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Approval to lodge industrial al ocation update
Cabinet paper
1. We seek your agreement to lodge the at ached Cabinet paper, subject to Ministerial
consultation over the next week.
2. You reviewed an earlier version of the paper two weeks ago. Your feedback was that it
was ‘on the right track’.
3. 9(2)(h)
4. Agency consultation on the draft Cabinet paper is complete. Al consulted agencies
supported the paper and no substantive feedback was received. Changes, as tracked in
attachment 1, were made for these suggestions:
i
Treasury requested the financial figures use up to date secondary market NZU
prices instead of the BEFU forecast NZU price.
ii MBIE requested the NZ Steel specific section identify the impact on the firm from
policy change, to copy what was already in the recommendations.
5. In addition, Te Puni Kōkiri asked if any Māori businesses would be impacted by the
updates to allocative baselines. We have confirmed that no allocation recipients have
identified as Māori businesses, however this has not been noted in the Cabinet paper.
6. We recommend you note these changes and ask your office to begin Ministerial
consultation on the Cabinet paper (attachment 2).
7. We also ask you to agree to lodge the Cabinet paper on Thursday 5 September for
consideration at Cabinet ECO Commit ee on 11 September, subject to feedback from
Ministerial consultation.
BRF-5189
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Attachment 2: Clean version of Cabinet paper
BRF-5189
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Policy and Privacy
Office of the Minister of Climate Change
ECO - Cabinet Economic Policy Committee
Progressing updates to industrial allocation in the Emissions Trading Scheme
Proposal
1
I seek Cabinet agreement to delegate powers to allow the Minister of Climate Change
to make decisions and issue drafting instructions for updating industrial allocative
baselines in emissions trading scheme regulations.
2
I also seek Cabinet agreement to set an electricity allocation factor (EAF) for New
Zealand Steel Development Ltd (NZ Steel) for its industrial allocation under the New
Zealand Emissions Trading Scheme (NZ ETS).
Relation to government priorities
3
The proposals in this paper support the coalition agreements between the National
Party and our coalition partners – restoring confidence and certainty in the NZ ETS
and strengthening and streamlining Government regulation.
Executive Summary
4
New Zealand’s industrial allocation system protects firms in certain industries from
facing the full costs that the NZ ETS would otherwise place on them. The purpose of
industrial allocation is to reduce the risk of industrial activity reducing or closing in New
Zealand and production moving elsewhere in the world.
5
Under the industrial allocation system, firms in industries that are emissions intensive
and exposed to international competition receive New Zealand units (NZUs) from the
government each year. Allocations are based on the industry-wide average emissions
intensity of an activity (an “allocative baseline”), and the actual level of a firm’s
production. The value of allocations made in 2023 was $400 million.1
General update to all industrial allocative baselines
6
Industrial allocation “baseline” settings – that is, emissions per product unit – have not
been updated since they were first set in 2010 and consequently are out of date.
Officials have collected data to support updates to the baselines so that allocations
reflect firms’ actual emissions intensity and emissions costs. This process is part of
implementing reform legislation from last year.
7
Updating baselines to reflect this new data would affect firms ranging from small
glasshouse tomato and rose growers to some of our largest firms, such as Methanex.
Some firms would see a reduction in their allocation, and some would see an increase.
Overall, there will be a net reduction in allocations made to industry of 150,000 units,
valued at $9.0 million2.
1 5.6 million NZUs at the 2023 carbon price in regulations of $71.97
2 Using the secondary market price of $60 as at 20 August 2024. All financial forecasts of changes to
allocations use this price in this Cabinet paper.
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8
I seek Cabinet approval for delegation to the Minister of Climate Change to make
decisions and issue drafting instructions for amendment regulations to the Climate
Change (Eligible Industrial Activities) Regulations 2010, updating the baselines. The
new baselines are outcomes of applying methods prescribed in the Climate Change
Response Act 2002 and no policy decisions are required.
9
I seek Cabinet approval to make decisions and issue drafting instructions for technical
amendments to two activity definitions that are eligible to receive industrial allocation.
I will bring the amendment regulations to Cabinet before the end of 2024 for approval.
10
I recommend these updates are first applied to change 2024 allocations. This will
prevent further over-allocations and address instances of under-allocation in the
current year. Provisional allocations for the current year, originally made on projected
production values, are adjusted for final production data. This basic process is an
annual one that participants in the scheme are used to. The difference this time is that
the adjustment would use the new allocative baselines.
