Emissions trading scheme has created a 14 billion dollar asset for big emitting businesses

Last week the web site Carbon News pointed out two seemingly unrelated records achieved by New Zealand's emissions trading scheme.

On 15 November 2022, the New Zealand secondary carbon market reached a new record maximum price of $88.50 per emission unit.

On 19 October 2022, the Environmental Protection Authority released an update of the total number of privately owned emissions units held in the Emissions Unit Register. It was also a new record. Private firms who must mostly be ETS 'participants' (i.e. emitters) held 158,897,263 emission units.

This chart of NZU spot prices shows what we already know: that prices have tripled in the last 24 months.

I put the NZU price movements down to two factors.

First: the emissions trading scheme price cap of the "fixed price option" (unlimited units could be surrendered for $25.00 until the end of 2019 and then $35 for 2020) was replaced by quarterly auctions of units from 17 March 2021 onwards.

Second: the Climate Change Commission keeps advising the Government that the price floor and price caps should consistently track upwards. The most recent example is the July 2022 Climate Change Commission advice NZ ETS unit limits and price control settings. It again recommended an upward trajectory for the carbon price floors for the emission unit auctions. This is Figure 7 from page 56.

Conventional thinking might be that a higher emission unit price is a good thing. A sign of the emissions trading scheme being finally fixed so that it reduces emissions. However, that is unlikely if the 'stockpile' of privately held emission units keeps growing. As this bar chart shows.

These holdings of units are current investment assets in the balance sheets of firms. That can be easily marked to market value by the latest record NZU price in the spot market. Which has just broken a record in reaching more than $88 per unit. And 158,897,263 privately held emission units valued at $88 each equals $14 billion dollars!

The stockpile of emissions units isn't a good thing as it threatens climate targets and the potential supply of emissions units to the market is just one of the many reasons why the emissions trading scheme does not cap emissions.

Conventional thinking might be that a higher emission unit price should incentivise firms to sell their units. Thus reducing the stockpile. However, this is not happening. The stockpile is growing and is now worth a whopping 14 billion dollars! This $14 billion will be an investment asset on the balance sheets of firms participating in the emissions trading scheme.

Recall my recent post about New Zealand Steel Limited consistently being allocated more units than they surrender. Their holding of units is always accumulating.

They don't sell any of their units for two reasons:

1. they don't need to because of the continual annual over-allocation of units under Industrial Allocation and,
2. NZ Steel Limited, having read the Climate Change Commission's advice to Government, expects the price to continue to rise - further boosting the market value of their "investment asset".

So why sell an investment asset when you expect it to appreciate? You don't. Your strategy is "hold"

Industrial allocation - free emissions units given to emitter industries in New Zealand

What is Industrial Allocation?

The Ministry for the Environment says

Allocations of New Zealand Units are given to businesses carrying out certain activities.

I prefer what Motu Research say. That one (out of five) ways of allocating emissions units in an emissions trading scheme is industrial allocation; which Motu define as

"Receiving them (emissions units) for free"

(See Leining, Catherine and Suzi Kerr. 2018. A Guide to the New Zealand Emissions Trading Scheme. Report prepared for the Ministry for the Environment. Wellington: Motu Economic and Public Policy Research)

I have posted in detail about industrial allocation to New Zealand Steel and to New Zealand Aluminium Smelters Limited

In both cases I argued that both companies were being over-allocated units. That these transnational corporates were given far too many emission units, well in excess of their direct (or Scope 1 emissions). And that such excessive allocations of units not only removed any price signal, they insulated the emitter from any emissions trading scheme price signal.

This over allocation is because the emissions factors used to calculate the unit allocations (allocation baseline) include overly generous compensation (extra units) for upstream energy cost increases caused by the NZ emissions trading scheme.

This concept of emissions trading scheme costs embedded in energy or electricity supplies is called the "Electricity Allocation Factor".

The Ministry for the Environment explicitly states that Industrial Allocation does not remove the price signal or result in over-allocation of units.

Businesses still face NZ ETS costs for a proportion of the emissions stemming from the activity. For example; highly emissions intensive firms face NZ ETS costs of 10% of their emissions

That statement asks you to ignore the extra emissions units allocated for these upstream ETS related energy costs. In the cases of NZ Steel and NZ Aluminium the ETS energy cost calculations result in far more units than 10% being allocated. Both NZ Steel and NZ Aluminium receive more emissions units than they surrender. They are almost always net sellers of units and not net buyers.

However, I want to look at Industrial Allocation in the round. How many emissions units have been given away since 2010? Is it a big number?

The Environmental Protection Authority annually publish data on the final industrial allocation of emissions units. So some analysis can be done.

How many units? The answer is fifty five million or 55,001,914 emissions units have been given away from 2010 to 2020.

This bar plot shows the 55 million emissions units year by year.

I will come back to the question 'is 55 million a big number?' in another post. Another question raised by the bar plot is 'why does the annual allocation increase after 2016? I will come back to that too.