Evolution of the New Zealand Emissions Trading Scheme: Linking

The New Zealand Emissions Trading Scheme (NZ ETS) was conceived as New Zealand’s gateway to the international carbon market, with two objectives: assisting New Zealand to meet its international climate change obligations; and reducing domestic net emissions below business-as-usual levels. Underlying these objectives was the principle of least-cost compliance for both the New Zealand government and NZ ETS participants. Uniquely among emissions trading schemes (ETSs) to date, from 2008 through mid-2015 the NZ ETS operated with buy-and-sell linkages to the Kyoto market that did not constrain domestic emissions and were used to set the domestic price. As international Kyoto unit prices plunged from 2011 onward, so did New Zealanders’ incentives to invest in higher-cost domestic mitigation. Instead, NZ ETS participants complied by purchasing large numbers of Kyoto units. In November 2012, the government announced it would take its post-2012 commitment under the United Nations Framework Convention on Climate Change (UNFCCC), not the Kyoto Protocol. NZ ETS participants responded by surrendering low-cost Kyoto units and banking New Zealand Units (NZUs), which were expected to remain usable in the longer term. In mid-2015, the NZ ETS delinked from the Kyoto market. As of 2017, the NZ ETS operates as a stand-alone system, with a substantial participant-held NZU bank largely as the unintentional legacy of past linking. The government now faces important decisions about the future of unit supply in the NZ ETS and linkages to international markets. This paper examines New Zealand’s experience with linking and delinking its ETS to capture lessons that could be of value to policy makers in New Zealand and other countries. It finds that the considerable opportunities to a small ETS market from linking can be negated if the environmental, economic, and political risks are not managed strategically. It also highlights some of the technical and political challenges of negotiating bilateral linking agreements. New Zealand’s future policy on ETS linking, and more generally its support for international mitigation as part of its global contribution, need to ensure the integrity of the country’s contribution to global mitigation and support strategic domestic decarbonisation in the longer term.