An Effective NZ ETS: Clear Price Signals to Guide Low-Emission Investment

Smart investment needs    
Clear ETS price signals    
Set caps with price bands    

Early in 2016 Motu Economic and Public Policy Research gathered together a group of participants from diverse backgrounds and sectors to engage in a deep dialogue on key issues that affect the New Zealand Emissions Trading Scheme (NZ ETS) in order to generate new insights and strategic options to improve its effectiveness.

Backed by a series of four working papers and four meetings in Wellington, dialogue participants came together in March 2017 to discuss an integrated proposal for managing unit supply and prices in the NZ ETS in a way that generates more predictable price signals to guide domestic decarbonisation. This document presents the proposal that emerged from the group’s work, namely:

1. Near-term supply constraint to guide price: A “Cap” – a fixed amount of emission reduction units distributed by auctioning and free allocation each year – establishes the supply constraint which enables the market to generate pricing signals. The Cap is set annually for five years in advance and extended by one year each year.
2. Near-term price safeguards: A “Price Band” (Price Ceiling and Price Floor) enables adjustment of unit supply within the Cap via a Unit Reserve to safeguard against near-term price risk and allow gradual transitions to long-term price changes. The Price Band is set annually for five years in advance and extended by one year each year.
3. Long-term signals: Future decisions on Caps and Price Bands are each guided by indicative ten-year trajectories (i.e. an upper and lower limit, or corridor, for emissions from ETS sectors and emission prices).
4. Independent review and advisory mechanism: An independent body reviews the ETS supply and price settings to inform government decisions.
5. Managed access to international emission reductions: All international emission reductions applied toward New Zealand’s targets will be quality assured to manage risks with environmental integrity and other considerations. They will be directly acquired by the government (the only option available for the foreseeable future under the Paris Agreement). In the longer term they may also be acquired by ETS participants (if this option is enabled under a future market mechanism). In this case, the quantity must be limited and displace other supply under the Cap.