Climate Change Leadership Forum report number: 6
Cluster B meeting Minutes from 22 May and associated papers
Cluster B
Meeting 8 – Case Studies
June 4, 1-5pm, Deloitte
Minutes
1. Case study progress reports: Fletcher Building, Pan Pac Forest Products Ltd., NZ Steel, Fonterra.
Presentations from Andrew Shelley (CRA) and John Stephenson (NZIER) are attached. Associated discussion included requests that the following be added to the modelling.
- Can the models explore the effects from using average vs. and marginal emissions from electricity generators? Some case studies model electricity emissions for leakage purpose using average emissions across all forms of generation but marginal emissions when considering price impacts. Others use the marginal emissions for both. It is not clear which sources of electricity would be affected if a major user were to lower/cease production. It is also unclear which sources set the electricity price and this is likely to vary from the short to the long run. A recent Electricity Commission report may shed light on this. We should use a consistent set of assumptions across case studies about both the price impact through electricity and the emissions implications of changes in electricity demand and show the sensitivity to these assumptions.
- Can we apply consistent rates of free allocation for the purposes of the case studies? Each consultant currently applies a range of allocation scenarios. The forms of these are specified in the terms of reference (historical, output-based, timing of phaseout). What is not specified is what percentage of emissions are covered. The reports should provide information on how many free allowances 90% of 2005 emissions would imply. The free allocation scenarios should be consistent across case studies: e.g. 80% or 60% of emissions in later years.
- John Stephenson will seek clarification of the investment decision making process and motivations in the NZ Steel case and if possible, how they would think about the impacts of carbon prices.
- The Fonterra case study needs to be explored in the context of the impacts on the farming sector as a whole. All rural land use options affect land values and hence leakage potential. The cost of the direct emissions from Fonterra (milk processing) and from meat processing need to be included in a comprehensive assessment of the impact of the ETS on farming where economic regrets as well as substantial losses of value could arise. This should be done through a separate process (outside Cluster B)
2. Reports to select committee and CCLF
At this stage, cluster B will submit a short non-firm-specific summary of case study progress to the select committee. This is attached to these minutes.
The next CCLF meeting is on June 24th, and the consultants may not have completed their reports by that date. It was agreed that something more than the select committee report would be prepared for CCLF; the exact format will be determined at a later date.
Preliminary feedback from Climate Change Leadership Forum leakage case studies1
4 June 2008
Preamble
Four case studies of six separate plants were commissioned by government with cooperation from the companies involved. The aim of the case studies was to provide detailed analysis of potential leakage2 from these firms under an ETS. The case studies complement existing general equilibrium modelling of the macroeconomic effects of an ETS. We employed experienced consultants with no preconceptions and asked them to objectively analyse the situations faced by each plant/company in order to provide highly credible input to the policy development process. The participants in the process suggested that firms are not currently well prepared to make optimal decisions in response to the carbon price.
We were particularly interested in the issue of economic regret. Regret could arise if a plant is closed or production contracts solely because we temporarily face an uneven playing field with respect to our international competitors. Some of our case study plants produce for export while others produce import substitutes. Regrets arise when we are unable to reopen the plant when a global agreement (or border taxes) is in place, even though if the plant were still in New Zealand it would now be profitable. Social regret particularly arises when the fall in production has effects on workers and communities that the firm does not take into account in its decision-making. The decision to leave may be optimal for the firm but sub-optimal for society.
We have structured this paper around the following diagram which shows the decision making process that we need to go through when deciding whether to provide free allocation to ‘level the playing field’ for New Zealand firms. The results presented so far are very preliminary and only intended to be illustrative.
Figure 1 Decision tree for providing free allocation to address economic regret
1 Caveat: These notes are as reported by Suzi Kerr and may not reflect the views of all meeting participants.
2 Leakage arises when a product’s manufacture is re-located to countries without a carbon cap, leading to an increase in global greenhouse gas (GHG) emissions and potential economic and social disruption from the re-location of that production
Would the firm maintain production under a global agreement or with border tax adjustments?
