The New CCR

The Ministry for the Environment opened its consultation for the annual update of NZ ETS settings two weeks ago. A lot of attention is being paid to the proposals for changes to the Cost Containment Reserve (CCR) as some of the options being suggested have dramatically higher trigger prices than their current levels.

While the changes to the CCR are material and deserve serious consideration, there is another type of CCR looming which may prove even more influential. This new type of CCR is (what I am informally calling) the “Conifer Cost Containment Reserve” (or CCCR) which is the growing forecast volume of NZU supply from new forests joining the NZ ETS, many of which are pine trees.

The Climate Change Commission said in its NZ ETS advice that 60,000 hectares of new forest is expected to be planted in 2022 and in addition that 160,000 hectares had registered to join the NZ ETS in the last year alone. The scale of these figures, and the possibility that these new forest areas could continue to arrive into the NZ ETS, should focus market participants’ attention on these forestry drivers.

To explain the growing materiality of the CCCR, the chart below shows four annual NZU supply volumes:

1. The CCR volume recommended by the CCC in 2027: six million units
2. The CCCR volume that would be delivered in 2027 if 60,000 hectares of new forests were planted each year from this point forward: five million units
3. The CCCR volume that would be delivered in 2027 if 100,000 hectares of new forests were planted each year from this point forward: eight million units
4. The CCCR volume that would be delivered in 2030 if 100,000 hectares of new forests were planted each year from this point forward: 19 million units

While the settings for the CCR might be in the limelight for the Ministry’s consultation, it is the CCCR which may eventually steal the show. This is because the CCR might come out of the consultation with smaller supply volumes which only become available at much higher prices, making it much less important as a driver of NZU price. The CCC has recommended that the full CCR volume in 2027 should only be available if NZU prices reach $268 at auction. By contrast, the CCCR is available today and at current market prices.

The influence or power of any price control mechanism is a function of both the volume that it has available to it, as well as how close in price it is set to the current market price. The fixed price option (FPO) was a good example of a strong price control mechanism in action - it had a lot of volume available to it and it was set close enough to the market price to be utilized. In its last year of operation the FPO pumped out more than 30 million units and strongly impacted the secondary market price.

While this article doesn’t focus on the auction reserve price, by this same logic the changes proposed by the CCC could raise the influence of this price control mechanism in the short to medium term. This is because the influence and role of the auction reserve price will be larger if its price setting is moved closer to the market price than it is today. But the power of the auction price reserve will also itself drop away over time as auction volumes fall and it has less ability to influence outcomes.

While the lessons we might take from the history of the NZ ETS is that the price control settings are really important to the development of the NZU price, our focus might have to shift in the future. The overall supply and demand volumes of the scheme, including the market's views on the stockpile volume, could become much more important than they have been in the past. The outlook for the future of the CCCR settings is much more likely to hold the keys to understanding the future NZU price than the settings for the CCR.