Technical Advisory Group Stationary Energy and Industrial Process Component of the New Zealand Emissions Trading Scheme

Progress to date

The SEIP TAG has now met on nine occasions. The TAG has set up a number of sub-groups to progress issues in more detail. These include:

  1. Data requirements
  2. Methodologies (Regulations) sub-group
  3. Eligibility sub group
  4. Allocation sub group
  5. Progressive obligation sub group
  6. Sub-group on electricity market price effects.

The need for adequate data to support the TAG’s analysis of allocation methodologies has been a significant focus of the TAG to date. While there has not been a specific group set up to address these issues they have been discussed in the wider TAG meetings and in the eligibility sub groups.

Groups 2 (Eligibility) and 3 (Allocation) have merged because of the close overlaps between the issues and the group membership.

The structure of this interim report is based around these six areas of work.

1. Data issues

The need for comprehensive firm level data has been identified by the TAG as a key requirement for understanding the implications of different eligibility and allocation methodologies.

Focus over the last two months has been on securing access to the Statistics NZ (“SNZ”) dataset “Manufacturing Energy Usage Survey 2006” (“MEUS”). SNZ have already supplied some high level analysis to the TAG based on the MEUS data (refer to table 1, in Annex IV). This has enabled us to identify the number of firms and tonnes of emissions at various threshold levels.

However, the TAG also needs to see some more detailed impacts on a sector by sector basis. SNZ cannot currently provide this with the MEUS data because firm confidentiality must be maintained, and a sectoral analysis will enable the usage of some of our major emitters to be identified by deduction (e.g. Rio Tinto in the aluminium sector). To circumvent this issue, SNZ have sent letters to 18 of our major emitters, asking for permission to release their MEUS data to the TAG. This process is currently underway, with the letters sent by SNZ last week. Once these letters have been signed by all the major emitters, we can perform a more detailed sector by sector analysis of the MEUS dataset (see table 2.1 in Annex IV).

There are some other concerns that the MEUS data will not be able to satisfy the specific requirements of the TAG.

  • The MEUS data covers stationary energy (“SE”) only, so does not include Industrial Process (“IP”) emissions. However, MED collects IP data and has been able to estimate the total (SE+IP) emissions (refer to charts 3.1 to 3.3 in Annex IV).
  • The MEUS data is only for the single year (ended March 2006). So we are unsure how the 2003 and 2004 years look and also how the industries may have grown since 2005/06. Concern has been expressed about the need for emissions projection information to better improve the group’s understanding of how the different allocation methodologies would impact on growth versus static growth firms, in this regard it has been suggested that the focus should be on the top twenty firms (they account for around 80% of emissions).
  • The MEUS data is dominated by a small group of large emitters, so the impact of allocation methodologies on Small to Medium enterprises (“SME’s”) may be more difficult to assess. However, EECA collects “Energy Audit” data for SME’s, and this dataset could be used to supplement the MEUS analysis.
  • We also need to consider the Trade exposure test. One approach is to subset the MEUS data using only Industry groups we consider would be trade exposed.

Because total emissions are dominated by a small group of large firms, MED has also been able to source publicly available information on energy usage by these firms. This has enabled some high level analysis of how different allocation methodologies could affect each of these major emitters.

Summing up, the Co-Chair noted that:

  1. MED’s work was proceeding satisfactorily
  2. The need for an additional survey of smaller firms remained an open question and
  3. There was high interest in emission projection information for the larger emitters especially

Next steps

  • Follow up authorisation letters from major emitters to enable SNZ to produce MEUS threshold tables by industry groups (refer to tables in appendix IV)
  • Produce MEUS threshold tables with only trade exposed industry groups included
  • Produce growth estimates for top 20 energy emitters
  • Review allocation methodology work with MEUS data for major emitters
  • Progress other potential data sources such as EECA energy audit database

2. Methodologies

The Methodologies (Regulations) sub-group was tasked with developing methodologies for the activities related to the:

  • Stationary Energy and Industrial Process sector, Schedule 3, Part 3 and 4
  • Opt in for stationary energy, Schedule 4, Part 4
  • Other removal activities, Schedule 4, Part 2, Subpart 1

The sub-group is chaired by Carmen Blackler of Contact Energy and includes representatives from the energy and industrial sectors plus officials experienced in energy and emission reporting matters.

Point of obligation and opt in

An upstream point of obligation is adopted in the draft Bill as was previously outlined in the government consultation document “The Framework for a New Zealand Emissions Trading Scheme” published in September 2007. In the stationary energy sector large downstream users of coal or natural gas may choose to opt in, and become the point of obligation for the coal or natural gas they purchase directly from a mandatory participant.

