Cluster B

August 4, 2008

Leakage Case Studies

General conclusions from discussion between Cluster B meetings – these were not discussed on August 4: 

  • processes/plants/firms are most vulnerable at the point where they need to make investment decisions whether these are in maintenance or new plant.
  • Loss of new investment could be irreversible because capital markets in New Zealand are thin and investments may require an ideosyncratic investor who has local knowledge and linkages
  • The social regrets from leakage would include the effects of value added in other operations (this was reemphasised in the August 4 discussion but not formally concluded).

These points will be incorporated in the report that was previously sent to select committee and the CCLF together with the conclusions from below.

1. Progress

The Pacific Steel report is likely to be concluded by next week. The consultants are making a final visit to the company on Monday August 11.

Bluescope has been delayed by international travel on both sides.

The Fonterra case study is still in the process of being finalised.  The general lessons are consistent with other NZIER case-studies (PanPac and Bluescope).

The following are specific comments and conclusions from case studies received.   This is not an attempt to summarise the main findings of the reports but a record of the key points raised in the meetings.

2. Pan Pac Forest Products

Report title: ‘Leakage risks: Case studies of allocation scenarios and risks of economic leakage under an NZ ETS”

Cluster B members had concerns about how this report defines ‘leakage’. Bringing forward plant closure is not necessarily a source of economic regret if the plant is likely to close at some point.  However, given uncertainty about long term closure, this could be interpreted as a general weakening in the profitability of the plant. We are comparing outcomes with and without a global agreement; other issues are captured within this definition.

The case study indicates high costs from an ETS. This is not surprising as Pan Pac is a high electricity user. The pulp processing plant has a highly skilled workforce which may be unable to find comparable work if the plant were to close.

Pan Pac’s long value chain offers a number of response options. It is unlikely to begin exporting unprocessed timber due to crude oil prices, but woodchip can be diverted for heating. This could lead to closure of the pulp operation.

Different risks at each level of the value chain argue for free allocation at plant level rather than firm level. In this scenario, if the plant closed it would lose its allocation. Different parts of the company may be offsetting others, but this is not desirable (or likely) long term.

The report does not focus on the role of oil costs and exchange rates in these decisions.

Key generalisable conclusion: 

  1. For free allocation we need to consider the plant separately from the firm and focus on the specific processes that are at risk.  Integrated companies are unlikely to close but plants may and much value may be lost.

3. Golden Bay Cement

 Report title: “Impact of the NZ ETS on Cement Manufacturing”

Cement manufacturing is emissions and energy intensive. High carbon emissions are an unavoidable component of the chemical processes used to create cement’s precursor product, clinker. Producing clinker quickly becomes uneconomic with emissions charges in place. This effect occurs across a range of exchange rates and oil prices.

For Golden Bay cement, large scale cement imports are unlikely because of high transport costs, but importing clinker is possible. If this occurs we will lose a potential buffer against international conditions and no longer utilize local limestone resources. Importing clinker would result in the continued utilization of the clinker grinding mills at its current plant, but would result in closure of most of its current facilities at Portland, being its two quarries and the processing operations for grinding limestone and kiln processing. 

Closing part of an operation has implications for allocation. Would a firm retain its initial allocation if it outsourced individual processes? If we apply the decision tree for economic regrets, free allocation should be to clinker rather than cement. In terms of the SEIP TAG’s discussion of allocation at process, plant and firm level, this case study offers a clear argument for process-based allocation. For other cases the decision is more complicated – for plants producing multiple products it can be hard to tie emissions to individual products.

The effects of outsourcing individual processes are different for multinational companies. GBC is likely to face average costs for any clinker it purchases – if it is only a processor of clinker it may make sense for them to be linked to an international clinker producing company.

GBC profitability is sensitive to oil costs and exchange rates. At low carbon costs, oil prices would create a barrier to transporting clinker.  Long-run decision making is driven by long run expectations of local fuel prices, oil costs and exchange rates.  These expectations are the basis for the analysis of the impacts of carbon prices and allocation options.

There are some mitigation options both through additives to clinker and cement and through use of biomass energy but they are limited.

Golden Bay Cement is unlikely to close overall.  It can be difficult to separate parts of a business both in terms of the emissions associated with them and their profitability.

Key conclusions: 

  • Producing clinker in New Zealand would rapidly become uneconomic with carbon prices and this is true for a range of exchange rates and oil prices.
  • Address free allocation policy to the process level. 

4. Glasswool

Report title: “Impact of the NZ ETS on Glasswool Insulation Manufacturing”

Glasswool manufacturing produces no process emissions. Carbon costs are low and are unlikely to close Tasman Insulation New Zealand, but may cause production to move across the Tasman to a greater or lesser degree. Australia could compound any comparative advantage in the long run by attracting greater investment in the short run. This company will thus be quite sensitive to Australia’s progress towards an ETS and the form of that ETS.

Cluster B members noted that this case study will be of greater value when we are able to do comparisons with Australia. However, because there is no clear driver for manufacturing in either country, it is very difficult to tease out relevant factors. The long term branding of ‘pink batts’ provides some protection against competition from outside Australasia.  It is unlikely that the Auckland plant would close under any conditions but the smaller Christchurch plant may close.

Conclusion:

  • policy needs to be sensitive to the development of the Australian ETS.
  • Methods of calculating emissions (e.g. electricity factor) can be critical to whether some SMEs meet thresholds for free allocation.

5. Reporting and future directions

 There is potential to use these findings to discuss potential allocation options.

Consultants will discuss report distribution with case study firms. The TAG has delegates from competitors; CCLF is open to OIA requests. A compromise would be for the consultants to present overview findings to the TAG.

Motu will edit the earlier note to the Select Committee to include new non-firm-specific discussion based on conclusions presented here and present that new note, together with some illustrative material from the case studies to CCLF on Wednesday.

Issues that have not yet been addressed, and on which these case studies and the remaining case studies may shed light, are the appropriate level of allocation and the decision between output-based and fixed allocation (that is removed only if process, plant or firm closes).  These could be the focus of a future meeting.