CERs and ERUs

• There are no restrictions on volume of CERs or ERUs that can enter NZ ETS.
   
• CERs and ERUs relating to nuclear projects will be excluded.
   
• CERs from HFC23 projects may be excluded (due to associated environmental concerns). These projects have represented the largest asset class transacted on the Primary CDM market in the past two years. Their exclusion may therefore increase anticipated purchase prices for NZ participants on the CER market.
   
• t-CERs and l-CERs from forestry projects will also be excluded from the NZ ETS, due to their temporary nature.

AAUs

• There is no CP1 limit on the volume of AAUs that may enter the NZ ETS.
   

• These are not common 'currency' in other domestic schemes. They are allocated to governments under Kyoto, so little (if any) trading by firms.
   

• Future competition for AAUs in the market will be from other countries in a Kyoto deficit position, and potentially financial traders.
   

• Some reputational risk exists for purchasing excess AAUs (or 'hot air') - where perception of no environmental additionality.

RMUs

• International trading not active in RMUs (generated by countries through land use and land use change to forestry projects).

International Bilateral Linking

Options for direct bilateral linking with other countries have been considered, and key enabling design issues for such linking are noted by the Government as being:

• core obligation (cap and trade or intensity-based models);

• sectoral coverage;

• units of trade;

• the existence of any price caps or safety valves; and

• rules and penalties for non-compliance.

Linking with Australia

Bilateral linking with an Australian domestic ETS is considered by the Government to be an option and of “major interest to New Zealand for linkage given the close economic relationship between the two countries”. NZ ETS should not "restrict future linking opportunities".

Points of note:

• Australia is not a party to the Kyoto Protocol;

• Australia seems likely to have intensity-based caps (not absolute volumes);

• NZ needs to ensure its Kyoto Protocol liability is not increased through linking; and

• NZ ETS bilateral linking is unlikely prior to 2012.

NZ ETS Price Drivers

International carbon market pricing and the NZ Government’s allocation methodology are likely to be the two key price drivers in the future NZ ETS. Any future regulated limits on importing Kyoto units (CERs, ERUs, AAUs etc) to NZ will also influence pricing.

CERs are the obvious choice for international allowance purchasers. Penalties in the NZ ETS will likely determine the risk appetite for most participants.

• With high non-compliance penalties, guaranteed delivery  or secondary market CERs may be the most appropriate purchase for many NZ firms.
   

• Alternatively, NZ firms could consider purchasing early and take a portfolio approach with some relatively cheaper but non-guaranteed delivery primary market CERs.