Carbon Pollution Reduction Scheme: Corporate responsibility becomes business as usual

Climate change is no longer an issue for just your environmental or sustainability team. It is about to become an everyday challenge for your organisation and will - or should be - occupying the attention of your organisation's most senior decision-makers, including your chief executive officer, chief financial officer, chief risk officer and chief information officer. JON STANFORD and ROD MARSH from Deloitte Economics explain.

Climate change and corporate responsibility

Nobel laureate Milton Friedman once railed against proponents of corporate responsibility, arguing that anyone who believed that "business is not concerned 'merely' with profit but […] has a 'social conscience'" was "preaching pure and unadulterated socialism". Cold war paranoia aside, general perceptions of corporate responsibility's role have moved onto a different plane in the last decade. Investors now take account of sustainability indices, Australian banks are rushing to sign the Equator Principles and strategy luminaries like Harvard's Michael Porter claim that corporate responsibility can be "much more than a cost, a constraint, or a charitable deed - it can be a source of opportunity, innovation, and competitive advantage."

While the argument about the value of corporate responsibility continues (the Economist more recently called some corporate responsibility efforts "delusional"), in Australia it is about to become moot as far as greenhouse gas (GHG) emissions are concerned. The Rudd Government's push to introduce emissions trading by 2010 will soon make a focus on reducing GHG emissions the new business as usual. We need to learn to do business in a carbon-constrained economy. Fast.

Emissions trading, Garnaut and the Carbon Pollution Reduction Scheme Green Paper

At its roots the reasoning behind the proposal for emissions trading is simple: a substantial cost should be levied on GHG emissions because economic actors need to confront the reality that our market economy has a massive externality cost that needs to be incorporated by charging us all full freight.

The core proposal may be simple, but the implementation and design of an effective emissions trading scheme is far from it. The complexity of the issue can be seen in two recently released documents that have been the focus of much attention over the last month: the draft Garnaut Review report and the Federal Government's Green Paper on the Carbon Pollution Reduction Scheme.

Garnaut offers a preliminary assessment of the potential economic effects of unmitigated climate change in Australia - emphasising how serious an economic and environmental challenge it is for Australia. We face perhaps the greatest challenges of any developed nation: irreparable damage to our traditional agricultural sectors; increased severe weather events; and serious challenges to community health. Key markets for our resources in the developing world are also likely to be significantly affected by climate change.

After assessing the impacts of unmitigated climate change, Garnaut offers his proposals for the major policy lever for addressing Australia's own GHG emissions - an emissions trading scheme - and the potential for international market linkages and collaboration.

The Government commented recently that the Garnaut report represents only one input into the policy process and the content of the Green Paper on the newly dubbed "Carbon Pollution Reduction Scheme" confirms this. Although the Green Paper adopts the most obvious of Garnaut's broad recommendations - that Scheme coverage be broadly based in terms of both economic sectors and greenhouse gases included - it makes a number of pragmatic policy decisions not canvassed by Garnaut. The most significant of these are the decisions to lower the fuel-excise on a cent-for-cent basis to minimise the immediate impact of the scheme on motorists and the transport sector, to offer free permits to a reasonably broad set of emissions intensive, trade-exposed industries (EITE industries) and to compensate coal-fired electricity generators.

Changing our economy, changing the environment in which you do business

The proposed Carbon Pollution Reduction Scheme will be the most substantial economic intervention Australia has seen since the Labor Government's trade liberalisation and financial market reforms in the 1980s.

The Government will issue carbon pollution permits up to a total emissions cap for the sectors of the Australian economy covered by the scheme. Each permit allows the emission of one tonne of CO2-equivalent (the measure that makes comparable all six gases included in the Kyoto Protocol). Those organisations which fail to surrender sufficient permits will be liable to a penalty.

Although only 1000 of Australia's biggest emitters will be directly liable under the scheme, those liable are likely to pass on the additional costs of the carbon pollution permits they must purchase, driving the costs of the scheme throughout the economy. By pricing carbon and setting a cap on Australia's emissions the scheme will impose a slow, powerful and inexorable force on the Australian economy. It will influence production, consumption and investment decisions, change relative prices and costs, demand structures and supply chains. It will present opportunities to some sectors and limit others. Some organisations will prosper; others will linger for a while and then disappear. The Green Paper proposes a series of transitional arrangements designed to minimise the initial 'shock' to the overall economy. These include free permits to emissions-intensive, trade-exposed industries and assistance to coal-fired generators. There will also be a Climate Change Action Fund to assist business with the transition to a carbon-constrained economy, by providing partnership funding for investment in low-emissions and energy-efficient processes and communicating best and innovative practice to SMEs.

