Address by Greg Evans, Director of Economics & Industry Policy To PACIA'S National Conference

Introduction:

Thank you for the opportunity to be here today and to contribute to this discussion. PACIA is certainly a highly valued and significant member of ACCI and our two organisations have had strong engagement in the area of carbon mitigation policy.

Let me start by briefly outlining the policy position of the Chamber (ACCI).

I am pleased to say that ever since the early 2000’s we have maintained a consistent approach and it has also been at odds with the prevailing policy of both the Liberal and Labor governments of the day.  Namely the adoption of a domestic carbon pricing mechanism should be contingent upon the operation of a broad based international agreement involving developed and developing nations.

This does not imply in any way that we should shirk the task of reducing the growth of emissions but as the business group with the largest membership comprising some 350,000 businesses – until an international mechanism is established our members have indicated this should be done through efficiency and technology improvements.

This is what we regard as the operation of the market – business responding to the demands of the community, customers and consumers to deliver products and services but with a greater awareness of the principles of energy efficiency and hence lower carbon intensity.

Enduring change and progress in industrial development has never happened via government wielding a large stick in the form a punitive tax or a harsh regulatory response – this approach is more likely to lead to economic dislocation, job losses, deferred investment or the relocation of business outside the application of those rules.

It is also the approach favoured by green groups but their naïve and ideological interpretation of economics and distrust of markets will be detrimental to the prospects for Australian workers.

By contrast it is Innovation, technology and efficiency measures that will deliver sustainable and affordable reductions in emissions without a harsh adjustment task imposed upon the economy.

Those who doubt this can happen should consider between 1990 and 2008 Australia has recorded a 17% reduction in CO2 emissions per unit of GDP even without an explicit carbon price. Whereas the USA has recorded a 31% drop in the same measure again without the intervention of costly government regulation or taxes.

However such is the nature of absolute policy debates in Australia if you don’t support the current carbon price model then the position is unfairly presented as:

  • Opposing a reduction in emissions
  • Support for a much costlier approach
  • You are a climate change sceptic
     

ACCI rejects all elements of this characterisation.

Those that oppose a unilateral carbon pricing have also been labelled as opponents of economic reform and tarred with the same brush as the groups that resisted tariff reform in the 1990’s – for the record the Australian Chamber of Commerce and Industry our predecessor organisation supported the wind down of tariffs. Without any argument this reform delivered substantial benefits, unfortunately the imposition of a tax on our competitiveness works in the opposite direction.

Our view:

In this debate the Chamber unambiguously represents the views of business as energy users but more particularly small and middle ranking enterprises that face the prospect of a doubling of electricity prices by 2015 and according to energy providers perhaps a quadrupling of tariffs by 2020, with the increase attributable in most part to carbon pricing and other mitigation measures.

It is true these businesses range across many sectors and have varying degrees of exposure to escalating energy costs  however where they are the producers of goods and in many instance services they are trade exposed or they have limited market power.

Consequently these entities will have limited capacity to pass on higher energy prices or the higher cost of other inputs. Nor are such businesses able to adjust their processes to substantially alleviate associated price impacts.

Therefore their earnings and competitiveness will suffer as will jobs and expansion opportunities and to seal the deal no net environmental gain will be delivered.

Guiding principles:

ACCI remains committed to the most efficient means of carbon mitigation accordingly Australia’s climate change policy response should, and let me list some of the points:

  • Place Australia at an equal footing with the rest of the world and in particular with our trade competitors and not necessarily our trading partners. Any unilateral carbon price regardless of its design elegance is not a least cost approach and it will be detrimental to our international competitiveness, export jobs and economic expansion opportunities
  • Ensure that Australia continues to have access to affordable, clean, efficient and sustainable energy supplies. Government policy should be fuel neutral and not subsidise renewables nor barrack for example for a shift to gas for base load requirements especially where this ignores the full life-cycle emissions associated with extraction, processing and transportation
  • Support improvement in energy efficiency (both in its supply and in demand management), the development and deployment of new technologies
  • Address the barriers to individuals and firms energy efficiency uptake, including the lack of available and accessible information
  • Any future carbon pricing model in Australia needs to replace and not be in addition to the vast array of existing mitigation measures including the renewable energy scheme, feed in tariffs an all other forms of budget support across commonwealth and state jurisdictions

The Way Ahead:

  • The Australian economy has been built on access to an affordable and secure energy supply and a carbon price threatens both.  A carbon price which seeks to shift investment towards reliance on intermittent renewable energy and much more expensive open cycle gas turbine generation for peaking requirements, is moving Australia towards entrenching high energy costs as an economic cornerstone
  • The modern and expanding Australian economy cannot rely on renewable energy and the uncertain and increasingly expensive domestic supply of natural gas for electricity generation. However, this is where the carbon pricing model is directing Australia. In addition, using natural gas for electricity generation will over time cause significant consequent increase in gas tariffs for both business and households; Moreover a shift to gas raises concerns about security of supply and price volatility – this is mitigated in USA for example through substantial gas storage capacity yet this does not exist in the this country
  • Unfortunately the required investment in more efficient and cleaner coal fired generation  (such as ultra-supercritical technology) which is necessary for carbon capture and storage (CCS) readiness will be stalled again, foregoing the advantage of a reliable and affordable base load generation option
  • The immediate government focus and support should be directed at efficiency and technology approaches and assessing the capacity of the economy to deal with changes in the energy fuel mix over time.  This would deal with the question of certainty and encourage investment in modern generating capacity
  • It should not be overlooked that the existing government policies have already imposed an implicit carbon price. The renewable energy target and feed-in tariffs raise the price of energy for all users while rebates to consumers for initiatives including solar hot water rebates come at a substantial cost to the budget which are not sustainable
  • Therefore ACCI welcomes the Productivity Commission study on the effective carbon prices that result from emissions and energy reduction policies in place or committed in Australia and other key economies, which is due to be released today. In the report, the Commission should consider the price of carbon in both Australia’s major trading partners and our competitors who export resources and energy
  • Finally the impact of carbon pricing will not only affect business but also add to inflationary pressures across the economy, both directly in higher energy prices for consumers and indirectly in the provision of goods and services including in the areas of health, education and the provision of public transport. To assess the impact of various carbon pricing models, a comprehensive modelling exercise needs to be conducted to ascertain the full impact of higher energy prices on the Australian economy. We are not confident the Commonwealth Treasury will deliver such a report

Given the Australian economy dependence on fossil fuel with 77 per cent of our electricity generation from coal, the nature of our open economy with a 58.5 per cent trade to GDP ratio and the high emission intensity of our industry, Australia has more to lose than any other major economy under a carbon pricing framework.

The debate about carbon pricing mechanism to date has centred on the following myths and distorted arguments:

Australia’s high per capita GHG emissions

This is presented as some form of national shame but it ignores the nature of Australia’s industrial development, the contribution of cheap energy to wealth creation and inconsistently treats the export dividend from coal and other resources as an economic salvation yet where those resources are consumed domestically they should be penalised.

In other words the citizens of Asia should have access to cheap energy yet this should be explicitly taxed if provided to ordinary Australians.

33 other countries around the world have a carbon price

No other country has comprehensive ETS or carbon tax of the type contemplated in Australia. In china for example, long term climate change policy focuses on:

  • Improving energy efficiency
  • Developing clean coal and the niche role of renewable technologies
  • Expanding carbon sequestration potential through afforestation

Only big polluters will pay

The perception that carbon tax only penalises dirty polluters is of course misleading as the price impact will cascade through the economy and along supply chains and where this can be passed on through to an end consumer.

For example, using the information from the National Greenhouse and Energy Register (NGER), at a carbon price of $26 per tonne, we can see the significant annual cost of a carbon price on diverse areas of the economy.

While large trade exposed industries may be compensated to some extent to protect their competitiveness, small and medium sized enterprises (SMEs) will bear the brunt of cost increases in the form of higher energy prices and higher input costs given their limited ability to pass on these cost increases to consumers.

Creation of “green” jobs

The proponents of a carbon price often argue that green jobs will be created to replace conventional “brown” jobs. However studies have found that across a range of European countries where governments have invested in the renewable energy sector indicates that for every so called green job created another four jobs are lost somewhere else in the economy. This is due to the opportunity cost associated with directing large capital flows to economically inefficient areas and the lasting impact of much higher energy prices becoming entrenched in the economy.

Moderate impact of a carbon tax relative to other cost factors

An argument has been advanced that the economic impact of a carbon price is likely to be moderate compared to the appreciation of the Australian dollar and the increases in costs such as fuel prices
Yet a unilateral carbon tax will impose an additional and ongoing cost to Australian businesses and the impact will be felt across the economy.

