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Submission to Inland Revenue Department
on Implementing the Carbon Tax
From
Contact Energy
8 July 2005
20050708_IRD_Implementing_Carbon_Tax_v4.doc
General Comments
Contact Energy welcomes the opportunity to comment on the issue of carbon tax
implementation.
Contact is generally supportive of the government’s proposed implementation policy.
We agree that the framework should balance the competing tensions of accuracy
and simplicity, and that the implementation of the tax should, to the extent possible,
minimise compliance costs by those parties paying the tax and claiming rebates.
Contact is concerned, however, about the ongoing uncertainty regarding the tax, both
in terms of the tax rate and its continuity. The discussion document notes that the
rate is set at $15 per tonne of CO2 and will not be changed before 2012 “unless it
diverges significantly and on a sustained basis from the international price” and that
the policy regarding changing the amount of the tax will be developed at a later date.
Contact notes that the price of carbon on the European market has been significantly
above NZ$15 for the past three months1, which raises the possibility that the tax rate
may need adjusting. We submit that it is crucial, from a forward planning and
investment perspective, to have more certainty about this process.
Likewise, the foreword to the discussion document characterises the carbon tax as “a
transitional path toward full or partial emissions trading.” It is important for
infrastructure investors to have a more complete understanding of how and when the
government envisages the transition to emissions trading to occur.
In terms of the tax implementation itself, Contact notes that the framework outlined in
the discussion document is at a relatively high level and that many details will still
need to be worked through. Stakeholders should therefore be provided with
adequate time to analyse and consult on the draft carbon tax legislation. Equally
important, there should be sufficient time between the enacting of the legislation and
the date the tax comes into force for stakeholders to implement their own internal
carbon tax accounting procedures.
Responses to the specific questions raised in the discussion document follow.
1. To what extent, if any, should the carbon tax legislation override existing
contracts for the supply of energy resources to allow pass-through of the
tax, and what would the consequences of this be?
2. For what energy sources might a contractual override be necessary?
Contact is supportive, in principle, of legislatively allowing the specific emissions
factor on a fuel source to be passed through on existing fuel supply contracts. These
factors are known, proven quantities, and the calculation of an emissions charge on
this basis – emissions factor times quantity of fuel sold – is a transparent and
verifiable procedure.
Contact notes, however, that energy producers will face increased costs due to the
carbon charge that will not be incorporated into the emissions factor. A significant
example is the tax liability that gas producers will incur in stripping carbon dioxide
from natural gas to comply with the specification for pipeline gas. Other examples of
increased production costs include the use of carbon-based fuel in an energy
producer’s operations, perhaps for processing or transportation.
It appears that the consultation paper suggests that these additional costs of the
carbon charge – those arising from the energy producers’ use or processing of
1
At the time of writing it is over NZ$41 per tonne of CO2 (Source: pointcarbon.com, 29/7/05)
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energy – should explicitly not be allowed to pass through an existing contract2.
Contact supports this position and believes that it is the correct policy on two
grounds. The first is that existing contracts provide for the supply of a specific
product: specification gas, for example. In this case, the contract is for the on-spec
gas, not for the treatment of raw gas. To allow the costs of the treatment to fall, by
way of legislative amendment, on the purchaser of the gas would be to allow the
business risk that the producers face in providing the spec gas to fall inappropriately
on their consumers. In addition, allowing upstream CO2 stripping costs to pass
through would create large transaction costs, as contract parties would need to come
to agreement over a methodology to calculate the pass-through amount and a way to
verify that the costs were accurate. This is a significant issue because of the wide
variation in CO2 quantities, and the way in which gas from different fields is “mixed” in
the pipeline by different amounts at different times.
In the long term, these issues are of lesser concern, because they will be able to be
factored into the negotiation of new contracts. For existing contracts, Contact
submits that the carbon charge should only be passed through based on the
emissions factor of the fuel being purchased.
3. Is there a need to tax transitional stockpiles if they are very large?
4. Is there a need to consider the carrying cost of the tax on very large users’
stockpiles?
Contact submits that the considerations in designing a carbon tax framework for fuel
stockpiles are different than those for fuel quantities that will be consumed in a
relatively short timeframe. It is the purposes of holding the fuel and the timing of the
release of the greenhouse gases that differ. Contact therefore submits that it is not
just transitional stockpiles that should be given special consideration in the design of
a carbon tax, but rather all long-term storage of generation fuel.
