Why it matters

Right now, a large chunk of the economy is having its pollution subsidised, holding back the incentives and opportunities for these industries to cut pollution.

This is expensive, and is getting more expensive each year as the carbon price rises over time. Treasury estimated that industrial allocation cost the Government $600 million in 2022. If any subsidies should be put in place in the transition to a zero carbon future, it should be to support the transition of industries, not prop up their pollution.

This is fundamentally incompatible with our climate goals in the Zero Carbon Act, because in 2050 (when the country is meant to be at net zero emissions), 30% of these industries’ emissions will still face no carbon price.

It is also unfair. Everyday households play their part by paying the carbon price in our petrol and electricity bills. As the emissions cap shrinks to try meet our targets, the burden of meeting those targets increasingly falls on individuals, while some of our biggest polluting industries continue to get a free pass to pollute.

It's not good long term planning. Maintaining this pollution subsidy for decades to come while the rest of the world accelerates action is locking thousands of jobs into fossil fuel dependency, and liable to shock transitions as the rest of the world takes faster action.

We are proposing to end the system of free carbon credits by 2030.

• The level of free credits would phase out by 14% each year between 2025 and 2030, at the same time as a Carbon Border Adjustment Mechanism is phased in on imports.

• Businesses currently receiving free credits would need to pay for their pollution in full by 2030. Overseas imports of the same products (like steel, concrete etc) made in a more polluting way would face a tariff at the border, so that domestic producers would not be at a competitive disadvantage, but would still face the price incentive to reduce their emissions.

The current subsidy of millions of carbon credits a year would be repurposed in two ways:

1.Cut pollution

Half of these credits would be ‘cancelled’, tightening the overall supply of credits and shrinking the overall emissions cap, leading to steeper cuts in climate pollution, and a fairer distribution of reductions between these previously subsidised industries and the rest of the economy.

• This could lead to 10 million tonnes of extra emissions reductions between 2025 and 2030. That’s the equivalent of taking 727,000 cars off the road.

  
  

2.Unlock green jobs

The other half of credits would be sold back to polluters as part of the supply of credits that polluters have to purchase to cover their emissions (thus also incentivising more emissions reductions), generating revenue that can be used to invest in climate action, particularly to help these industries with the upfront costs of decarbonising (in the form of loans or in return for equity stakes). This would generate a total of around $1.4 billion by 2030, and $3.5 billion by 2035. These funds could be used as a contribution to:

• Up-front transitional assistance (such as through expanding the Government Industry Decarbonisation Initiative scheme) to support decarbonisation options that are available specifically in industries currently getting free credits.

• Maintain demand for locally produced steel, concrete and wood processing through sustainable infrastructure investment via a Ministry of Green Works or public procurement policy.

• A just transition fund for any affected workers.

• Loss and damage finance for developing countries and those on the frontlines of climate change.

By ending free carbon credits, providing upfront loans for industries with decarbonisation options, and protecting domestic producers from more polluting competitors with a carbon border mechanism, the government can accelerate emissions reductions and ensure every sector is taking responsibility for its pollution.

The Solution: End Free Carbon Credits

The potential for change

What are the decarbonisation options in these industries, and how much could they reduce emissions by currently?

Steel (NZ Steel, owned by Bluescope) - 1.8 million free credits in 2023. Emissions profile: 1.48 million tonnes CO2/year - the equivalent of 600 000 cars.

New Zealand Steel’s decarbonisation potential is already being partially realised through the introduction of Electric Arc furnaces, thanks to co-investment by the previous government of $130 million. This will reduce its emissions by 45%. Details of how much NZ Steel’s allocation of free carbon credits will be affected by this decarbonisation and the receipt of direct funds from the government to enable this have not been made clear. Further reductions are possible for NZ Steel by using green hydrogen to reduce ironsands into iron. This would require a large amount of additional renewable energy to produce the green hydrogen, but if done, NZ Steel’s emissions would be negligible.

Concrete (Fletcher concrete) - 594,000 free credits in 2023. Emissions Profile: 600,400 tonnes C02/year - equivalent to 250,000 cars.

