Industrial Allocation NZ ETS

Industrial allocation in the NZ ETS is a mechanism that provides free New Zealand Units (NZUs) to eligible businesses. It is designed to prevent carbon leakage by supporting activities that are both emissions-intensive and trade-exposed (EITE), ensuring they remain competitive against foreign firms not subject to similar carbon costs.

What is Industrial Allocation in the NZ ETS?

The New Zealand Emissions Trading Scheme (NZ ETS) is the government’s primary tool for meeting its domestic and international climate change targets, including the 2050 targets set out in the Climate Change Response (Zero Carbon) Amendment Act. However, imposing a price on carbon presents a unique economic challenge for New Zealand’s export-heavy economy.

Industrial allocation, often referred to as “free allocation,” is a provisional policy measure designed to smooth the transition to a low-carbon economy. It involves the government gifting New Zealand Units (NZUs) to specific industries rather than requiring those industries to purchase them at market auction or from the secondary market. This policy is not intended to be permanent but serves as a buffer for industries that are vital to the economy yet vulnerable to international competition.

The primary logic behind this allocation is to maintain the competitiveness of New Zealand businesses. If local producers of commodities like steel, aluminium, or methanol face high carbon costs that their international competitors do not, they may be forced to shut down or relocate. This scenario does not reduce global emissions; it simply moves them offshore—a phenomenon known as carbon leakage.

The Concept of Carbon Leakage

To fully grasp the necessity of industrial allocation, one must understand carbon leakage. Carbon leakage occurs when businesses transfer production to other countries with laxer emission constraints. This can lead to an increase in total global emissions, undermining the environmental integrity of the NZ ETS.

For example, if a New Zealand cement manufacturer faces strict carbon pricing that drives up the cost of local cement, construction firms might import cheaper cement from a country without carbon pricing. The emissions associated with producing that imported cement still enter the atmosphere, but the New Zealand economy loses the manufacturing activity and jobs. Industrial allocation mitigates this risk by reducing the effective carbon cost for these vulnerable sectors, ensuring that New Zealand products remain price-competitive globally while the rest of the world catches up on climate policy.

Eligibility for EITE Businesses

Not every business in the NZ ETS is eligible for industrial allocation. The policy is strictly targeted at activities that are considered Emissions-Intensive and Trade-Exposed (EITE). To qualify, an activity must meet rigorous tests set by the government.

The Trade Exposure Test

To be considered trade-exposed, there must be trans-oceanic trade in the good produced. This acknowledges that New Zealand is an island nation reliant on exports and imports. If a product faces competition from international markets—either because it is exported or because it competes with imported goods—it generally meets the trade exposure criteria.

The Emissions Intensity Test

The emissions intensity test is the primary filter for eligibility. It measures the amount of emissions generated per unit of revenue. Based on this metric, eligible activities are categorized into two levels of assistance:

• High Emissions Intensity: Activities with emissions intensity greater than 1,600 tonnes of CO2 equivalent (CO2e) per NZ$1 million of revenue. These activities initially received an allocation rate of 90% of their allocative baseline.
• Moderate Emissions Intensity: Activities with emissions intensity between 800 and 1,600 tonnes of CO2e per NZ$1 million of revenue. These activities initially received an allocation rate of 60% of their allocative baseline.

Currently, there are roughly 26 eligible industrial activities. These include heavy industries such as the manufacture of iron and steel, aluminium smelting, production of cement and lime, manufacture of methanol, and certain agricultural activities like the production of fresh tomatoes, cucumbers, and capsicums in heated greenhouses.

How Free Allocation is Calculated

The calculation of industrial allocation is “output-based.” This means the number of free NZUs a business receives is linked to how much product they actually produce, rather than their historical emissions. This approach encourages efficiency; if a firm can produce the same amount of product with fewer emissions, they get to keep the surplus NZUs, creating a financial incentive to decarbonize.

