Over recent times, the ETS was widely criticised for reforms that allowed users to import so-called "hot air" credits of dubious integrity – something which coincided with a resumption of deforestation – before overseas credits were eventually banned.
This afternoon, the Government flagged more changes it said would increase the incentive to drive down emissions.
Acting Climate Change Minister Julie-Anne Genter said, up until now, New Zealand's ETS had been the only emissions trading scheme in the world which didn't have a cap.
"The ability to set a cap will help New Zealand meet its international climate change targets, as well as any new domestic targets."
She expected the reforms would also give more certainty to those participating in the scheme.
"Submitters to the recent ETS consultation told us that ETS settings needed to be more predictable so participants could confidently take further action to invest in low-emissions activities," she said.
"We're putting in place a predictable process to manage the cap over time."
This would include annual announcements looking forward five years.
Auctioning would be introduced into the ETS in a way that aligned the supply of units with New Zealand's emission reduction targets, she said.
"The cost containment reserve, operated through the auctioning mechanism, will replace the current price ceiling, or fixed price option (FPO), once it is ready."
The cap would include setting the number of units to be auctioned and the settings for the new cost containment reserve.
Currently, market participants could choose to pay $25 for every tonne of emissions they emit instead of buying units from emissions unit holders.
Genter emphasised the changes would not affect the fixed price option.
"The fixed price option for surrenders due in 2019 will continue to remain at $25 in order to maintain regulatory predictability," she said.
"We want the ETS reforms to be well-managed and well-signalled and this means keeping the FPO in place while those reforms go through."
The Government would also investigate the potential introduction of a price floor in the scheme.
"We heard from submitters that having a price floor in the ETS might encourage investment to reduce emissions, so we are going to investigate this option further."
No decision had been made as to when the ETS would be reopened to international units but, at this stage, they would not be a first choice, she said.
"If, in future, the Government decided to allow international units, we would ensure that the units were of high environmental integrity," she said.
"We're confident that these changes provide an important balance between predictability for market participants, and flexibility for the Government to manage the ETS so that it supports our emissions reduction targets."
Forestry Ministry Shane Jones said the inclusion of permanent forests in the scheme would give landowners more incentive to plant more trees.
A new permanent post-1989 forestry activity within the ETS would replace the current Permanent Forestry Sink Initiative (PFSI), but participants already in that scheme would not be affected.
Currently, it wasn't possible to enter a post-1989 forest as a permanent forest in the ETS, even if it would never be harvested.
Other key changes included setting up an infringement offence regime for low-level offending against the ETS rules, and taking steps to improve market governance.
The changes expected to be introduced to Parliament next year as amendments to the Climate Change Response Act 2002, the legislation that established the ETS.
A second round of decisions on the ETS are also expected next year.
