New Zealand leads on forest carbon

While cap-and-trade legislation stalls in the US and Australia, Copenhagen’s limited progress holds back REDD, and the inflexibilities of the Kyoto Protocol’s CDM keeps a lid on reforestation activity, New Zealand is in many ways leading the world in the use of forestry for compliance-based carbon markets. Forestry and land-use projects have largely been led by the voluntary carbon market internationally. But now a Kyoto-linked market for forest carbon offsets under New Zealand’s emissions trading scheme (NZ-ETS) is off and running, albeit at a modest pace so far.

The NZ-ETS has a significant place for forestry, which became the scheme’s first covered sector back in 2008. But the focus is not solely on domestic offsetting. Under the New Zealand government’s unique application of Kyoto rules, forest owners are taking advantage of its offer to convert domestic carbon credits, NZUs, to internationally tradable AAUs. These Assigned Amount Units are the UN carbon allowances allocated to Annex 1 developed countries and through which emissions trading is carried out at the government-to-government level under Kyoto.

AAUs are also flowing to Kiwi foresters under the Permanent Forests Sink Initiative (PFSI), a dedicated forest carbon scheme that pre-dates the NZ-ETS. Under the PFSI, land reforested after 1989 and subject to a long-term conservation covenant earns AAUs for carbon stored from 2008. Only limited harvesting is possible. Together, the ETS and PFSI make New Zealand the only place forest carbon sequestration can be turned into permanent UN carbon credits, making this a more attractive option internationally for carbon forestry investors than the UN schemes CDM and JI.

Under NZ-ETS rules, forests planted post 1989 on land cleared before that time can qualify for NZUs, and in turn AAUs. Credits are issued only on the carbon sequestered since 2008. But this still creates a sizeable potential pipeline of carbon credits if landowners and foresters decide to take advantage. According to government estimates, there are about 600,000 hectares of eligible post-1989 forest land holding up to 90 million tonnes (Mt) of potential NZU carbon up to 2012. But only around 700,000 forest-related NZUs are estimated to have been issued last year, the bulk of which were converted to AAUs. Uncertainties and risks attached for both buyers and sellers are as yet holding back the forest carbon market somewhat.

Chief among those are harvest liabilities for sellers. Practically all the ETS-eligible forest has been grown for harvest. While allowed under the NZ-ETS, carbon liabilities when cutting down trees introduce significant business risks and planning questions for owners, says Richard Hayes, a director of project developer and investor EITG. NZUs have to be surrendered to cover the associated carbon losses. So while credits can’t be claimed for carbon stored before 2008, harvest liabilities extend over all the carbon, right back to planting. Consideration has to be given to accruing a reserve of credits or buying NZUs on the market to cover obligations, and there are timing decisions around those options.

Nelson Forests is one company proceeding cautiously over realising the carbon credit benefits of its forests, lying on owned and leased land on the South Island. While registered to receive credits for the carbon stored since 2008, things get more complicated in future years when harvest liabilities arise for forests planted between 1990 and 2008 which could see liabilities cancel out credits. “We’re not going to be making any speedy decisions,” said Andrew Karalus, Nelson Forests’ forestry manager. Political uncertainty also remains an issue given the chopping and changing in government policy in recent years. Forestry interests have little confidence that things won’t change again, while the weak Copenhagen climate conference outcomes introduce further doubts over the future for the carbon market, Karalus said.

A lack of clear price signals for AAUs and NZUs also makes forest owners hesitant. As with most fledgling carbon markets, buyers and sellers have been loathe to share pricing details. The small number of forestry credit sales made since mid-2009 are thought to range between €8 and €10 per tonne - below secondary CER prices on European markets of €11 to €13.50 over that time. In the biggest of the deals, the Norwegian government bought 520,000 AAUs from South Island forestry company Ernslaw One last July, at a price believed to be around $NZ20 (€10, $US14) a tonne. City Forests, owned by Dunedin Council, this year sold 150,000 tonnes to a big emitter at a similar price. And generator Mighty River Power has made a forward purchase agreement for NZUs to flow from a 2400-hectare reforestation project on the shores of Lake Taupo on the North Island. The deal with a Maori group comes with social and environmental benefits which is believed to have seen a premium paid above the $20 price mark.

Local players are talking up the AAU market to potential government buyers and carbon traders in Europe and other Annex 1 countries. They emphasise the unique ability to access permanent Kyoto carbon credits from forestry, cheaper prices than CERs, and all underwritten by a developed-world government with robust land ownership system. Permanent Forests International (PFI) in Christchurch says most of the forest eligible for carbon credits is in the hands of small landowners. The company is aggregating their small parcels into marketable AAU pools and expects to have 50,000 tCO2 ready for sale in coming months. “There is an opportunity for overseas buyers to come in and buy Kyoto credits at lower than the prevailing international prices,” said PFI’s Ollie Belton. But that could mean the supply of forest credits available to domestic emitters in NZ-ETS may dry up. “Local emitters could see lots of NZ offset credits go offshore this year,” Belton says.

PFI estimates NZ-ETS emitters will have an NZU shortfall of around 40Mt overall across the Kyoto first commitment period to 2012, which would have to be met by either paying the fixed price, buying CERs or buying local forestry offsets. Much of this year’s supply will emerge over the next month or two as foresters register their 2009 credit claims by a March 31 deadline. But others doubt there will be much domestic demand for forest credits this year. While the settings are largely in place for the start of the of the ETS in earnest this July, market uncertainties and transition arrangements have limited NZU demand. There is little incentive yet for emitters to jump in and buy forest credits to offset emissions. Those high-emitting sectors that are covered this year – power generation, industrial processes and transport - are only liable for 50 per cent of their emissions until 2013. This, and a fixed carbon price of $NZ25 per tonne initially, makes it easier for emitters to plan their obligation with certainty and not worry too much about chasing cheaper offsets.

Emitters’ real focus is on how to best to minimise their emissions liabilities by “intelligent use of the rules” and lobbying for generous permit allocations, Hayes says. Another market observer says that at best there may be modest domestic demand this year for forest credits as emitters try to bargain prices down far enough below $25 to make offsetting worthwhile.

Ian Hamilton
Carbon Positive