The announcement clears up a considerable amount of uncertainty that has bedevilled markets for the last 6 months. Of course, some uncertainty about transition arrangements remains, and in all probability considerable horse-trading about the fine print lies ahead. But at least we know most of the broad-brush strokes: the pricing of the tax for the next 3 years, the scope of its application, the scale of compensation to households and business, the exclusions, and Treasury’s macro-economic forecasts.

Is there anything new to be said about the carbon tax that has not already been covered by the mainstream media? What can one say that is informative, useful or interesting rather than the saturation spin we have been subjected to? It’s a tough gig. Don’t ask me why, but in contemplation of Kevin Rudd’s “great moral imperative of our time”, and Julia Gillard’s response, I’m reminded of a conversation between Woody Allen and a woman in an art museum in his 1972 classic “Play It Again, Sam”.

Last Sunday, the Federal Government unveiled a large chunk of the carbon tax details. As part of its plan to secure a clean energy future, the Government has adopted a new long-term target: to reduce carbon pollution by 80% compared with 2000 levels by 2050. In essence, around 500 companies will have to pay $23 for every tonne of carbon dioxide they emit. The rationale includes promoting more gas-fired or renewable electricity generation; converting coal-fired boilers to gas-fired boilers; making energy-efficient buildings more attractive to tenants; providing an incentive for households and businesses to use energy more wisely, and prompting innovation in technology to reduce pollution.

Among developed economies, Australia is the most exposed to extreme weather conditions, which some blame on climate change. Because 80% of electricity generation in Australia is dependent on coal-fired power stations, thanks to our cheap and abundant coal resources, the country has the highest per-capita carbon emission levels. The scheme will include a raft of subsidies, exclusions and compensations to soften the blow to households and some special interests, a sign that Government is acutely aware that the plan – to be introduced in July 2012 – is a political hard-sell.

Under the proposals, which still need parliamentary approval, an initial three-year fixed-price carbon tax will increase by 2.5% each year in real terms (ie above inflation), before moving to a market-based emissions trading system in 2015. Many of the top 500 polluting companies will receive carbon credits covering up to 94.5% of their carbon emissions initially, some with additional subsidies in the first few years. A carbon tax will not apply to agricultural emissions or emissions from light on-road vehicles, but will apply to fuels used in domestic aviation, marine and rail transport.

The Government will allocate around 40% of carbon tax revenue raised to help businesses, including a Jobs and Competitiveness Program worth $9.2B, and assistance for manufacturers worth $1.2B through the Clean Technology Program. As mentioned, the most emissions-intensive and trade-exposed activities will initially be eligible for 94.5% shielding from the carbon tax. A second category of assistance will provide a shielding level of 66%, which will apply to activities assessed as having a lower risk of carbon leakage. Liquefied Natural Gas (LNG) projects receive a supplementary allocation to ensure an effective assistance rate of 50%, in recognition of the wide dispersion of emissions among some prospective LNG developments.

A new Climate Change Authority will provide independent advice to the Government on pollution caps, the performance of the carbon tax and other initiatives. The Government’s Renewable Energy Target will supposedly deliver around $20B of investment in renewable energy by 2020, with the objective that 20% of Australia’s electricity will come from renewable sources by 2020.

Figure 1. Australia’s Carbon Pollution Profile

Source: 2009 emissions from the National Greenhouse Gas Inventory 2011, DCCEE analysis

The announcement clears up a considerable amount of uncertainty that has bedevilled markets for the last 6 months. Of course, some uncertainty about transition arrangements remains, and in all probability considerable horse-trading about the fine print lies ahead. But at least we know most of the broad-brush strokes: the pricing of the tax for the next 3 years, the scope of its application, the scale of compensation to households and business, the exclusions, and Treasury’s macro-economic forecasts.

We’ll focus on some of the expected winners and losers most affected. So who are they?

First point to make is that it will be very hard to escape the effects of the tax completely as every company will be affected in some way, whether directly or not. The overall effect on the Australian economy is bound to have widespread consequences for consumer confidence, capital investment decisions, and potentially international competitiveness. But this is big-picture stuff. If we focus on individual sectors and on individual companies, perhaps we can get a clearer picture.

Steelmakers are amongst the most exposed to the tax because they have huge carbon emissions as part of their fabrication processes. Companies such as BlueScope Steel Limited (ASX:BSL) and OneSteel Limited (ASX:OST) will be severely affected. The Productivity Commission will review the treatment of the steel industry as part of the Emissions Intensive Trade Exposed assistance review in 2015. Australian steel makers currently face considerable pressures from factors other than a carbon tax, including fierce international competition, increases in raw material costs (such as iron ore and metallurgical coal) and subdued growth in the Australian construction industry. The Steel Transformation Plan will provide $300M assistance over five years to encourage investment and innovation in the steel manufacturing industry, and hopefully transform it into a more efficient and economically sustainable industry in a low-carbon economy.

