Development of Industrial Allocation Regulation under the New Zealand Emissions Trading Scheme

• 1 Overview
• 2 Activities
• 3 Electricity Allocation Factor
• 4 Revenue Rules
• 5 Emissions Rules
• 6 Other Issues
• Annex 1: List of Submitters

Development of Industrial Allocation Regulations under the New Zealand Emissions Trading Scheme: Summary of Submissions

Executive Summary

Surrender obligations of the New Zealand Emissions Trading Scheme (NZ ETS) will apply to emissions from stationary energy and industrial processes from 1 July 2010. From this date, obligated firms will be required to surrender emission units to cover their emissions, reflecting New Zealand’s obligations under the Kyoto Protocol. A price on emissions will start to be reflected in energy and some product prices.

The Government intends to give some emission units (called ‘allocation’) to firms most likely to be adversely affected by this price on emissions. This allocation will be targeted at those firms conducting activities that are both emissions intensive (with an emissions intensity over 800 tonnes of CO₂e per $million of revenue) and trade exposed (ie, to international trade which means both imported goods which are made in countries which do not have a price on carbon, and goods exported to countries that have no price on carbon).

In December 2009, the Government launched a consultation on the development of regulations for the allocation of emissions units to industrial sectors under the New Zealand Emissions Trading Scheme. The consultation document, entitled Development of Industrial Allocation Regulations under the New Zealand Emissions Trading Scheme:

• sought notification of instances where submitters were undertaking activities likely to be eligible for allocation
• included draft activity descriptions for review and comment
• proposed requirements for data to be submitted under Gazette notices to establish eligibility and allocative baselines.

The Government received 57 submissions in response to the consultation document (by 5 March 2010). A list of organisations and people that responded to the consultation document is included in Annex 1.

Activities proposed in the consultation document

A number of draft activity descriptions were included in the consultation document. These drafts were based on definitions developed in Australia for activities that had either been found to be eligible or were under consideration for eligibility there. Submitters were asked to indicate whether any of these activities were undertaken in New Zealand.

Submitters indicated that the following activities are undertaken in New Zealand:

• Aluminium smelting
• Carbamide (urea)
• Carbon steel
• Cartonboard
• Caustic soda
• Clinker
• Ethanol
• Glass containers
• Hydrogen peroxide
• Lime
• Market pulp
• Methanol
• Newsprint
• Packaging paper
• Tissue

The Government will take these activities through to the data collection stage to assess eligibility and develop allocative baselines.

Petroleum refining was included as a draft activity definition in the consultation document, and is being undertaken in New Zealand. However, this will not be progressed at this stage because the sole firm involved in the activity (the New Zealand Refining Company) already receives protection from costs from the NZ ETS through the operation of its Negotiated Greenhouse Agreement with the Government.

A number of the submitters who indicated that they were undertaking activities for which draft activity descriptions were included in the consultation paper requested changes to the draft descriptions.

Where changes were proposed, the Minister for Climate Change Issues considered the merits of the proposed changes on a case-by-case basis, referring to the matters he must have regard to in finalising activity descriptions under section 161E(1) of the Climate Change Response Act 2002. On this basis, changes were made to the following activity descriptions:

• Carbamide (urea) / ammonia – an integrated activity definition will be developed.
• Cartonboard – the activity definition will be extended to include log billets as an input, and uncoated cartonboard and sheets of cartonboard will be added as defined products in the activity definition.
• Clinker – will be extended to include the cement milling process and renamed; a clearer definition of ‘contiguous’ will be added to the description.
• Lime – the title of the activity will be changed to ‘production of burnt lime’.
• Market pulp (referred to as ‘dry’ pulp in the consultation) – different allocative baselines will be included for the different types of pulp (high / low yield, and high / low freeness). The moisture content range of market pulp will also be extended to reflect that being produced in New Zealand.

A fuller summary of the changes suggested and the Government’s analysis and decision for each activity description where changes were suggested is set out in section 2.

