Progress report on the Stationary Energy and Industrial Processes Technical Advisory Group (SEIP TAG)

Briefing for the Climate Change Leadership Forum
Prepared by the Emissions Trading Group
Date: 29 July 2008

Executive Summary

The Stationary Energy and Industrial Processes Technical Advisory Group have produced an interim report. This report was delivered to the Offices of the Minister of Finance; Minister of Agriculture and Forestry; Associate Minister of Finance (Hon Phil Goff); Minister for the Environment; Minister Responsible for Climate Change Issues and the Associate Minister of Finance (Hon Clayton Cosgrove) on July 10. Please find the executive summary of this report attached. A TAG is due to give a final report by September 2008.

In addition to producing the report the Allocation sub-group of the SEIP TAG held a full day meeting on 10 July, during this meeting consideration of the Australian Carbon Pollution Reduction Scheme was considered.

Technical Advisory Group Stationary Energy and Industrial Processes Component of the New Zealand Emissions Trading Scheme: Interim Report, 9 July 2008.

Summary

Purpose of this interim report

This report is an interim progress report from the SEIP TAG to the government. The paper sets out:

  1. progress to date
  2. outstanding issues
  3. next steps

Role of the SEIP TAG

The SEIP TAG was established to provide guidance and advice on technical design elements of the stationary energy and industrial process emissions components of the NZ ETS. The SEIP TAG comprises 16 experts, including government officials (three) and industry experts (see membership list in Annex I).

The key task of the SEIP TAG is to provide advice to the government on options for providing assistance to industry.

Some clarification is warranted at the outset as to what is meant by assistance to industry in this context and related terminology, for example, 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 and related design issues were referred to the SEIP TAG for further evaluation.

Specific issues related to this task are:

  1. Defining and evaluating different options for free allocation or other assistance.
  2. As part of the above, defining thresholds (size and scope) for assistance, rules for entry, trade exposure tests, recognition of early action etc
  3. Defining activity data and emission factors to assess the basis for free allocation or other assistance
  4. Defining points of obligation and in particular advising on whether and how to administer opt ins/carve outs
  5.  Advising on specific issues about electricity – how to assess the impacts of emission prices on costs of electricity, as an input to options for assistance

The Terms of Reference of the TAG do not extend to design features that are specifically addressed as provisions in the Bill, for example the definition of emission obligation. For this reason participation in the TAG is in no way indicative of support by members of the TAG for the design features of the ETS laid out in the Bill.

What has become apparent from the work of the TAG over recent months is that it will not be possible to achieve unanimity on all issues. As is highlighted later on in this report, some industry members and officials on the TAG have, in some cases, clearly stated differing positions on the implications of the legislative framework in which the TAG is working. It is also evident from the work of the regulations sub-group that differing commercial opinions will inevitably lead to contrasting views on a number of issues.  This is also expected to arise to some extent as the TAG advances its work on allocation methodologies. While the TAG has agreed to seek unanimity to the extent possible, where this is not possible, reservations from individuals or groups of members will be duly noted.

Progress to date

The SEIP TAG has now met on nine occasions.  The TAG has set up a number of work streams/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 and
  6. Sub-group on electricity market price effects

Informed by the work of sub groups the TAG has reached a number of provisional recommendations and mapped out a work programme for the next 3 months. All recommendations are provisional. The TAG has agreed that no recommendations are final until their work is completed.

  1. Data issues
    Much of the focus of the TAG to date has been on the need for good quality firm specific data. While progress has been made in accessing existing databases, concerns remain about the adequacy of existing data as a basis for comparing the different allocation methodologies. As a consequence the TAG is looking to complement existing data with a search for new additional data including projections.
  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 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 group has summarised its work in a final report, attached in Annex III to this report.

    Next steps
    Officials anticipate releasing an exposure draft of the SEIP Regulations by the end of July.
  3. Eligibility
    Informed by the work of the sub group on eligibility the TAG has provisionally recommended that the primary rationale for providing assistance in the form of free allocation of NZUs is to avoid economic regrets . Consequently the TAG provisionally agrees that that the key criterion for defining eligibility should be a measure of trade exposure.

    There should also be the application of a materiality threshold (i.e. being trade exposed is of itself not sufficient to be eligible to receive free units). The proposed approach to determining eligibility would be a two step process: A firm/process/product should be eligible if they are:

    Firstly     trade-exposed and
    Secondly their emissions are
    1. above a specified threshold (e.g., 5,000, 10,000, or 50,000 tonnes ), or
    2. their emissions costs are greater than a specified proportion of production costs.
    A number of members of the TAG have expressed a preference for a low threshold, but a recommendation on this will not be made until analysis of the available data is complete.
  4. Allocation
    The TAG has identified five methodologies, in effect two broad options and a number of variants as set out in Table 1.

Table 1 Allocation Options

 

 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.

