120% Pure Subsidy NZ Aluminium Smelters Ltd Part 2

I have had some very good comments on the 120% Pure Subsidy post about the quantity of free emissions units that NZ Aluminium Smelters Limited/Rio Tinto Alcan NZ Limited (I will just call them 'the smelter') has received under the NZ ETS in 2010. Enough good comments that they justify a second post on NZ Aluminium Smelters free units.

Simon Terry of the Sustainability Council points out that we shouldn't be surprised at the high level of free allocation of units to big emitters. Simon Terry documented this in June 2008, in the report Corporate Welfare Under the ETS, which looked at free allocation of units to eight energy intensive companies under the proposed NZ ETS.

In particular, Simon Terry reminds us that in the NZ ETS the free allocation of units includes a factor to compensate for NZ ETS related electricity price increases. As the NZ ETS will make some power generation more expensive to the extent that it uses fossil fuels (Huntly Power Station for example). This explains why the 'allocative baseline' factor for aluminium smelting is 2.645 units per tonne aluminium when the emissions factor for the MfE Greenhouse Gas inventory is 1.67 tonnes CO₂-e per tonne aluminium.

This feature of using free allocation of units to compensate emitters for electricity price increases is explicit in the Labour Government's original emissions trading scheme proposal Framework for a New Zealand Emissions Trading Scheme, Report no. ME810, (also a 149 page pdf) , released in September 2007.

As indicated by the fourth bullet point under the heading “5.3.1 In-principle decision on levels of assistance through free allocation”.

"indirect emissions associated with the consumption of electricity, as well as direct emissions from ... industrial processes will be included in the concept of emissions from industrial producers...The basis for allocation for electricity consumption will be one that compensates firms for the cost impact".

Another regular commenter, Password1, says my analysis is totally incorrect because I have left out the indirect emissions from using electricity, that I am not comparing the same sets of data, and that I need to redo my calculations based on what is in the legislation. Further, my assertion that there has been an "overallocation" of units "is wrong, wrong, wrong".

Password1 concludes that

"The smelter is not getting a ‘refund’ – they are facing a proportion of the full cost of emissions both at the point of aluminium production and from being passed down from the electricity generator."

Okay maybe I will redo my calculations. So off I will go down the rabbit-hole and look into this electricity factor. So what is the proportion of the 'allocative baseline' factor for aluminium smelting, 2.645 units per tonne of aluminium, is to compensate for NZ ETS-related electricity price increases?

This idea of fossil-fuel-thermal power costs (increased by the NZ ETS) affecting a smelter that only exists because of hydroelectric dams on Lakes Manapouri and Te Anau seems a bit bizarre. Especially since NZAS's supply contract is with Meridian Energy, the 100% renewable power company.

However, the wholesale electricity market works by preferentially using the lowest priced generation offer in any one half-hour trading period. Brian Fallow points out that this means that wholesale price is set by the most expensive block of electricity offered into the market which is needed to ensure demand is satisfied and that block may be from Genesis Energy's Huntly coal and gas thermal plant.

When demand is high and hydro lakes are low, thermal power sets the wholesale price. As was the case through much of 2008. When demand is low and hydro lakes are full, then the Huntly Power Plant may be on the substitutes bench and the NZETS costs won't flow through to the wholesale electricity price.

So it does seem that there is some level of carbon price from the NZ ETS reflected through the wholesale price that ends up in the electricity price paid by the smelter. However, it is quite hard to quantify this price.

Allocative baselines are discussed in June 2010 in this Cabinet paper. Paragraph 37 tells us that the electricity allocation factor is 0.52 tCO₂-e/MWh. Paragraph 40 tells us that an analysis of the smelter's electricity contract with Meridian Energy indicates that the use of this factor would result in over-allocation of units as the actual extra electricity costs are less than 0.52 tCO₂-e/MWh.

