Why New Zealand’s Carbon Emissions Trading Scheme auctions are exciting investors

The environment is not the only winner as New Zealand steps up its fight against greenhouse gas emissions, says our New Zealand Country Director David Ritchie.

New Zealand is holding regular “carbon credit” auctions as it steps up its fight against greenhouse gas emissions, offering exciting opportunities for market traders and hedge fund investors.

The New Zealand Emissions Trading Scheme (NZ ETS) was set up in 2008, making it one of the first countries to establish an emissions trading scheme to counter the threat of climate change.

In essence, the scheme puts a price on emissions. All sectors of New Zealand’s economy apart from agriculture pay for carbon pollutants through it, making it one of the world’s most wide-ranging emissions trading schemes.

The NZ ETS is the New Zealand Government’s primary tool in its long-term commitment to reduce greenhouse gas emissions, in line with the 2050 target set by the Climate Change Response Act 2002 and the global goals in the Paris Agreement. Reforms introduced last year put a cap on emissions covered by the scheme.

The scheme offers fresh trading opportunities for experienced operators wanting to expand. Those joining the NZ ETS face compliance obligations; for example, an entity coming to New Zealand from an overseas base must satisfy corporate residency conditions to take part in the scheme.

How the NZ ETS works

In some countries, emissions trading works around so-called “cap-and-trade” schemes. The NZ ETS specifically trades in “carbon credits” known as New Zealand Units (NZUs), which can be held and sold by secondary market traders and via live bidding at the quarterly auctions.

Energy and heavy industry companies are the main polluters. Traders buy credits from those removing carbon from the atmosphere and sell them on to companies requiring additional permissions to emit, creating a market.

By restricting the total number of credits in the system, allowable emissions in any year are limited. If a business is given too few credits to cover its expected emissions, the price of each credit rises according to the rules of supply and demand. Consequently, businesses must decide whether to buy credits or decarbonise production; often, it will be a combination of both.

Over time, the New Zealand Government can further reduce the number of NZUs available in line with its emission reduction targets.

The scheme helps reduce emissions in three main ways:

• It forces businesses to measure and report on their emissions
• Businesses must surrender one NZU to the Government for each tonne of emissions they generate in a year
• The number of NZUs available to emitters is limited under the scheme

In a similar way to how the financial system efficiently allocates capital around an economy, carbon traders facilitate effective distribution of carbon credits. Eventually governments expect such schemes to reduce and eliminate carbon discharges. In the meantime, open-market trading in carbon credits is building an invaluable framework for minimising pollution.

Potential of the emissions trading market

There are currently around 40 market participants in the New Zealand scheme. Auctions, managed by New Zealand’s Exchange (NZX) and the European Energy Exchange (EEX), are run every calendar quarter, generating around NZD $200m.

As participating businesses buy and sell units from each other, this price signal allows companies to make economically efficient choices on reducing emissions and provides an incentive for them to reduce their emissions.

The price of New Zealand carbon has risen dramatically since the 2020 reforms, increasing from about NZD $25 per unit to about NZD $42 in the last auction.

The market-led solution is growing fast globally and is predicted to become one of the most important segments of the commodities trading sector. Hannah Hauman, Trafigura’s head of carbon trading, told a recent conference hosted by the Financial Times that carbon had the potential to be ten times bigger than the crude oil market.

Investment institutions including hedge funds are raising capital aimed at capturing returns from the reducing supply of carbon credits and corresponding increases in their value. At the same time, they provide necessary liquidity to ensure smooth market operations.

How Intertrust Group can help

Intertrust Group’s New Zealand office can help you set up a structure to participate in the NZ ETS scheme. We can assist with the compliance obligations and demands that come with NZ ETS membership. Also, ongoing entity maintenance providing governance and local support.