Timing of Emissions
In electricity generation, stockpiles are held not to meet daily generation
requirements, but rather to enable the holding company to respond to electricity
shortages. For example, Contact has a significant amount of fuel oil stored at its
generation station at New Plymouth. This fuel oil is not used for daily generation; in
fact, New Plymouth currently runs on natural gas. However, the generation plant is
being refurbished to give it the capability to run on fuel oil as well. The storage of fuel
oil will thus act as insurance against interruptions in the area’s gas supply and dry-
year electricity shortages.
Fuel that is purchased for daily generation needs will generally be burned shortly
after its purchase, so that the paying of the carbon tax, through the purchase of the
fuel, and the release of the greenhouse gases from its consumption are roughly
coincident. For fuel stockpiles, in contrast, there could be years between the
purchase of the fuel and its consumption.
2
Paragraph 5.24 of the consultation paper classifies venting by the petroleum permit holder
as “own-use”.
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Public Good Aspect
There is also the public good aspect of generation fuel stockpiles to consider.
Stockpiles are a means of insuring against the effects of an electricity supply
shortage, such as a dry year event. The stockpiled fuel acts as a buffer against the
relative scarcity of water in the hydro lakes, enabling thermal generation stations to
compensate to some extent for the decreased output of the hydro stations. The
existence of these stockpiles is thus in the national interest, as a resilient, flexible,
and reliable electricity supply system underpins our economy and our way of life.
Incentives on Generation Stockpile Holders
These characteristics mean that it is logical from a policy perspective to treat long-
term generation fuel stockpiles differently from fuel that will not be stored for long
time periods. Taxing fuel purchased for stockpiling would mean that stockpile
holders would have to carry the additional cost of the tax until the fuel was burned
and the tax recovered through the sale of the electricity thus generated. This
situation would tend to incentivise generation companies to hold less stockpiled fuel
than they otherwise would.
Further, levying a tax on stockpiles held as of April 2007 would compound this issue
by creating a large and immediate tax liability on holders of large fuel stockpiles.
Again, this situation would create an incentive on the holding companies to minimise
or eliminate stockpiled holdings at that date in order to lessen the amount of tax
owed.
In both cases, from a national electricity security of supply point of view, such
situations would be undesirable, as they would tend to lead to decreased stockpile
amounts and therefore lessen the industry’s ability to respond to a supply shortage.
Further, taxing such stockpiles if and only when they are consumed more properly
reflects the underlying policy intent of the carbon tax; that is, to tax emissions when
they occur.
Taxing Emissions is a More Robust Framework
Contact therefore submits that fuel stored for generation, regardless of the type of
fuel, should attract the carbon charge only when it is consumed. This would mean
that when fuel is drawn from storage for generation, the carbon tax would be
payable; and when fuel is purchased to add to storage, the carbon tax paid on the
fuel purchase would be refunded.
Contact considers that this treatment of fuel stored for generation – levying the
carbon charge at the time of consumption, rather than at the time of acquisition – will
deliver more robust policy outcomes than the proposal contained in the discussion
document as:
• It ensures the carbon tax is paid when the fuel is used; that is, it avoids the
issue of the additional holding cost of large stockpiles from the imposition of
the carbon tax;
• It avoids compounding the above issue by having to pay carbon tax on
opening stockpiles;
• It avoids the subjectivity of the quantum of the stockpiles on the
commencement of the carbon tax;
• It avoids stockpile adjustments should the government reduce or increase the
rate of carbon tax from $15 per tonne of carbon dioxide emissions;
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• It ensures that emissions from burning stock fuels are taxed at the current
rate of carbon tax, rather than the historic rate; and
• It avoids undesirable incentives, such as the incentive to reduce the level of
stockpiles to avoid the holding cost of the carbon tax otherwise payable.
Proposed Methodology
In practical terms, we suggest that any methodology for the taxation of generation
fuel stockpiles needs to be robust and verifiable. To that end, we recommend a
monthly calculation that is based on the difference between the amount of fuel
removed from the stockpile and the amount of fuel purchased and added to the
stockpile (i.e., fuel removed results in carbon tax payable, and purchases provide a
carbon tax refund). That is, there would be no regular measurement of the actual
volumes of the stockpile.
This proposed system would ensure accuracy and minimise compliance costs by
using existing accounting processes. In Contact’s case, we accurately measure the
quantum of the fuel purchased and the fuel removed from our fuel oil stockpile on a
monthly basis, and this is the method used to value the quantum of fuel stock on
hand for financial reporting purposes. Using this methodology would minimise
compliance costs and increase certainty to businesses, as it would use existing
accounting procedures. It would also provide certainty to Inland Revenue that the
amount had been calculated accurately, as the process could be audited based on
records kept for financial reporting purposes, without relying on subjective physical
measurement techniques.
