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Development of Industrial Allocation Regulation under the New Zealand Emissions Trading Scheme

• 1 Overview
• 2 Activities
• 3 Electricity Allocation Factor
• 4 Revenue Rules
• 5 Emissions Rules
• 6 Other Issues
• Annex 1: List of Submitters

2 Activities

2.1 Introduction

As noted in the consultation document, the allocation of emission units will be awarded on the basis of emissions from activities, rather than on the basis of firms or sites. Each eligible activity will be defined by an ‘activity description’, which will include a starting point (the input of a specified substance or substances) and an end point (the output of a specified saleable product) that is created by some form of physical, chemical and/or biological transformation.

Activities will be eligible for allocation if their emissions intensity is greater than 800 tCO₂e per $ million revenue.

The activity description details which emissions and revenue should be included for the purposes of determining eligibility and allocation.

The consultation document included draft activity descriptions. These were based on those developed in Australia for the proposed CPRS for activities that had either been found to be eligible or were under consideration for eligibility there. The activity descriptions in these cases were based on the draft Australian activity descriptions.

Submitters were asked if they had comments on the proposed descriptions. In addition, submitters were asked to identify whether there were any other activities they were undertaking in New Zealand that might meet the eligibility threshold, and to provide evidence to show a case for possible eligibility.

This section outlines such comments and changes that are proposed, as well as those activities that were not identified in the consultation document but which have since been identified as potentially qualifying as emissions intensive/trade exposed.

2.2 Activities proposed in the consultation document

2.2.1 Overview – draft Australian activities undertaken in New Zealand

Of the draft activity descriptions included in of the consultation document, submitters indicated that the following activities are undertaken in New Zealand:

• Aluminium smelting
• Carbamide (urea)
• Carbon steel
• Cartonboard
• Caustic soda
• Clinker
• Ethanol
• Glass containers
• Hydrogen peroxide
• Lime
• Market pulp
• Methanol
• Newsprint
• Packaging paper
• Tissue

The Government will take these activities through to the data collection stage to assess eligibility and develop allocative baselines.

Petroleum refining was included as a draft activity in the consultation document, and is undertaken in New Zealand. However, this will not be progressed at this stage because the sole firm involved in the activity (the New Zealand Refining Company) already receives protection from a cost of CO₂ through the operation of its Negotiated Greenhouse Agreement with the Government. This is discussed further below.

Other draft activity descriptions included in Annex 1 of the consultation document will not be progressed further because there do not appear to be any New Zealand companies undertaking these activities. These include:

• Bulk flat glass
• Carbon black
• White titanium dioxide
• Silicon
• Zinc smelting
• Alumina refining
• Fused alumina
• Fused zircon
• Printing and writing paper
• Iron ore pellets
• Magnesia
• Production of pig iron
• Integrated production of lead and zinc
• Sodium carbonate and sodium bicarbonate
• Synthetic rutile
• Integrated iron and steel^{Footnote 2}

2.2.2 Proposed changes to draft Australian activity descriptions

A number of the submitters who indicated that they were undertaking activities for which draft activity descriptions were included in the consultation document requested changes to the draft descriptions. Where changes were not proposed to the draft activity description adopted from Australia, no substantive changes are being made, on the basis that the Australian activity definitions are broadly consistent with the matters that the Minister must have regard to in finalising activity descriptions under section 161E(1) of the Climate Change Response Act 2002.

Where changes were proposed, the Minister considered the merits of the proposed changes on a case-by-case basis, referring to the matters he must have regard to in finalising activity descriptions under section 161E(1) of the Climate Change Response Act. A summary of the changes suggested and the Government’s analysis and decision for each activity description is set out below.

• Aluminium smelting – One submission was received on this activity. This submission related to the inclusion of liquid fossil fuels in data collection, and further comment is provided on that aspect in this summary of submissions.
• Carbamide (urea) / ammonia – Ballance Agri-Nutrients, the sole manufacturer of urea and sole submitter on this activity, suggested that instead of separate activity definitions for the production of ammonia and the production of urea (the approach adopted in Australia), an integrated ammonia-and-urea activity definition should be developed. They argued that, unlike in Australia where ammonia can be and is traded as an intermediate product, there are operational and infrastructure barriers to ammonia being imported to or exported from the existing Ballance Kapuni site.
  
