Last month, Blake Schaefer (ECP Partner) and Clark O’Bannon (Senior Investment Analyst), traveled to New Zealand for meetings with key personnel involved in the New Zealand Emissions Trading Scheme (“NZ ETS”). Launched in 2008, the NZ ETS has been around longer than the California Cap-and-Trade program (for which trading started in 2012) and almost as long as the European Union ETS (“EU ETS”) established in 2005. The NZ ETS covers forestry, fossil fuels, stationary energy production, industrial processes and waste, but omits agriculture (which accounts for nearly half of New Zealand’s emissions).

The NZ ETS has similarities to other carbon pricing mechanisms; however, a major differentiating factor is the unlimited use of offsets, nearly all of which are derived from forestry projects based in the country. By not imposing a cap on the use of offsets (approved project-based reductions) the NZ ETS is effectively only a cap on net emissions (as opposed to gross emissions), which are the total emissions minus any offsets, such as those from forests.

Program reforms made in 2020 preceded the first New Zealand Unit (“NZU”) auction held in March 2021; this launched a period of significant demand at auctions and in the secondary market that tripled the price to just under NZ$90. However, subsequent regulatory uncertainty drove the NZU price to below NZ$40 by the summer of 2023.

Since then, a scheduled program review has been cancelled (August 2023) and a new government promising a more hands-off approach was elected (October 2023), resulting in relative price stability in the NZ$65-75 range. Uncertainty still exists regarding how the government may change the ETS to better align with the country’s Nationally Determined Contribution under the Paris Agreement (adherence to which is required under its free trade agreement with the European Union). There is also a lack of clarity on how forestry offsets will be treated in the future, as an oversupply of offsets is a key risk to the overall success of the scheme.

One reason for ECP’s trip to New Zealand was to learn more about these market dynamics and analyze their impact on our investment thesis for NZUs. As with any market, there are always competing interests at play. In New Zealand, this is currently manifested via sometimes differing views between forestry groups, and agricultural communities, and the Indigenous Māori population, on the rules governing forestry offsets. Furthermore, input from the Climate Change Commission (“CCC”), an independent body that advises the government on goals and benchmarks for the program, might conflict with implicit goals signaled by the Minister of Forestry to lower costs imposed on participating forest owners.

A consistent feature of investing in environmental commodity markets is that one may never reach a conclusive answer to all the questions surrounding the outlook for a specific commodity; however, managing our portfolios to mitigate against uncertainty while maintaining a full understanding of market fundamentals is a cornerstone of the ECP investment process.