NZUs last fixed at $64.50 on Commtrade this morning, just above the auction floor price of $64.

With prices on the secondary market so low, it is looking highly likely that the auction floor will be the reserve price, as a confidential reserve price is only required to stop units being sold at auction “significantly below” prevailing secondary market prices.

If there is a confidential reserve price, all bids must be above that price for the entire auction volume for the auction to be successful. But if the auction floor price is the reserve, that opens up the possibility of a partial auction clearance in the case of low demand, with any of the 3,525,000 units on offer that remain unsold carried over to the next auction.

Although a partial auction clearance would mean the government receives some revenue when it desperately needs to boost the coffers, it could lead to market stability taking a hit, as Carbon Match’s Lizzie Chambers notes.

“That could really underwhelm investor sentiment and even run the risk of tipping natural sellers on to the secondary market at levels below the $64 auction floor - just one of many scenarios and not a prediction!” Chambers says. 

“But it's important to understand the mechanics of the auction and that the $64 floor doesn't underscore the whole market. There are no price guarantees for NZU holders,” Chambers says.

The government needs the auction revenue to fill a growing ‘fiscal hole’ but has also promised a strong and stable ETS, as its main tool to reduce emissions. A stable ETS doesn’t gel with the risk of a partial auction clearance.

The NZX and EEX, which run the auction, only calculate the confidential reserve price - and whether one is needed - on the morning of the auction, and the market isn’t notified whether there is a confidential reserve or not, with participants only finding out post-auction.

The confidential reserve price is calculated for each auction using a confidential methodology based on recent secondary market prices and taking into account market volatility. Both the methodology and resulting reserve prices are kept confidential so the confidential reserve price doesn’t become the target of strategic bidding behaviour.

The government recently changed the methodology, so it would remain confidential.

Participants wanting to sell

John O’Brien, managing director, Carbon Market Solutions, says he has fielded lots of calls from market participants wanting to sell their NZUs.

“Basically there’s no appetite to greatly increase prices because everyone knows there’s an oversupply in the short term.

“Everybody knows that the priority of the current government is to reduce inflation, so there’s no appetite to greatly increase NZU prices, because a high carbon price under the ETS drives the price of petrol up, increasing inflation. The market understands that.

“No-one is going to bid above $64 because you’re guaranteed to pick it up at the auction at that price.”

O’Brien is predicting the market will stay flat for some time.

Nigel Brunel, former head of commodities at Jarden, wrote on Linkedin that it was not a surprise demand for NZUs on the secondary market was low. “Of course, why would I step and buy when I know I can most likely buy at the auction floor next week?”

It’s a big contrast from the last ETS to auction clear, which was in December 2022. At that auction, all 4.825 million units on offer cleared at $79.

But that was before the period when the carbon market went into a downward spiral after the government failed to adopt Climate Change Commission advice around auction settings, with all of last year’s ETS auctions failing to clear.

Secondary market prices only began to recover after a court case, taken by Lawyers for Climate Action, forced a government U-turn on policy settings.

Writing on Linkedin, Christina Hood, ETS expert and head of Compass Climate, noted how close the spot price was to the auction floor. “Oof - NZ ETS price down to $64.50 ahead of next week's auction, only just above the auction floor price of $64. A very good thing that Lawyers for Climate Action NZ got that floor price raised.”

Market underwhelmed by CCC recommendations

Last week, the Climate Change Commission advice to the government was released recommending a drastic reduction in carbon units auctioned under the ETS - effectively halving the volume from next year.

However this has led to a slump in prices, rather than the secondary market gaining ground, suggesting the market doesn’t believe the government will follow CCC advice, and is perhaps focussing instead on the current oversupply, as well as the long list of problems the CCC has identified with the ETS.

As well as recommending reducing auction volume, the CCC says the ETS needs an overhaul as its current design means it is driving afforestation rather than reducing gross emissions. However one of the government’s first climate actions on taking office was stopping a review of the ETS initiated by the previous government.

Climate Change minister Simon Watts also recently reiterated his promise not to make significant changes to the ETS.

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Disclosure: Nigel Brunel is part-owner of Carbon News.