What you can do

The effects of the scheme will be asymmetrically distributed across and within sectors of our economy - this asymmetry will itself be affected by government assistance. Wherever you sit, the movement to a carbon-constrained economy means that it is imperative that you understand a number of new things about how your organisation works. You will need new information about your business, your energy use, your supply chains, your target markets and your key carbon exposures. You will also require high quality and flexible management and resilience in the face of change.

Each step of the new journey towards reducing emissions will be challenging and many organisations will need assistance. Organisations - your organisation - should:

  • determine your exposure to a carbon price by examining your carbon footprint and emissions intensity
  • establish whether you are a liable "entity" under the Carbon Pollution Reduction Scheme
  • test your National Greenhouse and Energy Reporting System (NGERS) compliance and readiness if you are likely to be one of the 1000 organisations liable under the scheme - see
  • evaluate the tax implications for your business under the scheme
  • ensure that all your emissions monitoring, accounting and reporting systems are not only NGERS compliant, but are integrated into your financial systems
  • identify opportunities and key growth sectors for investment. (The Scheme is not only about risk, but also about opportunity. It will drive investment in low-emissions technologies and secondary trading markets.)
  • find efficiencies and economies in your supply chain and logistics to help maximise your operational efficiency to minimise the carbon costs that will be passed on through the scheme
  • determine the impact of a carbon-price on your existing and future business, as part of your due diligence before making a major capital investment or restructuring your investment portfolio
  • determine whether you are eligible for assistance under the scheme

    What remains to be revealed?

    The Federal Government has reserved its final decision on the medium-term emissions trajectory and emissions (and possible price) caps that will ultimately drive the price of carbon pollution permits under the scheme - these are due in December 2008 with the White Paper and the Exposure Draft of the Scheme legislation. Until these decisions are made there can only be indicative projections of price increases under the Scheme and the ultimate decisions will be made when we understand what actions other countries will take.

    The specific plans for revenue recycling remain unannounced and it is these plans, like the thresholds for EITE industry status, where we can expect to see some serious lobbying of government, particularly as the specific challenges of getting the scheme legislation through the Senate become clear.

    Indeed, the issue of passing costs through needs significant further analysis given its potential impacts across the economy where forward contracts do not have clauses anticipating the changes the scheme will bring (unlike the GST legislation which dealt specifically with this issue).

    Putting Australia's efforts in a global context

    The truth is that only a truly global response will help Australia avoid the damaging effects of climate change. While each country needs to take action for the policy to be effective, there is a great temptation for individual countries to try to avoid being part of any international mitigation scheme and 'free ride' on the efforts of others.

    Garnaut's characterisation of this issue as a 'diabolical' policy problem is certainly correct for the design of Australian emissions trading. A hard-line Australian mitigation effort not reciprocated internationally could well lead to an unintended, but highly damaging, outcome where Australia's economy may be weakened. In this case, we would be less able to respond to severe climate change outcomes.

    At the same time, a weak scheme with too many loopholes and exemptions has the potential to lower our international credibility and potentially delay effective international action that would reduce the probability of high impact climate change events.

    Somewhere between these two extremes there is a 'sweet spot' for Australian action, but it is unlikely to be able to be determined in advance.

    Ultimately, this will be how the scheme will be judged - by the care with which it takes the Australian economy into a carbon-constrained world and the extent to which it leads and influences the global mitigation effort.

    Whatever the outcome, the scheme will embed climate change mitigation efforts throughout our economy. Climate change will cease to be an issue of corporate responsibility and become part of the business as usual environment.

    To read the Green Paper, click here.

    Jon Stanford is Deloitte Economics' key partner focused on climate change and emissions trading issues. He has been intimately involved with the provision of public policy advice to business and both state and federal governments in the climate change arena for more than a decade and is currently advising the Northern Territory government on its climate change strategy. Rod Marsh works with Jon as a Director in Deloitte Economics practice. He is currently working on climate change projects for the Victorian and Northern Territory governments and with private sector clients as well as on the assessment of carbon market risks and the design of emissions mitigation portfolios.

    This article first appeared in Business Community Intelligence, August 2008