and in on-farm methane point-sources like effluent ponds. I wonder to what extent different pasture management practices might affect soil biological activity including that of methanotrophs, which from what I can tell are aerobic and function better in free-draining, uncompacted soils.
thanks, Richard
Richard
As far as I know, very little.
I was myself part of a team led by process engineers at Canterbury Uni that developed a proposal to undertake some work related to these little critters that convert methane to carbon dioxide. But alas, last week we were told by Govt that our proposal was not funded. These proposals take a lot of time. But proposals that lie outside the existing dominant paradigms and existing research streams of work always struggle to get funding. This particular proposal required some ‘science stretch’ and without doing that work we could not say whether or not we would be successful. We will probably have another go at funding next year, but each year that goes by is a year of wasted time.
Keith
Thanks Keith and some great discussion;
So looks like a matter of time before the animal farming community get pinged; and with no way to mitigate the methane except cutting animal numbers;;
Does it make sense then,despite the shambles of carbon trading, to plant 40 hectares pinus 40 ha of redwood and 10 ha of totara to offset this impending problem?
Also any comments on bromoform?
Any breeding possibilities?
davew
Pingback: The carbon price marches on | Posts from Keith Woodford