1 Introduction

Overview

The New Zealand Emissions Trading Scheme (NZ ETS) is part of the Government’s response to global climate change. It is the primary means by which New Zealand will meet its obligations under international agreements such as the Kyoto Protocol. Under the NZ ETS, some businesses will have a legal obligation to surrender ‘emission units’1 to cover their direct greenhouse gas emissions or the emissions associated with their products. The consequent need to acquire these units will effectively put a price on emissions of these greenhouse gases.

The surrender obligations of the NZ ETS will apply to emissions from stationary energy and industrial processes and liquid fossil fuels sectors from 1 July 2010. From this date many energy producers (such as transport fuel producers and electricity generators) and some businesses undertaking industrial processes that lead to direct emissions of greenhouse gases (such as the production of iron or steel) will face obligations and a price on emissions. In many cases this price will be passed through to consumers; for example, through higher electricity and gas prices. However, the Government intends to give some emission units (called ‘allocation’) to the most adversely affected firms. This allocation will be targeted at firms that face a significant increase in costs and have a limited ability to pass these costs on to customers. In other words, it will be targeted at those firms that are conducting activities that are both emissions intensive and trade exposed.

This consultation document sets out the Government’s approach to developing regulations under the Climate Change Response Act 2002 (“the Act”) that make people eligible to receive allocations. It:

  • sets out the process for awarding allocation under the moderated NZ ETS
  • seeks feedback on a number of technical matters
  • invites people who believe they meet the tests for allocation to identify themselves and provide some preliminary data to demonstrate this.

The Climate Change Response Act 2002 requires the Minister for Climate Change Issues to consult during the development of regulations that make people eligible to receive allocations. This consultation document forms part of this consultation.

The reason for allocating to affected parties

Many New Zealand-based firms operate in markets in which prices are set internationally. This includes both firms that are exporting and those that produce goods that compete against imports. For these ‘trade-exposed’ firms, an increase in the costs of production in New Zealand as a result of the NZ ETS will make them less competitive relative to firms in other countries that are not facing an increase in their production costs. The impacts will be greatest for those that have significant emissions and therefore face significant increases in costs. These are the firms that have emissions-intensive, trade-exposed (EITE) activities.

The concern is that this reduced competitiveness may result in reduced production and output in New Zealand and a corresponding increase in production and output in other countries. This could result in both:

  • emissions leakage – New Zealand emissions fall and, although we are better able to meet our international emissions obligations, there is no reduction in global emissions
  • economic regrets for New Zealand as a result of losing business activity that may not return, even when emissions pricing is more widespread internationally.

In response to these concerns, allocation is being used to maintain production in New Zealand to reduce emissions leakage and maintain industrial capacity to reduce economic regrets. These two objectives influence the approach taken to allocation, particularly the use of an intensity-based approach that provides incentives to maintain production. At the same time, the allocation approach needs to maintain incentives for emission reduction through improvements in the emissions intensity of manufacturing.

One of the main reasons for the amendments to the original Act was to reduce the adverse international competitiveness impacts of the NZ ETS, including using a slower rate of phase-out. Another reason was to achieve greater alignment with approaches proposed in Australia to maintain cross-Tasman competitiveness.

Because it is expected that emissions pricing will be introduced in many more countries over time, including New Zealand’s major trading partners, the need to protect competitiveness is likely to reduce year by year.

How will allocation work?

Costs will increase for industry because of the requirement to surrender emission units, so allocation of emission units is an effective way to limit net costs. The size of the cost increases will change with the price of emission units, and so will the value of the allocation to limit these costs. As was noted above, allocation of emission units aims to maintain both production levels and productive capacity. These objectives have different implications for allocation.

Business decisions about production levels are made on the basis of the marginal costs of production. Other things being equal, a firm will produce another unit of output so long as the revenue it receives for that next unit is greater than the cost of producing it. The introduction of the requirement to surrender emission units affects the marginal cost of production because each additional unit of output results in more emissions and an additional requirement to surrender emission units. If a firm is given a lump sum allocation of emission units (ie, it is given the same number regardless of how much it produces), allocation will not change costs and revenues at the margin, or the decision to reduce production.

In contrast, if the number of emission units a firm is given changes with the amount it produces (an ‘intensity’ or output-based approach), then allocation changes marginal costs and revenues: producing another unit of product both increases the requirement to surrender emission units (or increases pass-through costs) and results in an additional allocation that limits the increase in net costs.

Decisions about maintaining capacity (staying in business) are made on the basis of average costs and revenues. A firm will keep operating if its profits are greater than its costs of capital. This can be achieved by intensity-based allocation. Intensity-based allocation will be used under the NZ ETS.

Similarities with Australia

To summarise, the approach to allocation in the Act is:

  • targeted at trade-exposed, emissions-intensive activities
  • intensity-based
  • phased out over time.

This is very similar to the approach being developed in Australia as part of its proposed Carbon Pollution Reduction Scheme (CPRS). This provides opportunities to manage across-Tasman competitiveness impacts and to benefit from the considerable amount of work the Australian Government has done on industrial allocation.

There are a number of good reasons for aligning with Australia. This approach can reduce trans-Tasman competitiveness concerns (which are a proxy for international competitiveness concerns more generally). Also, making use of technical work completed in Australia could accelerate the allocation process.

However, regardless of whether or not the CPRS is passed into law, the Government intends to move ahead with implementation of industrial allocation in New Zealand.

1 A ‘New Zealand unit’ or other unit created under the Kyoto Protocol.