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.
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!
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:
they don't need to because of the continual annual over-allocation of units under Industrial Allocation and,
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"
In the wake of the Morgan Foundations hard-hitting report "Climate Cheats", Simon Johnson (aka Mr February) asks if New Zealand Steel received millions of emission units for free under the New Zealand Emissions Trading Scheme industrial allocation provisions and yet still bought millions of the dubious international Russian units (ERUs) to make windfall arbitrage profits. (N.B. 1 March 2017, I have added an 'Addendum' which is more detail about "ETS-electricity-pass-through costs" in response to a commenter at the cross-post at the Hot Topic blog.
The Morgan Foundation's latest report "Climate Cheats" has been sizzling across the various media in the last four days.
The language of the report is refreshingly non-neutral and unashamedly emotive. It is in equal parts compelling and condemning.
Carbon credit scheme a farce, reported the Herald. Climate change cheating, said Radio New Zealand. Dodgy deals, climate swindle, climate fraudsters, junk carbon scam, said report author Geoff Simmons.
As a consequence, "Climate Cheats" is an easy and engaging read - no mean feat given the topic - that is also thoroughly well-researched. It really is a 'high integrity' credit to it's authors (if you pardon the pun).
In this post I want to look specifically at one particular type of corporate conduct - arbitrage profiteering - covered in "Climate Cheats".
Geoff Simmons, on page 28, describes arbitrage like this:
"Meanwhile polluters in New Zealand benefited through a collapse in the price of emissions, while some even creamed off profits by exploiting the price difference between different types of carbon credits."
How does an emitting company make an arbitrage profit in an emissions trading scheme? I think a data-driven worked example might be informative.
the number emission units to surrender under the NZETS, I estimate as half of the emissions under the "two-for-one" deal
and the number of any of Geoff Simmons favourite dodgy Ukrainian or Russian Emission Reduction Units owned by New Zealand Steel, as compiled from the EPA Emission Unit Register.
Let me sum that up in a table.
New Zealand Steel free unit allocation, greenhouse gas emissions, and NZETS surrender liability and ERUs
Year
2010
2011
2012
2013
2014
Units allocated
494,704
989,304
1,003,730
1,029,352
1,073,489
GHG emissions (t)
1,646,890
1,736,250
1,718,930
1,747,500
N/a
Estimate of units to surrender
411,722
868,125
868,125
873,750
N/a
Allocation less surrenders
82,982
121,179
135,605
155,602
N/a
Allocation/Liability (per cent)
120%
114%
116%
118%
N/a
Emission Reduction Units owned at 31 December
0
0
0
1,022,527
1,001,714
Let's visualise that dense data into a bar chart.
The first conclusion I draw from the chart is that in each year from 2010 to 2014 New Zealand Steel's free allocation of emission units (the purple bars) always materially exceeded their estimated liability to surrender units (the mid-pink bars) to match actual emissions.
The surplus units were not needed to compensate for increased energy costs caused by the NZETS as the NZETS did not cause any energy costs to increase. The free unit allocation was and is simply a transfer of wealth to New Zealand Steel in the form of a tradable right or voucher (the NZU emission unit) that is highly liquid.
The second conclusion is that although New Zealand Steel never needed to buy any extra emissions units to surrender under the NZETS, New Zealand Steel still owned about a million Emission Reduction Units at the end of both 2013 and 2014
So if New Zealand Steel always had more than enough free units to meet it's obligation to surrender units under the NZETS, why would it also buy international units? There is only one plausible answer. It is to make an arbitrage profit.
Why am I so sure New Zealand Steel carried out arbitrage trades with its NZUs and surrendered cheap dubious ERUs rather than the free gifted NZUs for 2013 and 2014? It's the maths.
If New Zealand Steel had used its free NZUs to meet its 2013 unit surrender obligation, the number of NZUs would have to be roughly consistent with my estimate of half of it's emissions or 873,750 units. All NZETS emitters collectively surrendered fewer units (732,667) for 2013! It is mathematically impossible for New Zealand Steel to have met those surrender obligations with NZUs. It must have used ERUs.