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 links 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
  • Day meeting of the eligibility/allocation sub group on 22 July
  1. The Progressive obligation
    The TAG has concluded 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 TAG recommends no further work on this option.
  2. 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.

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 the subsequent recommendation not to proceed with this option is another significant output from the TAG to date.

Work in the eligibility and 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 some changes to the Bill made by the select committee, in particular changes to the legislation enabling new entrants, add another level of complexity to the issues the TAG is addressing.

Outstanding Issues/Concerns

Industry members of the SEIP TAG have during the past six months raised a number of concerns that are generally specific to key elements of the draft legislation. As such, many of these issues have been raised with and discussed by Select Committee. These issues, while largely outside of the Terms of Reference of the SEIP TAG, are noted here.

  • Concern about the ability to develop an allocation plan within the constraints of the legislation: Specifically while a number of industry members of the TAG agree that there should be a new entrant reserve, and that intensity based allocation is a good option at this stage of the ETS, these members consider that to do either or both of these within a cap set by 90% of TE 2005 emissions is not feasible, or even logical. Their strong view is that it is not possible to develop a plan that prevents leakage and economic regrets if a new entrant reserve and/or intensity based allocation is provided within the 90% cap. However, the TAG as a group has not yet considered in detail or reached any decisions on the issue of a new entrant reserve or intensity based allocation methodology within the 90% of 2005 emissions cap.
  • Concern about the availability and quality of firm specific data: Allocation planning requires data and information, particularly with regard to emissions and the risks of leakage.  The SEIP TAG’s work programme commenced prior to this data being available.  Some data, particularly with regard to emissions, is now available.  However, more data is required.
  • Concern that 90% of 2005 emissions corresponds to significantly less than this level for companies that have increased emissions since 2005, and that setting the cap at this level will result in an insufficient level of free allocation to prevent closure for some firms.
  • Concern that liquid fossil fuels used in the stationery energy and industrial process sector do not receive a free allocation  The view held by some industry members is that this ‘omission’ in the legislation will lead to economic regrets.
  • Concern that current drafting in the Bill precludes persons who opt-in under schedule 4, part 4 from receiving a free allocation (even though they could be eligible to receive an allocation because of their increased costs if they did not opt-in).
  • Concern that persons who use industrial heat or steam including that from co-generation plants (as a substitute for direct use of coal or gas) are also precluded from receiving a free allocation.
  • While the majority of the TAG has reached a provisional agreement that the key criterion for defining eligibility should be a measure of trade exposure, some industry TAG 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).
  • A concern has been expressed from some (but not all) industry members that current draft legislation ties a person’s ability to opt-in to having purchased coal or gas directly from participants who mined the coal or natural gas. However, other industry members believe the issue of gas market complexity is the reason why opt in for the gas sector is necessarily restricted to direct contractual relationships with the miner to prevent compliance uncertainty.

Comment from government members of the SEIP TAG:

The Terms of Reference (TOR) of the SEIP TAG do not extend to design features of the NZ ETS  that are specifically addressed as provisions in the draft legislation, for example, the size of the total pool of free allocation for industry, and the phase out of free allocation.  The reason for defining the TOR of the SEIP TAG in this way is because high level design decisions of this nature involve trade-offs that have equity and economic implications for all sectors of society.  The pros and cons of the draft legislative framework for an allocation plan to industry sectors, for example, is of interest to a wide variety of stakeholders and not only those represented on the SEIP TAG. 

Most of the outstanding issues/concerns listed above relate to design features of the ETS that are set out in the draft legislation and therefore are outside of the TOR of this group. These concerns are duly noted. Industry members of the TAG have made it clear from the outset that their acceptance of the TOR does not imply their acceptance of design features of the proposed NZ ETS contained in the draft legislation.  However, as these issues largely fall outside the TOR of the TAG, government officials have not responded to them in the context of this report. Officials on the TAG note that the government’s rationale for these high level design decisions has been well explained over an extensive period of consultation and engagement. Furthermore, officials note that the Climate Change Leadership Forum (CCLF) was specifically set up to provide advice to the government on these high level design issues.  Finally, officials note that the majority of these issues have been raised before the Finance and Expenditure Committee in submissions from industry stakeholders and have been taken into consideration in their deliberations and the report back from the Committee.

 Next steps for the SEIP TAG

  1. First meeting of the electricity emission factor sub group on 1 July
  2. Allocation/eligibility sub group full day meeting on 22 July
  3. Next full SEIP TAG meeting on the 5th of August
  4. Further SEIP TAG meetings scheduled for 2 and 30  September
  5. Preliminary report on recommendations pertaining to an allocation plan (date tbc)
  6. Final report from the SEIP TAG 30 September

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

It should be noted that some industry members have raised concerns that trade exposure is too narrow a definition of competitiveness at risk. Those 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

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