Analysis: NZ carbon scheme faces first challenge

WELLINGTON/SINGAPORE Wed Jun 15, 2011 6:13am EDT

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WELLINGTON/SINGAPORE (Reuters) - From moribund to modestly active, New Zealand's carbon trading scheme has picked up since the entry of big polluters a year ago but faces a major challenge in how to ramp up pressure on firms to take more steps to cut emissions.

The emissions trading scheme, or ETS, remains the first national scheme outside Europe's $120 billion a year program.

Industry is questioning whether New Zealand should toughen its scheme given the glacial pace of U.N. negotiations on a new climate pact and slow progress in other competitors in bringing in a national price on carbon. Neighboring Australia is struggling to win support for its carbon pricing plan.

A toughening could boost trading of pollution permits in the ETS, deepening the market, which is currently limited by availability of tradable New Zealand Units, a price cap of NZ$25 for NZUs, lack of national emissions reduction target and a series of sweeteners for industry during the first phase to end-2012.

Each NZU represents a tonne of greenhouse gases.

Climate Change Minister Nick Smith declared the past year a success, saying trading had been in line with expectations.

"There is broad acceptance across the business community as to the merits of an ETS, but there still remains some quite difficult decisions about the pace of which we advance this scheme forward," Smith said.

The three-year old ETS was expanded on July 1, 2010, when the transport, industry and energy sectors, which account for about half of the country's emissions, were included.

Since then, average weekly trade of NZUs in the over-the-counter market has averaged about 300,000, according to data from Thomson Reuters Point Carbon. Forestry was the first sector in the ETS, which started in 2008.

"We really have pioneered something in terms of emissions trading insofar as how the market was regulated. I don't think we've pioneered anything in terms of markets," said Richard Hayes of EITG, a carbon project developer and advisory.

EITG joined other firms in submitting recommendations to the government as part of a mandatory review of the ETS that will be released on June 30.

The ETS is meant to fight climate change and cut New Zealand's greenhouse gas emissions, which are far above the level pledged to the United Nations under the Kyoto Protocol.

Polluters such as coal-fired power generators, refiners and cement plants have to buy NZUs to meet government-set emissions obligations, while foresters are given NZUs for the carbon locked away in their trees. Exporters are given a large number of NZUs for free to equalize carbon costs with competitors.

Hayes has called for rolling issuance and surrendering of NZUs, instead of set annual dates for these, to ensure smooth supply and reduced costs for market players.

SWEETENERS

Smith declined to comment on changes the government will look at. But it is expected to include the possible extension of sweeteners, such as surrendering only one NZU for every two tonnes of emissions, beyond the current expiry date of 2013.

Agriculture, a major export earner and which accounts for almost half of emissions, enters the ETS in 2015. Dairy exporter Fonterra is New Zealand's largest company, and is still liable through its milk processing operations.

New Zealand was exposed to greater emissions costs than other agricultural producers, so it was imperative transition measures remain until competitors move to similar schemes, said Fonterra's General Manager Sustainability John Hutchings.

Greenpeace said the sweeteners offer a lifeline to heavily polluting industries and are not sending a strong enough message to change long-term investment decisions.

"This will render the ETS ineffective and risks locking New Zealand into a high-carbon, inefficient economy," campaigner Nathan Argent told Reuters.

State-owned Genesis Energy, which operates New Zealand's largest power station, said it also wants the transitional measures to continue, and it also want to see greater depth and liquidity in the market.

"What companies like ours need is certainty of policy and liquid markets in which to function," Genesis Public Affairs Manager Richard Gordon said. "We can cope with the ETS, we can live with it, but we need certainty."

Both Genesis and Fonterra said they have been active in the market since July last year, however both companies said there were issues with market liquidity, with too few credits coming to market.

Hayes said another major problem was lack of information.

"There's an absolute lack of concrete, discoverable and open information and that has a pretty significant downstream effect the operation of businesses."

Lack of supply has seen spot prices for NZUs slip over the past few months to sit below NZ$20, which Fonterra's Hutchings noted was likely due to sellers, which are mostly foresters, sitting on credits awaiting better prices.

The Ministry of Agriculture and Forestry says about 14 million NZUs have been issued to date to forest owners that fall under Kyoto Protocol rules and that about 57 million will be issued during the 2008-12 period.

The government also estimates nearly 12 million NZUs will be given to exporters by end 2012.

Carbon consultant Stuart Frazer said the market was currently narrowly focused on compliance, and it would not develop into a fully liquid market until it had reached a point where secondary traders were active in the market.

The price cap is also limiting the chance for polluters to buy U.N. carbon offsets called certified emissions reductions, currently trading around 12.40 euros

($17.85).

The ETS allows these to be imported and used for compliance and a recent drop in the value of the euro, CERs and strengthening New Zealand dollar saw polluters snap up large volumes of CERs before currency movements priced out U.N. units.

Smith reiterated the review would be influenced by the progress of international negotiations.

Frazer said there were risks with pegging the scheme to international progress and that the government could lose focus on the way scheme could best function.

Smith also believed the ETS was lowering emissions and encouraging greener investments.

Greenpeace disagrees, saying many decisions were still based around fossil fuels, such as State-owned miner Solid Energy's plans to mine lignite to convert into liquid fuels.

($1 = NZ$1.22)

(Editing by David Fogarty and Manash Goswami)

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