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Will Lost ETS Revenue Result In $800 Million Hole In Tax Cut Plan And New Borrowing?

Recent price falls in the New Zealand market for carbon credits leaves the Government facing the prospect of a significant loss of revenue from carbon auctions this year. The March financial statements from Treasury highlight lower-than-expected revenue from the Emissions Trading Scheme (ETS) due to a drop in the price of New Zealand Units (NZU) from $70.00 to $58.35 compared to forecast, and the price has deteriorated further to below $50 since then. One of the most closely watched numbers in the Budget forecasts will be the updated estimates from Treasury of the latest price drop on Crown revenue, particularly as revenue raised from ETS auctions is earmarked to fund the Government’s tax cut program.

This year the ETS auctions will sell 14.1 million NZUs, with a reserve price of $64/NZU. If bids do not reach the reserve no NZUs will sell and if demand is low, the auction can partially clear at the reserve price, leaving some NZUs unsold that will roll forward to the next auction in the schedule. Clearly, with prices hovering in the mid-$40 range it is much cheaper for emitters to buy their NZUs on the open market rather than at the auctions. This raises the very real prospect of either a significant reduction in revenue if each auction only sells some or all of the NZUs available at the minimum price versus a higher price, or a total failure of the auction with the result that the Crown receives no revenue at all. In 2023 all four ETS auctions failed and Crown revenue was zero. In the latest auction in March 2024 only some of the NZUs available sold and all sold at the minimum price. Market commentators are picking the June auction to fail under the current market and predict significant risk of failure for all auctions this year.

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This is the result of a loss of confidence in the Government’s management of the ETS, heightened by an ambiguous consultation on annual settings for the ETS auctions in 2025-2029 that suggested lowering prices at auctions and gave no clear indication of the Government’s goals for reducing the oversupply of NZUs that has accumulated over meany years and is damping prices and will make reducing emissions harder in the long term. The Climate Commission published their annual advice on ETS auction settings in March, with a clear direction to reduce NZU supply at future auctions and to maintain prices at current levels. This should be the default outcome unless the Minister provides reasons for not following that advice; in this case, the Government’s consultation gave a muddled response and, remarkably, introduced the idea of reducing auction reserve prices without any hint of what those new prices might be, any reason for the price change or any evidence to support why this was necessary. Lower prices only benefit emitters and reduce the incentives to lower emissions. A Cabinet decision to modify the Climate Commission’s advice in 2022 was the reason all auctions failed in 2023, so the current situation in which the Minister seems to be second-guessing the Commission’s advice resulting in a collapse in market confidence was entirely predictable.

Changing the settings on the ETS usually passes without comment but in this case, the Government is facing an own goal of lost revenue due to their mismanagement of a tightly controlled market in which the Minister sets the minimum price, controls NZU supply and the Crown is the single largest trader of NZUs. At around $1 billion of revenue per year, this is a significant earner for the Crown. If the ETS auctions remaining for 2024 all fail, the Crown will miss out on an estimated $800 million (at $70/NZU, which was Treasury’s forecast price earlier this year). If even half of the available NZUs sell at the minimum price, in a similar partial clearance as in the March auction, the loss is more than $350 million. This money is set aside to fund the tax cut program and the numbers are so large that they cannot be covered by other ‘unders and overs’ in Crown revenue, so the question is, will this shortfall lead to increased borrowing to pay for tax cuts?

The impact of this loss of carbon revenue will be revealed in updated Budget forecasts but the real crunch will be the next ETS auction in June. If the Minister continues with the current approach of allowing the market to operate in a vacuum regarding forward auction volumes and the long term ambition for the ETS, which is now the Government’s key (and only) tool for meeting our climate targets, this auction will likely fail and a major financial hole will open up in Crown revenue. The Government has shown urgency in addressing other issues but so far climate change hasn’t been treated as an urgent problem; this might change if the loss of $800 million puts the upcoming Budget at risk.

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