The first Crown auction of New Zealand Units (NZUs) in the Emissions Trading Scheme (ETS) is scheduled for 17 March 2021. Auctions will align the supply of NZUs with Aotearoa New Zealand’s (NZ) emissions reduction target and emissions budgets.

In this FYI, we outline how the auctions will work, and what participants should expect.

Introduction

The price of NZUs at auction is set to become a barometer of how our economy is responding to decarbonisation pressures. Put simply, as the pressure to lower emissions increases, all players in the economy will become increasingly conscious of price pressures related to the greenhouse gas intensity of their activities.

In this way, auctions will likely start to garner wider interest and participation than simply from compliance participants.^[1]

Here are some things to consider if you are getting involved.

Participation in auctions is accessible

Anyone with a holding account in the NZ Emissions Trading Register (Register) can participate in auctions, as long as they register and meet the auction requirements. These include posting collateral for at least 25% of the intended bid, at least 5 working days in advance of the auction. Bidders should start the registration process early, as there are information and verification steps to satisfy.

Holding accounts can be opened by most individuals, NZ entities, Australian companies and other overseas companies registered on the NZ Companies Register.

Persons interested in participating in auctions should review the auction guidelines, available here.

Price planning

Given the collateral requirements, bidders will need to develop a good idea of the quantity and price they will bid, well in advance of the auction. Bidders should note that they will pay the auction clearing price for their allocated NZUs, which might be higher or lower than the amount they themselves bid. This will need to be factored into financial preparedness.

Price controls

Auction prices will be affected by a number of key regulatory settings that aim to ensure stability in the secondary market:

• The price floor of $20 per NZU (prices below this will not be accepted);
• The number of units available for auction (linked to emissions budgets);
• The cost containment reserve - if the interim clearing price at an auction goes above $50 per NZU^[2], further units will be made available at the same auction from the reserve (this may lower the clearing price);
• The confidential reserve price, discussed further below.

Upward pressure - confidential reserve price

A key development that will affect auction pricing is the move to introduce a confidential reserve price (CRP)^[3]. The existing price floor of $20 per NZU is well below the current market price on the secondary market, where NZUs are currently selling for above $38 per unit. The CRP will prevent NZUs from being sold at auction at a price significantly below the market price. If the auction clearing price is less than the CRP, the auction will not sell any units. Unsold units will be rolled forward to the next auction in the same calendar year.  

As a form of price control, the CRP will avoid the auctions unduly influencing the secondary market. Without a CRP, there is a risk that auction participants will strategically bid to undercut the secondary market price. This would undermine the integrity of the NZ ETS by undercutting the incentive that a strong NZU value plays in encouraging forestry and emissions reduction activities.

By way of illustration, when NZX (the auction operator) ran simulated trial auctions on 27-28 January, prices were below the current market price. On both days, 4.75 million virtual units were sold, with market clearing prices of $28.30 and $30 respectively.

Upward pressure - policies and limits

One of the prominent pressures that might soon play out in auction pricing is that the Climate Change Commission’s draft recommended emissions budgets allow for a lower amount of emissions than the provisional emissions budget. The provisional budget was used to inform the NZU supply and price control settings for 2021-2025

The market will be keenly aware of the probable direction of NZU pricing, with the Government likely to adopt policies and further limits to increase downward pressure on the level of emissions (with likely upward pressure on prices).

Downward pressure - fixed price option

For compliance participants in the ETS, auctions replace the Government’s fixed-price option of $35 per unit (FPO). This year, ETS participants can still use the FPO, in addition to buying units at the first auction, or on the secondary market.

It is possible that the availability of the FPO will apply some downward pressure on auction pricing, but this could be offset by participants planning ahead for next year’s surrender obligations and being conscious of the overall likely upward trend.

Secondary trading

While we have focussed on auctions in this article, there are also many opportunities and structures for obtaining and disposing of NZUs in the market.

If you want to get involved in auctions, or learn more about any aspect of NZU trading, please get in touch with our experts (pictured right).