Carbon Reduction And The Stock Market

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This story features ORIGIN ENERGY LIMITED, and other companies.
For more info SHARE ANALYSIS: ORG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

 By Greg Peel

While Big Industry in Australia has had a very tough year in the face of what is now popularly known as the Global Financial Crisis, it would have been counting its lucky stars yesterday that the GFC arrived ahead of the Australian government’s carbon reduction bill and not the other way around. Rudd won government last year for many reasons but a more stringent approach to carbon emission reduction was clearly one of them, as least as far as the general public was concerned. For Big Industry, the previous Howard climate change denial policy was far more attractive.

The earlier “green paper” – a generic expression to outline a framework of a bill and encourage discussion rather than a specific reference to green-ness – was delivered at a time when the credit crunch had hit, but the global meltdown phase had not. The GFC has already forced the Rudd government to completely readdress its fiscal policy platforms, and has now forced a rethink on carbon emission toughness. It would have been a lot easier to hit Big Industry hard when commodity prices were still rocketing in the first half of 2008.

In short, the white paper – the paper that follows the green paper and outlines specifics, allowing final tweaking before being presented to parliament as a bill – on the Carbon Pollution Reduction Scheme has proven to be very, very accommodating. Accommodating, that is, to Big Industry. For those Aussie Battlers who voted for strict emission reduction, their reward is just higher utility costs.

The magic number green groups were looking for started at 25%. Rudd delivered 5%, and so there’s little surprise green groups are not very happy. The CPRS will be initially based on an emission reduction target of 5% by 2020 from 2000 levels. A 5% reduction will seem like a drop in the ocean to those residents of Sydney’s Neutral Bay who watched a retaining wall on their block of units wash away in the king tides on the weekend. However the government has sold it on the basis of those 2000 levels. If you take into account Australia’s rapidly growing population over the last eight years, a reduction of 5% from 2000 equates to a reduction of 27% on 2000 population levels. Or so the maths goes. This brings the real reduction up to more like the same level of the tough European scheme, but it’s a spurious argument.

The biggest stumbling block for national reduction schemes ever since the Kyoto Protocol was drafted has always been the “why should we if they don’t” argument, with a specific finger pointing at China as well as India and others. So Rudd has cleverly stymied such an argument by suggesting that the reduction target to 2020 will be increased to up to 15% if other countries begin falling into line. The next step is a 60% reduction by 2050, but that’s so far away as to be meaningless.

The most important change from the green paper to the white is the free permit kick-in level reduction from 1500t of carbon per $1m revenue to 1000t. Companies producing over 2000t will recieve 90% of their permits for free and the 1000-2000t band will recive 60%. A permit will start at $25/t with a cap of $40/t in the initial phase. There will be a watchdog body set up to police “windfall” profits potentially arising from the free permit system, such that permits can be taken away.

The reduction in the carbon threshold to 1000t is effectively a nod to Australia’s globally significant LNG industry. The LNG industry offers up a bit of a catch-22 in carbon reduction schemes because it is itself a polluter, but cleaner than oil or coal. So should it be penalised or rewarded? The $40 cap and watchdog measures are in response to the disaster that was the European reduction scheme Phase I. Europe was initially far too lenient on free permits and exemptions from the scheme altogether, resulting in some companies profiting from being big polluters and the price of a permit eventually collapsing.

But Rome wasn’t greened in a day.

For the time being, the Agriculture industry is exempt. Europe, to its detriment, originally made the transport industy exempt as well but this was all part of the downfall and clearly a reason why the Australian transport industry is not exempt. The other big feature of the white paper is nevertheless the accompanying compensation packages offered to allow industries to adjust in the first phase. Coal-burning power generation – the polluting Daddy of them all – scored $3.9bn. Other packages were offered, including money to assist low and middle income Australians with their inevitably higher utility bills.

Talk about softly-softly – a monkey would be totally oblivious if you snuck up on him with this carbon policy.

But for the readers of FNArena the most important question is: How will the CPRS impact on my stock portfolio? The very simple answer is: It won’t – much.

Analysts providing views on the CPRS this morning are in unison in suggesting everyone has come off lightly. As the biggest polluters of all, coal-fired power generators are actually the biggest winners given the level of free permits and compensation. This means AGL Energy ((AGK)) is sitting pretty and Origin Energy ((ORG)) is not too badly off either. Both already have their own “green” projects underway to provide their own offsets, so its a bit of a win all around. Electricity distributors will receive no freebies, but then they can simply pass the cost on to the consumer.

Because of the reduction in the threshold to 1000t, Woodside ((WPL)) and Santos ((STO)) are now much better off than the original green paper suggested. Both companies are looking over the fine print nevertheless. One issue raised by analysts is that the white paper has not determined whether the CPRS will be applied on a net company basis or on a project basis. Clearly this is of importance, as some projects are more carbon-costly than others. It is easier to abandon one project than it is to restructure a whole pipeline based on net carbon emission.

Oil Search ((OSH)) is completely exempt because PNG does not have a CPRS.

Renewable energy is a big winner, as one assumes it should have been. Not only do renewable energy companies generate carbon credits, but the government is commited to the further step of settling on a renewable energy target by the end of the year. Thus polluters will be forced to both buy carbon credits from renewable sources as offsets and also buy in a mandated amount of renewable energy.

There is yet no clarification on the grey area of forestation as a carbon sink. It is not as simple as suggesting the planting of any tree provides a measurable carbon offset.

Analysts have only had one day’s chance to absorb the 800+ pages of the white paper, so between now and Christmas we can expect a few more company specific updates. In the interim, it is clear that investors have little to fear.

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