Most concrete emissions are from cement production. Emissions can be cut by around 10% by reducing the amount of cement in concrete and using other waste materials. The cement production process itself can be partially decarbonised through switching out fuel sources from fossil fuels (they're already doing this through waste tyres, but more sustainable alternatives like woodchip from forestry waste can be used too). Concrete is a widely available and cheap product. If its cost increased due to increased carbon price, this could lead to more discerning use of concrete in construction - focusing on essential areas. The cement importer Holcim already supports the introduction of a Carbon Border Adjustment Mechanism as a better alternative to free credits.

Synthetic Nitrogen Fertiliser (Ballance Agri-Nutrients) - received 333,000 free credits in 2023. Emissions profile: 1.2 million tonnes CO2/year, equivalent to 520,000 cars.

Ballance Agri-Nutrients produces 1.9% of New Zealand’s emissions. This is just from their from direct production process. Greenhouse gas emissions released from the use of synthetic nitrogen fertiliser on farms (nitrous oxide, and methane by enabling dairy intensification) do not currently fall under the Emissions Trading Scheme. However, the technology already exists to fully decarbonise the production process. Ballance has outlined a ‘Te Ata’ plan, which if implemented, could achieve 50% reduction from switching out natural gas to renewable fuel. The other 50% of emissions can be decarbonised through green hydrogen used as a feedstock in the chemical process to create the fertiliser (if that hydrogen is sourced via renewable energy).

Methanol (Methanex) - 948,000 free credits in 2023. Emissions footprint: 1.67 million tonnes CO2/year, equivalent to 700,000 cars.

Methanex is responsible for 2.9% of New Zealand’s emissions, through their use of fossil fuels to produce methanol. While the production process can be made more efficient, and/or a blend of alternative fuels like biogas can be used, conventional methanol production cannot be fully decarbonised. The core product is based off fossil fuels. It therefore does not have a place in New Zealand’s low carbon future beyond 2030, according to the Climate Commission. Due to 95% of methanol produced being exported, Methanex would not benefit from a Carbon Border Mechanism. It will be important to have a just transition for Methanex workers.

Aluminium (NZ Aluminium Smelters, owned by Rio Tinto) - 593,000 free credits in 2023. Emissions profile: 600,566 tonnes CO2/year, equivalent to 250,000 cars.

Tiwai Point smelter produces 0.8% of New Zealand’s emissions, and uses 13% of the country’s electricity supply. Direct emissions - which come from smelting alumina into aluminium - can be erased by replacing the carbon anode with another material. Rio Tinto is already using an emissions free anode in production in Canada, in partnership with the Canadian government and Apple. There are also indirect emissions from the huge energy demand in the smelting process. By using so much of New Zealand's electricity supply, Tiwai smelter maintains demand for burning coal.

A 2021 government reform removed industrial allocation for NZ Aluminium Smelters electricity-related emissions, but this has been recently reinstated under its new electricity supply contract. If reactivated at previous levels, this will lead total a further 15 million credits on top of what it already receives, worth nearly $2 billion over the 20 year life of the contract.

The electricity-related emissions can be removed through demand management (e.g. winding down production in dry years or at peak demand), and increasing renewables in the electricity supply. There are already signs that this will be implemented in the smelter's latest deal with electricity generators.

Wood Processing, paper and packaging (12 companies) - 868,000 credits

Most emissions from wood processing come from two processes: kiln drying of timber, and MDF/particle board creation. Although only 12.5% of energy used in wood processing is non-renewable (mostly natural gas, some coal), this accounts for ~75% of wood processing emissions. So, replacing non-renewable fuels with renewable options will significantly reduce emissions. However, most of their fuel use likely has high heat needs, which is difficult with renewables. It would require government investment and structural support in the wood processing industry transformation.

How does a Carbon Border Mechanism work, and are any other places using one?

A Carbon Border Mechanism protects domestic industrial production from competing producers operating under looser carbon regulations. It prevents emissions leakage (where production shifts offshore rather than comply with regulations) by placing a cost on imported goods to compensate for increased domestic production costs for greener processes. This encourages exporters to reduce their emissions in order to make their products more competitive.

