Supply certainty means an ETS can set an efficient price.
To date, New Zealand has focused on the “trade” in cap-and-trade. We are long overdue for our own cap on unit supply and it is finally on the horizon. The role of the cap is to constrain domestic emissions and enable the market to set an efficient emission price in line with our targets. Since 2012, the government has had the option in legislation to auction units under an overall limit (essentially a cap) on auctioning plus free allocation, but this has never been actioned. In December 2018, the government announced its intention to begin auctioning under a cap in 2020.[i]
The choice of cap has distributional implications for the relative emission reduction responsibility and cost allocated to ETS versus non-ETS sectors and government (hence taxpayers) in order to achieve a given target. It determines how much money accrues to government through auctioning and how much gets sent offshore to purchase IERs. It also shapes perceptions at home and overseas regarding New Zealand’s mitigation ambition.
In our preferred approach,[ii] a volume-limited cap on unit supply would encompass auctioning, free allocation and a unit reserve for price management. The cap would not bind forestry or industrial removals. Banking would shift supply and smooth prices over time. The cap would be fixed in advance for a period of five years, extended by one year each year, and guided by a 10-year indicative trajectory (corridor) for emissions.[iii] It could be reviewed and adjusted more quickly in response to clearly defined force majeure events.
In the context of the Paris Agreement, the cap architecture in the NZ ETS must accomplish two critical goals: enabling the government to exert domestic sovereignty over New Zealand’s decarbonisation pathway, and sending a clear and credible signal to the market about long-term supply to guide ambitious low-emission investment.
[i] Genter (2018); Ministry for the Environment (2018c)
[iii] This differs from the auction model in the Climate Change Response Act 2002, under which the government announces the overall limit five years in advance but only years 1 and 2 are truly fixed, leaving years 3–5 open to adjustment with advance notice. In our model, each year 6 extension would be expected to have an immediate price impact across the preceding cap period because it would alter expectations of future supply, so there would be no need to adjust cap volumes for years 3–5.