Chaos Rains as NZETS Placed Under Review
OMF Financial, a leading local Carbon Broker, said ‘locally the market is a little stunned and still digesting the news of a complete review of the ETS and possible reversion to a carbon tax’.
‘Given 50% of our emissions are from Energy, Waste & Transport which are unlikely to be changed in a revised ETS we feel the ETS should have been allowed to continue in order to establish a carbon market.
Forest owners have deals to do and some emitters wanted to start buying now. We don’t think a carbon tax is the answer as its better for the market to establish pricing as opposed to the government. Being market participants we are biased.’
Mike Smith of Southem reiterated the sentiment from the forest sector saying ‘The New Zealand Government’s decision to suspend the emissions trading scheme has been described as “absolutely catastrophic” for the economy and the burgeoning carbon market’s credibility.
The newly elected National Party-led Government has announced a policy agreement with its ACT Party partner to suspend the emissions trading scheme (ETS). A parliamentary select committee will review the ETS and resurrect the possibility of introduce a carbon tax instead.’ http://www.southem.com
ETS Review may be Lucky for Some Forest Owners
We have noted with concern sales that our clients have become aware of and asked if this is an option for them. This relates to both the ETS and voluntary markets. The ETS being on hold has curtailed many sales contingent on the issue of credits.
The sales of concern are those that provide a forward contract for sale with little realistic regard for the two intrinsic risks: having credits for harvest, and the contractual obligation related to loss of the sequestration by fire, pest, or any other reason.
The other counterparty risks exist for any over the counter sale (OTC). The ETS suspension has curtailed this and given those foresters time to think. The sequestration isn’t going anywhere, so in effect the money has simply gone back in the bank.
What are the Risks of Trading in the ETS?
This is a question we are often asked especially by forest owners. The risks relate to those of any sale, will they pay, generally referred to as counterparty risk. This is complicated by the nature of credits and delivery dates but essentially it’s the same as any financial transaction.
The risks related to selling emissions units are peculiar to this market alone. The major risk with forestry in the ETS is the harvest liability. You must have credits to meet this liability or buy them at the time. This liability is the amount deemed to be emitted when you harvest your trees or around 60% of the carbon in the forest. Selling now without having credits available at the known price at harvest is a significant gamble.
Those selling a forest credit for $30 today have no idea, as does anyone the, price they will pay to buy that credit back at harvest. With forest planted in 1990 harvest may be only 10 years away. There is little chance the ETS will have achieved its desired outcome of a low carbon economy and driven the credit prices to near zero in that time. More likely is that carbon prices will have increased dramatically.
Prices according to off shore reports may go as high as $100 US per tonne. So if you received $30 now and had to pay back nearly $200NZ in 10 years for each credit then you would have made a bad business decision. All for $16,000 per hectare at harvest!
Government officials made it clear in their road show in late 2007 having one age class forest was risky and that steps should be taken to deal with this before forest owners should trade their credits.
Forestry is a specialised business. The link between simply selling a commodity and getting the best price, AND, protecting the forester , building the systems into silviculture, inventory measurement, and all the other issues unique to forestry that matter so much, IS NOT being made clear by many brokers who have recently seen the potential and jumped on what they see as a money spinner. The simplistic approach we are seeing, while appealing initially, has some very large long term risks.
What about the Voluntary Market?
This is another area of confusion. Most of this comes from the lack of or inaccuracy of information available. The only reason anyone is discussing this market is due to the ETS being under review.
Voluntary markets also involve the sale of CO2 credits. The difference is that the credits are not recognised in Kyoto.
This means they cannot be used in the NZETS or any other government ETS. They have been issued by a range of organisations carving out a commercial niche who write a “standard”. Some are well recognised and definitely worth looking at, having environmental integrity and a reasonable buyer following.
The most recognised has been the Chicago Climate Exchange. However its prices are low and it is generally accepted this is a reflection of the buyer’s perception of the credits environmental integrity.
Recently CCX decided to exclude foreign credits from its market. EITG has experience with creating these credits and looked at them only as an exercise while the ETS became law.
The problems with voluntary credits vary. One is that the standard must be internationally acceptable. There are several that are. Most when applied to NZ plantation forestry conclude the forests lack “additionality”. What this means is the forest was planted with no regard for the credit income so any credit income is just a free ride.
One approach to compensate for this is to ‘dress up’ existing forestry, change the harvest dates, add FSC stewardship or other arrangements so that there is an arguable move to benefit the environment. Beware of this, buyers are sophisticated and far from stupid and these actions really transparent to buyers.
