Why is the government subsidising pollution in the form of free credits?

“Industrial allocations”, sometimes called “free allocations”, are carbon credits the government gives to certain businesses for free. Businesses qualify for free credits if they are deemed to be ‘Emissions Intensive and Trade Exposed’ i.e. that they have significant emissions, but would face a competitive disadvantage if they had to pay for their emissions while similar industries in other countries wouldn’t. The purpose of free credits when the Emissions Trading Scheme was set up was to be a transitional measure to protect industries and jobs in New Zealand until other countries started to also price their emissions, or the cost of decarbonising these industries reduced and technology advanced. This is called preventing “emissions leakage”. The original Emissions Trading Scheme legislation intended free credits to be phased out by 2030, however their phase out was delayed and subsequently removed by successive governments. In 2020, legislation initiated a gradual phase out of 1% per year, which will continue at increasing rates over the next three decades. In 2022 this subsidy is 88 percent of emissions costs for highly emissions intensive activities, and 58 percent of emissions costs for moderately emissions intensive activities. At the current phase out rate, highly emissions intensive industries will be receiving a 30% subsidy in 2050, when the Zero Carbon Act requires net emissions to be at zero.

Who is getting free carbon credits, and how big a problem is it?

In 2021, free carbon credits made up 6.6 million of a total 33 million units in the emissions cap (i.e. 20% of credits surrendered by polluters that year were given to them by the government for free). Just four businesses received 75% of these free credits: NZ Steel (owned by Bluescope), Ballance - a fertiliser company, Methanex - a fossil fuel company exporting methanol, and NZ Aluminium Smelters (owned by Rio Tinto) - making aluminium for export. These four businesses are responsible for 7.45% of NZ’s gross emissions. Other industries that receive free carbon credits include the wood processing sector, the concrete/cement industry, and vegetable greenhouses. In total, sectors that receive free carbon credits currently make up 10% of New Zealand’s climate pollution. If agriculture was to enter the ETS from 2025, it would also receive free credits to cover 95% of its emissions. When agriculture is added into the picture, that’s 60% of the country’s pollution getting a free pass to pollute. So it’s important that we tackle this system of free credits before it becomes an even bigger problem.


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. In 2020 alone, the free carbon credits were worth $600 million. 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, as 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 is 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.

The solution:  End free carbon credits

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:

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.

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 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) - 2.15 million credits

Recently the government announced a deal with New Zealand Steel to reduce its emissions by 45% by helping fund this transition to the tune of $130 million. but the details on how much NZ Steel’s free carbon credits will be affected by this other source of funding by the government is not clear. Further reductions are possible for NZ Steel by using green hydrogen to reduce ironsands into iron, which would require a large amount of additional renewable energy capacity to produce the green hydrogen. If this was done, NZ Steel’s emissions would be negligible.

Concrete (Fletcher concrete) - 700,000 credits

Most concrete emissions are from cement production. Emissions can be reduced emissions by around 10% by reducing the amount of cement in concrete and using other waste materials. Furthermore, the cement production process can be partially decarbonised through switching out fuel sources from fossil fuels (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. Increase in costs due to increased carbon price may lead to a more discerning use of it in construction for essential areas. The Cement importer Holcim supports the introduction of a Carbon Border Adjustment Mechanism as a better alternative to free credits already.

Synthetic Nitrogen Fertiliser (Ballance Agri-Nutrients) - 322,000 credits

Ballance Agri-Nutrients produces 1.9% of New Zealand’s emissions (from direct production process. Much more from use on farms.) Can be reduced by 100% on current technology. Synthetic nitrogen fertiliser releases a lot more climate pollution when used on farms, in the form of nitrous oxide emissions, and methane through enabling dairy intensification, however these emissions do not currently fall under the ETS. On it’s own, the production of synthetic nitrogen fertiliser can be fully decarbonised. Ballance has outlined a ‘Te Ata’ plan, which if implemented, could achieve 50% reduction from switching out natural gas to renewable supply for fuel for manufacturing fertiliser. The other 50% of emissions can be decarbonised through green hydrogen used as a feedstock in the chemical process to create the fertiliser, when that hydrogen is sourced via renewable energy.

Wood Processing, paper and packaging (12 companies) - 1.29 million credits

Most emissions from wood processing are in process heat 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 likely these are for high-heat needs - this is technically possible, but requires large investment to create high heat with renewables. This requires government investment and stuctural support in the wood processing industry transformation.

Methanol (Methanex) - 944,000 credits

Methanex is responsible for 2.9% of New Zealand’s emissions Methanex uses fossil gas to produce methanol. The conventional methanol produced in New Zealand cannot be fully decarbonised, just made more efficient. A blend of alternative fuels like biogas can be used, but the core product is based off fossil fuels. This 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) - 629,000 credits

Tiwai Point smelter produces 0.8% of New Zealand’s emissions, and uses 13% of the country’s electricity supply. Direct emissions come from smelting the alumina into alumium. The direct emissions 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 in the electricity grid. 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 signs that this is possible in the smelter's latest deal with electricity generators.


How it would work

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 and prevents emissions leakage where production shifts offshore rather than comply with regulations. This places a cost on imported goods to compensate for increased domestic production costs for greener processes and encourages exporters to become cleaner 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 is in the process of implementing a Carbon Border Adjustment Mechanism, with the first reporting period ending in January 2024. This will be phased in to replace the system of free carbon credits in the EU. 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 has also explored the possibility while the UK is currently consulting on the issue.

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 through public procurement policy. This will ensure they do not go out of business in the process 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 in the construction sector (right material, right place), which increased costs will accelerate, as well as incentivise the use of things like cross laminated timber to construct more buildings.

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 that don’t have decarbonisation options 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’s 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 - things like funded retraining, 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 recently?

NZ Steel will receive $110 million from the government towards switching a steel making furnace and two kilns from coal to electricity. A further $30 million is allocated as performance incentives if NZ Steel if the project is commissioned by 2027 and 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. Free allocation has broken the ETS, which is clearly not creating the 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.

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