Here is a hypothetical example of what New Zealand Steel might have done.
According to a Carbon Forest Services webpage that tracks emission unit prices, on 11 October 2013, New Zealand units (NZUs) had a market price of $4.20 each and the Russian or Ukrainian Emission Reduction Units (ERUs) had a market price of 35 cents each. One NZU was worth 12 times as much as an ERU.
If New Zealand Steel had purchased 1 million ERUs on 11 October 2013 at 35 cents each or $350,000, it could then surrender 873,750 of them to the Government to match it's 2013 emissions.
Based on that 'if', New Zealand Steel would then be in a position to sell all the 1,029,352 New Zealand units of the 2013 allocation at $4.20 each for a possible value of $4,323,278. The hypothetical profit would be $3,973,278.
Alternatively New Zealand Steel would keep the 1,029,352 NZUs and wait for their price to appreciate. In that case, the hypothetical but unrealised profit would be greater than $3,973,278.
That is just one possibility based on NZU and ERU prices on one date. I suggest you browse over to the Carbon Forest Services emission unit price chart and hover over it to see the differences between ERU and NZU prices from early 2013 to 2015.
Even when NZUs hit a historic low price of $1.60 in February 2013, they were still 9 times more valuable than ERUs. Choose your own combination of price difference and possible profit from buying ERUs and selling NZUs.
Note 6 Other Income says that in 2015 Carbon Permit income was $AUD 4.4 million. Footnote (a) says that the income is from the NZETS as the Australian Carbon Pricing scheme was abolished in July 2014.
Note 7 on page 63 says that 'Direct carbon emission expense' was a credit of $AUD 1 million.
Footnote (d) page 64 says that the current year carbon emission credit was due to the carbon 'true-up' of the Port Kembla steelworks.
So Bluescope Steel Australia made a carbon profit both sides of the Tasman! New Zealand Steel made $AUD 4.4 million out of the NZETS. So much for facing a carbon price at the margin!
Conclusion
New Zealand Steel really have achieved the ultimate emission trading scheme "two-for".
New Zealand Steel received a free allocation of emission units that is greater than the number needed to surrender for emissions. The availability of the cheaper imported Russian and Ukrainian international units highlighted by "Climate Cheats" gave New Zealand Steel the opportunity to make windfall arbitrage profits. New Zealand Steel did not pay a carbon price at the margin. New Zealand Steel probably made windfall arbitrage profits.
It seems that the more free units you give a company, the more it abuses the privilege of having an emissions trading scheme. "Climate Cheats" gives us an excellent history of the deeply unethical way the National-led Government has managed the New Zealand Emissions Trading Scheme. The whole scheme is now so morally compromised it has no valid ethical basis to continue. Where I differ from the Morgan Foundation is what to do about it. They want to fix it. I think it should be abandoned.
I think overall you are probably right that allocation has been a windfall to NZ Steel.
But there are some things that your analysis seems to be missing. NZ Steel are the second largest consumer of electricity in NZ and the electricity market passthrough costs (not emissions) associated with this form part of the Govt’s compensation. This means that the windfall might not be as large as your analysis suggests (as their ETS costs depend on more than just their direct emissions).
My reply was;
Troy,
Yes I skimmed fairly lightly over the issue of ‘NZETS energy/electricity market pass-through costs’. It is a very wonky issue to blog about.
It all depends what the NZETS ‘energy/electricity market passthrough costs’ to New Zealand Steel actually are. These costs must have declined if emissions units prices drop from dollars to multiples of ten cents. I think I am fairly safe in assuming they are insignificant if not zero to NZ Steel. Check these references.
Officials supporting the 2012 Finance and Expenditure Select Committee queried the five major electricity generating companies about NZETS costs flowing through into wholesale electricity prices. Their reply was; “costs being passed through directly from the NZETS are not visible or distinguishable due to the wholesale market pricing mechanism and these costs are not directly passed through due to competition factors”.
