Low price may tighten New Zealand's carbon credit supply in 2025 due to auction failures

New Zealand's carbon market could face supply tightness in 2025 if the local carbon credit price continues to languish below NZ$50/mtCO2e ($30.66/mtCO2e), as lower spot price is expected to increase the likelihood of auction failures this year, taking nearly 11 million mt of supply off the market, market sources said.

Under the New Zealand emissions trading scheme, auctions account for the largest share volume of New Zealand Unit supply available in a year, followed by units from forestry projects. Some units are allocated freely to industrial participants.

Platts, part of S&P Global Commodity Insights, assessed the price of NZUs at a near 10-month low of NZ$46/mtCO2e on May 20. This was way below the auction reserve price of NZ$64/mtCO2e, the minimum price below which units cannot be sold in an auction.

It is difficult to reconcile the current spot price with the market fundamentals, a carbon analyst said.

The last auction in March cleared partially at the floor price of NZ$64/mtCO2e, with 2.97 million units awarded of 3.53 million available.

All the unsold units are rolled over to the next quarterly auction until the end of the year, after which they are retired.

There was a high risk of the rest of the auctions failing in 2024, a carbon trader said. "Every time units don't get sold in an auction, there is increased likelihood that the next auction will fail as there is just too much volume on offer," the trader said.

"The market is pricing NZUs well below the NZ$64/mtCO2e minimum price where the government will sell additional units at auction so it is unlikely that the June auction will see any NZUs sold," Auckland-based carbon fund manager, Salt Funds Management, said in its quarterly report released on May 13.

Market participants echoed the scenario that considering the number of units being held by speculators and forestry participants, there will be a relatively less volumes left for the emitters for their compliance requirements in 2025.

"Yeah, I think so, it will start to contract quite a bit [in 2025]," the trader said.

NZU supply

A total of about 169 million mt of NZUs were being privately held as of March 2024, according to data from the New Zealand Environmental Protection Authority.

At least 92 million mt of that supply was locked up for hedging, forestry harvest labilities and long-term use, according to data from the country's national climate body, Climate Change Commission.

The estimated surplus of NZUs was around 68 million units at the end of September 2023, CCC data showed.

However, with the spot price at more than nine-month low, many forestry participants will be less inclined to sell their units.

Forestry participants will be hesitant to sell their units below NZ$64/mtCO2e and brokers are saying that unless the foresters need cash immediately, they are not selling, said Luke Donovan, Partner at Apostle Funds Management.

Another 40 million NZUs were locked up with speculators, who are unlikely to sell at low prices, according to market sources.

The auction supply for next year might further come under pressure with CCC advising the government to cut the auction volume of NZUs for 2025 by more than half to 5.9 million from 12.6 million to align the ETS with the country's national climate target.

"When you come into next year, the compliance entities will have only two years of certificates, which is not enough," Donovan said, adding, "If you are only hedged out two years, that is a considerable risk."

The auction floor price in 2025 is set to rise further to NZ$68/mtCO2e from NZ$64/mtCO2e, requiring participants to bid even higher to get any units in the auction.

"Price needs to kind of rise somewhere between 25% and 35% in order for this market not to be incredibly tight," Donovan said.

While participants might be able to buy NZUs in the auction by bidding higher than the spot price, it was unlikely to happen.

"If a participant just wants to buy some volume in the auction and they do not want to go secondary then it is an expensive price," a second carbon trader said. "It is a crazy thing to do."

More participants

The NZU market is also expected to see more demand and speculation with the expected listing of NZU futures contract on the Sydney-based Australian Securities Exchange.

"If you get a situation where you have additional speculators enter the market because it's more attractive or because there's a futures contract and it enables them to access the market, then all of a sudden it's going to be particularly tight," Donovan said.

Market participants said that many traders are expected to start trading the NZU futures contracts, which is likely to make transactions more efficient and easier to access.

The latest signal for available supply will be the government figures for the unit holdings, which will be released after the May 31 deadline for emitters to surrender NZUs to offset their emissions.

"With no NZUs sold at auction in 2023 and only a partial clearance of the first auction of 2024, the market will be watching to see how big a reduction in NZUs held has occurred and whether the CCC has calculated the surplus versus future supply correctly," Salt Funds Management said in the report.