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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

5 Emissions Rules

5.1 Introduction

The key issues that were raised on the proposed data rules relating to the calculation of emissions during the consultation process were:

• eligible emission sources
• interpretation of ‘direct use’
• materiality
• co-generation
• other issues and comments on emissions rules.

A number of submissions raised issues on the electricity allocation factor, which formed part of the emissions rules. This is discussed in section 3.

5.2 Eligible emissions sources

5.2.1 Summary of issues

During consultation, some submitters, including New Zealand Coal and Carbon, Methanex, Kenroll Industrial Coal & Canterbury Coal, Horticulture NZ, Oceana Gold, Meat Industry Association, Rio Tinto Alcan NZ, and the Coal Association proposed that liquid fossil fuels (LFF) and upstream emissions from the extraction/transport of coal and natural gas be included as eligible emissions sources. For coal, such upstream extraction-related emissions includes fugitive coal seam methane (FCSM). Some, but not all of these proposed additional emissions sources are included in the CPRS.^{Footnote 7}

Submitters noted that the NZ ETS costs imposed through upstream emissions from natural gas and FCSM or LFF are no different in nature from the proposed list of eligible emissions sources, eg, coal or natural gas use.

5.2.2 Analysis

The objective of the industrial allocation regime is to provide transitional assistance for those activities that face the greatest competitiveness risk, by protecting them from a significant portion of the costs imposed by the NZ ETS.

However, the objective of the industrial allocation regime does not necessarily imply compensation for all emissions sources. As the provision of industrial allocation has a fiscal cost, it is logical for the Government to target assistance at those emissions sources that are likely to be most material for the largest number of companies. In addition, the administrative complexity of providing assistance for particular emissions sources is a relevant consideration, particularly if it is likely to impact on the ease and speed at which sectors receive allocations.

Therefore, it is necessary to consider, in relation to each additional proposed emissions source:

• whether including the new emissions source would make a material difference to the eligibility of most activities likely to receive industrial allocation
• the complexity of including each proposed emissions source and implications for timelines and administration of industrial allocation
• equity and consistency across all sectors
• the cost and fiscal implications of including each proposed emissions source.

It has been estimated that the NZ ETS costs incorporated in LFF are likely to represent less than 1% of the product price for the majority of activities being considered for eligibility. For some activities the costs might be around 1–2% during the transition phase and higher thereafter.

Providing for upstream natural gas emissions in the calculation of emissions for industrial allocation is not likely to be material for the majority of activities. In the case of methanol, the potential impacts are more material.

The fiscal impact of including liquid fossil fuels, fugitive coal seam methane and allowing for upstream natural gas emissions, could be around $21 million per annum through to the end of 2012 (assuming an allocation at 50% of normal levels during the transition phase, and a carbon price of $25/tCO₂e) and around $78 million per annum from 2013 (assuming a carbon price of $50/tCO₂e).

Including LFF emissions would significantly complicate the activity-based approach because it heightens the importance of determining the edges of an activity. In Australia, the process of defining activities took between 3 and 12 months for each activity, in large partly because of prolonged discussions over activity boundaries.

Including FCSM emissions, whilst relatively straightforward, is likely to significantly benefit only one activity. It is also not in line with the situation in Australia, where FCSM emissions are not included in the calculation of assistance under the EITE programme.

In the case of upstream natural gas, inclusion of this emissions source raises questions about whether other downstream emissions sources should be included. This would result in significant complexities. Fairness and consistent treatment of all uses of natural gas, not just as a feedstock, are also significant concerns.

5.2.3 Decision

The decision about whether to include additional eligible emissions sources is a carefully balanced choice. However, the Minister has decided that the list of eligible emissions sources will remain the same as those proposed in the consultation document (ie, excluding LFF, FCSM and upstream natural gas emissions sources). This is because:

• for the vast majority of activities, the exclusion of the proposed emissions source appears unlikely to be very material
• LFFs could be material for some activities at margins of eligibility, but this is only one of a number of factors that could impact on the eligibility of these sectors
• inclusion of LFFs and upstream natural gas would raise significant complexities with implementation regarding decisions relating to activity boundaries and fair treatment across sectors
• the fiscal costs of including LFF, FCSM and upstream natural gas emissions could be significant; $21 million per annum during the transition phase, potentially rising to $80 million after 2013.

The 2011 review is an opportunity to revisit eligible emissions sources in the context of a wider review of the NZ ETS and allocation, before the end of the transition phase.