The New Zealand Emissions Trading Scheme evaluation report 2016 states on page 38;“The prices of emission units have been too low to affect business costs either for participants or those who receive costs passed down from participants”.
In this post there is still a gratuitous image of Marlon Brandon as the Godfather but the post is about one of NZ's biggest companies; New Zealand Steel. They just opposed the possible ending of the supposedly temporary "two-tonnes-for-one-unit" deal. That's a bit rich when their idea of the ideal "two-for" is to receive millions of emission units for free under the New Zealand Emissions Trading Scheme industrial allocation provisions and yet buy millions of the dubious international Russian units (ERUs) and make windfall arbitrage profits.
"The one-for-two surrender obligation allows participants from the liquid fossil fuels, industrial processes, stationary energy and waste sectors to surrender one unit for every two tonnes of emissions (ie, a 50 per cent surrender obligation)."
However, Garey has his facts wrong in assuming the loss of the two-for-one deal will increase his NZETS liability. On page 13 of the NZETS review discussion document, it states;
"It should be noted that if the one-for-two surrender obligation is removed, the amount of free allocation provided to emissions-intensive and trade-exposed activities will automatically be increased to correspond with the increased surrender obligation."
So New Zealand Steel will have to surrender twice as many units. But its free allocation of units will double. One bit of corporate welfare in the NZETS is removed and another takes its place! Talk about the NZETS as an insurance policy for big emitters that protects them from any incentive to reduce emissions!
I could respond by saying I sympathise with Mr Garey. I mean, really, who does understand the NZETS? However in his interview with Radio NZ he goes on to indicate that if the NZETS is toughened up, then his parent company, Bluescope Steel, may just decide to close the Glenbrook Steel Mill. Nice steel mill you got. Shame if something happens to it. That is just typical arrogant big business behaviour. So I have no sympathy for Mr Garey.
There are some obvious questions to try to answer with actual emission unit data from the New Zealand Emission Unit Register, which records legal title for all valid carbon credits/emissions units in the New Zealand. How many units were NZ Steel given for free under the industry allocation plans? What were NZ Steel's NZETS-liable greenhouse gas emissions from processing steel from iron sands? Were they allocated more units than they had to surrender? Did they also make arbitrage trades in any of the dubious Russian or Ukrainian emission units?
We know that New Zealand Steel has been receiving free allocations of emission units as the allocations are listed on the Ministry for the Environment's web page Industrial allocation decisions.
Another MfE web page Eligible industrial activities tells us the formula for the unit allocation is (LA × ∑ (PDCT × AB)) ÷ 2.
The level of assistance (LA) for New Zealand Steel is 90%. There are four products (PDCT) each with it's own allocative baseline (AB). The products and allocative baselines are 3.2613 units for each tonne of iron or steel, 0.119 units for each tonne of cast carbon steel, 0.28 units for each tonne of vanadium-bearing steel and 0.163 units for each tonne of flat hot-rolled carbon steel.
Or a total of 4,590,579 units over the five years. NZ Steel received more units than any other industry. More than smelter operator New Zealand Aluminium Smelters Limited. I know this as back in 2012 I made a pie chart of the 2011 free unit allocation data. That showed that of the 3.472 million units allocated to industry in 2011, 90% went to thirteen NZ companies. Here is that pie chart.
Now I want data on the greenhouse gas emissions from processing steel from iron sands. The New Zealand's Greenhouse Gas Inventory 1990–2013 reports the greenhouse gas emissions from steel production from iron sands in tonnes of CO2-e. New Zealand Steel is the only iron sands processor so these are New Zealand Steel's emissions. The emissions are;
(There is no total for 2014 as we won't see the next greenhouse gas inventory for the 2014 year until later this year)
I want to compare the number of emissions surrendered with the number of units given as free allocation. Ideally, I would have the number of units actually surrendered by New Zeland Steel each year. In a transparent system we would know that, would we not? Unfortunately, the NZETS is not transparent and the units surrendered are not available to the public.
