Tuesday, May 30, 2023

Eric Crampton: Does the Government's deal with NZ Steel make sense?

After spending an embarrassing amount of time trying to figure out whether paying NZ Steel an enormous amount of money to install a new electric furnace made any kind of sense, I have finally come to a conclusion.

If the subsidy does make sense, it would indicate severe problems in how industrial allocations have been handled. Problems that I would hope are being addressed in the system’s review.

How the government runs industrial allocations also needs a lot of clarification and greater transparency.

So what’s the issue?

Last weekend, the government announced a $140 million subsidy to NZ Steel to install a new electric arc furnace for recycling scrap steel. The government expects the measure to prevent some 800,000 tonnes of annual carbon dioxide emissions.

The government’s press release estimated the project will cost $16.20 for every tonne of avoided emissions. It was unclear whether that figure included the cost that NZ Steel was covering as part of the deal. If it did not, the cost per tonne would have been closer to $35. Either way, the cost would be well below the current carbon price in New Zealand’s Emissions Trading Scheme.

These kinds of subsidies can enjoy a fair bit of popular support. Everyone knows net emissions must come down. And governments picking and choosing winners in this kind of way sounds attractive to people who think governments are good at that kind of thing.

But normally these kinds of subsidies simply do not stack up. The Emissions Trading Scheme puts a price on carbon dioxide emissions. If NZ Steel could spend less than $40 per tonne of emissions to avoid having to pay $55 for a carbon permit, for some 800,000 permits per year, why would they not already have done so? Failing to make the investment is like throwing money away. Do they not like money? It’s usually safest to assume that businesses like having money as compared to not having money.

That makes these kinds of subsidies a terrible bet – normally. If a business’s investment project really does make sense, then nobody is better placed than the business itself to figure that out. And if it makes the wrong call, the company’s own money is on the line.

So subsidies either wind up paying companies to do something they were already going to do, or they pay them to do something that doesn’t make any sense. Neither option is good.

Enter the first complication: industrial allocations.

When the ETS was first set up, the government worried some production might just shift overseas, potentially increasing global emissions.

The government dealt with the problem through industrial allocations. Industries where this kind of carbon leakage was a potential problem got, and still get, free ETS credits.

Now, you might think that companies with these allocations have no incentive to reduce emissions on their own. But the scheme is cleverer than that. Industrial allocations scale down if a company’s output decreases. But if a company can halve its emissions while maintaining output, it gets to keep the free emissions credits, until some future review.

In that case, subsidising companies to cut emissions still does not make sense. Investing less than $40 per tonne of emissions avoided would let the company sell off surplus credits for more than $50 each. Multiply that 800,000 times over for a few years and the investment is still a great deal.

Except, in this case, it might not have been.

The legislation that set industrial allocations provided them for specific activities. If you made steel from iron sand, you’d get an allocation. If you made steel from recycled materials, you would not.

Flipping to using recycled steel would not have freed up credits to sell. It would have ended them, providing a strong disincentive for investing in a technology – even if the technology makes sense.

So we finally come to my conclusion. If the subsidy makes sense, it is only because the way industrial allocations are handled is somewhat broken.

And that makes the subsidy’s timing particularly strange.

The government is currently reviewing industrial allocations. Legislation is going through Select Committee. The underlying problem could have been fixed there. And who knows whether there are similar problems in other industrial allocations. If the legislation provides the appropriate fix, why provide a direct subsidy?

Solving each through a subsidy could prove pricey. It isn’t just that the subsidies themselves are expensive. It’s that when subsidies are available, companies lobby to get them regardless of whether they make any economic sense.

The government has turned its ETS revenues into spoils for lobbyists.

Other companies, seeing NZ Steel’s subsidy, demand their own subsidies. It will be great for the lobbyists, but not so much for the rest of us.

And it sure would be nice to have better available records on how all of this works. It’s far from transparent.

Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE


Ken S said...

Surely the heading for this article should be "Does anything done by this Government make sense?"

CXH said...

Is it actually meant to do anything in reality and does the government care either way. There is an election coming and the government, plus the greens, are accused of not doing anything towards mitigating climate change. Suddenly, a few months out, we get this wonderful reason for the spin docs to show how much they care.

After all, what's 140 mill added to the kids future debt . A drop in the bucket compared to the press exposure for caring at last.

Robert Arthur said...

It is curious that the govt might be concerned about moving emmissions off shore. That is waht the obsession with complxs high energy to produce, short lived electric cars does. Would be better to encourage long retention of the existing i.c. fleet

Anonymous said...

CXH is right. It was all a PR stunt. With an election looming they needed to be able to beat their chests over something. With all the smoke and mirrors surrounding it, but with a nice photo opp and an easy to digest sound bite, what better charade. Pity us mugs will end up paying for it, again.

Helen Weston said...

Why is it that so many are so scared of CO2 - carbon dioxide? Without it, NO-ONe would need to worry about anything!!!!!

Anonymous said...

The lobbyists play this government like a whole orchestra but what happens when the music stops? I hope the clueless idealogues all get run outta town after October. Most transparent government ever!