Most suggestions to seek voluntary credits relate to pre-2008 forest, which is outside of the NZETS and Kyoto. There was a potential window, but it is by no means certain. Some promoters insist that you can get credits retrospectively back prior to 2008. We disagree. This was potentially possible from the CCX until they closed their market to non US credits earlier in 2008.
If one looks to create voluntary credits after 2008 a real problem of ‘double dipping’ exists. To use voluntary credits the standard will usually require (and should) a confirmation from MAF that it is not double dipping. MAF have given us such a letter relating to our pre 2008 work with CCX.
The penalties of receiving two lots of credits on the same forest for the same period could be severe. Not worth the time we suggest.
There is also a misunderstanding that because a credit would exist under the ETS, it will also exist under a voluntary market. That is the ETS is in effect a ‘credible’ voluntary standard. It is not.
The ETS is a political mechanism the government creates to distribute and trade the credits the government receives under Kyoto and to comply with its Kyoto obligations. These are the AAU (assigned amount units) of which New Zealand receives 309mt for 2008-2012. In addition the project credits of Kyoto can be traded. Those project credits can also be limited as the EU does in its ETS. We do not know if the government here will do this yet due to the review.
A final point we believe needs to be made is that the selling of carbon credit carries with it an obligation to continue to keep the carbon stored. This is particularly so with many voluntary standards. What happens if the forest burns down? The buyer may be relying on that carbon being contained in the tree. Its not, so did you in effect guarantee this? This point is not quite the same with an ETS where the government converts your NZU into the AAU. The AAU has a sovereign guarantee so the buyer is safe. However the government may well require you to offset losses as they do already with harvest.
What Voluntary Standard should NZ Foresters avoid?
If intending to look at the voluntary market for forest that may be within the scope of the NZETS, then the question becomes what standard do you choose? The standard is very important as it dictates both price and market acceptability.
Buyers of credits purchase to fill a need. What they need them for varies, but what is consistent is that they will come looking if the credits evaporate, are proven to lack credibility, and increasingly cannot be traced.
For forest outside the ETS, offset projects, and non forestry projects, then voluntary markets have potential and are an option. Do not take our comments on the voluntary market as being negative. It is a viable and useful market, but comes with many provisos for forestry.
There are credible standards. A recent standard with few registered projects, is the Voluntary Carbon Standard (VCS). We have heard of statements made in New Zealand that the Voluntary Carbon Standard can be used for New Zealand exotic forestry! This is a very broad statement and difficult to apply to NZ forestry. The main reason to question this is that the VCS has a projects based test (see www.v-c-s.org )
Coincidentally recent research from University of Canterbury Forestry School: Merger and Williams state in relation to VCS ‘the projects test requires the execution of an investment barrier test’ and concludes ‘the project proponent must give evidence that his/her activities are NOT common practice’ (www.fore.canterbury.ac.nz/research)
This relates to so called ‘additionality’. In essence showing you did something different for an environmental purpose that you would not have otherwise considered. We have some difficulty with a suggestion that growing Pinus Radiata can be considered as being NOT common practice in NZ.
What this suggests is existing afforestation (as all pre 2008 forest is) is unlikely to qualify under VCS in our view. These plantations are and were COMMON practice!!!
Using CDM Credits to Cover Future Forest Harvest Liability – FACT or FICTION
Before we cover this, recall that CDM (clean development mechanism) credits or CER’s are from projects in developing countries that reduce carbon emissions. These projects are subject to intense scrutiny and based on forecast estimated emissions reductions. The credits they generate are approved by the United Nations. The credits called CER’s can be used in developed nations. This requires approval of both the host government and the recipient government (an Annex B country).
Can we use CDM CER credits to cover harvest liability? The short answer is yes under the current ETS. That’s because the NZETS does not limit these credits being brought into New Zealand.
This may not be the case after the review.
Will EITG use CDM credits for its carbon pool?
At this time we are active in CDM projects and are currently registering projects with the UN and commencing more new projects. These projects do include forestry, but are mostly in other industries and gases other than CO2.
So why don’t we promote them? Well, we do to an extent, and we may bring them to NZ to use for our emitter clients. The problem is there are real issues and as above, a review, with some potential limits or restrictions.
CER’s may provide a useful hedge, but we do not believe foresters should rely on this market to cover their harvest liability. We are cautious, but with good reason.
CER credits are permitted in the EU ETS so prices have been as high as Euro 21 ($50NZ) and currently sit around 15 Euro ($36NZD). Recent NZ ETS trades are $30.
