Welcome to the climate economy

03 Sep 2007Archived News Energetics in the News

PUBLISHED: In the Black magazine - By Giles Parkinson - Cheryl Bowler, Principal Consultant - Carbon Markets & Strategy, Energetics Pty Ltd. is asked to comment on the impact of carbon trading on business conduct.

 

DEALING WITH GREENHOUSE EMISSIONS WILL HAVE A DRAMATIC EFFECT ON HOW COMPANIES CONDUCT BUSINESS IN COMING YEARS.

You can’t see them, you can’t touch them, yet most people are now familiar with the concept of greenhouse emissions. Scientists are convinced that their accumulation in the atmosphere, provoked largely by human activity, is causing catastrophic climate change, and many want them traded out of existence.

How that is achieved will likely have a dramatic impact on the way corporations conduct their affairs in coming decades. It will create new assets and new liabilities. It will impose demands for new governance structures, and have implications for tax accounting, regulatory and auditing regimes. It will impact on internal resources, and it will pose profound challenges (and opportunities) to business structures, markets for products and corporate reputation.

Welcome to the so-called carbon economy. Or should that be carbon-restrained economy? However you wish to phrase it, efforts to reduce the world’s reliance on carbon-polluting activities may well be the biggest single challenge – and opportunity – for business since the industrial revolution.

Carbon emissions have been recognised as an issue within sections of the scientific community for more than 100 years, and within sections of business and government for nearly two decades. But despite the signing of the Kyoto Protocol in 1996, it was not until Al Gore’s film An Inconvenient Truth, last year’s publication of the Stern report (the first to identify the potential economic and corporate impact of climate change) and the latest reports from the Intergovernmental Panel on Climate Change, that the issue became the subject of everyday discussion in the boardroom, as well as on the street.

“The uniqueness of the carbon market is that it is a commodity that is becoming part and parcel of almost any company’s activities,” says Craig McBurnie, a director of commodity derivatives at ABN Amro who heads the bank’s carbon-trading operations in Australia.

Andrew Peterson, the head of the climate change services team at PricewaterhouseCoopers, agrees. “All business is at risk, it’s just a question of how it is managed,” he says. “The identification of winners and losers ignores the fact that business is very adept at identifying risk and strategically responding to that risk. We will see new openings, new opportunities and (new) business decisions based around this issue.”

Petersen says the biggest challenge for European businesses, where a carbon-trading scheme has been in force since 2004, was that they were not prepared for its commencement. “That’s a big take-away for Australian business,” he says. In that sense, adds Deutsche Bank’s Paris-based commodity research analyst Mark Lewis, Australian companies seem well focused. “I’ve been astonished at how quickly the logic of what is being proposed is being internalised by Australian companies,” he says. “I am very impressed at how strongly they have concluded that the introduction of this scheme will change patterns of behaviour.”

He points to decisions on projects such as brown coal power plants. In Australia, he says, no financier would back such an idea, simply on the basis of climate risk. In Germany, however, despite its strong reputation for developing clean technologies such as wind and solar energy investments are still being made in brown coal energy production.

The biggest impact for all businesses from carbon trading will be increased energy costs; how they treat these costs is another matter. “Some people will see it as a pass-through cost.” Says Cheryl Bowler, a carbon-trading expert at Energetics. “But the first thing to do is to be more energy efficient – that way you use less fuel.”

Many companies, such as PwC, have declared their intention to make themselves “carbon neutral”, which usually means making efforts to reduce energy consumption and finding mechanisms to offset what energy they do consume. Peterson says PwC committed to making itself carbon neutral by 2008 because it was a responsible move by the organisation, and it has generated enormous positive feedback from staff and clients.

Bowler says aiming to become carbon neutral is a valid goal for those organisations that want to go beyond mere compliance. But they should be aware that mandatory carbon trading will result in increased energy costs, and therefore higher costs for any offset schemes. “Mandatory trading will drive up costs, and those that have been carbon neutral will have to pay more,” she says. “People should look at (energy) reductions first.”

The issue is highly complex and such decisions are having impacts on suppliers and up and down the business stream. There is anecdotal evidence that firms asked to tender for services contracts are being interrogated about their carbon credentials.

Part of the problem is the ownership of the emissions – no easy matter in complex manufacturing processes.

“The ownership of emissions can be very complex,” says Bowler. “There needs to be legislated standard. Companies need to know that what they are doing is acting to reduce their own carbon footprint rather than someone else’s.

Carbon trade-off?
Australian politicians, environmental organisations and business groups have been arguing about the merits of a carbon-trading system for years. But the fact is that carbon trading has existed in some form in Australia for more than a decade.

