Industrial Allocation NZ ETS

Industrial allocation in the NZ ETS is a protective mechanism that provides free New Zealand Units (NZUs) to businesses conducting activities deemed both emissions-intensive and trade-exposed (EITE). This policy aims to prevent carbon leakage by reducing compliance costs for NZ firms competing internationally against producers in jurisdictions with weaker climate policies, while gradually phasing out support to incentivize decarbonization.

What is Industrial Allocation in the NZ ETS?

The New Zealand Emissions Trading Scheme (NZ ETS) is the government’s primary tool for meeting domestic and international climate change targets. However, imposing a price on carbon presents a unique challenge for domestic industries that export goods or compete with imported products. If New Zealand businesses face high carbon costs while their international competitors do not, there is a risk that production—and the associated emissions—will simply move offshore. This phenomenon is known as “carbon leakage.”

To mitigate this risk, the government utilizes Industrial Allocation. This is a provisional policy that grants eligible businesses a distinct number of New Zealand Units (NZUs) at no cost. These free units can be used to surrender against their emissions obligations or sold on the secondary market. It is crucial to understand that this is not a permanent subsidy; rather, it is a transitional measure designed to smooth the economic shift toward a low-carbon economy without decimating the country’s industrial base.

The allocation is activity-based, meaning it is tied to the output of specific eligible industrial products (e.g., tonnes of aluminium, litres of ethanol) rather than the raw emissions of a specific facility. This structure encourages efficiency; if a business can produce the same amount of product with fewer emissions than the industry average, they keep the surplus NZUs, creating a financial incentive to decarbonize.

The Economic Rationale: Preventing Carbon Leakage

Carbon leakage occurs when climate policies in one country lead to an increase in emissions in another country with less stringent regulations. In the context of the NZ ETS, if the carbon price drives a local cement manufacturer out of business, New Zealand might simply import cement from a country without a carbon tax. The global atmosphere sees no benefit—emissions have simply “leaked” across the border—but the New Zealand economy suffers a loss of jobs and GDP.

Industrial allocation acts as a shield for these Emissions-Intensive Trade-Exposed (EITE) activities. By receiving a portion of their required NZUs for free, the effective marginal cost of production remains competitive with international markets. The Ministry for the Environment (MfE) monitors these settings closely to ensure they align with the Climate Change Response (Zero Carbon) Amendment Act.

Eligibility for EITE Businesses

Not every business in the NZ ETS qualifies for free allocation. Eligibility is strictly reserved for activities that meet specific thresholds regarding emissions intensity and trade exposure. The government has assessed various industrial activities to determine if they qualify as EITE.

Emissions Intensity Thresholds

To qualify, an activity must be emissions-intensive. This is historically calculated based on the emissions per million dollars of revenue. There are two tiers of assistance based on this intensity:

• High Emissions Intensity: Activities with an emissions intensity of 1,600 tonnes of CO2-equivalent (tCO2e) or more per NZ$1 million of revenue. These activities originally received an allocation rate of 90% of their allocative baseline.
• Moderate Emissions Intensity: Activities with an emissions intensity between 800 and 1,599 tCO2e per NZ$1 million of revenue. These activities originally received an allocation rate of 60% of their allocative baseline.

Trade Exposure Requirements

Trade exposure is the second pillar of eligibility. This criterion acknowledges that businesses competing in global markets cannot easily pass on carbon costs to consumers without losing market share. If they raise prices, buyers will switch to cheaper, high-carbon alternatives from overseas. Most major industrial activities in New Zealand, such as steel manufacturing, aluminium smelting, and wood pulp production, are considered trade-exposed.

