Article: Bracing for the new, low-carb economy

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Bracing for the new, low-carb economy

Bracing for the new, low-carb economy
June 21, 2008 - 1:52PM
Bankrupt power generators, regular blackouts, abandoned cement and steel factories, a 10c a litre jump in petrol prices, spiralling electricity bills and unaffordable air travel - welcome to Australia in 2010.

An emissions trading scheme has just been introduced and the worst fears of Australian businesses have been realised.

It's a dramatic - and unlikely - worst-case scenario but one which business leaders have been trotting out for politicians and bureaucrats recently as the Federal Government finishes the design for a new carbon trading system which will, at the very least, transform the corporate landscape.

The introduction of a carbon price will affect every company in Australia, boosting the cost of electricity, transport and fuel.

It has been likened to the GST and globalisation in terms of the impact it will have on the economy.

And investors and analysts are concerned that some companies just aren't ready for it.

A green paper outlining the form and structure of the emissions trading scheme is expected to be issued by the Federal Minister for Climate Change, Senator Penny Wong, on July 16, with draft legislation expected by the end of the year.
The big decisions the Government needs to make relate to pricing and compensation for those sectors hit hardest by the change.

Companies are now making their case for why they are "emissions intensive" or "trade-exposed", and therefore entitled to compensation - or, as they prefer to describe it, "transitional arrangements". The Government will inevitably be forced to favour some companies and sectors over others.
"Every company is trying to get on the trade-exposed, emissions-intensive barrow and the Australian Government has a very tough political decision to make," Chris Leon, the chief executive of Cement Australia, says.

"It will have to pick industries to protect over other industries. There is no doubt this will change the competitive landscape within Australia."

In the meantime, businesses are reluctant to lock in long-term electricity contracts, big investment decisions are being put on hold and shareholders and analysts are busily trying to predict the carbon liability for companies in their stock portfolios.

"Once Penny Wong's green paper comes out, then I think you're going to see an absolute revolution and sea change here," Michael Molitor, a senior adviser with PricewaterhouseCoopers, says.

A fierce lobbying effort is under way to influence the design of the scheme. It is expected to be a "cap-and-trade" system, in which total emissions are capped at a certain level and companies will need permits to pollute.

Excess permits can then be traded. Debate is raging about whether the permits should be auctioned or handed to companies.

The Government's chief climate change adviser, Ross Garnaut - whose draft final report to the Government is expected on July 4 - has said he is in favour of auctioning all permits, which would place a significant financial burden on companies.

He is keen to avoid a repeat of the fiasco in Europe, where polluters were allocated more permits than they needed and sold them for a substantial profit.
Most companies the Herald spoke to argue for a mix of free and auctioned permits.

It's expected the scheme will cover about 70 per cent of emissions, which means most industries will be included.

However, agriculture and waste will probably be left out and there is heated debate about whether the inclusion of petrol and transport should be delayed.

So far, the Government has shown a bias towards a broad scheme, covering all large polluters.

The wide range of possible outcomes for companies is making executives nervous as they wait for Senator Wong's green paper.
And some are taking aim.

"We realise there is a cost of carbon but it's how you introduce the cost without making it hyper-inflationary and an industry killer," the chief risk officer at Qantas, Rob Kella, says.

"There will be a strong realisation for the Government at some point that they will have to look at the short-term impacts of this."

Rio Tinto is concerned that the Government is moving too fast. The company is pushing for a trial period ahead of a 2013-2014 start for the trading system.

"If you're dealing with something that is worth billions of dollars, then it is worthwhile spending the time to make sure it's a well-designed scheme," Neil Marshman, Rio Tinto's head of climate change, says.

Truenergy's Richard McIndoe goes further. He warns that without proper compensation, some power companies will go under, triggering national blackouts.

"If existing incumbents are financially impaired or made bankrupt, then there will be a need to attract new investors to a sector that has been financially decimated and that's a difficult call," he told the Herald.
Not all companies are so negative.

"As long as it covers everyone - all transport needs to be involved - and allows for a level playing field, I think the sooner it is introduced the better," Virgin Blue's chief executive, Brett Godfrey, says.

Origin Energy's head of carbon markets, Petrea Bradford, meanwhile, insists it "is not going to be a doom and gloom scenario".

