"Free" units that benefit big business are not the issue

By Suzi Kerr, Senior Fellow, Motu Economic and Public Policy Research.

Radio NZ is reporting that various big kiwi businesses received millions of dollars worth of emissions credits from the Government. In our opinion, this is not the biggest issue for the NZ ETS going forward, though there are compelling reasons why this free allocation should phase out faster.

Two issues that are key for New Zealand are the overall ambition of our ETS, which drives price, and controls on the quality of units surrendered in our system when we re-connect to international markets. This is clear in recent reports from the Environmental Protection Agency.

During the 1 July 2014 – 30 June 2015 year, New Zealand firms surrendered 32 million emissions units, the vast majority of which they had purchased. If they had paid current NZ prices for those units, emissions would have cost them (and their consumers) around $189 million.  If prices were at the 'social cost of carbon' those units would have been worth more than $1.5 billion.  That would send a real economic signal.  The problem is not the system but the level of the price.

In November 2012 the government chose to withdraw from the Kyoto Protocol but still allow the use of international units to meet obligations until May 2015. So, for part of the 2014/2015 year, firms benefitted from receiving free allocations of New Zealand units (currently worth around $7 each) while surrendering international units (worth around 35c). This has ended in May this year and now only NZ units are accepted. Some businesses did get a windfall out of this transition, but it doesn’t indicate a failure in ETS design – rather a failure in management of the transition out of Kyoto.

The current system of free allocation is not a gift to big business; it is tightly targetted and total levels of free allocation are low relative to other systems.  Whether a firm receives a free allocation does not depend on the size of the firm. A firm receives free allocation if it carries out an activity which is at risk of relocating – or not receiving new investment – in New Zealand. It is impossible to know whether any given firm would actually relocate – or not invest – without this protection. The rules target the most ‘at-risk’ activities.

During the 1 July 2014 – 30 June 2015 year in total 5.1 million units were ‘allocated’ (which means given away for free).  These free units are out of a total of 30.2 million units surrendered to government to show compliance with the ETS. So only 16% of the total units surrendered were freely allocated in New Zealand. In comparison, in 2013, 90% of Californian ETS units and 50% of European units were given away.

The amount of units a firm receives depends on the quantity of the activity they carry out. Firms with a higher scale of at-risk activities get higher allocations and tend to be larger firms. Larger firms also have higher costs under the ETS. In general, the free allocation a firm receives is related to, but lower than, the costs they bear.

Firms that receive this free allocation still have a full incentive to make their production processes cleaner. If they produce the same amount of steel, aluminium or cucumbers with fewer emissions they bear lower emission costs but get the same free allocation.

The free allocation aims to avoid New Zealand lowering its emissions by simply moving high emitting production offshore. That would do the global environment no good. The free allocation also aims to protect jobs and companies during the transitional period while New Zealand has emission pricing while our competitors do not. Companies who are producing internationally traded goods cannot pass on costs to their consumers in the way that others, such as local fuel retailers, can.

When the ETS was introduced in 2008, New Zealand was one of the only countries with emissions pricing; this meant the risk of relocations seemed high. Now 15% of global output is produced under an emissions trading system. Continuing to protect these kiwi companies may be less valuable, in terms of the environment, jobs and maintaining New Zealand’s industrial sectors, than it once was.