The New Zealand Initiative supports the government’s commitments under the Paris Climate Agreement and to achieve net zero emissions of long-lived greenhouse gases from 2050. We consider the New Zealand Emissions Trading Scheme (“ETS”) is among the world’s leading cap-and-trade systems for reducing greenhouse gases.

Industrial allocations (“IAs”) serve to prevent leakage, which as MfE correctly notes can raise global emissions (p7). By preventing job losses caused by leakage, IAs can also enhance public support for emissions policies.

Leakage is the result of different (implicit or explicit) carbon prices across countries. Businesses can arbitrage these differences by relocating production to countries with lower carbon prices. In addition, trade-exposed domestic businesses can fail if forced to compete against offshore companies who derive a competitive advantage from a lower carbon price.

By aligning the effective carbon price with offshore prices, free allocations of emission units can prevent leakage and business failures. IAs can adjust the effective carbon price for trade-exposed businesses so that carbon pricing is neither a source of competitive advantage or disadvantage, neutralising leakage and failure risks.

The problem is that the current formula for allocating New Zealand Units (“NZUs”) to trade-exposed businesses does not take relative carbon prices into account.