11
An alternative would be for the updated baselines to take effect from 1 January 2025,
reflecting a potential argument that the change for some firms is significant and an
outcome of a one-off regulatory process to change industrial allocation settings, and
therefore should only apply prospectively. However, I do not recommend this approach
because:
11.1
It would prolong an overall over-allocation of 150,000 NZUs to industrial
allocation recipients for one year, at a cost to the Crown of $9.0 million,
11.2
the 2024 date of taking effect has been signalled in various communications to
firms over the course of the review of baselines,
11.3
a 2025 date of taking effect would likely prompt concerns from firms whose
allocations would increase under the new baselines, and
11.4
9(2)(h)
Specific update for NZ Steel’s electricity allocation factor
12
NZ Steel has been receiving an industrial allocation for consuming electricity from on-
site cogeneration since 2010. However, a recent independent review has found that
this co-generated electricity is not affected by emissions pricing, meaning that NZ Steel
has been receiving an allocation to compensate it for costs it is not actually facing. The
cost to the Crown is approximately 225,000 NZUs per year, or $13.5 million.
13
NZ Steel has not contested this finding but has sought a ‘phased transition’ for changes
to its industrial allocation. The Crown separately has a funding agreement with NZ
Steel for the installation of an electric arc furnace. The project is running ahead of
schedule and expected to deliver one million tonnes of emission reductions per year
from the end of 2025. 9(2)(b)(ii)
.
14
I propose to remove NZ Steel’s over-allocation from using co-generated electricity and
develop a specific electricity allocation factor (EAF) for NZ Steel, reflecting its actual
circumstances. Unlike the general baseline updates, I propose that this change should
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take effect from 1 January 2025. I consider that this later date is warranted because of
the significance of the change for NZ Steel, who have argued the nature and timing of
the change was not clear in communications at the time of negotiations around the arc
furnace project.
Future updates
15
I expect to receive data that affects allocative baselines and the EAF each year,
requiring further updates to the regulations. These updates follow a legislative formula
and there is no discretion involved. Unlike, the one-off updates to baselines discussed
above, these changes would become routine and ongoing. Consequently, I seek an
ongoing delegation from Cabinet to make decisions and issue drafting instructions to
amend update baselines each year due to annual updates to the general EAF and
other components of allocative baselines. I will ensure that Cabinet still has visibility of
any changes that could have significant impacts on firms.
Background
16
New Zealand’s industrial allocation system protects firms in certain industries from
facing the full costs that the NZ ETS would otherwise place on them. The purpose of
industrial allocation is to reduce the risk of industrial activity reducing or closing in New
Zealand and production moving elsewhere in the world. This would have economic
and social consequences to New Zealand and would potentially increase global
emissions.
17
Under the industrial allocation system, firms in industries that are emissions intensive
and exposed to international competition receive New Zealand units (NZUs) from the
government each year. The allocations allow firms to offset their NZ ETS-related costs.
Allocations are based on the industry-wide average emissions intensity of an activity,
and the actual level of a firm’s production.3 4
18
Firms receiving industrial allocations include the obviously emissions intensive and
trade exposed industries such as steel and cement manufacturing. But less obvious
industries are also eligible, including the growing of some vegetables in glasshouses,
and production of newsprint and whey powder.
19
Firms that receive industrial allocation are still incentivised to reduce emissions. They
are as exposed to emission costs as other firms. NZU allocations are made to firms so
they can recover some of the NZ ETS costs on their fuels and activities by surrendering
or selling their allocation. As trade-exposed firms, by definition, they cannot pass all of
their NZ ETS costs to consumers.
20
Decisions on eligibility and entitlements for industrial allocations were, in general, last
made in 2010. Those decisions were made on firm level data from 2006 to 2009 and
are significantly out of date. Twenty-six industrial activities are eligible and over eighty
firms receive allocations from the Environmental Protection Authority each year. The
value of allocations made in 2022 was over $600 million and this is recognised as an
expense in Crown accounts.
3 2023 allocation numbers will be published by the Environmental Protection Agency shortly.
4 The rate of industrial allocation or the ‘level of assistance’ is currently being phased-out at one
percentage point each year. Highly emissions intensive activities receive an allocation equivalent to
86% of their NZ ETS costs, and moderately emissions intensive receive a 56% allocation.
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Analysis
General update to all allocative baselines
21
Industrial allocation “baseline” settings – that is, emissions per product unit – have not
been updated since they were first set in 2010 and consequently are out of date. I have
collected data to support updates to the baselines so that allocations can better reflect
firms’ actual costs. This process is part of implementing reform legislation from last
year, which allowed baselines to be updated.
22
The proposed baseline update would affect firms range from small glasshouse tomato
and rose growers to some of our largest firms such as Methanex. Some firms would
see a reduction in their industrial allocation, and some would see an increase, although
overall there will be a reduction in the allocations made to industry.