According to Energetics’ Bowler, informal trades of carbon took place in the mid-1990s, many of them as some form of carbon offset with forestry groups. A voluntary market created by the Australian government called “Greenhouse Friendly” attracted the first major carbon transaction in 2001, when Origin, BP the Oil Company of Australia and Santos signed an agreement over the venting of methane gas from the Yellowbank gas production facility in western Queensland.

Greenhouse Friendly is now the fastest growing carbon market in the country and is used to create and promote carbon-neutral products such fuels, paints and even flights.

Other legislated schemes have also been created, including renewable energy certificates (RECs) created by legislated renewable energy targets introduced in 2001. NSW also introduced a greenhouse-abatement scheme (NGAS) in 2003, while Queensland created gas electricity certificates (GECs) to promote the construction of gas-fired plants in that state.

But the major focus for the business, consumers, legislators and environmentalists remains on how and when a national carbon-trading scheme, designed to heavily reduce the amount of carbon emissions in the country, will be introduced. The Australian government has promised this no later than 2012, but despite calls from energy producers and other business groups, few details of targets and of the structure of the scheme have been released, and won’t be released until after the election later this year.

What is clear is that the introduction of a national carbon-trading scheme will have a profound impact on Australian business. Prime minister John Howard describes it as the most important decision affecting Australia’s economy over the next 20 years. Billions of dollars of assets and liabilities will lie in decisions on how permits are allocated, whether they are given away or auctioned, and which industries, if any, are awarded “carbon holidays”.

Despite the signing of the Kyoto Treaty in 1996, national and international carbon markets have been slow to develop. But they are now starting to gain momentum. According to Deutsche Bank’s Lewis, global turnover trebled from US$10bn in 2005 to US$30bn in 2006. Much of this (about US$24 =bn) was in the first phase of the European compliance scheme, known as ETS, while a further US$5bn came from the clean development projects (CDM) developed under Kyoto.

Other schemes also exist. These include the Chicago Carbon Exchange, a voluntary scheme with legally binding targets – which includes Australian companies such as AGL – and a joint scheme created by several states in the north-eastern corner of the US. Australia’s state governments have also discussed the introduction of their own schemes, should the federal government fail to implement its own, and the Australian Climate Exchange is about to be launched in an attempt to bring together the carious local schemes.

Lewis expects the carbon market to grow to at least US$100bn by 2010. These are relatively small numbers compared to other commodity markets, but they could soar into the trillions of dollars if the US and other countries were brought into trading schemes. “The potential is enormous,” he says.

Both the ETS and the CDM have received much criticism. The ETS because it has initially failed in its primary objective (to encourage a reduction in carbon emissions and an investment in clean technology) as a result of too many permits being allocated, particularly to countries that overestimated their past and future emissions. Another weakness was the decision to give permits away rather than auctioning them, which resulted in windfall gains for some companies in the energy sector.

Nevertheless, says Andrew Peterson, who heads the climate change services team at PricewaterhouseCoopers, the European scheme has been identified as fundamentally sound and in its second phase, which begins next January, it is expected to be a stronger price signal designed to push companies towards energy efficiency and/or investment in clean technology.

Peterson says a carbon market needs to satisfy three key tests if it is to be effective. “It has to be accountable, and it has to be transparent,” he says. “Thirdly, it has to have integrity – both economic integrity and environmental integrity. If that’s not going to be achieved, then they need to look at other forms of strategic response. The advantage Australia has is that it is still five years away from implementing a trading scheme. This gives time for companies to compile verified emissions data, to decide on how to do allocations.”

The Australian government has said it will introduce a cap-and-trade system – a similar principal to the ETS. What is not known is what reduction targets will be set, a key factor in the setting of annual price mechanism. This is frustrating energy producers and retailers, who need to factor in price estimates in new projects. Energy producers are also hoping the various trading schemes will be standardised and folded into one national scheme.

Both Lewis and Peterson argue that a successful scheme must have rigorous standards on emission data, and believe a scheme will be more effective permits are sold rather than given away.

Lewis says it is a fallacy to believe that selling permits will cost consumers more. “Whether you auction them or give them away doesn’t affect the market price. That is set by supply and demand, Lewis says. “If you give them away, the biggest beneficiary will be shareholders.”

Bowler says even if companies take advantage of a cheap source of abatement – such as the light global giveaways in NSW – that’s still not necessarily a bad thing. “The whole point is to get ideas out of the woodwork from areas you don’t expect,” she says. After all there’s nothing as inventive as a capital market.

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