At times of market and economic uncertainty, combined with relatively low expected returns for many asset classes, we should consider more widely the assets we hold.
It’s important to have a portfolio strategy, designed with discipline, embracing market opportunities while preparing for the unexpected. There are several components of a well-constructed portfolio, including a robust strategic asset allocation that’s consistent with your long-term goals and objectives. A mix of asset classes and strategies all have a role to play. In more recent times, we’ve been challenged to look beyond traditional alternative asset allocations like gold, silver, commoditised debt and emerging markets (amongst others).
This is where carbon has a role to play. Growth in carbon markets may have wide-ranging implications for climate finance, corporate strategy, and global trade. Now when constructing a portfolio for retail investors, carbon can be a serious consideration. It is our view that the New Zealand carbon market was surprised last year when the Government rejected the Climate Change Commission’s (CCC) advice to reduce the number of NZUs up for auction and raise the price settings.
We understand the rationale for the CCC’s recommendations may have been that it wanted to reduce what is perceived as excess supply in the system. In short, it looked to raise the auction floor price, reduce the number of NZUs auctioned and move the Cost Containment Reserve (CCR) much higher than present levels. The CCR is the price level where the Government will sell more NZUs if demand exceeds the regular auction supply.The Government considered the recommendation was likely too inflationary as our petrol, electricity use and landfill trips all have a carbon cost embedded into them.
Given the NZU market had seen the CCR as a magnet previously and both CCRs were fully used in the 2021 and 2022 auctions, it was concerned carbon prices would jump too high on the CCC recommendations. The Government decided to keep with the current plan of the CCR being $80.64 in 2023 and to rise it incrementally to $129.97 by 2027.
The market underwent a significant correction on that announcement – one of the biggest seen in its fifteen-year history, falling $20 or 25% from a high of $88 to the current price of $67. So where to from here for prices? There are two questions. What will the Government do next, and then where do prices go from here?
Whether you agree with the Government’s view or not is somewhat irrelevant. NZUs have been deflationary since the announcement, and whilst we need higher carbon prices – not lower to decarbonise – the ETS is a market where prices will change, both up and down. Regulatory risk is the fundamental risk you assume if you trade in the ETS.
The reality is that domestic and international targets remain. It’s just become harder to achieve. Unless we start making emission reductions now, carbon credits on the ETS become shorter in supply. The ETS covers roughly half of our emissions – circa 40 million tonnes per year. That’s approximately the amount of NZUs that need to be surrendered by liable entities in our ETS every year. Some liable entities are fuel companies, coal and gas users and electricity companies.
They collect the carbon from us in cash, buy NZUs in the market or at auction, and hand them to the Government every year. 1 NZU equals 1 tonne of CO2e emissions. Looking at the following table, you can see if emissions remain flat and the government supply falls from 2023 to 2027 through auctioning, the market will be short 45 million tonnes in 2027 if the CCR is taken out every year, and 85 million tonnes in 2027 if it is not.
Source – CCC and Jarden This means that the shortfall will have to come from actual emission reductions, such as forestry or the current registry stockpile. All these (extra) NZUs sit in the hands of private actors. We know some will come to market, but we don’t know how much. What is required is approximately 10 to 20 million NZUs per year for supply to equal demand – we’re not sure that is achievable. Carbon prices may be impacted.
Tobias Taylor is Director, Wealth Management Adviser at Jarden. The information and commentary in this article are provided for general information purposes only. It reflects views and research available at the time of publication, using external sources, systems and other data and information we believe to be accurate, complete and reliable at the time of preparation. We make no representation or warranty as to the accuracy, correctness and completeness of that information, and will not be liable or responsible for any error or omission. It is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision or taking any action. Jarden Securities Limited is an NZX Firm. A financial advice provider disclosure statement is available free of charge at https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement