The Government's recently announced NZ ETS review contemplates the largest expropriation of privately owned assets in New Zealand since the passing of the Petroleum Act 1937, where ownership of all underground crude oil in New Zealand was vested in the Crown.
If the Climate Change Response Act 2002 (CCRA) is amended in the manner the Government appears to favour, then all forests currently registered in the NZ ETS could be forced out of the NZ ETS and into an inferior new scheme. And more than 96 million NZUs held in private ownership could be taken and reclassified as "removal units" of much lesser value.
A legislative change of this kind is a classic illustration of expropriation involving the taking or impairment of private property rights.
Under the new scheme, instead of receiving NZUs which can then be sold on established markets to anyone, at any time, at competitive prices, foresters will receive removal units which, in all likelihood, will only be able to be sold to the Government at prices and at times and on terms which the Government dictates - in other words the new scheme will create a monopsonistic market for removal units.
The consultation paper says that the price which the Government will pay for removal units will not be linked to the price of NZUs. The reality is that the new scheme will only work if (1) the price the Government pays for removal units is substantially less than the price it gets from the sale of NZUs at NZ ETS auctions; and (2) the Government is able to decide the number of removal units it purchases and the timing of those purchases.
The consultation paper mentions a reverse auction mechanism as one possibility. This would involve holders of removal units placing sale bids on terms imposed by the Government in the hope those bids might be low enough to be accepted by the Government. The Government could presumably decide not to buy any removal units for a certain period.
Removal units will almost certainly prove to be illiquid assets - particularly when contrasted to NZUs.
Under the reclassification, NZUs which were originally allocated from forestry activities, will become removal units in the new scheme. As at 31 March 2023 the number of NZUs in this category stood at 95,743,143. At the top of the spot market ($88), these NZUs were worth over $8.4 billion dollars. What they will be worth after the reclassification is anyone's guess. However, there seems little doubt that each removal unit will be worth substantially less than an NZU and can be expected to decrease in relative value as time goes on.
On the other hand, the reclassification will add immediate value to the NZUs which are not reclassified. This is because in one fell swoop the entire "surplus" of NZUs in the carbon market (estimated by the Climate Change Commission in 2022 to be between 33 and 66 million) will be wiped out. The Government makes no mention of this in its consultation document, but it is likely to be a major driver behind the reclassification proposal.
What was first required in this review was a thorough assessment of the issues identified by the Climate Change Commission and an equally thorough assessment of the costs and benefits associated with the proposed reforms.
The consultation document says (page 54) that before the Government makes its final decisions on the NZ ETS review, detailed modelling and analysis will be undertaken and that this analysis will examine how proposals will be applied to existing NZUs and existing forests and will be informed by evidence gathered through the consultation. That detailed modelling and analysis should have been undertaken before the Government released its review document.
In its recent draft advice, the Climate Change Commission proposed that a separate mechanism could be created to incentivise afforestation. This appears to be the genesis of the new scheme. What the Commission has in mind is a separate mechanism that enables direct control over the rate of future forest establishment. Nowhere in the Commission's separate mechanism proposal does it suggest that existing forests should be forced into the separate mechanism or that existing NZUs originally allocated from forestry activities should be reclassified as removal units. The Government has therefore gone further than the Commission's draft advice.
The Government seriously damaged the NZU market back in late December 2022 when it declined to accept key aspects of the Commission's advice on pricing. As a result, spot prices for NZUs fell from a high of $88 to around $53. In putting up a half-cocked proposal in the form of the new scheme, which goes beyond the Commission's draft advice, the Government has exacerbated that damage by injecting more uncertainty into the carbon market. As a result, spot prices for NZUs have fallen further - to around $40. Ironically, the biggest loser from this uncertainty is the Government. If both of its NZ ETS auctions this year had not failed and the clearing prices been $88, the Government would have banked additional revenue of $787 million. This is nothing short of a fiasco - brought about, primarily, by commercial naivety as to how markets respond to risk.
If foresters are forced out of the NZ ETS and into the new scheme then the knock-on effect will be enormous, not only in terms of the fallout from countless impacted commercial transactions (many of which are long term) but also the lives of ordinary people who, to some extent or another, are directly or indirectly dependent on cash flows from the sale of NZUs. Iwi/Māori are thought to be at the forefront here. NZ ETS participants, traders and others (including international players) who are currently holding NZUs originally allocated from forestry activities, can expect to be particularly hard hit financially if those NZUs are reclassified as removal units.
One might also expect that many affected foresters, some of whom will have deferred harvest dates because of forecast upside from the NZUs they anticipated receiving, will look to advance harvests because of uncertainties associated with the new scheme. This of course will result in a loss of future sequestration and impact New Zealand's ability to meet its NDCs through domestic activities.
Another option which the Climate Change Commission put forward in its recent draft advice (and which incidentally is not explored at all in the Government's consultation paper) is limiting the area of new forest land that can register in the NZ ETS each year. The Commission proposed that an overall quota be set for such registrations and that this would provide the brake on any excessive afforestation (meaning future forest establishment) putting downward pressure on the NZU price. It even suggests that a quota auction system could provide an extra revenue source for the Government. Part of such quota could be reserved for Iwi/Māori on a right of first refusal basis. Successful bidders could be required to meet environmental and other conditions stipulated by the Government to ensure that "the right trees are planted in the right place, for the right purpose and managed well" (now Government mantra).
Obviously, such a quota system relates only to future forests, which is where the Commission perceives the problem to lie. The Government's consultation paper confirms this (page 25):
"At present, NZUs credited to forests are a small proportion of the overall supply of units available to the NZ ETS market. However, this proportion is expected to increase over time (as shown in figure 3) due to new forest registrations in the NZ ETS."
There is no reason why existing forests registered in the NZ ETS need to be moved en masse to the new scheme when effective control over new forestry registrations will avoid the risk of excessive forest establishment in the future.
If a quota system does not allow for the quantity of afforestation which the Government seeks in the future (to meet New Zealand's NDCs) then the new scheme could be introduced solely for that afforestation. Of course, how successful that will be in incentivising the planting of new forests is another matter entirely.
Introducing a quota system for future forestry registrations would be relatively straightforward and inexpensive for the Government, and it would not create the cost, damage and delay which will inevitably result from changes to the CCRA which force existing forests into the new scheme and reclassify existing NZUs originally allocated from forestry activities.
As already mentioned, a legislative change of this kind is a classic illustration of expropriation involving the taking or impairment of private property rights. Respect for property, as a fundamental constitutional principle, would require the payment of compensation to the affected parties (e.g., Legislation Guidelines, 2021). The expropriation of petroleum rights in 1937 ultimately resulted in no compensation being paid, largely for technical legal reasons. But it was the subject of extensive Parliamentary debates. The expropriation of crude oil under Māori land without adequate compensation resulted in strong opposition from Iwi/Māori on the basis that it was contrary to the Treaty of Waitangi.
The compensation being offered in the case at hand (membership in the new scheme and removal units in exchange for NZUs) is manifestly inadequate and unreasonable. Iwi/Māori will again want to ensure that the principles of the Treaty of Waitangi are being upheld. Thousands of individuals, corporations, trusts, charities, partnerships, joint ventures and other entities will be materially adversely impacted if these changes go ahead. What is being proposed by the Government is expropriation on an enormous scale. With billions of dollars at stake it would be surprising if legal redress was not sought by many of those affected.
These changes to the CCRA are merely Labour Government proposals at this stage. They will not be acted on until after the election in October, by which time there may be another political party/parties in charge. Everyone who could be adversely affected if these changes end up becoming law is encouraged to make a submission on the NZ ETS review before 11 August 2023. A quick submission can be made at: