Each year, the government gives away millions of emissions units to trade-exposed businesses under its Industrial Allocations (“IAs”) policy.

The policy is narrow but deep. In 2020, just 70 businesses received a whopping 7.7 million units. That is about 18% of the country's emissions which are covered by the Emissions Trading Scheme.

Nearly two-thirds of the gifted units went to three businesses: New Zealand Steel (2 million), the owners of the smelter at Tiwai Point (1.6 million), and Methanex (1.2 million).

With the recent increase in the carbon price, free allocations are now worth $500 million per year.

IAs exist because steel makers and other producers overseas do not pay a carbon price. The free units level the playing field, and stops companies leaving for lower carbon prices elsewhere, a process known as ‘leakage’.

Unfortunately, IAs have become more generous than they need to be. This is down to the formula used to allocate units. It is based not on each firm’s actual emissions, but on a benchmark rate per tonne of output for the sector, multiplied by each firm’s production.

The idea behind the benchmark approach is to preserve incentives to lower emissions. Firms who invest in greener production are not penalised with fewer free units next year.

Benchmarks were fixed in 2010. Since then, firms have indeed cut their emissions. The problem is that many firms now receive free units for more than 100% of their emissions. A recent study commissioned by the Ministry for the Environment looked at this over-allocations problem. Three of the four sectors it surveyed received more free units than the emissions they produced. One (unnamed) sector received three times too many units.

Such excess unfairly shifts the burden of reducing emissions to households and businesses. And with the carbon price at $65 – double its July 2020 value – IAs are putting hundreds of millions of dollars in the pockets of firms for increasingly questionable returns.

The government is now reviewing the IA system. Its reforms should continue to prevent leakage and keep incentives to lower emissions – but stop with the unnecessary giveaways.

We suggest replacing the current fixed benchmarks with sinking lids based on international emissions trends. This change could raise difficult measurement issues. But that is less troubling than gifting free money to high emitters in the name of climate change.

The government should move quickly.