The Minister intends to add one additional rule to clarify that only emissions which face an obligation under the NZ ETS may be included. This is necessary to exclude emissions sources for which an exemption under section 60 of the Act is in force. This is likely to be relevant to the proposed new activities of gold, animal by-product rendering, production of tomatoes, capsicums, cucumbers and roses where less than 1500 tonnes of used oil or waste oil may be combusted by individual firms. As these emissions are exempt from NZ ETS obligations under section 60, the rule ensures these cannot be counted for allocation.

5.3 Excluded emissions sources

5.3.1 Summary of issues

Submitters, including Business NZ, Fonterra, Methanex, and Evonik amongst others, argued against a number of exclusions proposed in the draft activity description, which are based on those listed in section 161E(2)(b) of the Act, and are consistent with the exclusions in the CPRS.

The particular exclusions raised most often by submitters were transportation elements and packaging (eg, of food or hazardous substances). The main arguments proposed by submitters were that it was difficult to accurately determine emissions from these minor sources or that the excluded emissions were ‘essential’ to the activity (eg, that packaging of hydrogen peroxide was essential to its production because it could not be sold without packaging).

5.3.2 Analysis

The exclusion of transportation to/from activities, and ‘complementary’ activities such as packaging has been consistently applied across all activities based on consideration of the principles set out in the Act, particularly section 161E(1)(c)(i) requiring activities be defined consistently and equitably across industries.

In general, anything excluded from the activity description lowers the total amount that a firm will be allocated. However, it is not clear that the exclusions will have a significantly material impact on any activities that are being considered for an allocation under the NZ ETS. For the most part, they represent a very small part of overall emissions and are not emissions-intensive activities in themselves. In many instances, submitters concerns relating to the inclusion of such emissions were around materiality, in that such emissions were so small that it would not be worth the effort to include them. Materiality issues are discussed later in this summary.

As already discussed with reference to whether or not liquid fossil fuels should be an eligible emissions source, there is considerable scope for firms to attempt to push out activity boundaries if exceptions are made to the generic list of exclusions. If these exceptions are made on a case-by-case basis, treating activities differently, this will raise significant issues for equity and consistency.

5.3.3 Decision

The list of draft exclusions listed in the consultation document are consistent with those developed for the CPRS and the principles set out in the Act. On balance, for the sake of equity between different parts of the industrial sector, to ensure that implementation of industrial allocation reflects the policy intent, and to assist in developing Gazette notices in an efficient manner, the Minister for Climate Change Issues will use his discretion under the Act to consistently apply the exclusions listed in the consultation document to all activities.

5.4 Interpretation of ‘direct use’

5.4.1 Summary of issues

Some submissions raised concerns on the interpretation of ‘direct use’ in Emissions Rule 1.

Some submitters have suggested a different interpretation of the meaning of ‘direct use’ of coal and natural gas from that intended by Emissions Rule 1. In particular, Solid Energy has submitted that the ‘direct use’ of coal should be interpreted in such a way as would allow them to count the emissions from downstream combustion of coal as direct use of coal during the proposed activity of coal mining.

The joint venture partners producing oil at Maari have proposed oil extraction as a new activity. The potential eligibility of this activity may depend on whether or not flaring of natural gas fits within in the definition of ‘direct use’.

5.4.2 Analysis

The phrase ‘direct use’ is not defined in the Act and there is scope for different interpretations of this.

In relation to the issue raised by Solid Energy, the fundamental question is who is able to receive allocation for burning coal, eg, the coal miner or the person purchasing coal who faces the additional cost passed through from miners.

The approach being followed to date for industrial allocation strongly suggests the latter, which would be consistent with the approach being taken for electricity and liquid fossil fuels. As with other fossil fuels, in terms of the carbon embedded in the coal, miners and importers face the same costs and obligations, indicating that there is no difference in their ability to pass-through these costs. Taking a different approach to ‘direct use’ of coal would therefore raise significant consistency and equity issues.

In addition, allowing this interpretation of ‘direct use’ and providing an allocation to coal miners would have significant implications for other activities and create considerable complexity. To avoid double-counting, actual coal use would need to be carved out from the downstream user. This could result in the coal user failing to meet the eligibility threshold. As with electricity and other fossil fuel producers who can pass through costs, there would also be a risk of windfall profits for coal mining.

5.4.3 Decision

The Government intends to provide greater clarity over the intended interpretation of this phrase to ensure there are no obstacles to eligibility decisions following the data collection stages. Given the arguments above, Emissions Rule 1 will be revised accordingly to be clear that ‘direct use’ means ‘direct oxidation or use as a feedstock’.

5.5 Materiality

5.5.1 Summary of issues

Emissions Rule 11 is about materiality and states that:

Best endeavours should be used in calculating emissions from small sources that are part of an activity.

