Carbon Pollution Reduction Scheme: White paper puts energy efficiency high on board agenda

The pending Carbon Pollution Reduction Scheme will come with significant costs and requires priority attention at every level of every affected organisation, Deloitte Consulting partner and national climate change lead CHRIS WILSON says.

AFTER a decade of intense national debate and a year of wide-ranging consultation between the federal Government and stakeholders, a critical policy decision has been made: Australia is to become a carbon-constrained economy.

The Carbon Pollution Reduction Scheme (CPRS) will change Australia's business environment fundamentally. The Government has rightly described the introduction of the CPRS as the biggest structural economic reform since the opening up of the economy in the 1980s and 1990s.

Critically for business executives, the CPRS white paper confirms that the Government does not intend to delay the introduction of emissions trading. This has serious implications for industry across Australia. It means that in a little more than 18 months, a complex and ambitious scheme will be implemented. Companies required to participate in the scheme must fast track the implementation of systems necessary to comply and where appropriate take advantage of the relevant incentive schemes and programs.

Pollution now has a price

Chief financial officers (CFO) across corporate Australia will have a new line item to manage. Greenhouse gas emissions now come with a price tag. Approximately 1,000 organisations are affected directly by the pollution reduction measures. And they will pass on the additional costs of purchasing emission permits and of managing their new obligations to the consumer. The impact of the legislation will therefore be felt throughout the Australian economy. The price changes over the next decade will most likely influence consumers' purchasing behaviour.

The cost impact will be significant. In the wake of the December announcement, the Australian Industry Group said the CPRS would add about $7 billion annually to business costs after compensation in 2010, when it takes effect under the Government's proposed approach, rising to $10.5 billion by 2020.

The primary reason for using a market mechanism - emissions trading - to pursue greenhouse gas abatement, is that putting a price on something reduces the effort required by the Government to ensure that producers, consumers and innovators make appropriate decisions.

On the other hand the Government cedes control over exactly how the desired outcomes will be achieved -over how firms will respond and how the scheme interacts with other pressures on the economy.

Notwithstanding a major economic modelling effort over the past year, the influence of such a broad approach on an economy already under pressure from the global financial crisis cannot be predicted with certainty. An example is the $7.5 billion difference between models prepared for the Government on the impact of emissions trading on the asset values of electricity generators using black coal - and this for a sector where the impacts of the CPRS are probably best understood.

In these circumstances the Government appears to have decided to be cautious in managing uncertainty and minimising the risks.

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A new management focus is now critical. Emissions trading means that carbon management is no longer merely an issue for a company's environmental or sustainability team, it is the new "business as usual" and will require priority attention at every level of every affected organisation.

As a result of the December announcement, it is now an everyday challenge for the C-suite (chief officers), who will need to consider the following options and approaches.

  • strategic challenges: review strategies to pursue opportunities and mitigate risks in the carbon-constrained economy
  • data integrity: know the emissions intensity of their operations
  • political risks: understand the various impacts of the policy on their key markets
  • impact of price: deal with changes in price for their key supplies
  • tax implications: appreciate the new business opportunities that a carbon-constrained economic future will present
  • accounting changes: be ready to cope with changes to accounting policy and financial reporting
  • compliance: comply with new regulatory obligations or face the penalties for failure to meet them
The price of failure to cope with the new environment will be substantial in terms of long-term shareholder value and short-term operational costs.

Strategic challenges

Most major carbon emitters understand their direct liability and the pass-through effects from fossil-fuelled electricity suppliers, but few understand the indirect costs and risks from "embodied emissions" of other upstream supplies. Fewer still understand the risks and opportunities from changes in downstream markets or the competitive dynamics of their new environment.

The CPRS is a strategic management issue for business, one that requires an understanding of market dynamics in a carbon-constrained economy. Businesses also need to be aware of major new opportunities, including arbitrage (simultaneous purchase and sale) on forestry permits or Kyoto treaty flexibility mechanisms, energy efficiency improvements and strategic pass-through of carbon costs.

How businesses manage their exposure to carbon prices - and this includes the sectors that receive substantial free permits - will become a major differentiating factor in the marketplace. Those who excel at managing the CPRS impact and any Government assistance will outclass their competitors.

The proposed Renewable Energy Target (RET) scheme, aiming to achieve a 20% mix of renewables by 2020 - is expected to support the building of an alternative energy industry and will result in opportunities to embrace new technologies across the industry. The ability to access available financial credits through government grants and rebates will present opportunities to industry and domestic users, as well as potential revenue opportunities through in-tariff schemes. It is expected that the levels of new investment and market based opportunities will increase as the legislation is introduced and the renewable energy industry begins to grow.

