The New Zealand government this week began its 100-day Kyoto Protocol true-up process that is likely to mean traders holding potentially millions of UN-issued offsets will see their assets cancelled.

As part of New Zealand’s compliance with the Kyoto Protocol’s first commitment period, all privately held Kyoto units in the national registry will be cancelled automatically after Nov. 18, the EPA announced.

The government will ensure that private holders of cancelled AAUs generated in New Zealand will get access to an equal amount of other permits eligible in the domestic carbon market, the EPA said, probably NZUs.

But any private company still holding units originating in other nations, whether AAUs, CERs, ERUs or RMUs, will have those cancelled without compensation.

“I am sure there will be a number of parties, both emitters and forest-owners, caught out by last year’s sudden law change banning Kyoto unit use for ETS forestry who will be holding collectively possibly millions of overseas Kyoto units,” Ollie Belton, principal with consultancy Carbon Forest Services, said.

CLOSED LOOPHOLE

In May last year, the government banned post-1989 forest-owners from using UN offsets to comply with the ETS.

The move aimed to plug a loophole that had allowed the foresters to voluntarily join the ETS, for which they received free NZUs from the government equal to the carbon stored in their forests. They could give units back when they harvested the forest, or at any time they wished to exit the market.

Many simply immediately sold the NZUs to emitters and bought much cheaper UN offsets instead, which they then handed back to the government at a 700-900% profit before exiting the scheme. The procedure could be repeated annually.

The unintended arbitrage opportunity was a result of New Zealand allowing ETS participants unlimited access to UN offsets to meet their targets, which meant the NZ market became a dumping ground for cheap offsets after the international carbon credit market tanked in 2011.

Post-1989 forest-owners made millions of dollars from the loophole without cutting a single tonne of greenhouse gas emissions, and the market in general welcomed the government’s decision to crack down on it.

But the government made the rule change overnight with no possibility for traders to get out of their positions. Many were stuck with offsets that had been made useless, and were forced to go back to the market to buy more expensive NZUs instead. The day the announcement was made, NZU prices rose 25%.

After Nov. 18, traders still holding those UN offsets will no longer have any chance to sell those offsets into the international market. Given the low demand, market participants did not expect anyone to be able to sell them in time.

“Given that New Zealand was taking the bottom-of-the-pile Kyoto units not eligible in the EU ETS it is unlikely that parties will be able to sell these surplus units before the 100 day true-up is over. So they will be stuck with them until they get cancelled,” Belton said.

CARRYOVER BOOST?

One option would be for the government to take the offsets off their hands at a price of a couple of cents each, although the EPA statement did not indicate the government planned to do this.

By buying the offsets, the government could increase the amount of units to carry over from Kyoto’s first commitment period, making future targets correspondingly easier to meet.

New Zealand has pledged to cut its emissions to 30% below 2005 levels by 2030, equal to an 11% reduction from 1990 levels.

New Zealand can carry over some 7.5 million each of CERs and ERUs, and an unlimited amount of AAUs. However, there is some uncertainty over their eligibility as the country has opted out of Kyoto’s second commitment period. A clarification is expected at the December climate talks in Paris.

A previous version of this article said the New Zealand government would ensure private holders of cancelled ERUs generated in New Zealand would get access to other units still eligible in the domestic ETS. That is not correct, the government has only made this pledge for AAUs.

By Stian Reklev – stian@carbon-pulse.com

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