Proposed new activities

Twenty-seven new activities were proposed by submitters as potentially eligible for industrial allocation. Of these, preliminary data indicates the following activities meet or are very near the threshold for eligibility:

• production of clay bricks and field tiles
• production of gelatine
• production of reconstituted wood panels
• production of veneer sheets
• production of protein meal (meat by-product rendering)
• production of six new dairy products – lactalbumin, lactose, milk minerals, whey cheese, whey powder, whey protein concentrate/whey protein isolate
• rose production
• fresh capsicum production
• cucumber production
• fresh tomato production
• iron and steel manufacturing from iron sand.

Draft activity definitions will be developed for these activities in consultation with industry, following which formal data collection will be undertaken to establish eligibility and allocative baselines.

Other activities for which data indicates are likely to be far below the eligibility threshold, based on the inclusions and exclusions in the final data rules, will not be progressed further at this time. 

At the time of writing, further information is being sought for a number of other activities that may or may not meet the eligibility threshold.

Electricity allocation factor

A number of submitters raised concerns about the electricity allocation factor (EAF) proposed in the consultation document of 0.52 tonnes of CO₂ per megawatt hour of electricity. The proposal in the consultation document reflected modelling work undertaken in 2008 for the Stationary Energy and Industrial Process Technical Advisory Group (SEIP TAG) on the expected increase in electricity price as a result of the introduction of the NZ ETS, and was the median of the range of outcomes. A summary of this work is available on www.climatechange.govt.nz.

Most submitters argued that the factor was too low. To support their contention, many cited analysis commissioned by the Major Electricity Users’ Group (MEUG) from Professor Andy Philpott and Tony Downward of Stochastic Optimization Ltd (SOL) which suggests that because of imperfect competition in the electricity market, prices will be higher than short run marginal costs. Others noted that the modelling by SEIP TAG was based on an assumed carbon price of $40tCO₂, whilst during the transition phase there will be an effective CO₂ price of $12.5/tCO₂e.

The Parliamentary Commissioner for the Environment (PCE) submitted that the EAF should be lower than 0.52 NZU/MWh. She estimated the impacts on the basis of the emission intensity of the marginal (in a new-build sense) new-entrant generators, rather than by estimating the impacts on the costs of the marginal (in an operational sense) existing generators. The PCE further suggested that the extent of price impact would vary substantially by the different times of day and year. Further work commissioned by the Ministry for the Environment also suggested that the EAF may be too high.

The consultation document proposed to use a different EAF for decisions on eligibility – 1 tonne CO₂ per gigawatt hour. This is the EAF used under the proposed Carbon Pollution Reduction Scheme (CPRS) in Australia and reflects the Australian electricity mix. All submitters supported this approach, with the exception of the PCE.

The Government notes that legitimate arguments have been submitted for both higher and lowers EAFs, but the various arguments provide no clear basis for an alternative number. A number of the suggestions made to alter the EAF raise questions about the approach used, particularly the assumptions regarding perfect competition in the market, and the interaction between the key drivers of electricity prices. To explore fully the implications of these issues would require another considerable modelling exercise, and is likely to require a range of assumptions.

The Government’s clear priority is to get the allocation process up and running to give industry certainty as soon as possible.

The Government believes that an EAF of 0.52 is a sufficiently robust approach for determining allocative baselines in the short term. The Government recognises that the EAF will need to be reviewed before the end of 2012, to ascertain its appropriateness beyond 2013. The Government proposes to maintain a factor of 1 NZU/MWh for determining eligibility of activities.

Revenue rules

The main issues raised were on the provision of historical financial data and calculating the market price.

Some submitters raised concerns about the impact of a commodity price ‘spike’ that results in the average revenues over the three historical years for which data must be submitted being significantly higher than what would be expected in future years. The impact of such a spike could result in some sectors dropping below eligibility thresholds. They argue that the Minister for Climate Change Issues has discretion to ignore data supplied that may be unrepresentative of revenues across a longer period of time. They also contrast the provisions in the Act with the proposed CPRS where firms submit data from across five years, and are able to exclude the impact of one of these years.