But there is some concern about the level of preparation across corporate Australia.

PWC surveyed 303 top executives at Australian companies with a turnover of more than $150 million late last year. Just 2 per cent said they had a high level of confidence in their greenhouse gas emissions data.

More than a third said they had no data at all and only 22 per cent said they had responded to climate change, according to the report, earlier this year.

While large energy, mining and building materials companies have been getting ready, smaller, Australian-focused companies are just realising the extent of carbon change.

"Based on the disclosure we've had, there is some significant concern about how those companies are shaping up to manage the issue," a senior analyst at AMP Capital Investors, Dr Ian Woods, says.

AMP Capital Investors estimates that if a $10-a-tonne carbon price were introduced, between 2.5 and 3.5 per cent, on average, could be wiped from the earnings of companies in the ASX100 index.

And many believe the actual carbon price could be up to four times that.
"I think the industry has always assumed that the government would take the softly, softly approach and now they are starting to wake up to the fact that there might be a stringent emissions cap, if not in the short-term then the longer term," the director of research and policy at the Climate Institute, Erwin Jackson, says.

Superannuation fund VicSuper commissioned a research firm, Trucost, to analyse the carbon exposures of Australia's top 200 listed companies.

It found those companies' direct emissions were equal to 133million tonnes of carbon. Nearly half of that amount was accounted for by just four companies: BHP Billiton, Rio Tinto, BlueScope Steel and Qantas.

Trucost found that assuming a price of $28.81, (based on the price of carbon in the European Union trading scheme at the end of March last year), 57 companies have a carbon exposure greater than 1 per cent of turnover and 20 companies have a carbon exposure of more than 10 per cent of turnover.

"As investors, climate change is a huge issue," VicSuper's chief executive, Bob Welsh, says. But both Mr Woods and Mr Welsh believe the cost of doing nothing now would be far greater for investors down the track.

"I've got people in my super fund who are now 21 years of age and I have people who are 65 years of age, so I need to balance that," Mr Welsh says. "..the sooner we take some action the less pain there will be. It's a tough call but it must be done."

Australia's energy sector accounts for 35 per cent of total emissions. The power sector will be turned on its head.

Brown coal, now the cheapest source of power generation, will become the most expensive and value of brown coal-fired power plants is expected to fall by up to 80 per cent.

Gas, which is about 50 per cent more efficient than coal in terms of its emissions, will become more competitive.

And the wind, solar and hydro sector, helped along by the Government's proposed 20 per cent mandatory renewable energy target, is expected to attract billion of dollars in new money.

Investors are already circling. British gas giant BG Group tried - and failed - to get Origin's blessing for a $13.6 billion takeover last month.

Royal Dutch Shell and Petronas of Malaysia both bought into the Queensland coal-seam gas industry, taking up stakes in Arrow Energy and Santos projects, respectively.

And this month a Japanese company, Mitsui, bought the Bald Hills windfarm project in South Gippsland.

Still, Mr Molitor says the market is underestimating the change.

"If you look at the scale of reductions required in Australia and the timing of those reductions and you look at the fact that gas is now being priced upwards, I would argue that there is still a dramatic mismatch between the scale of the problem and the size of the response."

Companies like Origin, AGL and Truenergy have diversified away from coal-fired generators into gas and renewable energy.

In fact, Citibank analysts estimate that AGL and Origin, which are both listed, will be net beneficiaries from the new scheme, adding up to 36c a share for Origin and 55c for AGL.

Richard McIndoe, managing director of Truenergy, which owns brown coal-fired power stations in Victoria, says the industry needs compensation and incentives to invest in cleaner technologies, such as carbon capture and storage.

"Industry and government modelling has shown that some sectors of the generation industry here in Australia will have value erosion of up to 80 per cent plus of their net present value," he told the Herald. "That isn't just an issue for equity, it becomes an issue for the banks lending to that sector as well.

"And it certainly raises a major concern over how the Government will attract future investment in the low emissions technology."

Truenergy, which is owned by Hong Kong company CLP Power, has pledged not to build any more coal-fired power stations and has invested in gas, solar and windfarms.