In 2013, I asked the Environmental Protection Authority (EPA) under the Official Information Act for the numbers of units surrendered by New Zealand Steel and some other companies. The EPA refused my request on the grounds that the Climate Change Response Act trumped the Official Information Act. In May 2014, after a delay of a year, the Ombudsmens Office agreed with the EPA. So much for transparency.
So I have to estimate the unit surrender obligation. I keep in mind the two-for-one deal. So my annual estimate of the number of units New Zealand Steel is required to surrender under the NZETS is half of the actual emissions (one unit covers two tonnes). Also NZETS surrender obligations started on 1 July 2010. So 2010 was a half year for free allocation and unit surrenders. So I take half of the 2010 actual emissions.
My data now looks like this
2010 2011 2012 2013 2014
Greenhouse gas emissions 823,445 1,736,250 1,718,930 1,747,500 NA
NZETS surrender obligations 411,722 868,125 859,465 873,750 NA
Free allocations of units 494,704 989,304 1,003,730 1,029,352 1,073,489
Lets make a chart. I think a bar chart will be a suitable choice. The colour scheme is lightest pink for actual emissions, mid-pink for my estimate of the units surrendered (emissions x 50%) and purple for the free allocation of units. The purple bars (free units) are noticeably larger than the surrender estimates. It appears that New Zealand Steel are consistently being allocated more free units than they need to surrender to match their direct emissions.
In summary, in the years 2010 to 2103, the actual number of units given to New Zealand Steel exceeded the estimated number to be surrendered by 82,982, 121,179, 144,265 and 155,602.
Does the free allocation of units include compensation for any other carbon-intensive energy inputs I have not taken into account? In principle, yes, as the original September 2007 Framework for a New Zealand Emissions Trading Scheme document makes this statement about free allocation to emitters;
"indirect emissions associated with the consumption of electricity, as well as direct emissions from stationary energy and direct emissions from non-energy industrial processes will be included in the concept of emissions from industrial producers".
Also the New Zealand Aluminium Smelter free allocation included an undisclosed quantum of units for the fictional coal content of electricity inherent in their energy supply from Lake Manapouri. Yes, I know that last sentence seems to make no sense at all. You really need to read the linked blog post!
The Heavy Industry Energy Demand Update Report (by Covec, Feb 2009) provides estimates of the carbon dioxide emissions from each energy input (except electricity) used by New Zealand Steel.
The Covec report estimates that in 2008 the coal emissions were 1,615,100 tonnes (93%), the natural gas emissions were 106,200 tonnes (6%), the coke emissions were 18,100 tonnes (1%) and the diesel emissions were 3,800 tonnes (0.22%). Adding up to 1,743,200 tonnes of direct emissions. Covec don't calculate the emissions content of the 426 GWh of grid electricity used in 2008.
The estimated natural gas emissions at about 100,000 tonnes per annum almost adds up to the 'surplus' allocated units which are between 120 thousand to 155 thousand tonnes annually. So its arguably plausible that part of the free allocation of units is to compensate New Zealand Steel for the increase in the cost of natural gas caused by the NZETS.
Except that there is no evidence that the price of natural gas or electricity or coal has increased because of the NZETS. And we have known that since 2011.
Officials supporting the 2012 Finance and Expenditure Select Committee queried the five major electricity generating companies about NZETS costs flowing through into wholesale electricity prices. Their reply was;
"costs being passed through directly from the NZETS are not visible or distinguishable due to the wholesale market pricing mechanism and these costs are not directly passed through due to competition factors".
The prices of emission units have been too low to affect business costs either for participants or those who receive costs passed down from participants.
So from 2010 to 2014 New Zealand Steel consistently received a free allocation of emission units that materially exceeded their estimated liability to surrender units to match actual emissions. The surplus units were not needed to compensate for increased energy costs caused by the NZETS as the NZETS did not cause any energy costs to increase. The free unit allocation was and is simply a transfer of wealth to New Zealand Steel in the form of a tradable right or voucher (unit) that is highly liquid.
