Carbon credits are becoming an asset class of their own, says Nigel Brunel, of OMF, in the third of our Financial Markets series. You may not have heard much about them lately, but they’re still going strong.
Carbon credits were a hot topic when the government first launched the Emissions Trading Scheme (ETS) 11 years ago, but there hasn’t been much talk about them since.
Their price started out high, then dropped dramatically when poor-quality overseas carbon credits swamped the market in the middle of the Global Financial Crisis (GFC). But gradually they’ve built in value again.
Carbon credits are a feel-good investment that can help New Zealand meet its climate change commitments.
What’s a carbon credit?
A carbon credit is a unit you can buy and sell that offsets pollution. Offsetting one tonne of carbon means there will be one tonne less carbon dioxide in the atmosphere.
The printing press for carbon credits within the ETS in New Zealand is forests. Trees absorb and store carbon dioxide, making them a great tool for beating climate change. Pollution in the atmosphere can be offset by growing more trees.
The ETS is New Zealand’s central mechanism for meeting its international obligations under the Kyoto Protocol, soon to be replaced by the Paris Agreement, starting in 2021. It’s a politically created market, effectively a market-based tax.
It’s a cycle. Forest owners earn carbon credits every year for their trees and sell them to emitters. Polluters buy one carbon credit unit to give them the right to produce one tonne of emissions. Emitters hand the units back to the government to offset their emissions.
For example, companies like fuel supplier Z Energy are a ‘point of obligation’. That means Z Energy has to offset our emissions because we’re buying petrol from it to fill up our cars.
We pay for Z Energy’s carbon through the fuel price. Z Energy will buy carbon credits and hand those to the government.
How it started
Countries who signed the UN’s Kyoto Protocol committed to reducing greenhouse gases. There are two ways to work this obligation into your economy, a carbon tax, or an ETS. New Zealand chose an ETS, which is fast becoming the global model for dealing with emissions domestically.
New Zealand has one of the world’s oldest emissions trading schemes, set up by Labour in 2008 and continued by the incoming National government.
Forests are the key
Most large emitters don’t invest in a forest directly and choose to buy carbon credits instead.
Before the Kyoto Protocol, forest owners just grew trees. They’d plant a forest and around 28 years later, they’d chop it down and sell the wood. Now, by planting a forest, they can earn carbon annually for the life of the forest.
Some forest owners plant permanent forests, which will never be harvested and will remain a sink forest for carbon.
With the price of carbon now at NZ$23 to NZ$25 dollars a tonne, that can be an attractive option for a landowner.
How can you invest in carbon?
There are several ways to invest in carbon.
1. If you’re a rural landowner, you could set aside some land for growing trees for carbon.
2. If you don’t already own land, you might buy a rural lot, plant a forest,
and just hold the carbon credits.
3. You could buy carbon credits and speculate they could go up in value. In 2012, units were around NZ$1.45 a tonne. But recently they rose to NZ$25.70. As of 1 August, they were at NZ$23. The price of carbon is expected to rise over the next five to 10 years as the Paris Agreement kicks in.
4. You could invest in an Exchange Traded Fund (ETF), which can be bought and sold on the stock exchange. Salt Fund recently launched a carbon ETF on the New Zealand Stock Exchange. It holds New Zealand carbon credits and can also hold foreign carbon credits. If you invest in it, you’re effectively buying into the carbon price.
The benefit of having carbon as part of your investment portfolio is that carbon is not correlated to other markets like shares.
We need more trees
New Zealand’s committed to reduce our emissions 30 per cent on 2005 levels by 2030. We can probably only meet about half of that domestically. We’ll have to buy the rest as carbon credits from international markets.
That’s because half our emissions come from agriculture and we are at 85 per cent renewable electricity generation already. There’s not a lot New Zealand can do domestically to meets its 2030 Paris commitment.
Our goal is to plant a lot more trees, but that’s really just a stopgap as we transition to a low-carbon economy. New Zealand’s goal is to be at net zero by 2050 for carbon emissions. Agriculture’s our biggest challenge.
Demand for carbon credits
The Paris Agreement comes into effect in 2021. It’s committed to reduce emissions to 2 degrees above pre-industrial levels, or ideally 1.5 degrees above, by 2030. Current contributions will lead to a world 3 degrees above pre-industrial levels, so there’s a lot of work to do.
International experts believe carbon prices need to rise to between US$75 and US$125 a tonne by 2030 to drive companies to find new clean technologies.
When the price of carbon gets higher, and less carbon is used, the price of carbon credits could eventually fall to zero. I believe it won’t happen in our lifetime, so it’s probably not a bad investment over the
next 40 years.
Air NZ has to pay
Air New Zealand has a ‘point of obligation’ under the emissions trading scheme because of the greenhouse gas emissions of its aircraft. The airline is required to buy carbon credits and give them to the government, as it is one of the country’s largest climate polluters. The airline’s doing what it’s required to do by law. But if you feel guilty about your air miles, when you fly, you can do more.
Just check a box to pay extra for your carbon credits, to offset your fuel use. Air New Zealand uses that money for its FlyNeutral programme of carbon emission reduction projects.
Nigel Brunel is the Director of Institutional Commodities at OMF. He’s been involved in the New Zealand carbon market since its inception in 2008. For more information, see www.omf.co.nz.
Published 22 August 2019
This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.
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