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NZ market's credibility, and purpose, at risk if dubious overseas units flood in.

While emitters fill their boots with CERs, trading in NZUs is very light and the bid/offer spread for NZUs on the online carbon marketplace Carbon Match, for example,

is wide. A slump in carbon prices over the past three months raises the stakes for the Caygill review of the emissions trading scheme, due any day now, and the Government's response to it.

Since July 1 last year the ETS has imposed a modest price for carbon emissions on domestic energy users.


Several features of the scheme were designed to ensure a soft start to carbon pricing.

One is the half obligation - buy one, get one free - under which firms with obligations under the scheme, including oil companies and power companies as proxies for consumers, only have to surrender one tonne of carbon credits for every two tonnes of carbon dioxide emitted.

In addition there are in effect two levels of price cap.

There is a formal cap of $25 a tonne (effectively $12.50 while the transitional half obligation applies).

The other ceiling is the price of internationally traded carbon credits which New Zealand emitters can use to meet their obligations instead of the New Zealand units (NZUs) the Government allocates free to forest owners or to trade-exposed industrial emitters as a form of protection.

These international units called CERs (certified emission reductions) are generated by UN-approved emission-reducing projects in developing countries.

The idea is that the atmosphere does not care where or how emissions are reduced. If it is cheaper for emitters to fund, via the CER market, emissions reductions elsewhere more cheaply than they can reduce their own, that is fine.

For the first year of the ETS the price of New Zealand units held steady at around $20 a tonne.


For most of that period NZUs traded at a discount to the international price of CERs.

It allowed the Government, in the scheme's first annual report, to hail the fact that almost all the units emitters bought and surrendered to it were ones which had been allocated to forest owners.

The flow of money was from domestic energy consumers to New Zealand foresters, providing at the margin a signal to burn less fossil fuel and to plant more trees.

Since the middle of this year, however, that happy picture has collapsed.

The price of CERs has plunged to around $14, a level at which few forest owners are prepared to sell.

As a result New Zealand emitters have been "gorging" on cheap imported carbon, not only for this year's obligations but next year's as well, says NZ Forest Owners Association chief executive David Rhodes.

Carbon brokers agree.

While emitters fill their boots with CERs, trading in NZUs is very light and the bid/offer spread for NZUs on the online carbon marketplace Carbon Match, for example, is wide.

The forest owners have been lobbying for restrictions on the use of imported carbon. It is one of the questions the ETS review panel, chaired by David Caygill, was asked to consider.

In addition, the longer carbon prices remain low, the weaker becomes the case for extending the half obligation, currently due to expire at the end of next year.

The demand side of the international carbon market is dominated by Europe.

One reason CER prices have tumbled is mounting concern about Europe's economic prospects.

The momentum of its recovery from the global financial crisis is faltering and there is an obvious risk that it will be the epicentre of another such crisis, unless the political handling of its sovereign debt issues becomes a lot less maladroit than it has been so far.

In addition there is a surplus of units allocated under the European ETS's second phase, which can be carried forward to the more stringent Phase III which begins in 2013.

Both of these factors on their own would reduce demand from European emitters for CERs.

In addition Europe is scaling back the extent to which its emitters can use CERs to meet their obligations.

And crucially it is banning CERs arising from projects which destroy certain industrial gases with high global warming potentials - hydrofluorocarbon-23 and nitrous oxide.

In the case of HFC-23 the value of the CERs vastly exceeds the cost of producing the gas in the first place, leading to the accusation that countries, especially China, have been ramping up production of the gas in order to pocket the profit from then destroying it.

About 75 per cent of the CERs issued so far have related to those industrial gases.

"If New Zealand does not take similar action [to the EU's ban] it is likely the New Zealand ETS will become a prime destination for these 'homeless' units, of which tens of millions of tonnes a year will be available," the Forest Owners Association said in its submission to the ETS review.

Left unchecked these environmentally dodgy CERs threaten to swamp the New Zealand market, damaging its credibility and snuffing out an incipient recovery in forest planting, it said.

The counter argument is that enabling lowest-cost compliance is one of the merits of emissions trading, as against a carbon tax, and the ETS is not intended simply to be a support mechanism for the plantation forest industry.

But the purpose of the scheme, to reduce emissions and begin the transition to a low-carbon economy, is subverted if the price is too low.

And under Kyoto's rules reliance on imported carbon credits is supposed to be "supplementary" to domestic action.

If dubious CERs are allowed, didymo-like, to crowd out domestic emissions reductions and an expansion of the forest estate, we will be left with a Clayton's ETS, which threatens rather than reinforces the clean, green brand.

It would also be likely to pose a high if not insuperable barrier to linking the ETS with an emerging archipelago of similar schemes overseas.

Linkage is important because New Zealand's emissions profile, with half of it arising from the bodily functions of livestock but comparatively little for electricity generation, limits the potential for cost-effective reductions within our shores.

Unfortunately there is little prospect of linkage with the mainland of the archipelago, the European ETS, as the EU's commissioner of climate action, Connie Hedegaard, reaffirmed while in New Zealand last week.

Not only is the New Zealand scheme too small to offer them much by way of additional liquidity, but also the Europeans don't like its reliance on forest offsets and consider that too small a proportion of our emissions are actually subject to a carbon price.

Whether embryonic carbon markets in, for instance, China and the western United States are as fastidious remains to be seen, however.

It also remains to be seen whether the Australian Government's carbon pricing policy survives long enough to morph from a tax into an ETS on schedule in 2015.

If it does, the Australians may find themselves with a choice between linking with the EU or the New Zealand schemes.

What price CER - in the other sense of Closer Economic Relations - then?