New Zealand’s climate body backs review of free allowances for major polluters

New Zealand's climate advisory body Climate Change Commission (CCC) expressed support to review the allocation of free carbon credits to major polluters under the country's Emissions Trading Scheme (ETS), it said in a letter released Feb. 4.

The development comes after a petition that urged the government to phase out free carbon credits for emissions-intensive and trade-exposed industries, which undermine the effectiveness of the ETS in combating climate change, according to critics.

The petition, submitted by environmental advocate Alex Johnson in June 2024, calls for an accelerated transition away from the current system of industrial allocation stating it creates an unfair advantage for large polluters and hinders the nation's progress toward its climate targets.

"With the government signaling changes to the Climate Change Response Act in 2025, it's a great opportunity to improve this policy so it works better for companies wanting to decarbonize and works better for taxpayers," a New Zealand-based climate policy expert said.

Free allowances and pricing

In response, the CCC highlighted the urgent need to reassess the role of free carbon credits in the ETS. It pointed out that the current framework may not adequately incentivize significant emissions reduction investments as firms often perceive a reduced allocative baseline in response to their efforts.

Initially, industrial allocation was capped at 90% of a sector's 2005 emissions. However, since the 2009 amendments, the NZ-ETS has provided uncapped output-based industry allocation with the primary goal of mitigating the risk of emissions leakage offshore.

The CCC noted that while industry allocations can mitigate emissions leakage risk, they reduce the motivation for both companies and consumers to cut their total emissions and take away revenue from NZ ETS auctions, which raises costs and fairness issues for other market participants.

The CCC's response also brought attention to the role of carbon pricing. The current market dynamics surrounding NZUs, including their pricing, will play a crucial role in shaping the incentives for businesses to invest in emissions-reduction technologies.

Platts, part of S&P Global Commodity Insights, assessed NZUs at NZ$63.95/mtCO2e ($35.75/mtCO2e) on Feb. 5, stable day over day.

"Important to always review industrial allocations to make sure they fit the current market activity and encourage reduction behavior. Likewise for price, higher price [of NZU units] equals more change to low emission alternatives," a New Zealand-based forester said.

Free allocations and climate targets

The CCC's response underscored the variable risk of emissions leakage across different industries, suggesting that a more tailored approach to carbon pricing could be beneficial.

The commission noted while industrial allocation levels the playing field between domestic producers and overseas producers that do not face an emissions price, it also weakens the emissions price signal to consumers to choose lower-emission alternatives.

"Industrial allocation recipients in the highly emissions intensive category currently receives allocations equal to 86% of their allocative baseline, and so consequently face a much lower effective emissions price," the letter stated.

The NZ-ETS as currently structured will not deliver or sustain the net-zero component of the 2050 target. The Commission's advice on the Second Emissions Reduction Plan (ERP2) highlighted that, beyond the mid-2030s, there will not be enough demand from remaining emitters in the NZ-ETS to incentivize the removals by forests needed to meet the net-zero component of the 2050 target.

The CCC emphasized the importance of stable and predictable policy settings within the ETS. Frequent changes to the system could lead to market volatility and uncertainty, ultimately undermining the effectiveness of the ETS in delivering the required emissions reductions.