In collecting emissions data for an activity, all emissions should be calculated unless they are explicitly excluded. However, it is recognised that some emissions sources will be small, and the effort required to accurately calculate these emissions may be out of proportion to their size. The consultation document proposed that in all cases, best endeavours should be used to calculate the emissions, but it is recognised that efforts may be less for some small sources.

Five submissions raise concerns on Emissions Rule 11 (Ballance Agri-Nutrients, Rio Tinto Alcan NZ, Methanex, Holcim, Coal Association, and Business NZ). The main concern was that because of the requirement to produce accurate estimates of emissions, they will be required to spend inordinate amounts of time to assess emissions from small and inconsequential sources. A particular concern noted was of the risk that emissions estimates will be audited later and that these might result in changes to eligibility status and/or levels of allocation.

Other concerns raised included that guidance on materiality thresholds over and above which deductions are required should be provided and that reference to accounting standards or tax ruling precedents to develop such thresholds should be considered. Questions were also asked about the degree of auditing certainty required.

5.5.2 Analysis

Firms require certainty on the approach the Government will take when checking data on small sources of emissions. The Government intends to use a pragmatic approach and proposes to revise Emissions Rule 11 to reflect this. Whereas best endeavours should be used to estimate emission levels, ‘simplified calculation methods’ are explicitly allowed for small emission sources.

The Government considers it important that firms make an attempt to quantify the emissions from excluded sources, but consider the amount of effort required should be proportionate to the materiality of the emissions source. To avoid the possibility of gaming from this increased flexibility of allowing for ‘simplified calculation methods’ a materiality threshold is proposed, which should give firms greater certainty over whether they are meeting the requirements or not.

5.5.3 Decision

The Government proposes an additional rule to require disclosure of uncertainties associated with estimates of emissions and revenues. It is useful for the Government to know the level of uncertainty attached to a number so that it can understand whether to spend additional time checking. It is useful for firms to be able to express this uncertainty, especially where there is a risk to them of getting the number ‘wrong’.

5.6 Co-generation

5.6.1 Summary of issues

Emissions Rule 5 sets out a methodology for allocating emissions from co-generation plants to the individual outputs of heat and electricity. Because all emissions associated with electricity are counted on the basis of consumption rather than generation, any emissions that come from on-site generation of electricity need to be subtracted. This rule provides a consistent way of doing this. The submission from Fonterra discussed this. The issues raised are that the co-generation efficiency method should not apply to the eligibility assessment or that site-specific efficiency values should be allowed.

Some submitters, such as Fonterra, suggested firms be allowed to estimate their own efficiency values for steam and electricity production.

5.6.2 Analysis

While it is likely that different plants will have different efficiencies, it is unlikely that different efficiency values will have a significantly material impact on the eligibility of the majority of activities. Where it is likely to be a factor, other factors (such as the activity boundary and emissions intensity of all companies undertaking the activity) are likely to be more material.

The proposed values of 80% efficiency for steam and 35% for electricity are based on the World Resources Institute / World Business Council on Sustainable Development protocol.^{Footnote 8} These are relatively conservative values and maintain incentives to improve efficiencies over and above these values. When obligations and allocations are taken into account, it is highly unlikely that use of these values will reduce the economic incentive for firms to invest in co-generation as a potentially efficient response to the emissions price created by the NZ ETS.

Allowing firms to choose their own efficiency values would introduce additional uncertainty and complexity into the process, as it would require site-specific values and assumptions to be validated.

5.6.3 Decision

On balance, considering the benefits for individual activities against the impacts on the process as a whole, the Government considers the benefits of simplicity and certainty outweigh the need to allow for individual efficiency values.

5.7 Other issues and comments on the emissions rules

5.7.1 Summary of issues

A number of submitters requested more guidance on the emissions rules. In addition to those issues discussed above, more guidance was sought on the requirements around electricity generated on-site and the treatment of Other Removal Activities. Methanex submitted that the CO₂ content in natural gas supplies in New Zealand has been increasing due to the relative decline of Maui gas production and corresponding increase in supply from other gas fields with higher CO₂. Methanex suggest Emissions Rule 8 should be amended so that they can weight historic emissions to account for this in the same way as the EAF and revenue can be weighted.

5.7.2 Analysis and decision

To cater for these points and other detailed issues of clarification, the Government will publish, alongside the Gazette Notice calling for data, guidance notes to assist interpretation of the rules by firms. In some cases, issues of clarification will be generic to all activities, in some cases specific to some or one. Direct support will also be provided to help individual companies interpret the rules in their particular circumstances.

The discussion above in section 4 on which financial years revenue data must be submitted also addresses the issues pertinent to the financial years for which emissions data must be submitted. No change has been made to Emissions Rule 8.

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