In emissions trading systems, tradable emissions units issued by the government are usually sold at auction or given out for free. In the New Zealand Emissions Trading Scheme (NZ ETS), free allocation is currently given to industrial producers who are emissions-intensive or trade-exposed.

Industrial free allocation can serve a useful purpose: preventing domestic production and associated emissions from shifting offshore to jurisdictions with less ambitious climate change policies and less efficient production. However, it also poses high costs to Kiwi taxpayers, could make it harder to meet our 2050 climate target, and raises fairness issues across sectors. The government has collected evidence of the overallocation of free units which could give windfall gains to some producers.

This document examines a range of options for reforming industrial free allocation: changing the eligibility criteria or calculation methodology, substituting alternative measures, or accepting and managing emissions leakage. This paper does not make specific reform design recommendations as further research is needed to evaluate the merits of these options.