Unfortunately the actual extra electricity costs, the degree of over-allocation and the fiscal cost of allocation to the smelter, have all been blanked out from the cabinet paper, apparently as 'the information is commercially sensitive'. I appear to be at the end of that rabbit-hole.

The next rabbit-hole is to check the emissions factor that gives emissions of CO₂-e from tonnes of aluminium produced.

In terms of emissions reported and units surrendered, Regulation 35 of Climate Change (Stationary Energy and Industrial Processes) Regulations gives a 10-variable formula for the calculating the smelter's emissions from production. I am missing about 4 of these variables. So that's also a dead end for duplicating the emissions and the units to be surrendered.

But why don't I just use actual numbers? The Ministry of Economic Development Chief Executive's Report shows that the New Zealand aluminium manufacturing sector has only one NZ ETS 'participant' and that the sector, and therefore the one participant, the aluminium smelter, reported emissions of 615,814 tonnes CO₂-e for the 2010 year and 312,294 tonnes CO₂-e for the six months from 1 July to 31 December 2010.

So 312,294 tonnes were emitted in the six month period of obligation to surrender matching units. So we divide by 2 for the two-for-one unit deal, and that results in 156,147 units to surrender.

210,421 units were allocated to the smelter for the six months according to the Environmental Protection Authority.

That's 54,274 more units allocated than surrendered or alternatively the units allocated to the smelter exceeded the units surrendered by the smelter by 135%.

This result is pretty much a mid-point between my previous estimates which were from 147% to 122%, as summarised in this table.

Table 1 Low actual and high estimate of units to surrender
	Low	Actual	High
Units to surrender	143,342	156,147	172,526
Units allocated	210,421	210,421	210,421
Excess allocation (units)	67,079	54,247	37,896
Excess allocation (per cent)	147%	135%	122%

Summing up

1. The smelter was allocated 210,421 emission units in the six-month NZ ETS compliance period in 2010. Without any reasonable doubt, this represents 54,274 more emission units than it surrendered to match emissions.
2. At today's NZ unit price of $14, the value of the units allocated is $2,945,894. The value of the excess of units allocated above units surrendered is $759,836. That is the value of the taxpayer's gift to the smelter.
3. An unknown (or undisclosed) proportion of the free units are intended to compensate the smelter for NZ ETS-related electricity price increases in a year characterised by highest level ever of renewable generation.
4. I can't prove that the amount of free units allocated is more than the sum of the units to be surrendered for emissions plus some units as compensation for electricity price increases. But I think it is highly likely.
5. In any case, it hardly matters whether the volume of free allocation is either just under 100% of costs or whether its 135%. Both options pretty much effectively negate the carbon price on the smelter and mean no real incentive to reduce emissions.

The bottom-line for me is that if the smelter was exempted from the NZ emissions trading scheme, they would at least be paying the some carbon price as a 'downstream' electricity user where some costs of fossil-thermal power generation are factored into the wholesale electricity price when fossil-thermal power is not priced out by cheaper hydro-generation.

Because of the allocation of units for power price increases, the smelter faces a lower carbon price than if it was exempt from the ETS and just paid its power bills.

There was an argument that the NZ emissions trading scheme might be weak but at least it was better than nothing. In the case of the smelter, its game over for that argument.

Greek debt crisis

This evening's economic analysis highlights the Greek debt crisis and is bought to you by John Clarke and Brian Dawe.

Trans-Tasman Emissions Trading Scheme Challenge Part Two

Yesterday the Australian Parliament adopted legislation for its greenhouse gas emissions trading scheme.

So I thought I would write another post on the theme of the "Trans-Tasman Emissions Trading Scheme test series", this time looking at the key differences between the New Zealand Emissions Trading Scheme and the Australian Emissions Trading Scheme. The number one key difference between the two emissions trading schemes is in how clearly each scheme sets the carbon price.

1. Unequivocal carbon price vs volatile carbon price.

Unlike the NZ ETS, the Australian ETS will set an absolutely clear and unequivocal price on greenhouse gas emissions.

