A Hotelling collapse?

I used to teach Hotelling pricing of non-renewable resources when I covered environmental econ as part of my current policy issues course. 

I'd tell the students that one sure way to screw up Hotelling pricing is to introduce a lot of uncertainty about underlying property rights. 

If you think that the government will swoop down in a few years and cancel all oil drilling, you'll ignore the optimal Hotelling pricing paths in favour of selling as much of it as possible while it were still possible. If that happened in only one country that wasn't huge relative to the market, it would screw up the geographic location of extraction but not the overall time path. If it happened everywhere, you'd distort intertemporal choices. 

And that leads to a very plausible explanation for the collapse in NZ ETS prices. BusinessDesk and CarbonNews both report on it. Similar stories. Here's BusinessDesk:

One broker told BusinessDesk that he had even settled one off-market trade at nearly $35 with a forester who needed to raise some cash quickly by selling a small holding of NZUs.

All market participants spoken to by BusinessDesk had similar stories, with very low volumes, very little interest in buying and confusion – particularly from forest owners and those holding forestry-created NZUs.

Eligible forests get an NZU for every tonne of carbon their trees absorb.

Until now, there was, for all intents and purposes, no difference between the NZUs created by the government and those created by forests.

However, the government has become concerned about the amount of tree planting that was being driven by the carbon price, particularly over ‘carbon forests’. This is where trees, mainly pine, are planted solely for carbon credits and with no intention of harvesting the logs.

If you have a carbon forest and you think government is going to do something horrible, you'll want to dump your credits before it happens.  

The options put forward by the government to change the ETS range from tweaking the rules to some form of separation of forestry NZUs and government NZUs. This could mean emitters not being allowed to use forestry NZUs to settle all or part of their ETS obligations. Another option is to have two ETS systems, one using government-issued NZUs to settle their obligations and another where the government, and presumably others, would buy forestry NZUs. 

One broker said the situation was “chaotic and it is causing confusion”. The problem is, with so many options on the table, no one knew what their NZUs were worth now or what they might be worth in the future.

So NZU are now a punt on whether the government is going to renege on having a net zero emissions target and have the ETS shift to a focus on gross emissions, and presumably whether a change in government would stick with that. 

Ugh. 

Here's CarbonNews:

Paul Harrison, managing director of Salt Funds Management, has switched their carbon fund out of forestry removal units to only non-forestry units to mitigate risk.

 

The government is consulting on changing the classification of forestry units as an option in its review of the Emissions Trading Scheme, so Harrison says non-forestry units might gain value. “We think there will be a premium for those units under option 3 or even option 4 [of the ETS review.]”

Harrison expects the government will allow some kind of “grandparenting,” where an old rule continues to apply to some existing situations while a new rule applies to future cases, so existing forestry units could retain their value.

But officials didn’t give out reassuring signals that would happen during webinars on the ETS review.

 

“There is a risk that they don’t grandparent. [Switching to non-forestry NZUs] is a bit of insurance on that side,” Harrison says.

Big ups for everyone involved in breaking the Hotelling price path here. Y'all are great. MfE, Climate Commission, James Shaw - take a bow.  

Update: more detail from Carbon News.