23
These
decisions are technical in nature. After receiving the actual data about the NZ
ETS costs that different activities face, the next step is to calculate the allocative
baselines using a formula set out in the Climate Change Response Act. The Minister
of Climate Change sets the resulting allocative baselines in regulations.
24
I seek Cabinet’s approval to delegate to the Minister of Climate Change the power to
make decisions and issue drafting instructions for amendment regulations to the
Climate Change (Eligible Industrial Activities) Regulations 2010. The first update to
allocative baselines since 2010 and there will be impacts on New Zealand businesses.
25
Some individual firms will be more impacted than others. 9(2)(b)(ii)
26
I will bring the amendment regulations to Cabinet for approval when drafted. Once
implemented through regulatory change, the updates will result in 150,000 fewer NZUs
being allocated per year ($9.0 million).
27
Appendix 1 outlines the estimated financial impact of updates to general allocative
baselines for different industrial activities.
28
Indicative new allocative baselines have been communicated to firms.
Timing of when changes take effect
29
I recommend that these updates are in force from 1 January 2025, but have effect as
soon as possible, which is from 1 January 2024, to prevent further over-allocations and
to address instances of under-allocation in the current calendar year. This can be done
through the annual true-up process that will occur in May 2025. Provisional allocations,
originally made on projected production values, are adjusted for final production data.
This basic process is an annual one that participants in the scheme are used to. The
difference this time is that the adjustment would use the new allocative baselines.
30
The alternative would be for the updated baselines to take effect from 1 January 2025
instead, reflecting a potential argument that the change for some firms is significant
and therefore should only apply prospectively (I am proposing a 1 January 2025 date
for a specific change affecting only NZ Steel for that reason, described below).
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31
Cucumber, tomato and capsicum growers have raised concerns publicly regarding the
start date for the changes as their baselines will be reduced in line with the significant
drop in their emissions costs.
32
However, I do not recommend a date of 1 January 2025 for the amendments to take
effect because:
32.1
It would prolong an over-allocation of 150,000 NZUs to industrial allocation
recipients for one year, at a cost to the Crown of $9.0 million
32.2
the 2024 date of taking effect has been signalled in various communications to
firms over the course of the review of baselines,
32.3
a 2025 date of taking effect would likely raise concerns from firms whose
allocations would increase under the new baselines, and
32.4
9(2)(h)
Approval for changes to two activity definitions
33
For this year’s allocative baseline updates, I am also seeking a one-off agreement to
make decisions and issue drafting instructions for technical amendments to two activity
definitions, which currently do not accurately reflect the activity inputs and outputs.
These are technical changes to activity definitions for the production of carbamide
(urea), and production of protein meal, which will not materially affect their allocations.
Last year’s data collection used these two updated activity definitions.
Specific update for NZ Steel’s electricity allocation factor
34
Producing iron and steel from iron sand is a highly emissions intensive and trade
exposed industrial activity. In line with the purpose of the industrial allocation policy,
NZ Steel receives an allocation to reduce the risk of emissions leakage.
35
The estimated impact of the NZ ETS on electricity prices is described as the electricity
allocation factor (EAF). NZ Steel uses co-generated electricity supplied by Alinta at its
Glenbrook plant. Since 2010, NZ Steel has been receiving industrial allocation from its
use of co-generated electricity as if that electricity was from the grid; that is, using the
general EAF.
36
To test the accuracy of that allocation, an independent expert reviewed the relevant
electricity contract. It was found that that emissions pricing has no impact on the price
for most of the electricity from the co-generation plant. The exception being a small
amount of natural gas, as the contract allows for gas market price pass through. The
cost to the Crown of this allocation is approximately 225,000 NZUs per year, or $13.5
million.5
37
I propose to remove NZ Steel’s over-allocation from using co-generated electricity and
develop a specific EAF for NZ Steel, reflecting its actual circumstances. This will
reduce NZ Steel’s allocation by 225,000 NZUs per year ($13.5 mil ion)
5 This figure assumes a carbon price of $60.00 per unit.
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Timing of when changes take effect
38
NZ Steel has not contested the finding that it is currently over-allocated. However, the
Crown separately has a funding agreement with NZ Steel for the installation of an
electric arc furnace. Both NZ Steel and the Crown have put considerable resources
towards that project. It is running ahead of schedule and expected to deliver one million
tonnes of emission reductions per year from the end of 2025.
