Cementing allocations

Recall that New Zealand issues industrial allocations under the ETS to avoid inefficient carbon leakage. 

Basically, if emissions are charged here but aren't charged abroad, and production shifts from here to there because of our charges, net emissions can increase rather than decrease.

That is obviously counterproductive. So industrial emitters facing competition from places with unpriced carbon get allocations of NZU. Done right, it maintains the incentive to reduce your emissions because you can sell off your surplus NZU. But it has to be done right.

The obvious way of doing it right would be to scale industrial allocations not by the NZ plant's emissions but by emission intensity overseas. If a tonne of cement abroad has x tonnes of associated CO2 emissions, then allocate x NZU per tonne produced here. Basically. Then, if emissions intensity abroad reduces, the plant here gets fewer NZU for its own production. It maintains an incentive to reduce your own emissions intensity, and avoids getting into spots where it would actually be carbon-efficient for production to shift to plants abroad that have lower emissions than plants here.

It gets messier if the import mix has stuff from places that are cleaner than here and stuff from places that are dirtier from here. If you scale to the average emissions intensity of the import mix (weighted by proportion of imports), there's still a potential problem. Suppose average intensity overseas drops and so allocations here drop. The NZ producer reduces production. But if that hole is filled by product from the dirtier plants overseas rather than the cleaner ones, you've wound up having inefficient leakage again. 

Carbon border adjustments are an alternative. But it gets messy with trade agreements. And you have to find a way of scaling the adjustment to the emissions intensity of the product. 

New Zealand's industrial allocations seem to have a bit of a problem in cement. 

Here's Energy News:

In a presentation to investors in June, Fletcher Building said a carbon border adjustment mechanism would level the playing field.

Currently, only goods produced in New Zealand face liability under the emissions trading scheme.

As an energy-intensive, trade-exposed emitter, Golden Bay Cement is eligible for an annual allocation of free carbon credits.

Data released last week shows that for last year's production, the company received 488,575 New Zealand Units, worth almost $27 million at the current spot price of about $55.

But the company says that a 2023 law change means that as the country's only cement manufacturer, it is now effectively being "rebaselined" every five years against its own emissions - which means that every time it cuts emissions it reduces the rate at which its free allocation is calculated.

"Significant investment in decarbonising local manufacturing is not viable without certainty a carbon border adjustment mechanism will be in place in the medium-term," it said in the presentation.

"Given regulatory settings, we have reviewed our capital plans for Golden Bay.

"The current investment plan retains flexibility to remain a domestic manufacturer or transition to an import model."

That just doesn't make sense.  

The government is reviewing the settings. Scaling to international emissions intensity would seem obvious. A carbon border-adjustment could also work but I have no clue whether it can be squared with trade agreements.

The annual allocation of free carbon credits to trade-exposed, energy-intensive emitters like Golden Bay Cement was last adjusted in 2023.

The company says that, in the absence of a CBAM or an equivalent mechanism, it would likely need to consider transitioning to an import model by the early 2030s.

That could result in a non-cash impairment and write-down of assets of up to about $165 million, as well as potential make-good and cash redundancy costs of up to $180 million.

For last year's production, Fletcher received 488,575 New Zealand Units, worth almost $27 million at the current spot price of about $55.

The company says it is engaging "productively" with the Government on the issue.

If cement produced abroad is more carbon intensive than cement produced here, then shifting to imports is the kind of carbon leakage that we ought to be avoiding.