The case studies shed light on whether firms are likely to be profitable in the long run.
The plants that are most likely to optimally be in New Zealand in the long term but at risk in the short term seem to be those with high electricity usage. Our relatively low-carbon electricity will provide us with a comparative advantage in a global agreement.
Issues with electricity pricing were much discussed when these preliminary case studies were presented to members of a sub-group of the Climate Change Leadership Forum, and seemed to potentially be as important as issues with the emissions trading system.
Some New Zealand plants are highly greenhouse-gas efficient in other ways so are also likely to be candidates for regret if they are lost.
How much leakage will there be?
Do long-term benefits to firms justify maintaining production despite lower short-term returns?
Our six case studies show that leakage can occur in many different ways:
- Plants may close.
- Firms may not maintain plants so they will gradually close.
- Firms may not make new investments.
- Firms may reduce production.
Many factors affect the likelihood of leakage
- Carbon costs are important when emissions are high relative to product value; however
- Most plants would not close because of carbon costs alone.
- Carbon costs adds to average cost and uncertainty.
- For some products, profitability is much more sensitive to exchange rates or oil prices than carbon costs.
- Firms show emotional attachment to some plants that will bias them toward keeping them open.
- Similarly, some investment decisions do not seem to clearly relate to calculations of simple economic value which makes it unclear how decision making will respond to carbon prices which we can only model in economic cost terms.
Firms could be prepared to bear some costs to maintain their future options to produce. In at least two examples the only option for leakage was complete closure and this would quickly be irreversible. Three reasons for the irreversibility were cited:
- Firms may be unable to regain resource consents
- Firms may sell land that provided an optimal site.
- Firms/industries may lose skilled staff
In contrast, firms able to reduce production but not completely close, or able to delay maintenance and so operate below capacity, would have greater ability to return to normal if a level playing field is achieved.
What are the social regrets that the firm may not take into account?
Does the cost of providing protection to the firm (cost of raising taxes) exceed the losses to society if production falls?
1 Job losses
Job losses lead to social losses if employees cannot find similarly rewarded work elsewhere. The local community can suffer particularly in the short term if the employees do not find employment locally. In a full employment economy these effects are unlikely to be large but in a recession they will be more significant.
We received employment information for only two case studies. It is not meaningful to give the specific job losses. Instead we calculate the number of tonnes of emissions per job directly affected and the cost to taxpayers of providing full allocation of allowances to guarantee protection against leakage.
| Tonnes per person | $ to fully protect job ($25 per tonne) | |
|---|---|---|
| Plant 1 | 1658 | ~ $40,000 per job |
| Plant 2 | 4361 | ~ $109,000 per job |
2 Environmental effects
Leakage also causes environmental losses because global emissions rise. Firms that close would almost by definition be high emitting firms, and these emissions will largely go to countries that are not covered by the Kyoto cap. Production would move to Australia only to the extent that our policies to protect trade-exposed firms vary. New Zealand emissions are covered by the Kyoto cap and must be matched by the limited number of Kyoto units. Increased production in non-Kyoto countries increases global emissions. In addition, New Zealand production moving offshore can create additional transport emissions. Switching away from our relatively low-carbon electricity would mean that global emissions rise still further.
How would free allocation options affect economic regrets?
If the three previous steps suggest that assisting a firm through allocation is socially justified we need to design allocation policy to best target resources to reduce economic regrets.
In at least one of our case studies we found that any leakage would likely be associated with plant closure. For this case, a rule that withdrew free allocation only when a plant is closed would potentially be effective. This is the default situation within the NZ ETS.
In at least two other cases, however, the firm would reduce production or close one production line within a plant (the highest emitting) but not close the whole plant. Under a lump sum form of free allocation, production could leak in these firms without the firm’s free allocation being affected. Providing this free allocation is a cost to the government, but would be ineffective in avoiding regrets.
The sub-group’s discussion suggested that the complexity of situations and decision-making rules would make it very hard to target free allocation only to those at genuine risk of creating social economic regret.