  Analysis commissioned by the Ministry indicated that it is unlikely that bulk ammonia would be traded in New Zealand in the next 10 years at least. Therefore, an integrated ammonia-and-urea activity definition would be neutral in terms of technology likely in New Zealand in the foreseeable future; an integrated definition would not have an inequitable impact between different firms carrying out ammonia production; and ammonia should not be regarded as an intermediate product when considering the principle set out in 161E(1)(c)(iii) of the Act. Accordingly, given the substantive difference in nature between the Australian and New Zealand situations, the Minister has decided that an integrated activity definition will be developed. This will be reviewed before 2016.

• Carbon steel – Three submissions were received around carbon steel. Two submitters identified that the production of cast iron is similar to that of carbon steel. Carbon steel is defined as having <2% carbon content, whereas cast iron has a >2% carbon content. Analysis into the distinction between the two outputs has determined that they are distinct products whose characteristics mean they are not close substitutes. Whilst they have similar inputs (being various types of cold ferrous feeds), there are also some minor distinctions in the process as well. This led to the recommendation to consider cast iron (>2% carbon content) as a separate activity from carbon steel. There were no further suggested changes to the activity definition.
  
  A further suggestion was to remove the term ‘continuously’ from the definition, to reflect that the casting process can be done in different ways (for example in a batching process). Also the inclusion of the term ingots as being distinct from a cast carbon steel product could be seen to limit other shapes of cast products. To provide clarity, the activity definition has been updated accordingly.

• Cartonboard – Carter Holt Harvey (CHH), the sole manufacturer of cartonboard and sole submitter on this activity, suggested a number of changes to the activity definition.
  
  The most significant was extending the activity definition to include log billets as an input. This suggestion was accepted because log billets are an input to the pulp production element of cartonboard production in the same way that wood chips are an input to other types of pulp production. Log billets are not chipped on site, but ‘stone-ground’ to produce the pulp. Thus, no intermediate product such as chips is produced as part of this process, and inclusion of the emissions associated with converting log billets to pulp is not inconsistent with the principles set out in the Act.
  
  CHH also suggested adding uncoated cartonboard and sheets of cartonboard as defined products in the activity definition. This was accepted as this better reflected the New Zealand situation.

• Caustic soda – Carter Holt Harvey (CHH), the sole manufacturer of caustic soda and sole submitter on this activity, did not raise substantive issues with the activity definition.
• Clinker – Two submissions were received on the proposed activity of clinker, both of which requested an extended definition which also included the cement milling process. The basis for these requests were that a) clinker is an intermediate product in the manufacture of cement and is not a tradable product in its own right; and b) a non-integrated activity definition does not reflect the structure of the New Zealand cement industry where clinker and cement are fully integrated.
  
  The Minister has considered the submissions of the cement industry alongside the matters to which he must have regard, as set out in section 161E (1). Analysis of the cement industry in New Zealand^{Footnote 3} and advice received by the Ministry on clinker imports indicates that trade in clinker that has occurred in New Zealand over the past 20 years was only as a result of unexpected plan outages, unlike in Australia where clinker is regularly traded as an intermediate product.
  
  The Minister has therefore decided that an integrated activity definition is most appropriate given the structure and operational practice of the New Zealand cement industry.

• Ethanol – Fonterra submitted that emissions associated with packaging should be included if that packaging operation is necessary to produce a tradable product. They went on to state that for most perishable food products the act of putting the product in packaging is an integral part of the process for making the saleable product.
  
  Packaging has been consistently excluded from all sectors’ activity definitions as it does not make up part of the transformation of inputs into outputs – the principle set out in section 161E(1)(a) of the Act – plus it has been deemed to be a complementary activity, and thus excluded on grounds of consistency and equity across activities – the principle set out in section 161E(1)(c)(i) of the Act.
  
  This approach has also been adopted for the proposed Australian CPRS.
  
  Accordingly, the Minister has decided not to change the draft activity definition.