Data integrity

Businesses will now need to maintain emissions records to levels of accuracy and robustness similar to those applied to audited financial statements. Only robust and audited carbon reporting will make it possible for the Government to:

  • determine which companies are included in the scheme
  • manage the assistance to be given to trade-exposed and strongly affected industries
  • register carbon trading activities and ownership of carbon permits
  • manage the related taxation issues resulting from the scheme
  • penalise companies that fail to comply with the scheme
Data integrity is also critical for companies to manage their risks effectively and to take advantage of new opportunities, including the assistance mechanisms in the CPRS.

Political risks

While the Government has made its decision, political risk remains a reality for consumers, especially business, because Labor lacks a senate majority. The initial reaction of the opposition and the Greens indicates that the next big hurdle for the CPRS will be a senate committee review when the legislation is presented to parliament in the New Year.

Negotiation of legislation through the Senate in the first half of 2009 will be difficult and when the enabling bill will become law is an open question, but the Decemberdelivery of the Government's CPRS white paper was a starting gun to the business community.

Business leaders should be under no illusion - the policy is coming and they should be fully prepared for it when it emerges from parliament next year.

Another risk for business is that a low target start to the CPRS may well see heavier emission caps imposed in the future. Future Government policy responses to increased evidence of climate change may well see imposition of changes that could challenge the viability of long-lived assets or strategic plays.

Impact of a carbon price

At the centre of any corporate strategy is the need for a full understanding of the way the carbon price will impact on a business' bottom line - and therefore an understanding of its own emissions and those of its suppliers. Energy efficiency and other abatement opportunities will need to be identified and costed. Due diligence on new investments, acquisitions, new plant and general business expansion will now require specific attention to be paid to carbon risks and opportunities.

The targeted 1000 businesses already need to deliver robust and verifiable reports on their carbon emissions under the National Greenhouse Gas and Energy Reporting Scheme (NGERS), introduced on 1 July 2008, but it appears that many are struggling to cope with the requirements of even this legislation. Passage of the Carbon Pollution Reduction Scheme Bill in 2009 will impose still greater pressures for good corporate governance.

The first thing affected companies need to do is to speed up their efforts to comply with the NGERS regulations. The NGERS stipulates that they must prepare robust reporting for their carbon emissions and energy use for the year ending 30 June 2009 by 31 October 2009.

For companies that want to take advantage of the assistance for trade-exposed industries, there will be a requirement to measure carbon emissions and energy use from as far back as 30 June 2004 and over the ensuing four year period in order to establish the extent to which government assistance may be obtained. The Government has increased the measurement period by two years in response to comments made by industry on possible cyclical impacts if the period was too short.

Tax implications

The CPRS white paper timetable has outlined that discrete tax legislative provisions are set to be released in late February 2009 in an attempt to treat all taxpayers fairly . The white paper details the Government's position in relation to the tax treatment of permits that may be issued under CPRS, including:

  • the adoption of the 'rolling balance method'. Taxpayers will be required to elect to use either historical cost or market value for all permits held at the end of that income year
  • permits must be surrendered before year end in order for a taxpayer to obtain a deduction in that income year
  • there will be no limit on the quantity of international permits that can be transferred into Australia. This provides unfettered access for Australian taxpayers into international carbon markets. Businesses should review their strategic plan, considering potential restructuring of current business operations, acquiring new businesses, treasury desk operations, expansion of activities offshore, major capital works expenditure, and a review of staff employment policies.

    Important taxation considerations needing attention include:

    • the timing issues for the surrender of permits and obtaining applicable tax deductions
    • eligibility for government support, grants and allowances
    • Government lobbying prior to the release of CPRS legislation in early 2009.
    The Carbon Pollution Reduction Scheme will induce significant structural change in the Australian economy. While some firms will be significantly challenged by the introduction of the Scheme, the Government's transitional arrangements are likely to minimise the 'shock' to the Australian economy.

    In a decade, the Scheme is likely to be seen as just another major factor that has altered the economic environment in which firms operate, akin to globalisation and the opening of the Australian economy to international markets in the late-1980s and 1990s.

    To survive in this new carbon-constrained economy, you will require excellent information about your own business, your supply changes and your target markets, knowledge of your key carbon exposures, high quality and flexible management and resilience in the face of change.

    This article first appeared in Business Community Intelligence, Febraury 2009