Currently, there are over 25 eligible industrial activities, including:

• Production of aluminium
• Production of cement and clinker
• Production of glass containers
• Production of nitrogen fertilizer
• Production of market pulp and paper
• Production of fresh tomatoes, cucumbers, and capsicums (industrial horticulture)

How Free Allocation is Calculated

The formula for calculating the number of free NZUs a participant receives is precise and output-based. It is not a fixed lump sum, which prevents businesses from reducing production solely to sell free units (windfall gains). The calculation generally follows this structure:

Allocation = Total Output × Allocative Baseline × Level of Assistance

• Total Output: The amount of eligible product produced in the year (e.g., tonnes of steel).
• Allocative Baseline: A fixed benchmark representing the emissions intensity of the activity (emissions per unit of output). This is usually based on the industry average efficiency.
• Level of Assistance: The percentage of coverage (starting at 90% or 60%) which is now subject to annual phase-out reductions.

By using an industry-average baseline, the system rewards the most efficient players. If a factory is more efficient than the average (the baseline), the free allocation might cover more than 90% (or 60%) of their actual emissions. Conversely, inefficient plants will find the allocation covers less of their liability, forcing them to buy more units or upgrade technology.

Phase-Out Schedules and Policy Reforms

The “free” nature of industrial allocation is changing. To meet New Zealand’s 2050 net-zero target, the government has implemented a phase-out schedule. Indefinite free allocation would blunt the signal of the carbon price and delay necessary technological innovation.

The Phase-Out Rates

Following reforms in the Climate Change Response (Emissions Trading Reform) Amendment Act 2020, the level of assistance is no longer static. Starting from 2021, the level of assistance began to decrease annually.

• Minimum Phase-Out Rate: The default reduction is 1 percentage point per year (e.g., 90% becomes 89%, then 88%).
• Accelerated Phase-Out: The government has the power to increase this phase-out rate based on recommendations from the Climate Change Commission. If the Commission determines that the risk of carbon leakage has decreased for a specific activity, or if the cost of abatement has dropped, the phase-out can be accelerated (e.g., 2% or 3% per year).

This creates a predictable, sliding scale of support that gives industries time to invest in decarbonization technologies, such as fuel switching from coal to biomass or electrification of process heat.

Addressing Over-Allocation and Baseline Reviews

A critical issue identified in recent years is “over-allocation.” This occurs when the allocative baselines (set years ago) are too high relative to current technology. In some instances, industries have received more free NZUs than their total actual emissions, resulting in a net profit from the ETS rather than a cost.

To rectify this, the government is undertaking a systematic review of allocative baselines. The goal is to update these benchmarks to reflect modern efficiency standards. If an industry has generally become more efficient, the baseline will be lowered. This ensures that allocation remains a protection against leakage, not a subsidy for pollution.

The Impact of Electricity Allocation Factor (EAF)

Another component of the calculation is the Electricity Allocation Factor (EAF). This compensates businesses for the indirect carbon costs embedded in their electricity bills (since power generators pass on their ETS costs). As New Zealand’s grid becomes greener (reaching towards 100% renewable), the carbon cost in electricity drops. Consequently, the EAF is also being reviewed and adjusted downward, which will further reduce the volume of free allocation for electricity-heavy industries.

The Future of Industrial Allocation

The trajectory for industrial allocation in the NZ ETS is clear: it will decline. The Climate Change Commission provides ongoing advice on whether the phase-out rates should be strengthened to align with the country’s emissions budgets.

Businesses currently receiving allocation must prepare for a dual-pressure environment: rising carbon prices (NZU spot prices) and shrinking free allocation volumes. This necessitates a strategic shift from compliance to active carbon management. Future policy updates may also introduce a Carbon Border Adjustment Mechanism (CBAM) as an alternative to free allocation. A CBAM would charge a carbon levy on imported goods, leveling the playing field at the border rather than subsidizing domestic producers. While not yet implemented in New Zealand, it is being actively discussed as the European Union rolls out its own CBAM.

For industrial operators, the message is urgent: rely on allocation for transition, not for long-term viability. The most effective hedge against rising ETS costs is the physical reduction of emissions.

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