There were also comments on the need for certainty over the requirements for the data to be submitted, particularly the need for clarity over the use of an observable market price if sales data is not available or in situations where revenue for the historic years does not provide a realistic projection of revenue in future years.

Whilst noting the commodity price spike has had different impacts on different sectors, the Government recognises that the commodity price spike is a material issue for many sectors.

Determining the appropriate level for revenue weighting in response to the commodity price spike is not straightforward. To inform the appropriate number, officials undertook an analysis of the average commodities price spikes across the ANZ commodities index. This study applied a regression analysis and a time series projection to develop an expected price in a number of the key sectors for New Zealand; and compared the commodities index prices against the expected prices in the three historic years. This analysis provides a guide to the extent to which the price spike deviated from ‘normal’ prices and therefore suggests an appropriate weighting.

On balance, given the above considerations, the Minister has decided that the revenue rules should be amended to allow the actual sales price or observed market price in the historical year with the highest annual price to be weighted at a lower rate than the other two years.

On balance, it has been decided that a single weighting will apply across all activities. This will avoid risks of inequities, is consistent with the approach taken to the other data rules, ensures that the data rule is as simple to apply as possible for industry, and ensures that it is simple to validate for government. The application of the weighting will be optional. This way no activity will be penalised by a weighting approach.

To assist activities that are likely to be most impacted by the price spike, a more generous weighting of 0.7 for the highest annual price and 1.15 for the lower annual prices will be adopted.

Additionally, following an analysis of issues raised in submissions, the Government intends to revise the revenue rules to:

• clarify that multiple outputs are feasible and how to determine the appropriate treatment of co-products or by-products (Revenue Rule1)
• allow firms to choose which one of two methods to determine the quantity of output (Revenue Rule 2)
• allow firms to choose between actual sales data and an observable market price and provide an accepted list of sources for obtaining an observable market price (Revenue Rule 3).

Emissions rules

Some submitters proposed that liquid fossil fuels (LFF) and upstream emissions from the extraction/transport of coal and natural gas be included as eligible emissions sources. Some, but not all of these proposed additional emissions sources are included in the CPRS.

Submitters noted that the NZ ETS costs imposed through upstream emissions from natural gas and fugitive coal seam methane (FCSM) or LFF are no different in nature from those imposed by the proposed list of eligible emissions sources, eg, coal or natural gas use.

The objective of the industrial allocation regime is to provide transitional assistance for those activities that face the greatest competitiveness risk, by protecting them from a significant portion of the costs imposed by the NZ ETS. This does not necessarily imply compensation for all emissions sources.

As the provision of industrial allocation has a fiscal cost, it is logical for the Government to target assistance at those emissions sources that are likely to be most material for the largest number of companies. In addition, the administrative complexity of providing assistance for particular emissions sources is a relevant consideration, particularly if it is likely to impact on the ease and speed at which activities receive allocations.

Further analysis of these points is included in section 5.

On balance, the Minister intends to keep the eligible emissions sources and exclusions the same as proposed in the consultation paper (ie, excluding LFF, FCSM and upstream natural gas emissions sources). This is because:

• for the vast majority of activities, the exclusion of the proposed emissions source appears unlikely to be very material
• LFFs could be material for some activities at margins of eligibility, but this is only one of a number of factors that could impact on the eligibility of these sectors
• inclusion of LFFs and upstream natural gas would raise significant complexities with implementation regarding decisions relating to activity boundaries and fair treatment across sectors
• the fiscal costs of including LFF, FCSM and upstream natural gas emissions could be significant, potentially $21 million during the transition phase rising to $80 million per annum after 2013.

Additionally, the Government intends to add one additional rule to clarify that only emissions which face an obligation under the NZ ETS may be included. This is necessary to exclude emissions sources for which an exemption under section 60 of the Act is in force.

Some submitters argued against a number of exclusions proposed in the draft activity descriptions, which are based on those listed in section 161E(2)(b) of the Act, and are consistent with the exclusions in the CPRS. The particular exclusions raised most often by submitters were transportation elements and packaging (eg, of food or hazardous substances). The main arguments proposed by submitters were that it was difficult to accurately determine emissions from these minor sources or that the excluded emissions were ‘essential’ to the activity.