• Glass containers – One submission was received from the sole glass manufacturer in New Zealand. They were happy with the proposed activity definition. They also raised issues around the data rules and use of the Australian Track with regard to eligibility (comment on this is provided elsewhere in this summary).
• Hydrogen peroxide – Evonik Degussa Peroxide Ltd, the sole manufacturer of hydrogen peroxide and sole submitter on this activity, did not raise substantive issues with the activity definition.
• Lime – Three submissions were received from firms undertaking the manufacture of lime in New Zealand. None of the submitters suggested any substantive change to the activity definition. One submitter recommended that the title of the activity be changed to ‘production of burnt lime’ to differentiate from the production of agricultural lime. This proposal was put to the other submitters who agreed that this would be a useful change. Any reference to the output of lime has now been changed to ‘burnt lime’.
• Market pulp (referred to as ‘dry’ pulp in the consultation) – Three submissions were received regarding the activity definition for market pulp manufacturing, with the main issue raised in all the submissions being whether a single activity definition covering all types of pulp should be used, or multiple definitions to cover the different types of market pulp (high/low yield, and high/low freeness).
  
  The issue is that the different types of pulp have very different emissions intensities. Accordingly, a single activity definition for both eligibility and allocation (the approach adopted in Australia) would have a significant negative financial impact on the most emissions intensive type of pulp (high-yield, low-freeness), and result in a net gain for the least emissions intensive type of pulp (low-yield).
  
  The key consideration in the analysis was the extent to which the different types of pulp were sufficiently distinct that they should be treated as separate products. In this respect, both the Government and the different sections of the pulp industry agreed that the different types of pulp are distinct and have very different quality characteristics, and may therefore need to be differentiated. It was also determined that the market pulp situation in New Zealand is materially different to Australia.^{Footnote 4}
  
  Because of this, the Minister has decided on a single activity definition for eligibility purposes, but different allocative baselines for the different types of pulp. It is thought that this approach reflects the differences between the different types of pulp (and between the New Zealand and Australian situations), and aims to provide each type of pulp with an allocation that reflects their emissions intensity, without significantly disadvantaging any type of New Zealand pulp producer relative to the proposed position in Australia. Separate activity descriptions for each type of pulp would be a second best option.
  
  All three companies also proposed extending the moisture content range of market pulp, as it appears that the moisture content of the pulp produced in Australia differs to that being produced in New Zealand. This proposal is accepted by the Minister.
  
  Some of the submitters also proposed that on-site chipping of logs be included within the activity definition. However, the Minister has decided that this process should continue to be excluded in the activity definition. This is primarily because:
  1. wood chips are a tradable product. As such, exclusion of on-site chipping is consistent with the general principles and approaches adopted for other industry sectors. In particular, the splitting of vertically integrated processes into component activities where intermediate outputs could be traded in New Zealand
  2. based on information provided by one pulp manufacturer, it is understood that the amount of emissions associated with on-site chipping is relatively small compared with other processes. Thus exclusion of on-site chipping is consistent with the purpose of allocation to ensure that allocation is targeted only at the most emissions-intensive activities
  3. it is consistent with the approach adopted in the proposed Australian CPRS.
• Methanol – Methanex, the sole manufacturer of methanol and sole submitter on this activity, made the following suggested changes to the draft activity definition:
  1. the transportation of finished product to the point of export should be added as an inclusion, because methanol is predominantly exported and transportation is an integral part of the activity
  2. the transportation of inputs, outputs and intermediate products within the activity boundary should be included as these processes are integral to manufacturing
  3. the exclusion of electricity consumption from complementary activities should be removed as it is immaterial and difficult to calculate
  4. gas users should be compensated for increased gas prices arising from use of gas and other emissions occurring upstream. Such compensation should occur via the use of a natural gas feedstock allocation factor.
  
  With respect to point a), the Government has determined it would be inconsistent and inequitable for transportation emissions to, from or between locations conducting an activity to be included for emissions intensive trade exposed (EITE) activities. When considering the general situation applying to all industrial sectors, there are considerable differences in who transports various products and how much transportation takes place among entities conducting a given EITE activity. This depends on business decisions that are quite separate from the EITE activity itself. Accordingly, the Government has decided that the transportation of inputs and outputs to and from storage at the same location of the activity is excluded from all activity definitions. To include them for methanol production would thus be inconsistent, and run contrary to principle 161E(1)(c)(i) of the Act.
  
  However, with respect to point b), emissions associated with the movement of products at the location and within the boundary of the EITE activity are included for all EITE activities, because that transport is properly regarded as integral and essential to the defined transformation taking place. However, this inclusion only applies to eligible emissions. In this respect, if the transportation is being undertaken using liquid fossil fuels, the emissions would not be eligible.