Contact strongly believes that the above treatment of long-term generation fuel
storage would provide an optimal policy outcome: certainty for taxpayers, minimal
compliance costs, and payment of carbon tax when (and if) carbon dioxide emissions
occur. It would also avoid creating a disincentive to hold such fuel stocks, thus
helping to ensure the country’s security of electricity supply.
5. How can the cost of filing returns be kept to a minimum while ensuring the
integrity and fairness of the tax?
Contact submits that the administration of the carbon tax should, to the extent
possible, be incorporated into existing tax administration procedures, such as those
for the payment of GST and import duties. Given it will calculate its obligations on a
monthly basis, Contact is comfortable with a monthly payments basis.
6. Are the proposed units for product quantities and emission factors
convenient and sufficiently precise?
The discussion document suggests that emissions factors for liquid fuels be
measured in terms of litres, but tonnes is a more common measure of fuel oil.
However, converting between the two measures is a straightforward calculation, as
long as the density of the fuel is known.
For geothermal emissions, the discussion document proposed units of tCO2-e / tfluid,
but Contact submits (as discussed further below) that geothermal emissions should
be measured in terms of but tCO2-e / GWh for generation and in tCO2-e / tsteam for
industrial process heat.
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7. Are the proposed timing rules for payment and rebates of the tax
reasonable?
Yes, as stated above, Contact is supportive of basing the carbon charge framework
on existing tax administration procedures. This includes the administrative rules for
amounts payable and for refunds.
8. Would firms claiming rebates face difficulties obtaining evidence of specific
emission factors?
Contact is not in a position to comment on NGA rebates, but there may be occasions,
such as in the case of fuel storage, where we may be eligible for a refund of the
carbon tax. In this case, we concur that use of a standard emission factor will most
often be the most appropriate calculation method.
9. Under what circumstances should a firm in your industry be required or
permitted to re-assess a specific emission factor (for example, because of
changes in the product being mined)?
As outlined below in the response to the geothermal question, Contact submits that
operators of geothermal fields should conduct testing and revise their emissions
rates on a yearly basis, to accommodate changes in greenhouse gas emissions over
time. We believe that yearly testing provides an appropriate balance between
accuracy of emissions measurement and compliance and testing costs.
There should also be some allowance made in the legislation to allow for emissions
factors to be altered in response to changed fuel composition, such as changes to
specification gas.
10. What evidence that the tax has been paid on a product should a firm
claiming a rebate be required to have?
For firms claiming refunds, there should be a bill of sale or invoice that shows the
date of fuel purchase. If the fuel was purchased after 1 April 2007, the purchase cost
should be inclusive of the carbon charge. Therefore, Contact submits that evidence
of fuel purchase after the date of the carbon tax introduction should be sufficient as
evidence that the carbon tax has been paid.
Issues for Specific Industries
Gas and Gas Products
Contact notes that the Appendix 2 table of emissions factors does not include an
entry for LNG. Imported LNG has a different composition than specification gas: it
consists primarily of methane and contains no carbon dioxide. Carbon dioxide in the
gas would interfere with the liquefaction process and is stripped if necessary during
treatment in the exporting country.
Contact submits that, if LNG were to be imported into the country, a separate
emissions factor would need to be established for this fuel source.
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Geothermal
Need for Pragmatic Framework
Contact notes that geothermal resources are one of the smallest contributors to
greenhouse gas emissions, but perhaps one of the most difficult to measure. As
noted in the discussion paper, different geothermal fields have different compositions
of gases in their steam, and different geothermal uses and technologies will release
different amounts of gases. For example, some processes and practices involve the
reinjection of CO2 laden fluids into the ground, and others do not.
There is therefore a need to be pragmatic in the way geothermal emissions are
determined. There should be a balance struck between the accuracy of emissions
measurement and the associated costs of emissions testing and measurement.
Because of the variability of emissions between fields and uses, each geothermal-
using plant should have its own specific emissions factor and method of testing that
takes account of its steam flows. Contact submits that the best way to achieve these
aims is to take advantage of monitoring and reporting protocols that are already
established for existing fields.
Yearly Testing Based on Established Protocols
For the geothermal fields that Contact operates – Ohaaki, Poihipi, and Wairakei –
total carbon dioxide emissions are monitored and reported on a yearly basis to
Environment Waikato, as a condition of the resource consents granted to operate the
fields. This testing is undertaken by independent contractors using internationally
accepted standard sampling and analysis techniques.