So New Zealand Steel, the emitter receiving the most free units in the NZETS, has faced no NZETS-related carbon price at the margin or in any sense. Instead of acting as a carbon price at the margin, the free unit industrial allocation regime in conjunction with the lack of energy cost pass-through has acted as an insurance policy or hedge contract - protecting New Zealand Steel from the carbon price!
This is the embodiment of fundamentally flawed design in the NZETS and it is symptomatic of the National Government's unethical approach of rewriting the NZETS to suit the whims of big business. It's also symptomatic of the earlier big business campaign to pressure the Labour Government to drop a carbon tax and move to the inherently less transparent NZETS.
You would think that this case study into New Zealand Steel could not get worse. However, it does get worse. From 2013 to 2015 New Zealand Steel engaged in arbitrage profiteering using the most dubious international emission units, the Emission Reduction Units.
We find that New Zealand Steel Limited did own some Emission Reduction Units.
2013 1,022,527
2014 1,001,714
I have amended the bar chart and added the Emission Reduction Units owned by New Zealand Steel as extra orange bars. It is interesting to note that the number of ERUs is fairly close to the number of free NZUs. Both were more or less 1 million for 2013 and 2014.
We have fairly persuasive evidence that New Zealand Steel was consistently allocated more free units than it needed to surrender for its actual emissions. Therefore New Zealand Steel never needed to buy any extra emissions units to surrender under the NZETS. Yet New Zealand Steel owned about a million Emission Reduction Units at the end of both 2013 and 2014
So if New Zealand Steel always had more than enough free units to meet it's obligation to surrender units under the NZETS, why would it also buy international units? There is only one plausible answer. It is to make an arbitrage profit.
Why am I so sure New Zealand Steel carried out arbitrage trades with its NZUs and surrendered cheap dubious ERUs rather than the free gifted NZUs for 2013 and 2014? It's the maths.
Data from the Emissions Unit Register, NZEUR Holding & Transaction Summary, which I have summed into another Google sheet, tells us that the total numbers of NZUs surrendered by all emitters were 732,667 in 2013 and 576,470 in 2014.
As those numbers (for the whole of the NZETS) are less than New Zealand Steel's estimated surrender obligations, it is mathematically impossible for New Zealand Steel to have met those surrender obligations without having used ERUs.
Here is a hypothetical example of what New Zealand Steel might have done.
According to a Carbon Forest Services webpage that tracks emission unit prices, on 11 October 2013, New Zealand units (NZUs) (the same type of units allocated to New Zealand Steel) had a market price of $4.20 each. On the same day the Russian or Ukrainian Emission Reduction Units had a market price of 35 cents each. One NZU was worth 12 times as much as an ERU.
If New Zealand Steel had purchased 1 million ERUs on 11 October 2013 at 35 cents each or $350,000, it could then surrender 873,750 of them to the Government to match it's 2013 emissions. Based on that 'if', New Zealand Steel would then be in a position to sell all the 1,029,352 New Zealand units of the 2013 allocation at $4.20 each for a possible value of $4,323,278. The hypothetical profit would be $3,973,278.
That is just one possibility based on NZU and ERU prices on one date. I suggest you browse over to the Carbon Forest Services New Zealand Unit & Emission Reduction unit chart and hover over the chart to see the differences between ERU and NZU prices from early 2013 to 2015. Even when NZUs hit a historic low price of $1.60 in February 2013, they were still 9 times more valuable than ERUs. Choose your own combination of price difference and possible profit from buying ERUs and selling NZUs.
It's not just me saying that this is unethical profiteering. Here are statements from forest consultant Ollie Belton, Herald Economics Editor Brian Fallow and Green MP Kennedy Graham.
"..trade exposed industries that were gifted up to 90% of their surrender obligations were able to meet all their obligations with the super cheap ERUs and bank the gifted NZUs. Since 2012, NZUs have had much higher market value than ERUs, generally more than five times as high, hence the arbitrage opportunity. Never have polluters had it so good. They have made hundreds of millions in arbitrage profits."