The list of draft exclusions listed in the consultation are consistent with those developed for the Australian CPRS. On balance, for the sake of equity between different parts of the industrial sector, to ensure that implementation of industrial allocation reflects the policy intent and to assist in developing Gazette notices in an efficient manner, the Minister for Climate Change Issues will use their discretion under the Act to consistently apply the exclusions listed in the consultation paper to all activities.

Some submitters have suggested a different interpretation of the meaning of ‘direct use’ of coal and natural gas from that intended by Emissions Rule 1. In particular, Solid Energy has submitted that the ‘direct use’ of coal should be interpreted in such a way as would allow them to count the emissions from downstream combustion of coal as direct use of coal during the proposed activity of coal mining. This is discussed in more detail in section 5 of this report.

The Government intends to provide greater clarity over the intended interpretation of this phrase to ensure there are no obstacles to eligibility decisions following the data collection stages. Emissions Rule 1 will be revised accordingly to be clear that ‘direct use’ means ‘direct oxidation or use as a feedstock’.

Materiality

Five submissions raised concerns on materiality (Emissions Rule 11). The main concern was that because of the requirement to produce accurate estimates of emissions, they will be required to spend inordinate amounts of time to assess emissions from small and inconsequential sources. A particular concern noted was the risk that emissions estimates will be audited later and that these might result in changes to eligibility status and/or levels of allocation.

Other concerns raised included that guidance on materiality thresholds over and above which deductions are required should be provided and that reference to accounting standards or tax ruling precedents to develop such thresholds should be considered. Questions were also asked about the degree of auditing certainty required.

The Government intends to use a pragmatic approach and proposes to revise Emissions Rule 11 to reflect this. Whereas best endeavours should be used to estimate emission levels, ‘simplified calculation methods’ are explicitly allowed for small emission sources.

An additional rule is proposed to require disclosure of uncertainties associated with estimates of emissions and revenues. It is useful for the Government to know the level of uncertainty attached to a number so it can understand whether to spend additional time checking. It is useful for firms to be able to express this uncertainty, especially where there is a risk to them of getting the number ‘wrong’.

Data preparation – general comments

Submitters made a number of comments about the data preparation, timescales and verification approach to be applied to data collection as part of the industrial allocation process.

The Minister recognises that firms will need assistance as part of the data collection process, and that this level of assistance will need to vary firm by firm.

Further guidance on data collection will be provided alongside the Gazette Notice call for data. Data will need to be submitted in a specified data form. This will simplify the data collection process for firms and provide greater certainty and consistency. Finally, the Government will provide direct assistance to firms through a major accountancy firm.

Where firms have made a formal request for additional time for data collection, the Government will increase the period above the 30 working day minimum.

The Government will ensure that the validation approach to be applied to data provided under the industrial allocation process is appropriate and reflects the self assessment approach to data and reporting under the NZ ETS. Changes to the data rules noted elsewhere in this summary will clarify the approach to be taken to uncertainty and materiality.

Significant penalties exist in cases where data is provided (or omitted) fraudulently. The Act contains a general requirement for person applying for allocation to keep sufficient records to enable the Ministry to verify that they are entitled to receive an allocation, and the Government retains powers of inquiry to verify this if necessary in future. Further guidance will be provided alongside the Gazette Notice on the record keeping that firms should aim for to ensure they are well prepared for any future verification.

The Government will provide for a secure data storage facility to ensure data submitted to it, as part of the industrial allocation process, is protected. Where firms would rather not provide data over the internet, they will be able to provide it on CD. Commercially sensitive data will be treated as such in a similar manner to which the Official Information Act applies.

Other issues

In addition to the key issues raised in the consultation document, submitters raised a number of other issues, including issues relating to data preparation and verification, and other more generic issues relating to the NZ ETS more broadly. General issues about the NZ ETS are out of scope with this consultation but discussed in further detail in section 6.

next