The formula generally follows this structure:

Allocation = (Total Output) × (Allocative Baseline) × (Assistance Level) × (Phase-out Rate)

Allocative Baselines

The allocative baseline is a critical component. It represents the average emissions per unit of product for a specific activity (e.g., tonnes of CO2 per tonne of aluminium) based on historical data. These baselines were originally set using data from 2006-2009.

Because these baselines were historical, technology has improved in many sectors, leading to a situation where some companies receive more units than they need to cover their emissions. This discrepancy has led to calls for reform and updated baselines, which the government is currently addressing.

Phase-Out Schedules and Policy Reforms

Industrial allocation was never intended to be a permanent subsidy. As the world moves toward the goals of the Paris Agreement, the justification for protecting industries from carbon pricing diminishes. Consequently, the New Zealand government has implemented a phase-out schedule to gradually reduce the volume of free allocation.

The Sinking Lid Mechanism

Under the Climate Change Response (Emissions Trading Reform) Amendment Act 2020, a statutory phase-out of industrial allocation was introduced. Starting from 2021, the level of assistance began to decrease annually.

• 2021-2030: The allocation rates (originally 90% and 60%) are reduced by 1 percentage point each year. For example, a high-intensity activity receiving 90% assistance in 2020 would receive 89% in 2021, 88% in 2022, and so on.
• 2031-2040: The reduction rate increases to 2 percentage points per year.
• 2041-2050: The reduction rate accelerates further to 3 percentage points per year.

This predictable decline provides businesses with a clear signal: they must invest in decarbonization technologies or prepare to pay for an increasing share of their emissions.

Climate Change Commission Recommendations

The Climate Change Commission (CCC) has advised that the current phase-out rates may be too slow to meet New Zealand’s 2050 targets. They have suggested that if other countries implement stronger climate policies, the risk of carbon leakage decreases, allowing the NZ government to accelerate the removal of free allocation. Businesses should monitor these policy discussions closely, as the phase-out schedule could be tightened in future legislative updates.

Addressing Over-Allocation

A significant controversy within the industrial allocation framework is the issue of “over-allocation.” This occurs when a business receives more free NZUs than the actual emissions they generate. This can happen because the allocative baselines were set years ago, and many industries have since become more efficient.

In some instances, receiving excess units allowed companies to sell the surplus for profit, effectively resulting in a taxpayer-funded subsidy that did not necessarily drive further emission reductions. To address this, the Ministry for the Environment (MfE) initiated a review of allocative baselines.

The reforms aim to:

1. Reset Baselines: Update the historical data to reflect current technologies and efficiencies.
2. eligibility Reassessment: Review whether certain activities still qualify as EITE.
3. Hard-to-Abate Sectors: Distinguish between industries that have viable technology to decarbonize and those that do not, potentially adjusting allocation rules accordingly.

Compliance and Reporting Obligations

Receiving free allocation comes with strict administrative responsibilities. The Environmental Protection Authority (EPA) manages the register and compliance for the NZ ETS. Businesses receiving industrial allocation must adhere to rigorous reporting standards.

Annual Allocation Returns

Eligible businesses must submit an annual allocation return. This document declares the total output of the eligible product for the previous year. The EPA verifies this data before transferring the corresponding number of NZUs to the business’s holding account.

It is crucial that this data is accurate. Under the NZ ETS, providing false or misleading information can result in severe penalties, including fines and criminal charges. Furthermore, businesses must retain records for at least seven years to facilitate audits.

The Future of Industrial Allocation

The landscape of industrial allocation is shifting rapidly. As global carbon pricing mechanisms evolve—such as the European Union’s Carbon Border Adjustment Mechanism (CBAM)—the justification for domestic free allocation changes. If New Zealand’s trading partners impose carbon tariffs, the risk of leakage diminishes, but the complexity of compliance increases.

For New Zealand businesses, the message is clear: the era of free emissions units is ending. The industrial allocation mechanism serves as a bridge, not a destination. Success in the future low-carbon economy will depend on strategic investments in energy efficiency, fuel switching, and process innovation today.

Frequently Asked Questions