The price will be $AU23 per tonne from 1 July 2012, then $AU24.15 in 2013-14 and $AU25.40 2014-15 (Securing a Clean Energy Future, The Australian Government's Climate Change Plan, p 26). From 1 July 2015, the carbon price will float within and upper and lower ceiling with the Government setting an overall 'Cap' or limit on GHGs (Securing a Clean Energy Future p 27).

The price for "New Zealand Units" under the NZ ETS is being set at a discount to the price of international Kyoto units in the volatile international carbon. So the NZ price is ...well...it's yeah whatever. As in this chart for 2010. Did you note that the Australian minimum carbon price of 23.00 Australian Dollars converts to 29.50 New Zealand Dollars? A price of 29.50 NZ dollars is off the scale of this chart!

And as in this updated chart for September, showing the fall in the international price driven by the Euro-Zone debt crisis is further pushing the NZ unit price down.

This direct importing of the international price into the NZ unit price is because of two intrinsic design features of the NZ ETS. The NZ ETS has no cap on domestic GHG emissions and no cap on free allocation of units to emitters. The NZ ETS is highly linked to international markets. It allows almost all international Kyoto units to be imported and surrendered by emitters. So an emitter would say to a seller of NZ units "Why should I buy your NZ units instead of international units, which I could sell in a much wider market, unless the NZ units are at a discount?"

Of course, the Australians, influenced by Ross Garnaut and Bob Brown of the Green Party, are not having a bar of this price volatility. In terms of the economics literature, this is absolutely the right way to go.

A clear and consistent carbon price out for several years will clearly signal to emitters which emission reduction technologies to adopt - ones that will break even at the set carbon price! The same goes for developers of windfarms and producers of biofuels. A clear carbon price into the future will give investors confidence that they will not lose their shirts putting capital into windfarms and biofuel plants. Carbon price volatility, like in New Zealand, just makes investment in either mitigation or substitution of fossil fuels a bad bet.

So why on earth would a big industrial emitter want to have an emission trading scheme like New Zealand's where they have an unpredictable and volatile liability to pay a carbon price instead of an unequivocal and consistent-over-time carbon price as set out in Australia's scheme?

The only answer I can give is that if like Rio Tinto NZ Alcan Limited, you are given more emissions units than you need for your actual emissions then it just doesn't matter what the price is.

150% Pure Subsidy: the NZETS gives Rio Tinto Alcan NZ more emissions units than its emissions

Last week, (back on 29 September 2011 actually), Green MP Kennedy Graham was questioning Climate Change Issues Minister Nick Smith over his apparent lack of consistency over subsidies for fossil fuel industries.

Kennedy Graham was wondering why former Minister for Climate Change Issues Nick Smith and Climate Change and Trade Negotiations Minister Tim Groser were happy on the one hand to oppose billion dollar subsidies to fossil fuel industries on the international stage, while on the other hand have the New Zealand Emissions Trading Scheme include subsidies in the form of generous free allocation of emissions units to big industrial emitters of GHGs.

The Hon Dr Nick Smith replied:

"...this Government is not providing subsidies to greenhouse gas polluters. I remind the member that we are the only country outside the EU to have an emissions trading scheme. Our aluminium smelter in Bluff is the only aluminium smelter in the world to face any price at all for its greenhouse gas emissions".

Lets examine this assertion in two parts; that the Tiwai Point Aluminum Smelter, receives no subsidies from Government and it faces a carbon/GHG price.

A brief recap, Tiwai Point Aluminum Smelter at Bluff, out on the edge of Foveaux Strait near Invercargill, is operated by NZ Aluminium Smelters Limited, which in turn is owned by Rio Tinto Alcan NZ Limited, a subsidiary of Canadian multinational Rio Tinto Alcan.

NZ Aluminium Smelters Limited has received an allocation of free emissions units under the NZ ETS. That is clear from that un-labelled pie chart I have been banging on about. The chart shows that iron, steel and aluminium production are to receive 40% of all free industrial allocation of emissions units.