The NZ ETS framework needs to manage matters like: the export and import of fuels, downstream fuel sales, the potential for orphan carbon liabilities, and situations where the carbon from fuels is embodied in products such as methanol. When products permanently embed emissions or where products temporarily embed emissions and are exported, they do not result in emissions within New Zealand, and therefore, if certain criteria are met, the participant carrying out the embedding will receive an NZU for each tonne of emissions embedded. Complexities in downstream product flows in the gas market in particular make it important to ensure any point of obligation other than at the miner creates no ETS liabilities to unintentionally remain with the miner or any infrastructure owner (e.g. Unaccounted for Gas derived from metering errors etc in the gas transmission system).

Matters considered by the sub-group:

The methodologies sub-group, after reviewing the provisions of the draft Bill, has systematically examined each activity listed under the stationary energy, industrial processes and opt in sections.

The methodologies sub group has, alongside officials, developed the attached documents:-

  • Table of methodologies by activity including point of measurement
  • Diagrams (hand drawn) to demonstrate the point of measurement along the supply chain
  • Emissions factor table (values to be added by MED)

In addition, the group has summarised its work in a final report, which is also attached for reference (Annex III).

Next steps (for officials)

Officials anticipate releasing an exposure draft of the SEIP Regulations by the end of July.

3. Eligibility

The Eligibility sub-group, chaired by Hans Buwalda of Fletcher Building, is working on criteria to determine who would be eligible to receive a free allocation of units. The sub group is focusing on a targeted free allocation model – targeted at identifying firms who are trade exposed.

The subgroup on eligibility recommends that the primary rationale for providing assistance in the form of free allocation of NZUs is to avoid economic regrets4. Consequently the majority of the TAG has reached a provisional agreement that the key criterion for defining eligibility should be a measure of trade exposure.

Note, some industry members have raised concerns that trade exposure is too narrow a definition to fully encapsulate the government’s economic regrets criteria. These members consider that competitiveness at risk should encompass firms that suffer an adverse impact on profits from investments that were made prior to the introduction of the ETS (leading to stranded assets).

Trade exposure has been defined as:

“Firms that are subject to a high degree of international competition on export markets and/or from imports (or the threat of imports), and the prices they receive for their goods and services do not reflect the cost of carbon.”

International competition is taken to mean that the goods and services are traded and priced internationally, and the ability for New Zealand firms to pass on costs is constrained.

Incorporation of a carbon cost in prices could be determined either from independent assessment of commodity prices or an assessment of the climate change policies and emissions price of competing countries (Annex I or otherwise).

The eligibility sub group also recommends the application of a materiality threshold (i.e. being trade exposed is of itself not sufficient to be eligible to receive free units). The sub group’s preliminary thinking is that a firm should be eligible for a free allocation if they are:

Firstly trade-exposed and their emissions are:

  • Above a specified threshold (e.g., 5,000, 10,000, or 50,000 tonnes5), or
  • Their emissions costs are greater than a specified proportion of production costs.

The sub-group’s preliminary recommendation is that, in order to ensure administrative transactional efficiency, the absolute threshold in the materiality test should take priority. The implication of this is that an absolute threshold should be set that most of the potentially-eligible trade-exposed would pass (while being certain that it is not so low that it would pass firms that are not energy / emissions-intensive). There will still be some small firms that pass the trade-exposure test, are energy/emissions intensive, yet do not have absolute emissions above the threshold. For these firms, eligibility would need to be established using the test of the materiality of their energy/emissions costs on their manufacturing production costs.

This two-step process to determining eligibility would, if implemented, go some way to addressing the concerns of small businesses that they could meet eligibility requirements. Although the two fundamental tests for eligibility (trade exposure and materiality) are separate, they may be mixed in the decision-tree contained in an on-line application process.

Another option being considered is that if one firm from a sector is eligible, then all other firms in that sector would also be considered eligible. Outstanding issues, depending on the method chosen, include whether eligibility is assessed at a firm or plant level.

An alternative approach being explored by this sub-group is whether the trade exposure test could be based on a product or sector basis (rather than at the firm or plant level). This approach could see certain industrial classification codes (i.e. Australia New Zealand Standard Industrial Classification (ANZSIC)) being listed and eligibility being determined on this basis. This discussion has since been taken up by the Allocation sub-group.

The sub-group now intends to further develop and test proposed criteria using real data. A major issue that has been raised during discussion of the sub group’s work in the TAG is the impact of different eligibility criteria (and tests) on small and medium size businesses.

Next steps

This work programme has now been merged with the work programme on allocation discussed below

4. Allocation

The Government’s rationale for providing assistance to firms in the form of free allocation.

One of the key principles underlying the proposed ETS legislation is that emitters face the full cost of their emissions. Firms face this full cost through the obligation to surrender NZUs for every tonne of their emissions. Most New Zealand firms will face increased costs of production under the ETS due to either being required to surrender NZUs to cover their emissions or due to facing higher energy and fuel costs. Many firms will be able to pass a portion of these costs down the supply chain to their customers. However many firms, typically those in trade exposed sectors, will not be able to pass the bulk of these costs on. To reduce the impacts on firms unable to pass these costs on, two forms of assistance were considered by the government in its Framework Document of 2007. The first being through the provision of free allocation and the other through a progressive obligation (the focus of a separate sub group discussed further on). Both of these options are being evaluated by the SEIP TAG.

