20 October 2011

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
Units to surrender143,342156,147172,526
Units allocated210,421210,421210,421
Excess allocation (units)67,07954,24737,896
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.

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