However, we don't need to do any guessing as the Ministry for the Environment has just released an analysis of how many free emissions units were allocated to whom under industrial allocation for the half-year compliance period 1 July to 31 December 2010.

NZ Aluminium Smelters Limited received 210,421 NZ emission units or 12% of the total allocated of 1.77 million units. By the way, only New Zealand Steel, the operator of the Glenbrook Steel Mill, received more units. They got 494,704 units.

How does this allocation of free emissions units compare with the number of emissions units that would need to be surrendered? Is the allocation more or less than the number of units surrendered?

With a bit of ferreting, I have found enough data to make some back-of-envelope-but-on spreadsheet calculations. Here are the inputs and constraints I used.

1. 2010 production of aluminium: 343,335 tonnes. From 2010 Sustainability Report , NZ Aluminium Smelters Limited.


2. Emissions factor for aluminium: Low estimate . 1.67 tonnes CO2-e per tonne Aluminium. From Ministry for the Environment's New Zealand’s Greenhouse Gas Inventory 1990–2009.


3. Emissions factor for aluminium: High estimate. 2.01 tonnes CO2-e per tonne Aluminium. From Heavy Industry Energy Demand Update Report Prepared for Ministry of Economic Development February 2009, Covec Ltd.


4. The compliance period for surrendering units is from 1 July 2010 to 31 December 2010, a half-year.


5. The obligation to surrender units is a half obligation because of the two units for one tonne of GHGs deal.


6. Free allocation of units is also reduced by a half.


7. Free allocation is calculated as 90 per cent of the allocative baseline (a benchmark number of NZUs per unit output)


8. The aluminium allocative baseline is 2.645 units per tonne of aluminium produced. From Section 7 of the Climate Change (Eligible Industrial Activities) Regulations 2010

I will first check my input assumptions by calculating my own estimate of the actual units allocated; 210,421.

Table 1. Estimate of emissions units allocated
2010 production tonnes Aluminium	343,335
Half year production /2 (1 July 31 Dec 2010)	171,668
Half obligation /2 (one unit/2 tonnes)	85,834
90% emissions-intensive-trade-exposed allocation	77,250
Allocation baseline (tCO2-e/t output)	2.645
Equals estimate of Units allocated	204,327
Difference (approx. 2.9%)	6,094
Actual Units allocated	210,421

My estimate of units allocated is 204,327, which is only 6,000 odd units (or 2.9%) less than the actual units allocated of 210,421. So it seems my inputs are roughly good enough.

Table 2 High and low estimate of units to surrender
2010 production tonnes Al	343,335	343,335
MfE Emissions factor (t Al/t CO2-e)	1.67	2.01
Estimated emissions 2010 t CO2-e	573,369	690,103
Half year compliance period (1 July 31 Dec 2010 /2)	286,685	345,052
Half obligation (one unit 2 tonnes /2)	143,342	172,526
Estimated Units to surrender	143,342	172,526
Actual Units allocated	210,421	210,421
Excess allocation (units)	67,079	37,896
Excess allocation (per cent)	147%	122%

Nick Smith implies that the free allocations reduce but do not remove the exposure to the carbon price. This is simply not correct. If it was correct, units allocated to NZ Aluminum Smelters would be less than units surrendered. However, units allocated exceed my estimates of units needed for surrenders.

I estimate that NZ Aluminium Smelters Limited were required to surrender between 143,000 and 172,000 emissions units for the six months to 31 December 2010. NZ Aluminium Smelters Limited were given, under 'industrial allocation', 210,421 units. My low and high estimates of the units to be surrendered exceed the actual units allocated by 37,000 and 67,000 units respectively.