The sub-group on allocation, chaired by Ray Deacon (Rio Tinto), has the task of defining and evaluating different allocation options.

Based on this work the TAG has identified five methodologies, in effect two broad options and a number of variants.

  • allocation on the basis of historical emissions; and
  • output (i.e. production levels) times some benchmark emissions factor (e.g. tCO2/t of product). The benchmark would reflect best practice.

As variants on this approach we include the potential addition of:

  • a new entrant reserve that would make additional emission units available to new entrants that did not have emissions or output in a historical year; and
  • an intensity-based approach that uses updated production data as the basis for the level of free allocation.

Evaluation criteria were presented as follows:

  • Efficient incentives for emission reduction
  • Incentives for efficiency improvement
  • Disincentives for leakage with economic regret
  • Rewards for early action
  • Certainty
  • Data availability
  • Administrative requirements.

In comparing these options it is assumed (as set out in draft legislation) that there is a pool of allowances for free allocation that is fixed. This paper discusses how that pool might be distributed.

The five approaches are set out in Table 2.

Table 2: Allocation Options

Table A1:MEUS data* already supplied by Statistics NZ
 

Emissions-based

Output-based
Initial basis 1(a) Historical emissions

Percentage of emissions in historical year(s) 		2(a) Historical output

Percentage of output in historical year(s) times an agreed benchmark emissions factor
New entrant reserve 1(b) Historical emissions + new entrant reserve

As above, plus a separate new entrant reserve		 2(b) Historical output + new entrant reserve

As above, plus a separate new entrant reserve
With Updating 2(c) Updated output

Percentage of output in a recent year times an agreed benchmark emissions factor

Work on issues associated with a New Entrants Reserve (NER) has commenced. Issues identified include:

  • Defining what plant is eligible (expansion versus stand alone new capacity)
  • Basis for allocation
  • Treatment of the carry-forward of emissions from a de-commissioned plant
  • Recognition of fuel availability and fuel-switching

Next Steps

  • Summary paper on the trade exposure test (late July)
  • Draft paper on issues relevant to the design of a New Entrant Reserve (late July)
  • Further evaluation of the link between allocation methodologies and choice of eligibility criteria e.g. whether allocation should be on the basis of firm / plant / sector / product / process
  • Road testing of allocation methodologies (late July)
  • Day meeting of the eligibility/allocation sub group on 22 July

5. Progressive Obligation

The Progressive obligation sub-group, chaired by Craig Palmer of Solid Energy, has concluded that a progressive obligation would not adequately target competitive at risk firms. The progressive obligation option was also considered to be more difficult to administer in an ETS employing an upstream point of obligation. As a consequence the sub-group recommended no further work on this option. This recommendation was agreed to by the TAG.

6. Electricity market price effects

The price impacts of the NZ ETS on firms with emission intensive processes that produce trade exposed products can occur from direct use of fossil fuels or indirectly via other energy inputs, in particular electricity. For some of these firms, e.g. in aluminium smelting, mechanical pulping and steel recycling, the price impact is expected to be predominately via an increase in the cost of electricity. The SEIP TAG is in the process of establishing a sub-group to advise on how this anticipated increased electricity cost may be quantified (refer to attached charts 3.1 and 3.3, which outline the potential impact of electricity emissions factors) and to consider the process of how the allocation of emission units for such firms might work.

The issue has previously been considered as part of the proposed carbon tax process of 2005. It is envisaged that the material and analysis produced at that time will be made available to the group, and will be utilised to inform the debate. Provision of this background material will be supplied to the sub group before its first meeting on Tuesday, 1 July 2008.

Progress to date – summary

Overall most progress to date has been in the methodologies work. Evaluation of the progressive obligation as an alternative to the free allocation model and subsequent recommendation not to proceed with this option is another significant output from the TAG to date.6

Work in the allocation sub groups has to some extent been held back due to concerns about the availability (or lack of) of relevant firm specific data to inform recommendations. Much of the focus of the TAG during the past six months has consequently been on data requirements. The TAG generally considers that these issues have now been addressed to a point sufficient to enable the TAG to proceed to the next steps of road testing eligibility criteria and allocation methodologies.

It is relevant also to note that most of the TAG’s work to date has proceeded in parallel with the select committee process. Many of the TAG members have been strongly committed in terms of time and resources to that process. With the Select Committee now having reported back to Parliament, and as mentioned above the resolution of some of the data issues, the TAG now expects to be able to proceed into a more intensive phase of work with the focus very much on allocation. TAG members note however, that the some changes to the Bill made by the select committee, in particular change to the legislation enabling new entrants add another level of complexity to the issues the TAG is addressing.

4  Economic regrets are largely associated with the closure or reduction in output from trade-exposed firms.

5  Note some TAG members have concerns with specifying a threshold at any level.

6  It is noted that proceeding with the progressive obligation would have required changes to the draft legislation.

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Last updated: 15 September 2008