Mining, smelting and gas will also face significant financial burdens. Coal miners have been especially vocal in resisting the tax, and point to many projects on the drawing board which may be vulnerable. Miners remain skeptical about Government assurances. “The carbon tax puts at risk current and future coal investments in Australia, the jobs of 40,000 direct employees and the jobs of 100,000 … other workers indirectly employed by the coal industry,” said Seamus French, head of Anglo American’s metallurgical coal business.

The Government will be providing assistance to some coal mines facing particularly high imposts as a result of the tax. A small number of coal mines have high volumes of “fugitive” emissions — mainly methane — most of which is released from coal seams during mining. These so-called “gassy” mines will face significant cost pressures: at $23 carbon price, the average non-gassy mine is estimated to face an emissions cost of around $1.40 per tonne of coal produced. By contrast, if no assistance were provided, the average gassy mine would face a cost of around $7.40 per tonne of coal produced, and the gassiest mines could face a cost of around $25 per tonne. The Coal Sector Jobs Package will provide $1.3 billion assistance over six years to the most emissions-intensive coal mines.

According to Rio Tinto Limited (ASX:RIO), the carbon tax will undermine Australia’s international competitiveness and hurt the nation’s export-competing industries. Rio Tinto MD Australia, David Peever said “We are deeply concerned the proposed carbon tax fails to shield Australia’s export sector and leaves it at a disadvantage compared to international competitors. It is crucial that Australia’s contribution to the global effort is in proportion to action being taken by overseas trading rivals so as not to disadvantage important trade-exposed industries.”

Bauxite miner Alumina is another which faces serious headwinds given its high emissions from refineries in WA and its aluminium smelter in Victoria.

The LNG industry gets some protection from the carbon tax, but domestic gas does not. This is a similar arrangement to the previous Carbon Pollution Reduction Scheme. The LNG industry in Australia is going through a massive expansion, with many billions of dollars committed to new projects based on vast resources and robust demand in Asia. LNG receives initial protection of 66% because it is trade exposed. Domestic gas does not receive any protection, despite the fact that electricity generated from domestic gas produces less emissions on a life cycle basis compared to electricity produced in Asia using Australian LNG. The impact of a carbon tax will vary between different LNG projects.

The large utility companies like AGL Energy Limited (ASX:AGK) and Origin Energy Limited (ASX:ORG) are in a somewhat more complicated position. Negative impacts on coal-fired power stations could be offset by higher electricity prices received from gas-fired power stations and renewable energy power plants such as wind. These vertically integrated utility companies often trade in sophisticated financial hedge instruments to limit exposures that might impact profitability, so accurately calculating the profit impact is a tricky business.

Figure 2. Electricity Generated By Fuel Source

Source: Australian Bureau of Agricultural and Resource Economics and Sciences, Energy Update 2011

The airlines will be charged for the carbon they emit every time they fly; burning jet fuel is already their biggest expense at current prices. Virgin Blue Holdings Limited (ASX:VBA) and Qantas Airways Limited (ASX:QAN) will have to work out if they can pass on the additional costs without suffering undue competitive pressures. Qantas has announced that they will be passing on all additional costs of domestic air travel from the carbon tax, estimated by Qantas to be between $110M and $115M. The final impact on Qantas’ earnings will depend on factors such as whether the higher price point is enough to discourage air travellers who would otherwise fly, and whether other domestic airlines intend to pass through all carbon tax related costs to passengers.

The big rail and logistics groups such as Toll Holdings Limited (ASX:TOL), Asciano Limited (ASX:AIO) and QR National Limited (ASX:QRN) appear to be relatively confident about passing higher costs on to customers. Toll has described the move towards an emissions trading scheme as “a responsible approach” and says it is in a good position to promote forms of transport that have relatively low emissions, such as sea and rail. Coal haulage companies like Asciano and QRN may be somewhat concerned that their coal mining customers might curtail production to reduce emissions, which would reduce their revenue streams.

Building materials companies claim the carbon tax will significantly affect their profits, increase the cost of building and favour foreign manufacturers. Boral Limited (ASX:BLD) chief Mark Selway has argued that the tax will cost jobs and make Australia’s manufacturing sector less competitive. Adelaide Brighton Limited (ASX:ABC) MD said higher production costs would almost certainly be passed on to customers, and confirmed that the concrete and lime producer would seek government assistance to help compete against cheaper foreign imports.

Brickworks Limited’s (ASX:BKW) chair Robert Millner wrote to shareholders to say that his group would experience a loss of earnings and that a carbon tax would encourage builders to use steel and cement products instead of bricks. Brickworks has said it is disappointed with the proposals, warning it will negatively impact housing affordability by increasing building product prices in Australia. Over the last decade, Brickworks claims it has voluntarily reduced its carbon emissions by 40% through the closure of old, inefficient brick plants and investment in new plants. It is Brickworks’ intention to increase prices “to fully recover the cost of the tax with price rises of up to 6%”.