39
NZ Steel has written to the Ministry for the Environment 9(2)(b)(ii)
Specifically, NZ Steel has sought a ‘phased transition’ for this change. The firm argued
that this is a material financial change to the assumptions supporting the funding
agreement between them and the Crown for an electric arc furnace, signed in October
2023. NZ Steel sought for the changes to have effect from the start of 2026.6.
40
There are no statutory timeframes for updating industrial allocation regulations
following the collection of emissions information. I do not propose that the changes
should have effect from the start of 2026, as sought by NZ Steel. Rather, I propose
that the new EAF should take effect from 1 January 2025.
41
1 January 2024 is the proposed date at which the more general baseline updates
would take effect, but I consider that a different date for the new EAF is warranted
because of the significance of the change for NZ Steel’s financial forecasting used
when deciding to invest in the electric arc furnace. NZ Steel argued the nature and
timing of the change was not clear in communications at the time of negotiations
around the arc furnace project.
42
A 1 January 2025 start date still leaves some risk that policy change could still impact
the arc furnace project. 9(2)(g)(i)
Ongoing delegation to make future updates
43
I expect to receive updated data that affects allocative baselines, and the electricity
allocation factor each year, requiring further updates to the regulations. These updates
are technical in nature and there is no discretion involved – the updates will follow a
legislative formula. Unlike, the one-off updates to baselines discussed above, these
changes would become routine and ongoing.
44
Consequently, I seek an ongoing delegation from Cabinet to make decisions and the
issuance of drafting instructions for updates to baselines each year. These changes
will be from annual updates to the general electricity allocation factor and other
components of allocative baselines. I will ensure that Cabinet still has visibility of any
changes that could have significant impacts on firms.
Cost-of-living Implications
45
Updates to allocative baselines will result in a reduction of approximately 3.5% in the
overall level of industrial allocation. Over time and at the margins, this will result in
6 There is no double dipping risk arising from the combination of industrial allocation and direct Crown
investment in the electric arc furnace. NZ Steel’s allocation will decrease significantly once the furnace
begins production due to allocation for that output being based on a different, updated set of allocative
baselines.
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more emissions-efficient producers gaining market share, drive emission reductions,
and change consumer behaviours.
46
The impact on consumers is expected to be minimal. One of the largest decreases in
allocative baselines is for growing fresh cucumbers. A cucumber grower will have a
78% reduction in their allocation from this change, which amounts to approximately
$60 per tonne of cucumbers. A tonne of cucumbers was valued at $2750 in 2020/21.
Financial Implications
47
The current fiscal forecast is based on the continuation of existing allocative settings.
They do not include the electric arc furnace emission reductions.
48
The fiscal implications from updates to all allocative baselines will be provided to
Cabinet when I bring amendment regulations for approval. It is not possible to precisely
detail these at this stage due to some emission factors are being worked into the
allocative baselines. However, I expect an overall reduction in industrial allocation from
these updates to be approximately 150,000 NZUs per year, or $9.0 million7.
49
The recommended option for NZ Steel replaces the use of the general EAF with annual
calculation that will result in a NZ Steel specific EAF each year. This change results in
a decrease of approximately 225,000 emission units per year allocated to NZ Steel
from 2025 to 2026, or $13.5 million.
50
The co-generation plant is expected to be impacted by the move to an electric arc
furnace. The contract with Alinta will need to be renegotiated because of that change
and the existing contract expires near the end of 2026. Therefore, no fiscal implications
can be provided beyond that year.
51
The combined reductions of industrial allocation against the forecast for 2024/25 to
2026/27 is shown in table 1 below. Reduced Crown expenses from unit allocations will
have a positive impact on OBEGAL. Since unit allocations are not a cash item, there
is no cash impact however reduced allocations could allow an increase in the NZUs
available for auction when decisions are next made on NZ ETS settings.
Table 1: Reduction in allocation expense from proposal
Fiscal year $ million
2023/24
2024/25
2025/26
2026/27
Unit allocation expense (updates)
-$4.5
-$9.0
-$9.0
-$9.0
Unit allocation expense (NZ Steel)
-$6.8
-$13.5
-$6.8
Total
-$4.5
-$15.8
-$22,5
-$15.8
Legislative Implications
52
The decisions in this paper will be reflected in the Climate Change (Eligible Industrial
Activities) Regulations 2010. I will bring amendment regulations to Cabinet later this
year for approval.
7 Using the secondary market price of $60 (20 August 2024) and assumes constant 2020/21 production
of iron and steel products from NZ Steel over the period.
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Impact Analysis
Regulatory Impact Statement (general baseline updates)
53
The Ministry for Regulation has determined that this proposal to amend industrial
allocation regulations is exempt from the requirement to provide a Regulatory Impact
Statement on the grounds that the government has limited statutory decision-making
discretion or responsibility for the content of proposed delegated legislation.