The supply of CDM credits is difficult to be certain on. The projects themselves are easily found as they are all published by the UN, as are the volumes and predictions. What is not clear in the forestry time frame (that is over a rotation of 27 years or so) is where the prices, the rules on acceptability, and the volumes of credits issued will actually be.
So can you use a CDM credit to cover harvest liabilities?
- The CDM projects are for 7 (renewable twice for 7 years) or a fixed 10 years – significantly shorter than a forest rotation of 27 years so the CDM project may not be generating credits at harvest time at all. If the project is 7 years then it must be renewed at year 7 and 14. Renewal may be denied and any credits that could have been created are no longer available to offset harvest
- The CER credits from CDM are worth more than an NZU so why would a project owner sell them in New Zealand when they can get more overseas right now?
- Very few companies in this market ‘own’ the project. We don’t. We create the project with the owners. The projects are usually very large with credits of 250,000 tonnes/pa seen as small. The owners want the best price. That means NZ buyers will pay the international market price which at present means the EU price.
This all suggests that the only safe way to offset the harvest liability with CDM credits is to buy them now (a forward contract), but of course that means you pay the current market price. CERs are worth more than an NZU so that does not make commercial sense.
Otherwise it’s just a promise from an off shore company to sell you a CER at fixed price lower than the price today in 10 or 20 years time – if their projects are renewed and if the credits are issued. All speculative and risky in our view there are better ways.
The CDM market has been changing. Projects have gone from being easy to register to being very difficult. This is a good thing in our view from an environmental integrity perspective.
During this period of change notable companies were forced to write down the value and quantity of credits they had publicly stated that they held. This is because CDM credits are a projection of what will happen and reviews and revisions as a result of initial over optimism, meant in some cases the overestimation of the credits was 30% or more. This also of course significantly affected the value of their shares. If NZ foresters had been relying on these credits to cover harvest they would have been exposed to unnecessary risk.
We don’t recommend relying on CDM credits to cover your forest harvest liability.
EITG view of the ETS Review
What we know is the Government is committed to Kyoto. Exiting would place us directly in conflict with our close trading partners.
We also know loss of carbon due to harvest will still be a part of Kyoto and therefore part of policy.
We see Australia with a planned ETS, Europe already with an ETS and Japan and the USA planning theirs.
We also see non compliance with emissions agreements as an excuse for trade barriers.
In the review therefore we see the Government subject to some significant constraints.
The first is the accounts don’t allow a cheque to be written for $3bn to agree to the flexible land use alliance wish to relocate forestry by right with no deforestation liability for pre 1990 forest. We think the government will push for this policy in Kyoto post 2013.
We see a Government committed to employment and business and will protect industries at risk from climate policies such as Kyoto.
We see efficiency as key and the policy of Australia in particular and other trading partners as guiding our actions.
So our view is we will align with the Australian ETS as it emerges particularly adopting their cap of AUD $40 on the carbon price. This creates a carbon tax over $40 AUD and leaves the government to buy the credits with the $40 AUD.
We see the sectors already 100% exposed to emissions charges, which are transport, fossil fuels, forestry and electricity all remaining 100% exposed.
Finally we see a more proactive involvement with industry (read agriculture) at risk and initiatives both in lobbying and science to resolve the issues.
We are told the ETS review will be completed September 2009 around the time the AUETS is expected to become law.
EU Price Update
All allowances slid heavily as the continued uncertainty of the banking crisis continued to hit oil and energy prices in the last month. Prices of CER’s slid to an 12 month low in all categories.
How much Carbon is in your Forest?
EITG associate Ecometrix have released a new site that allows forest owners in New Zealand to assess their forest carbon and the number of NZU units they will receive under the current legislation from 2008-2012
To use this service simply go to http://www.eitg.ecometrix.biz
We then assess the data, match it to MAF standardized tables and provide a basic report back via email.
This is a sample output from the review:
We are finding that even with the MAF scaling down the amounts of carbon per ha in some places exceed 45 tonnes per annum!
Clarifications on the November Issue
Thanks to Ollie Belton, who corrected us saying the pre 1990 allocation for 2008-2012 is 21mt and not the 34mt we stated, rather the 34mt was for the period post 2012.
He also notes that while tCER’s can be held in the NZ registry they cannot be retired without the minister’s consent.
Terry Quilty ph 64 21 250 6789
fax 64 9 920 1093
Richard Hayes ph 64 21 310 301
fax 64 9 920 1093
Simon Baillieu ph 27 82 558 9616
Martin Albrecht ph 64 21 565 682
Iain MacDonald ph 64 27 438 2544
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