Carbon border adjustments are on the table as the Government seeks to level the trade playing field for industrial polluters without over-subsidising them, Marc Daalder reports

The Government suspects it is over-subsidising industrial polluters to the tune of $42 million a year in the form of free carbon credits and has suggested controversial carbon tariffs might be one way to solve the issue.

Large polluters who export some or all of their products are eligible to receive between 59 and 89 percent of their emissions discounted under the Emissions Trading Scheme (ETS), so they don’t struggle to compete against overseas firms which don’t face a carbon price.

However, the way in which the baseline for that discount is calculated is out of date, the Government says, and some companies are eligible when they really shouldn’t be. In fact, some sectors are receiving as much as a 300 percent discount on their emissions, instead of the 59 percent intended.

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Added up, the Government thinks it is distributing 1.2 million free carbon credits that it doesn’t need to be. That’s out of 8.28 million freely allocated units each year or 14.5 percent of the total. The Government estimates the value of that subsidy at $42 million, but the current market price for credits would put it somewhere around $57 million. That market price could also rise if fewer free credits were distributed.

While the level of free allocation will diminish each year under the Zero Carbon Act, that is unlikely to affect the over-allocation issue.

In a discussion document released on July 8 for consultation, the Government revealed the results of a year-long review of this free industrial allocation. It also offered up several potential solutions to the issue, including a carbon border adjustment (CBAM). This measure would see a carbon tariff applied to select goods imported from countries where they aren't subject to a carbon price, if the equivalent good is covered by the ETS. It could also provide carbon rebates to goods exported to countries where competitors' emissions aren't priced.

Carbon border adjustments have been proposed by the European Union as part of a landmark package of climate policies announced last week. In the United States, congressional Democrats have also advocated for such an approach. How the tariffs might be designed while keeping in line with international trade law is still unclear.

"CBAMs are often viewed as difficult to design and implement, given the need to be transparent, administratively efficient, environmentally effective, scientifically robust and compliant with World Trade Organisation rules," the discussion document noted. Carbon tariffs are also usually best suited to ensure fairness in the domestic market between New Zealand companies covered by the ETS and overseas firms that pay no carbon price. They might be less effective in protecting the competitiveness of exporters, which is the main goal of industrial allocation policy.

Two other options considered in the document, in lieu of continued free allocation, were direct payments to trade-exposed emitters or simply an exemption from having to surrender a certain number of carbon credits.

Some imports would face a carbon tariff at the border under the proposal. Photo: John Sefton

The paper also put up for consultation new methodologies and eligibility thresholds to ensure the Government isn't allocating too many free units. Part of the issue is that the baseline for industrial allocation is more than a decade out of date. Right now, trade-exposed firms that are highly emissions-intensive are given free credits equal to 89 percent of their average emissions in the late 2000s, while moderately emissions-intensive companies get 59 percent free allocation against that same baseline.

The problem with this is that many companies have become less emissions-intensive in the intervening 12 to 15 years. For example, one of the industrial activities covered by the free allocation policies (which was anonymised in the report to protect commercial confidentiality) has become 79 percent less emissions intensive since 2010. That means the allocation it receives actually covers 305 percent of its estimated present-day emissions (on average, across the given industry).

In fact, of the four anonymised activities surveyed - out of 26 covered by the allocation policy - all were receiving an over-allocation.

The Government's proposed solution is to immediately update the baselines to the average of annual emissions between 2016 and 2019. It is also seeking feedback on whether baselines should be updated as a one-off, annually, every five years or every 10 years. The latter appears to be its preferred solution.

In addition to re-setting baselines, the discussion document says new eligibility thresholds could be determined and their baselines updated. Currently, activities are eligible for an 89 percent allocation if they produce 1600 or more tonnes of CO2e for every $1 million in revenue or a 59 percent allocation for 800 tonnes and above.

Whether an activity meets those thresholds is based on average emissions intensity between 2006 and 2009. The Government is proposing to update this and is also consulting on adding more tiers between the 800 and 1600 levels.

"A framework could be developed to provide ‘higher resolution’ coverage that more effectively targets assistance levels commensurate with an activity’s exposure to an emissions price. This could be the introduction of a third or fourth threshold, or a sliding scale, which defines a bespoke level of assistance for each activity," the discussion document states.

Marc Daalder is a senior political reporter based in Wellington who covers climate change, health, energy and violent extremism. Twitter/Bluesky: @marcdaalder

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