Brian Fallow of the Herald described the arbitrage trades as corporate welfare.
"This is where the corporate welfare comes in. The ETS is designed to ensure that large emissions-intensive trade-exposed operations like the Tiwai Point smelter or the Glenbrook steel mill are only exposed to a carbon price at the margin - and a pretty narrow margin at that...But the collapse in international carbon prices has presented the smokestack sector with an arbitrage opportunity too.
They have been able to hoard their NZUs, in the expectation they will be more valuable in the future, and meet their obligations in the meantime with cheap imported Kyoto units instead".
.
Kennedy Graham placed it on the record at Parliament that he regarded the arbitrage trades as morally reprehensible.
"Emission-intensive, trade-exposed entities, which include aluminium, iron, steel, cement, whey, wood, and paper, are free to bank profits from the emissions trading scheme — cash for pollution. They receive free allocations of New Zealand Units as compensation for any energy price rises brought about by the emissions trading scheme...
These industries are also required to surrender units to clear liabilities. This is dependent on calculations based on their emissions profile. They can surrender New Zealand Units or Kyoto Units, such as emission reduction units and certified emission reduction units. These overseas units are valued between 10c and 40c.
They are engaging in the arbitrage by receiving free New Zealand Units from the Government, then selling them at market prices of $3 to $4, then buying cheaper overseas units such as the certified emission reduction units and emission reduction units for anything from 10c to 40c to surrender back to the Government.
They bank the profit. In some cases, this is in addition to existing tax-paid subsidies running into the tens of millions of dollars. Let me acknowledge that these activities are entirely legally, but they are morally reprehensible and they reflect Government stupidity and cynicism of the highest order".
Conclusion
New Zealand Steel really have achieved the ultimate emission trading scheme "two-fer". The NZETS's free allocation regime over allocates them more emission units than they need to surrender for their emissions and the availability of the imported international units gave them the opportunity to make windfall arbitrage profits. So instead of a carbon price there were unearned windfall profits.
I agree completely with Ollie Belton, Brian Fallow and Kennedy Graham that such arbitrage profiteering is morally reprehensible corporate welfare. Yes, the polluters have never had it so good. It seems that the more free units you give a company, the more it abuses the privilege of having an emissions trading scheme. This is just one example of how deeply unethical conduct in New Zealand Emissions Trading Scheme has been. The whole scheme is now so morally tainted it has no valid ethical basis to continue. The New Zealand Emissions Trading Scheme should be simply abandoned.
Update: 2 January 2017. I have updated the urls as the register has had a change of name to the New Zealand Emissions Trading Register. The New Zealand Emission Unit Register, which records legal title for all valid carbon credits/emissions units in the New Zealand Emissions Trading Scheme, can be searched.
What interests me is who owned these units? Who imported them? As Brian Fallow pointed out, the cheaper units collapsed the price of all units in 2011 and 2012
The imported units were not only too cheap and too plentiful. Most of them it appears were fraudulently issued.
In two scathing blogposts last December, No Right Turn traced the serial numbers of some Emission Reduction Units and Certified Emission Reduction units that New Zealand had "retired" to comply with the Kyoto Protocol, back to fraudulent projects in the Ukraine and Russia.
I have taken the annual lists of unit holders from the html tables on the Emissions Unit Register's website and uploaded them to Google Sheets. Here they are from 2008 to 2014. At some stage I will do some analysis. In the meantime, feel free to download them.
In this post there is still a gratuitous image of Marlon Brandon as the Godfather but the post is about one of NZ's biggest companies; New Zealand Steel. They just opposed the possible ending of the supposedly temporary "two-tonnes-for-one-unit" deal. That's a bit rich when their idea of the ideal "two-for" is to receive millions of emission units for free under the New Zealand Emissions Trading Scheme industrial allocation provisions and yet buy millions of the dubious international Russian units (ERUs) and make windfall arbitrage profits.