  With respect to point c), any emissions associated with complementary activities have been consistently excluded from all activities. This is to ensure the integrity and equity of the Industrial Allocation programme, as per principle 161E(1)(c)(i) of the Act.^{Footnote 5} However, Methanex’s point appears to relate more to materiality. Such materiality issues are being addressed through data collection methodologies, and are addressed later in this summary.
  
  With respect to point d), this relates to a broader more generic issue of eligible emissions. As such it is addressed later in this summary.

• Newsprint manufacture – Norske Skog, the only newsprint manufacturer in New Zealand and sole submitter on this activity, did not raise any issues specifically relating to the production of newsprint.
• Packaging and industrial paper manufacture – Carter Holt Harvey (the sole manufacturer of packaging and industrial paper and sole submitter on this activity) proposed that on-site chipping should be included in the activity definition. This was not accepted for the same reasons as set out for market pulp.
• Tissue paper manufacture – In Australia, the tissue paper manufacturing process is a two-stage integrated process, with the first stage being the conversion of chips and sawdust into pulp, and the second stage being the conversion of this pulp to produce tissue. Further, because it is possible for a manufacturer of tissue paper to ‘miss-out’ stage one and use market pulp as an input, the Australian activity definition allowed for two allocative baselines: one for each of these two stages. This is the approach used in the other paper producing activities.
  
  Presently, the production of tissue paper in New Zealand only involves the use of purchased market pulp to produce tissue paper. That is, they do not carry out the stage one process of integrated on-site pulp production. SCA Hygiene (the sole manufacturer of tissue paper in New Zealand, and the only submitter on this activity) therefore initially suggested that references to the first stage of the integrated process in Australia are not relevant to the New Zealand context and could be removed from the activity definition.
  
  Subsequently it has been determined that until 2007 SCA Hygiene used to carry out an integrated production process, and therefore it is appropriate to keep the production of pulp within the activity definition.

• Integrated iron and steel – There were no submissions on the integrated iron and steel activity. One submitter proposed a new activity definition for the manufacture of iron and steel from iron sands, and this will be treated as a new activity (commented on in the following).
• Petroleum refining – NZRC has sought a number of amendments to the proposed activity definition for petroleum refining relating to inputs, transformation, output, inclusions and exclusions for petroleum refining. Refining is protected by a Negotiated Greenhouse Agreement (NGA) which applies until 31 December 2022. The NGA means that NZRC will be compensated for costs arising from the NZ ETS regardless of whether petroleum refining is an eligible industrial activity. The Government does not propose to take forward this activity at this stage, but aims to give certainty well before NZRC faces any NZ ETS costs. Eligibility and allocative baselines for petroleum refining are dependent on the emission sources being included in the calculation for emissions, eg, refinery asphalt, refinery fuel oil, refinery fuel gas, refinery flare gas, other intermediate crude oil products and carbon dioxide vented from manufacturing hydrogen. It is planned that the Government will revisit this during the review of the NZ ETS in 2011.

2.3 New activities identified through the consultation process

Twenty-seven new activities were proposed by submitters as potentially eligible for industrial allocation.

Of these, preliminary data was provided for the following activities which indicates that they meet or are very near the threshold for eligibility:

• production of clay bricks and field tiles
• production of gelatine
• production of reconstituted wood panels
• production of veneer sheets
• production of protein meal (meat by-product rendering)
• production of six new dairy products – lactalbumin, lactose, milk minerals, whey cheese, whey powder, whey protein concentrate/whey protein isolate
• rose production
• fresh capsicum production
• cucumber production
• fresh tomato production
• iron and steel manufacturing from iron sand.

Draft activity definitions will be developed for these activities in consultation with industry, following which formal data collection will be undertaken to establish eligibility and allocative baselines.

Many submitters made comments and expressed preferences on the design of these new activity descriptions. These comments will be considered and discussed directly with industry representatives in the process of finalising descriptions.

Other activities for which data indicates are likely to be far below the eligibility threshold, based on the inclusions and exclusions in the final data rules, will not be progressed further at this time.

At the time of writing, further information is being sought from a number of other activities that may or may not meet the eligibility threshold.

Submitters will be informed directly of the status of proposed new activities.

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