Like ships passing through the night, the discussion on emission-intensive trade-exposed (EITE) industries seems to involve two separate conversations. One where those industries most affected (eg steel, aluminium, cement) talk about earnings impacts and job losses. And the other involving policy makers, equity analysts and NGOs questioning whether the impact would be quite so bad. Throw into this mix a very strong Aussie dollar with its detrimental impact on Australian-based export manufacturing and you end up with a very interesting cacophony of messages. What are we to believe is the true situation?
What’s prevented these conversations from meeting, at least through the public debate, is the lack of underpinning assumption made behind the numbers being presented. And the two critical assumptions here are the amount of assistance being provided and the proposed carbon price. [As an aside, there’s another assumption required, being the availability of abatement options, but that’s for another blog. Most estimates assume no abatement options]. A good example is BlueScope’s recent estimate of carbon costs of at least $450m through 2012-2020; how do you get to this number, what level of compensation and carbon price is assumed? Another is ACIL’s calculation of the raw carbon cost to the coal fired generation sector, the headline of which was a cut to earnings of $11bn (again, summed over the 2011-2020 period to make the number look bigger); this calculation presumably included the the ability to pass on costs, which most coal fired generators (other than the most greenhouse-intensive) will be able to do, recognising that this sector is not trade exposed. But it’s unclear whether any “compensation” or other assistance is added to the picture.
On what basis would one assume that no assistance would be made available? It’s peculiar, because EITE assistance has been a feature of ETS design in this country going back a decade. Combet recently made it clear that the starting point for negotiations on EITE assistance would be the CPRS package, which offered up to 94.5% in free permits. What’s even more peculiar is that for the company to make this case, it involves talking down to the greatest possible extent the future earnings potential, with a consequential impact on the share price.
Making steel in a blast furnace has a greenhouse intensity of roughly 2.4tCO2e per tonne of steel. So if you apply a carbon price of $20/tCO2e and then provide free permits to 94.5%, the actual price impact is around $2.6 per tonne of steel. This is in the context of steel prices forecast to rise significantly this year, and perhaps track towards US$1000/t by the end of the year according to some reports. Note also that a 10% appreciation in the Aussie dollar has a far more significant impact on exporters than a carbon price, on a $ per tonne of steel basis. I’m not saying there won’t be an impact from carbon; clearly there will be, and it will be material in EBIT terms, but given the other factors involved, it can’t possibly be the difference between continuing to operate versus shutting up shop.
Another illustration of the two conversation problem arose last week with the Murdoch press appearing to take delight in claiming that BHP Billiton CEO Marius Kloppers had changed his position in relation to carbon pricing. If you look at what he actually said, and what he said in September last year, you’ll see that there’s actually no change to his position. His well-considered speech to the Australian British Chamber of Commerce pretty much kicked off the carbon debate again in this country after the 2010 election, and included a call for a clear price signal, revenue neutrality and a trade-friendly system. His comments last week in relation to “dead weight cost” were clearly in the context of a situation of no assistance, whereas we all know that some form of assistance will be provided.
So it appears that the negotiation boils down to the gap between the government’s offer of 94.5% compensation and the EITE’s call for 100%. We are not too far apart here!
It’s easy to see how people can come to the, in my view misguided, conclusion that “a carbon price will kill the economy”. If the whole economy was populated by highly emission intensive and trade exposed activities AND there was no compensation provided, perhaps then I would agree with the conclusion. But clearly that’s not the case. Firstly the economy is a multi-faceted one with many sectors with a range of emission intensities. There will be some companies that will do well and others that will be worse off once a carbon price is applied. Secondly, clearly there will be EITE assistance. So calculation of impact should be done on that basis.
You’d expect that the EITES most impacted by a carbon price would use every tool at their disposal to minimise the cost impact on their business, including vigorous lobbying. But it would be a mistake to extrapolate the notion that just because they are thumping the table the loudest means the whole economy will be impacted in the same way. The carbon price gives effect to a structural shift in the economy, from higher emission intensive to lower emission intensive, but overall is predicted to still grow at a rate only 0.1-0.2% lower than the “business as usual” scenario. The “offset” is the range of sectors in the economy that will grow due to the carbon price signal.
I’m looking forward to seeing the outcome of the government’s deliberations on the level of the carbon price and the proposed compensation package, so we can all get on the same page.