Big picture, people

According to a tweet by the NBR, pundits are calling the Emissions Trading Scheme (ETS) dysfunctional after its $50 price cap was breached at Wednesday’s auction.

Big picture, people.

Wednesday’s auction was roaring success for the credibility of the ETS system, of the government’s emissions budgets, and of the political sustainability of a carbon price north of $50. The market told us it thinks carbon pricing is here to stay and that current and future governments will maintain the commitment to lower emissions.

As far as I know, Wednesday’s auction was functional and orderly, played out according to the legislated and regulated rules.

The market operator received bids. It determined an interim clearing price that was above $50. All 7 million units in the Cost Containment Reserve were made available for an offer price of $50. There were enough bids for all of those units to sell them all. The final clearing price was $53.85. You can read a step-by-step walkthrough of the price-setting process here.

Note that although the government offered those extra 7 million units at $50 a piece, it received the final clearing price for those units, $53.85 – fair market value at the time of the auction. Later, market prices shifted to reach $59 the following day.

The breach in the price cap was not surprising. Prices for New Zealand Units (NZUs) were trading above $50 on secondary markets in the days leading up to the auction, a clear sign that a breach in the price cap was a possibility.

Remember, the reason why the price cap can be breached at all is because of changes in 2020. The government exchanged price certainty for quantity certainty. That is, it gave the ETS a hard emissions cap, with the tradeoff being a soft price cap. Until 2020, it was around the other way. The government would issue unlimited emissions units to defend the price cap, thus raising emissions. Now it only has 7 million units to defend the cap.

The extra units issued to defend the cap will not raise emissions. The legislation requires any extra units must be backed. That means the government must offset the extra units elsewhere so that overall emissions do not increase. The government can choose to back units here or overseas, and it has at least three years to solve this (non-trivial) problem.

Structurally, this is a sound setup. Combining a price cap with a backing rule gives the government a way to manage the domestic carbon price, which is essential, without putting the country’s emissions track at risk. However, while the structure is right, settings need to change because as it stands the government does not have control of the domestic carbon price.

Governments need control of the domestic carbon price to protect the system. The ETS and emissions reduction more generally has to be politically sustainable every day between now and 2050 and beyond. I will talk about this further in future.

The outcome from Wednesday’s auction was predictable and inevitable. The process which delivered it was fully functional.

Wednesday was also a significant win for the environment, a vote of confidence in the commitment to lower emissions and reach its emissions targets, and that the ETS – widely understood to be the most effective tool we have to lower emissions – is here to stay.

That is worth celebrating and is a credit to the Climate Change Minister James Shaw.