Nick Smith says emitters are not being subsidised by free allocation. This too is simply not correct. Allocations greater than surrenders equals over-allocation or a net gain to NZ Aluminium Smelters Limited. The estimated over-allocation is from 124% to 147%. NZ Aluminium Smelters do not face a positive carbon price at all. If the NZ emissions trading scheme was a carbon tax, NZ Aluminium Smelters would have a negative carbon tax rate!

This perverse outcome is exactly why carbon taxes are in practice simpler, more effective, and a more robust way of carbon pricing than emissions trading.

The NZ ETS and agriculture's late entry; special pleading

An agricultural commenter has hit back at the NZ Emissions Trading Scheme Review 2011 and the New Zealand Herald editorial Farmers must share burden on emissions' for saying that there should be no further delay of the 2015 date when agricultural emissions will enter the New Zealand Emissions Trading Scheme (NZ ETS).

The Herald editorial had the temerity to comment on the government's "extraordinary generosity to farmers" in changing the "modest impositions" of the NZ emissions trading scheme on agriculture so that it "will become truly timorous".

David Anderson, who is described as a former editor of Rural News and a communications consultant in "teh" (sic) agribusiness sector, has just had an opinion piece in the Herald (27 September) arguing for a further delay in agriculture's entry into the NZ ETS.

Just as a brief re-cap, in the Clark-Cullen Labour Government's original version of the NZ ETS, agriculture was 'last in', with unit surrender obligations starting on 1 January 2013; i.e. after the end of the 2008-2012 Kyoto Protocol first commitment period.

In November 2009, Nick Smith and National changed the start or entry date to 1 January 2015 and confirmed that it would be processors and not individual farmers who would have the obligation to report emissions and surrender units. That was done in the Climate Change Response (Moderated Emissions Trading) Amendment Act 2009

As we know, Federated Farmers can be a bit emotive about the emissions trading scheme, with past President (and now ACT Candidate) Don Nicholson) describing it in 2009 as the road to hell paved with good intentions.

So lets have a look at David Anderson's arguments. The first argument is;

Why would we want to unfairly penalise New Zealand's agriculture sector - and one of the few sectors with the ability to help the country out of the current economic hole - by imposing taxes when our international competitors are not doing the same?

Because agricultural GHG emissions are the New Zealand's largest source of emissions! It's not that hard to understand.

In 2009, agricultural GHG emissions were 32.8 million tonnes (mt) of CO2-e out of a total of 70.6 million tonnes or 46.5 per cent of New Zealand’s total greenhouse gas emissions. The energy sector emitted 31.4 mt (44.4%). Industrial processes emitted 4.3 mt (6.2%). Waste emitted 2.0 mt (2.9%). Solvents and other products emitted 0.03 mt (0.04%) according to the Ministry for the Environment Greenhouse Gas Inventory 2011.

Other developed countries who have signed up for the Kyoto Protocol obligations just don't have agriculture dominating their GHG emissions like New Zealand. For example, here's a chart comparing New Zealand and Australian agricultural GHG emissions.

Lawyer Toni Moyes points out in a 2008 paper in the Ecology Law Quarterly, 35:4, pp. 911–966; Greenhouse Gas Emissions Trading in New Zealand: Trailblazing Comprehensive Cap and Trade that New Zealand is "fundamentally different" from European countries where carbon dioxide from the energy sector emits 80% of GHG emissions.

Moyes concludes "Thus, if non-CO₂ gases were excluded, the NZ ETS would ignore over half of the problem. Likewise, sectors typically excluded from ETS must be included in the NZ ETS in order to address the majority of emissions. The NZ ETS would be far less effective if agriculture, the single biggest emitter, was ignored."

I could not put that better. It is not "unfair" to include agriculture in the emissions trading scheme, it is essential.

Also, I have to point out that Anderson completely omits to mention the fact that agriculture, once it does enter the NZ ETS, will have (arguably) the most generous free allocation of emissions units of any sector of the economy. Under an ETS, emissions units must somehow get into a trading market. They may be either auctioned to emitters (obviously most wealth-enhancing for the tax payer) or "grandfathered", allocated for free to existing emitters. New Zealand has chosen to 'gift', or allocate for free, all domestic NZ units.

