WELLINGTON/SINGAPORE New Zealand's national emissions trading scheme, the first outside Europe, moves up a gear from July 1 but watered down rules, a flood of free permits and uncertainty over U.N. climate talks means the market could falter.
Banks and brokerage firms had been hoping the New Zealand carbon market would add another profitable layer to a $125 billion trade, especially given neighbor Australia's stalled scheme and lack of support for a climate bill in the U.S. Senate.
The New Zealand scheme began with the forestry sector in 2008 and from July draws in power generators, steel makers and transport. Combined, these sectors produce about half the nation's total greenhouse gas emissions.
But there is no emissions cap nor any limit on the number of free carbon permits for energy-intensive companies that export their products, such as New Zealand's largest listed company, Fletcher Building, and the country's only aluminum smelter, owned by Rio Tinto and Sumitomo Chemical
That, along with companies initially only having to surrender 1 unit for every 2 units of emissions, has led to accusations of some big polluters getting a free ride and that the scheme will fail to cut emissions of planet-warming gases such as carbon-dioxide.
"Between the period now and at least 2012, I think you won't find a huge market developing in New Zealand. There will be a market but it will definitely be nothing like what was originally envisaged," said Wayne King, managing director of advisory firm Carbon Market Solutions.
King also pointed to a mandatory review of the scheme set for 2011. This was creating uncertainty and fears about yet more changes after last year's major overhaul.
Under pressure from industry and its political allies, the government last year revised the scheme to allow all emitters between July 1, 2010 and Jan 1, 2013 to pay a fixed price of NZ$25 ($17.64) per ton of carbon liability.
But many analysts expect prices of domestic emission permits, known as New Zealand Units (NZUs), to fall well below that level, making it highly unlikely scheme participants would be interested in buying internationally tradeable Kyoto Protocol offsets called Certified Emissions Reductions (CERs). The scheme allows polluting firms to import unlimited amounts of CERs to meet their emissions obligations.
Benchmark CER futures are trading around 11 euros ($14.63) a ton on the European Climate Exchange.
Carbon analysts said there would be little offshore interest in the scheme.
"The delays, political wrangling and small scale of the market means it hasn't really been something to spend much time on," said Trevor Sikorski, BarCap's head of carbon research, in London.
A spokesman for Nick Smith, New Zealand's Minister of Climate Change, said it was likely prices of the units would be less than NZ$25.
Some trade-exposed emitters will receive up to 90 percent of their allocated permits for free at a rate that declines at 1.3 percent a year from 2013, effectively providing no incentive to cut emissions for years, greens and analysts say.
Power generators and transport firms will not be given free permits. Agriculture, responsible for the other half of the nation's greenhouse gas emissions, joins in 2015. New Zealand's largest company is Fonterra, the world's biggest exporter of dairy products, with annual sales of about NZ$16 billion, or about 7 percent of GDP.
Chief Executive Andrew Ferrier estimates the cost to his company will be NZ$25 million a year from July 1 and double that from 2013.
New Zealand's largest listed power company, Contact Energy Ltd, is similarly expecting initial costs to be about NZ$25 million a year. It said it would seek to participate in the market by buying units for below the capped price.
Analysts say it's hard to give a precise figure for demand and supply of permits in part because the government is still finalizing its allocation rules for firms receiving free NZUs.
The forestry sector will also be a major source of supply because trees capture and lock away carbon as they grow. As a reward, forestry firms will be given free NZUs totaling in the millions each year, although the exact amount depends on the number of forest firms that opt into the scheme.
Here, too, uncertainty over demand from big emitters, the price forest owners will get for their NZUs and exact carbon cost liabilities for harvesting or changing the use of their land have given forest owners pause over what to do with their NZUs. Many are hanging on to them for now.
At present they can sell them domestically, or convert them into sovereign Kyoto units called Assigned Amount Units that governments with Kyoto emissions obligations can buy.
So far, there have been a few reported trades involving forestry NZUs sold as AAUs at around 6 to 8 euros a ton.
Greenpeace called the scheme untenable and said it risked emissions rising for some energy-intensive companies because of the formula the government will use to allocate permits.
"It's about protecting the big polluters -- it's an enormous exercise in economic protectionism," said Greenpeace political adviser Geoff Keey.
(Additional reporting by Nina Chestney in London; Editing by Michael Urquhart)