The carbon tax will have a relatively modest impact on retailers and the banking sector, but both sectors will be concerned about the impact of the tax on consumer and investor sentiment, already at low levels. Bernie Brookes, MD of Myer Holdings Limited (ASX:MYR), said consumers would face higher prices as retailers passed on higher electricity costs. Mr Brookes said the carbon tax was the last thing discretionary retailers needed as they struggled to lift sales amid increased saving by consumers facing rising living costs.

According to Clime Investment Management Limited (ASX:CIW) analyst Vincent Chin, the most salient points for investors to understand are as follows:

• Mining, building material, steel manufacturers, utilities, energy producers and airlines are the greatest carbon emitters.
• While the major miners (particularly BHP and RIO) are the largest carbon emitters of the ASX listed companies, the amount of tax payable (at $23 per tonne) is actually very small compared to their forecast profitability – less than 2% of their net profit after tax (NPAT) in Financial Year 2013.
• On a NPAT basis (based on FY13 forecasts), the companies which are most impacted are BlueScope Steel, Virgin Blue, Adelaide Brighton, Envestra Limited (ASX:ENV), Qantas, Boral, OneSteel, and CSR Limited (ASX:CSR) – all with more than 15% of their profitability at risk. Other companies less affected but still taking a large hit include AGL Energy, Alumina Limited (ASX:AWC), Brickworks, and Woodside Petroleum Limited (ASX:WPL), with more than 5% of their market consensus FY13 NPAT at risk.
• On the other hand, the least impacted companies are the financials, particularly the major banks in term of the percentage of NPAT at risk (at less than 1%). It is probably fair comment to note that it is the banking sector (particularly Westpac Banking Corporation Limited (ASX:WBC) which has the reputation as being the most environmentally conscious.

Figure 3. Company CO2 Emissions

It is likely that many of these companies will be able to pass some or most of the tax on to their customers. In all probability airlines and utilities companies will find it easier to pass on most of the carbon tax to their customers compared with steel and building materials companies which may struggle.

At a $23 per tonne, the total amount of tax to be collected from reviewed companies is around $2.6B, roughly equivalent to around 2.5 % of the total forecast NPAT of these companies in FY13. It has been estimated that the 50 largest polluters will be responsible for paying approximately 75% of the carbon tax – thus an inherently narrow base on which to build the tax, and making it vulnerable to a change in fortune for those sectors and/or companies. Assuming that these companies represent about 70% by market capitalisation of the listed market, and that the entire listed market is roughly a third of total corporate Australia, then if the carbon tax raises $10B in FY13, this would represent a tax of about 0.7% of Australian GDP.

Some companies have already taken initiatives to offset their carbon emissions and developed hedges, offsets and a time-line to be carbon neutral. Thus, it is possible that the amount of carbon tax that is projected above may be reduced and that the ultimate after tax profit affect will be less pronounced.

The scheme adds to the deficit, but mainly in 2012 when the assistance to households comes into effect ahead of the collection of the carbon tax. According to Treasury modeling, taxing carbon is expected to slow Australia’s average income growth by around 0.1% per year. The modeling also suggests slightly less than a 1% rise in the CPI, mainly in 2013. Assuming these minimal impacts on either growth or inflation, it is hard to see any significant implications of the tax for monetary policy.

The plan involves a net cost to the Budget of $3.8B over the four years to 2014-15. The majority of this cost ($2.7B) is provided prior to the commencement of the carbon tax to assist households and businesses adjust. The ongoing fiscal cost is relatively modest, and includes the additional cost of the tax reform elements of the household assistance package.

Given the package has been negotiated with the Greens and the Independents, it is likely it will pass both Houses of Parliament by year end. With the Greens holding the balance of power in the Senate for the next six years, it appears unlikely we will see the tax repealed.

Australia is not alone in adopting some form of carbon tax or trading system. The European Union’s scheme started in 2005 and is the largest in the world. New Zealand launched one last year and authorities from California to South Korea are working on plans for similar initiatives. The carbon pricing plan puts Australia on track to have the biggest emissions trading system outside Europe and could perhaps provide some momentum to the development of a global carbon market.

Many listed companies have warned of price increases and job losses as a result of the adoption of a carbon tax. But putting the histrionics and the politics aside, in all likelihood the real effect on economic activity is unlikely to be as severe as feared. We will have to watch and wait for a few years before we really know. One thing we do know for sure, though – we are all going to be subject to a deluge of political posturing, partisan advertisements, righteous pronouncements and self-interested commentary from all manner of experts and business people. One idea if you want a peaceful refuge – go to an art gallery. Who knows, they may have a Jackson Pollock painting you can admire.The information provided in The View and myclime.com.au is intended for general use only. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein. myclime.com.au is intended to provide educational information only. Please be aware that investing involves the risk of capital loss.