According the Ministry for the Environment, free allocation of units to agriculture will be 90 per cent of the emissions baseline and will phase out at 1.3 per cent per annum from 2016. The baseline will be the industry average emissions per unit of output. The allocation will be uncapped, meaning that there is no set limit on the number of units that may be allocated. Further, there are NO eligibility tests or thresholds for agricultural allocation, meaning that all agriculture participants will be eligible for an allocation.

So the entry of agriculture to the NZ ETS in 2015 will be cushioned by 90%. Or the GHG price signal will be reduced by 90% (compared to other sectors) down to 10% via free allocation. The free allocation percent will be based on "average output", which will be gazetted in regulations. Any processor who does 'better than average' will be in for a windfall gain. Again this is hardly the imposition of an unfair tax.

Number two argument is:

I don't see how handicapping our main economic driver will reduce international greenhouse gases. Surely all that will do is shift the production of these agricultural greenhouse gases from New Zealand to another country?

This is the carbon leakage argument. That businesses and their emissions will relocate to other jurisdictions to escape a carbon price.

Dr Jan Wright, the Parliamentary Commissioner for the Environment, pretty much shot to pieces the agricultural carbon leakage argument in her submission on the 2009 amendments to the NZ ETS.

Dr Wright noted that National was proposing to base allocation of units to agriculture on the industrial allocation model in the Australian Carbon Pollution Reduction Scheme (which was in 2009 only a proposal and which was withdrawn in 2010).

"There is no justification for treating allocation to the agricultural sector the same as industrial processes, either here or in Australia. The impact of the ETS on agriculture is very different to that of industrial process sectors. Productive agricultural land can not be shipped offshore...Carbon credits should not be allocated to prevent an unlikely event."

The nail in the coffin is from Suzi Kerr, an economist who has specialised in permit trading. She had this to say in her submission to the NZ Emissions Trading Scheme Review 2011:
."A small, but crucial, point on agricultural emissions is that all available empirical evidence suggests that leakage of land and production out of the agricultural sector in response to greenhouse gas costs would be small. This evidence is summarised in Kerr and Zhang (2009).

Number three argument is;

It has always argued that it's crazy for New Zealand farmers to be hit with the costs of an ETS when they had no way of mitigating these

This is the 'Agriculture can't mitigate' argument. As blogger Idiot/Savant said in his blog No Right Turn, this is simply untrue. The Sustainability Council wrote a report A Convenient Untruth in 2007 that argues that there are significant mitigation options for agriculture.

Anyway, Anderson almost immediately contradicts this statement in the next paragraph when he states

"There is already evidence - which is also noted by Caygill's Review Panel - that the agriculture sector is reducing its greenhouse gases (my emphasis). Emissions per unit of product from agriculture have fallen by about 1.3 per cent a year over the past 20 years - due to improved management, animal genetics, pasture and crop genetics and technological changes. Opportunities for further reductions included the use of forestry on marginal or erosion-prone land, nitrification inhibitors, and "good practice" management techniques that increase productivity."

Its great that agriculture is reducing emissions! Those responsible deserve all credit for it. However, the advocates of agriculture such as Anderson need to be reminded that reducing emissions is the same as mitigating them!

Anderson's fourth argument is that

"critics and environmental doomsayers" are "making claims about farmers being subsidised".

And that it is unfair and selective to say farmers are getting a free ride.

Look, as far as I'm concerned, we all have an obligation to do something about climate change. New Zealand's climate change policy reflects that. New Zealand has emissions reduction targets and climate change policies and commitments under the Kyoto Protocol and the UNFCCC. All of us share the responsibility of making New Zealand's emissions reductions policies work. If we leave out agriculture, the sector of the economy that is the biggest emitter of GHGs, then that is unfair to everyone else. This is just agricultural special pleading over the emissions trading scheme.