Black coal-fired plants are less emissions-intensive. Even so, their value is expected to drop between 30 and 40 per cent under a carbon trading scheme, enough to potentially derail the sale of NSW's electricity assets.

The Australia Institute estimates the carbon liability of the NSW-owned black coal-fired generators between 2010 and 2030 is just over $15 billion. That's more than some analysts' valuations of the state's generation and retail assets combined.

Origin, AGL and Truenergy are all expected to look at the assets. But Mr McIndoe says "without some clarity on [carbon liability], it's very difficult to assess valuation either on the generation assets or the retail assets."
Another tricky issue for the Federal Government is how to treat petrol and transport.

Caltex says emissions from its refineries are equal to 2 million tonnes of carbon a year. Assuming a carbon price of $40 a tonne, it says $80million will be wiped directly from its earnings before interest and tax.
Australia imports just under a quarter of its refined petroleum products from countries such as Singapore, which don't have an emissions trading scheme.

Caltex, like other companies faced with competitors in markets where there is no carbon price, may get compensation for this because it is "trade-exposed".

But Caltex is most concerned about having to take on the liability for private motorists, which is another 35million tonnes of carbon.

That is expected to cost the company $1.4billion in permits, which it plans to pass on to consumers in the form of a 10c jump in the petrol price. The company says it's a big financial risk.

"Even a small amount of under-recovery on our customer's permit costs is going to have quite a large financial impact on the company," its head of government affairs, Frank Topham, says.

The New Zealand Government, which faces an election at the end of the year, recently buckled to pressure and agreed to delay the inclusion of petrol and transport in its emissions trading scheme until 2011.

So far all indications are that both petrol and transport will be included in Australia. Qantas says that will create a double-whammy for an industry already coping with a surging oil price that some predict will reach $US200 a barrel by the end of the year.

"The fuel price is creating its own natural challenge to the industry," Qantas's Mr Kella says. "The Government is talking about the auctioning of 100 per cent of permits in year one.

That will be a huge impact on us as a business and the industry. There will also be flow on impacts from the high price of fuel on industries such as tourism. We're not saying liquefied fuels should not be included in the scheme but the short-term impacts of that on our industry need to be considered."

Qantas says there should be more incentives for companies to invest in alternative fuels or cleaner technologies.

It has about 100 to 120 people working on the issue across the company, including an environment and fuel team and an emissions trading task force.

It is working with airports to cut down on the use of its auxiliary power units, the device on the plane used to start the main engines.

By switching that to ground power sooner, the airline can save a lot of energy.

It's also working with Air Services Australia to develop technology that lets planes to fly in and out of the airport in the most fuel efficient way.

Virgin has been a strong proponent of a national emissions trading scheme and last year launched a government-certified carbon offset program for its passengers.

While focus has been on big polluters such as energy and transport, an emissions trading scheme will affect all companies.

VicSuper's Welsh says property is a good example of a less obvious sector that will be significantly affected by the new system.

"Office buildings with a one or two-star energy rating will find it difficult to get tenants in the future because they have to pay more for electricity and if the building's not efficient it's got both a cost imposition and a branding issue," he says.

About 98 per cent of commercial buildings have a one or two-star rating and many will have to be retro-fitted.

"That's a good example of an opportunity but it's also a real issue for investors because perhaps those buildings are overvalued due to their low energy rating."

Financial services players are already positioning themselves for carbon trading.

Macquarie Bank has set up an emissions trading desk in London, is selling carbon credits out of China into Europe and owns half of Climate Friendly, one of the biggest players in the local carbon offset market.

Last month, Westpac bought 10,000 tonnes of carbon from AGL, at $19 a tonne, in a transaction that will settle in February 2012.

While the trade was largely symbolic - Australia is expected to emit 603 million tonnes of carbon in 2010 - it's a move to position Westpac as a specialist in the area.

Pacific Hydro foresees a lot of international interest, M&A activity and offshore money for wind, solar and hydro in the next 12 months.

"There is already a couple of billion dollars in investments sitting at the starting gate." says its head of corporate and government affairs, Andrew Richards.

Now the Government just has to set up the scheme and get it right.
"If the carbon price is too low, it won't stimulate change in the market place," says Molitor. "If it's too high, then you'll knock people's front teeth out. There's a sweet spot."