Contact proposes that these annual testing results be the basis for the calculation of
the emission rate on which the carbon tax is levied. We consider that this method,
using test results from individual fields, will more accurately reflect the emissions
from geothermal activities than attempting to develop a global geothermal field
emissions factor. This is because, as discussed above, emissions vary between
different steam fields.
Contact further submits that basing the carbon charge on annual testing represents a
reasonable balance between accuracy of measurement of emissions and the costs of
testing. While emissions do vary over time (particularly as wells age or new wells are
brought into production), we submit that the quantum of the variation is small in the
context of New Zealand’s total greenhouse gas emissions. Further, the use of
annual testing to determine an annual rate would capture such variations, as the rate
would represent an average over time.
As with the natural gas transmission and distribution network, there is a small amount
of unavoidable leakage of steam from many of the geothermal plants. Contact
submits that, as with the gas leakage and coal-seam gas cases, this amount is
negligible and virtually impossible to measure. It should therefore be excluded from
the scope of the carbon tax.
Measurement of Geothermal Emissions from Generation
Contact’s current testing protocols as required under its resource consents report
carbon dioxide emissions on the basis of content per tonne of steam. For the
purposes of determining an appropriate annual rate, we recommend that this
measure be converted to CO2 per MWh. It is a relatively simple procedure to convert
tonnes of steam to generation output at the time of testing, and basing the emissions
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factor on station output means that there is an independent, verifiable basis on which
to calculate each station’s carbon tax liability.
At present, methane emissions are not monitored on a regular basis from Contact’s
geothermal fields. Intermittent testing indicates that methane emissions are
generally insignificant but can vary widely between different geothermal fields. For
consistency, Contact therefore proposes that methane testing be incorporated into
our established annual monitoring regime and the results used to determine carbon
tax liability, as outlined above for carbon dioxide.
Interrelationship with the penalties regime
Contact is very concerned how it is anticipated that the penalties regime will apply to
the calculation of carbon tax in the context of geothermal activities and in particular
what the standard of care is.
We note paragraph 5.45 of the discussion document (emphasis added)
The government proposes to use this data as the basis for levying the tax on
major geothermal energy users. Normal requirements for taxpayers to take
reasonable care in calculating their tax liabilities will apply. The possibility of
an Inland Revenue audit will also ensure that there are clear incentives to
revise the estimated gas concentration – for example, if there is reason to
believe that it is no longer accurate – say, because a new well has been
introduced to the system.
Contact considers that annual testing is sufficient to determine an appropriate rate on
which the carbon tax would be levied. As discussed, the introduction of a new well
does not materially impact on the level of emissions, as steam is sourced at any time
from a series of wells and not a single well. In any event, the use of an annual rate
would provide a weighted average over time. Further, the concept of materiality
should be taken into account given the small level of emissions from geothermal
activities in relation to emissions from other sources.
Given the above, Contact is very concerned that penalties would even be considered
in this context. In relation to geothermal activities, Contact submits that penalties
should only apply if it miscalculates its liability; there should be no requirement to
depart from annual testing.
Measurement of Geothermal Emissions from Industrial Heat
For cases where geothermal steam is used for industrial processes, Contact submits
that the determination of emissions should be similar to that for generation (subject to
that use coming within the definition of “significant” use, as discussed below). For
each “significant” user, there should be an annual measurement of the greenhouse
gases included in the steam delivered to that user. That is, a user-specific emissions
factor should be established based on annual test results. The major difference
between industrial heat and geothermal generation is that the emissions factor
should be based on the specific characteristics of the plant and the nature of its
energy supply. The most measurements most likely to be relevant are tCO2-e / tsteam.
A related point to industrial geothermal users is that it is important that the carbon tax
regime avoid imposing a tax on a subsequent user of already taxed steam. Again,
this highlights the importance of considering each geothermal steam-using plant as
an individual case.
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Determination of “Significant” Use
The discussion document proposes that the carbon tax not apply to “small” users of
geothermal resource, as the costs of compliance would be excessive in relation to
their tax obligation. Contact submits that it is important to establish a definition of
“small”, so that existing and future geothermal resource users can have certainty
over the amount of carbon tax they will face. We suggest that a threshold of
expected emissions of 10,000 tonnes of CO2-e per year would be an appropriate
figure. Geothermal users who expect to emit less than this amount per year would
be exempt from monitoring their emissions and exempt from the tax. Industrial users
who use more than this amount of steam – that is, “significant” users – should be
required to measure their steam content annually, as outlined above, and to pay
carbon tax on their emissions.
8 8 July 2005
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