California has implemented a carbon border mechanism for electricity imports from jurisdictions without a carbon trading mechanism. The EU has also recently set up a Carbon Border Mechanism to gradually replace the system of free carbon credits. Importers of iron, steel, cement, fertilizer, aluminum, electricity, and hydrogen have to declare the embedded carbon of their imports and surrender the corresponding amount of carbon border certificates. Canada is in the process of establishing their own Carbon Border Mechanism; the UK is already underway with theirs; and Australia is currently consulting on the possibility.

How will making concrete, steel, and wood processors pay for their pollution affect the construction sector?

Products like steel, aluminium, concrete and engineered wood are needed to build a low carbon future like windmills, railways, cycleways, sustainable houses and electric cars. It is important that they pay the emissions from producing these products like the rest of the economy, and decarbonisation is possible in each of them, but as they transition there will likely be increased costs on using these products passed on to the construction industry. The government can absorb some of that cost and stimulate demand from these companies through major sustainable infrastructure investment through a Ministry of Green Works or a public procurement policy. This will ensure those companies do not go out of business. Some products such as concrete and steel that are ‘quick and easy’ to use but very emissions intensive can also be used in more discerning ways (right material, right place). Increased costs will accelerate this more discerning approach, and will incentivise the use of 'greener' products like cross laminated timber for construction.

How would this affect workers in these industries?

While most companies can reduce emissions in order to avoid the increased costs of carbon, paying an accurate carbon cost will be financially challenging for companies where decarbonisation requires a complete transformation to next-generation technology like Methanex. There are limits to a company’s ability to pass costs on to customers or find savings through efficiency and innovation. This might result in many workers losing their jobs. It is important that any affected workers have adequate support, and that no one is left behind in the transition. E Tū has outlined four key areas that are needed to ensure a just transition:

• Social dialogue and planning - involving workers in the transition plans.

• Supporting workers in transition - e.g. through funded retraining, or multi-employer redeployment schemes.

• Social protection - so that every worker whose job might be lost would have income support.

• Economic diversification - so regions that lose large employers have good replacement jobs to maintain thriving economies.
  

Funds generated by ending free credits can help to pay for a just transition for any affected workers.

How does this relate to the NZ Steel deal announced by the government in 2023?

In 2023, NZ Steel received $110 million from the government to go towards switching a furnace and two kilns from coal to electricity. The new system is due to come online at the end of 2025. A further $30 million will be given as performance incentives if NZ Steel can eliminate a further 800,000 tonnes of annual emissions by 2030. NZ Steel will pay the remaining $160-190 million. This will eliminate around 1% of New Zealand’s annual emissions and 45% of NZ Steel’s annual emissions, as well as making a significant contribution towards New Zealand’s emissions budgets.

While this is good news and a step in the right direction, it is disappointing that NZ Steel needed this investment from the government after not paying a fair price for their emissions in the first place. Due to free allocation, the Emissions Trading Scheme is not creating price incentives to decarbonise. This was clearly demonstrated by NZ Steel’s comments that they would not have moved forward with the project without the government support, as there “would be no direct financial benefit”. If we want more situations of large industries partnering with the government to reduce their emissions, this needs to be in the context of ending the free carbon credits they receive.

What is the current (2025) government's position on a Carbon Border Mechanism?

In late 2024, a Treasury and Inland Revenue report stated that it is unclear whether industrial allocation is a necessary or proportionate response to the risk and impacts of emissions leakage. It highlighted the urgent need to evaluate whether major polluters (e.g. steel, concrete and aluminium producers) are justified in receiving these free credits. The report recommended that a mandate to review the flawed free carbon credit system, and work on possible alternatives, should be included in the Second Emissions Reduction Plan (published in December 2024). However, an OIA request revealed that Minister Watts (Energy, Revenue, Climate Change) rejected officials’ advice to include this review in the Plan.

How it would work

For more detail, download our full policy briefing provided to MPs in July 2024 - Reforming industrial allocation: How ending free carbon credits can cut emissions and unlock green jobs in New Zealand’s industrial sectors