In June 2020, our Government made changes to the Emissions Trading Scheme (ETS). These changes have introduced auctions and removed price certainty for New Zealand Units (NZUs) within the ETS and have been stated to be an important step in New Zealand moving towards meeting the carbon targets it has set for itself, both domestically and internationally. In this article Brett Johanson and Melanie Craxton from PwC explain how the ETS now works and how councils with surrender obligations can operate under the new rules and structure, outlining key risks and how they can be mitigated.
Carbon risk management should be high on the agenda for local government for both the risks and opportunities it presents. As changes are made to compliance obligations, it is becoming more complex for organisations to navigate. This comes at a time when non-compliance pressures, for example organisational carbon footprint management, are also increasing for councils.
In this article we look at the Emissions Trading Scheme (ETS). We examine what it means for councils around the country and where they need to focus their efforts.
What is the ETS?
The New Zealand ETS is the Government’s primary tool for meeting its international and domestic carbon emission targets. It is a functioning carbon market where New Zealand Units (NZUs) are exchanged. A NZU represents a tonne of carbon dioxide equivalent - the cost of a NZU can be considered the cost of carbon.
How is the ETS relevant to local government?
Many councils are likely to be ETS participants, either through assets that are associated with a surrender obligation, such as landfills, or assets registered in the ETS which earn NZUs, for example forestry. Councils with surrender obligations have a responsibility to procure and surrender NZUs to the Crown to cover their emissions.
New regulations have increased the complexity for acquiring NZUs, and removed price certainty, creating many new challenges.
In addition, councils with forestry assets (both those currently registered in the ETS and but not under registration consideration) now have an opportunity to sell earned NZUs at increasing prices. The opportunity for these councils is growing but new ETS regulations also provide their own set of complications which will be important to consider.
How can councils acquire NZUs?
Options include:
● historically, through a direct fixed price purchasing option with the New Zealand Government (though not from 2022 onwards);
● sequestration of carbon dioxide or removal from the atmosphere (e.g. through forestry operations);
● purchase on secondary carbon markets; or
● auctioning of units by the Government (from March 2021).
A note on auction participation
From March 2021 councils are able to acquire NZUs by participating in Government-run auctions.
New ETS regulations cap the total number of NZUs in the ETS each year. This finite number of units will be made available through four auctions over the calendar year. It is different from the historic fixed price offer purchasing option where an ETS participant could procure as many units as they required at a certain price.
The introduction of auctions raises many issues for councils. With NZU prices expected to increase, it is important to have a plan for acquiring the NZUs needed through the quarterly auctions. This includes considering an auction bidding strategy, acknowledgement and understanding of other options to hedge price and quantity risk and ensuring those responsible for NZU acquisition have the necessary permissions to carry out the strategy. For example, auction participation requires collateral (e.g. cash and/or letters of credit) to be set aside at least five business days in advance of a size at least one quarter of the expected auction bid. This means that councils who wish to take part will need to consider funding and liquidity risks of participating as well as the logistics supporting the use of (potentially) large amounts of cash - especially when prices are expected to rise.
What are the ETS-related risks for local government?
Pricing is the biggest risk. Currently, there is a degree of stability to expected auction prices because auctions have a cost containment reserve ‘trigger price’ of $50/NZU. If this is reached, additional supply is put up for auction helping ease upward price pressures. The Climate Change Response (Emissions Trading Reform) Amendment Bill currently provides a ‘trigger price’ for the next four calendar years. However, the ongoing role of price control is unclear creating uncertainty in planning for the long-term. The Climate Change Commission has recommended that the ‘trigger price’ be increased to $70/NZU “as soon as practical”.
If prices increase, councils will need to consider how they are able to meet the costs without adding to the pressures already faced by ratepayers.
Compliance risk is another consideration. A new penalty regime came into force on 1 January 2021 meaning there will be negative financial implications for organisations that fail to meet emissions return, surrender or repayment deadlines, or if emission returns aren’t provided correctly. From June 2021 information on emissions (or removals) and any penalties imposed will be made public.
What can local government do to help mitigate the risks?
Having a robust carbon management policy to manage, monitor and report on compliance related carbon emissions over the short, medium and long term is key. The policy would instruct a risk limit framework that considers such matters as risk tolerance, materiality, delegations, annual plan consultation and approval cycle. An overall strategy including identifying the liabilities and creating a risk and reporting framework will help councils be proactive about the potential pricing risks and how they can manage these into the future.
If you would like to discuss this article further please do get in touch.
Brett Johanson, Partner PwC T: +64 21 771 574
Melanie Craxton, Associate Director PwC T: +64 21 851 308