Regulatory Impact Statement (NZ Steel electricity allocation factor)
54
A Ministry for the Environment Regulatory Impact Analysis (RIA) panel has reviewed
the “Emission costs incurred by New Zealand Steel Limited for co-generated electricity”
regulatory impact statement and considers that it meets the RIA requirements.
Climate Implications of Policy Assessment
55
The Climate Implications of Policy Assessment (CIPA) team has been consulted and
confirms that CIPA requirements do not apply to these proposals as they are not
expected to result in any significant, direct emissions impacts.
Population Implications
56
There are no significant population issues from the proposals in this paper. I have been
mindful of the fundamental purpose of industrial allocation, being to mitigate against
the risk of a loss in domestic production, with the local economic and societal impacts
this would bring to a region such as South Auckland.
Use of External Resources
57
Advice in this paper was based on the work of an independent expert (Concept
Consulting) and extensive engagement with NZ Steel throughout the analysis and
reporting phases which cost $30,000. The consultant has assisted officials several
times in the measurement of NZ ETS impacts on electricity contracts. A competitive
procurement process was followed for this work.
Consultation
58
The Treasury, the Ministry of Business, Innovation and Employment, the Ministry of
Primary Industries, Te Puni Kokori and the Energy Efficiency and Conservation
Agency were consulted on this Cabinet paper. Comments received have been
incorporated.
Communications
59
I intend to contact the chief executive officer of NZ Steel personally following Cabinet’s
decision.
Proactive Release
60
I intend to proactively release this paper and associated Cabinet committee papers
and minutes within 30 business days of final decisions being confirmed by Cabinet,
subject to redaction as appropriate under the Official Information Act 1982.
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Recommendations
The Minister of Climate Change recommends that the Committee:
Allocative baseline updates
1
Note that industrial allocation baseline settings – that is, emissions per product unit –
have not been updated since they were first set in 2010 and consequently are out of
date;
2
Note that data has been collected from all recipients of industrial allocation to update
allocative baselines;
3
Agree to delegate powers to make decisions and issue drafting instructions for
amendment regulations to the Climate Change (Eligible Industrial Activities)
Regulations 2010 to the Minister of Climate Change in accordance with the emissions
information obtained and with decisions in this paper;
4
Note that the new baselines set out in the amendment regulations will be the result of
applying methods set out in the Climate Change Response Act and will not involve
policy decisions;
5
Note that the amended regulations would be in force from 1 January 2025 but with
effect from 1 January 2024;
6
Agree the delegation in
recommendation 3 includes making decisions and issuing
drafting instructions to make technical amendments to the activity definitions of the
production of carbamide (urea), and the production of protein meal.
NZ Steel matters
7
Note that NZ Steel has been receiving an industrial allocation for consuming electricity
using the general EAF;
8
Note a large amount of NZ Steel’s electricity demand is supplied under contract with
Alinta Energy Ltd until near the end of 2026 through an on-site cogeneration plant;
9
Note that an independent review has found that that this co-generated electricity is not
affected by emissions pricing;
10
Agree NZ Steel’s electricity allocation factor wil be determined each year from 2025
from data on the amount of electricity consumed at the site, the electricity generated
by the co-generation plant, and the quantity of natural gas used by the co-generation
plant;
11
Agree the only emissions that can be counted towards NZ Steel’s electricity allocation
factor from consuming cogenerated electricity is that from any natural gas used by the
cogeneration plant
12
Agree that the change in recommendation 10 will take effect from 1 January 2025;
13
Note this change will reduce the number of units allocated to NZ Steel for 2025 to
2026, by approximately 225,000 units per year;
Ongoing delegation to make future updates
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14
Note updates to all allocative baselines in regulations will be needed each year from
2024 due to annual updates to the general electricity allocation factor and other
components of allocative baselines;
15
Agree to delegate an ongoing power to the Minister of Climate Change to make
decisions and issue drafting instructions for amendment regulations to the Climate
Change (Eligible Industrial Activities) Regulations 2010 in accordance with expected
annual data updates;
16
Note that regardless of this general ongoing delegation, the Minister of Climate
Change will ensure that Cabinet is informed of any updates to the regulations that are
expected to have significant impacts on firms.
Next steps
17
Invite the Minister to seek Cabinet approval for amendment regulations to update
allocative baselines before the end of 2024.
Authorised for lodgement
Hon Simon Watts
Minister of Climate Change
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Appendix 1: Estimated financial impact of updates to allocative baselines on different
industrial activities
9(2)(b)(ii)
8 Using the secondary market price of $60 as at 20 August 2024.
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