In the case of the appreciation in the AU$, some businesses benefit from cheaper imported inputs and raw materials and businesses can also hedge their exchange rate exposure.
Whereas increases in petrol prices are a global phenomenon and it does not impose a higher fuel prices unilaterally on the Australian economy.

We already have an implicit carbon prices across the economy

In 2008, the Productivity Commission identified 244 measures to reduce Australia’s carbon emissions. Recently, IPART has indicated that 6 per cent of the recent 18 per cent increase in NSW power prices is due to the RET. Moreover not one dollar of compensation has been paid to energy consumers for these price hikes. Moreover the Greens have indicated that these measures should stay in pace even after a carbon pricing regime is in place.

Fuel switching could happen overnight without significant adjustment costs and renewable energy can transform the Australian economy

The Treasury modelling out to 2050 makes the assumption that we can without cost move from one energy source to another and that new low emitting technology will seamlessly come on stream as required.

This is clearly not the case and even over a shorter period to 2020 it is unlikely we will see a substantial switch in our fuel mix – yet perversely we will however prevent the introduction of much more efficient and lower emitting coal fired generation. We will some gain in the gas energy share yet a renewable target of 20% in eight and a half years will become increasingly out of reach as consumers and taxpayers baulk at the unsustainable economic cost.

Heralding a ‘clean energy future’ or calls to ‘decarbonise the economy’ are mere slogans and are not an accurate portrayal of our energy future in the next two decades.

Certainty

It has been suggested that as the carbon tax will start at a low level, “way south of $40” as indicated by the Government, its impact will be also be small. That might be the case if the tax was to remain at that level for a long period of time. However, this isn’t so as the Government has announced that the carbon tax is merely a 3-5 year transitional arrangement towards an emissions trading scheme and more importantly the original 2020 targets of a 5 per cent reduction from 2000 levels will remain unaltered. However according to the greens a more ambitious target will be required.

Consequently any rational investor considering business expansion in Australia will factor in the higher price levels immediately—particularly given the uncertain nature and timing of the transitional process. A low start carbon tax with an undefined transition will not provide investment certainty and comfort for investors in any sector and accordingly they will factor in the “worst case” scenario in any investment decisions.

More about uncompensated businesses:

As I mentioned earlier while the Australian low and middle income households will be partially compensated for the increasing cost of living and the larger trade exposed industries may be compensated to some extent to protect their competitiveness, small and medium sized enterprises (SMEs) are left out in the cold and will bear the brunt of cost increases in the form of higher energy prices and higher input costs.
A unilateral carbon price also creates the following economic burden on SMEs:

  • SMEs have little, if any, market power to negotiate the rate of carbon pass-through from its upstream suppliers
  • SMEs are  likely to have already realised cheap efficiency gains in their businesses to remain competitive and thus have few, if any, opportunities to cut costs further
  • SMEs are thinly capitalised and unable to cope with even marginal cost increases
  • Additional costs diminish the already thin profit margin
  • Diminished profits will reduce the return on capital and labour

In 2009, ACCI released independent economic research on the impact of the Government’s proposed Carbon Pollution Reduction Scheme (CPRS) on small and medium sized enterprises (SMEs) some member companies of PACIA participated in the this exercise.

The study, entitled Securing SMEs in Australia’s Low Carbon Future, authored by international economics consultancy Castalia Strategic Advisors, looks at a snapshot of SMEs in four sectors: food processing, plastics, chemicals, and machinery and equipment manufacturing industries. As manufacturer each entity was trade exposed.

It conclusively demonstrated that increases in energy and transport costs will impact directly on SME employment and profitability. Examining a random sample of SMEs’ cost and revenue structures as well as company balance sheets in detail, the study found that the CPRS would generate additional costs that would erode SMEs’ EBITDA (i.e. Earnings before Interest, Tax, Depreciation and Amortisation) between 4 to 7 per cent on average.

The results were reported in an EBITDA basis yet assuming even moderate levels of debt and capital intensity, the final impact for many companies would see a shift from profit to loss making. For example, assuming 50:50 debt to equity ratio, a 5 per cent fall in EBITDA would translate into 13 per cent fall in profits.

In the medium term, the impact of a carbon tax on the SME sector is likely to be on both investment and employment. In the short term as the capital investment in the sector has already been sunk, the impact is likely to fall disproportionately on employment as SMEs adjust to the new tax. Although Treasury modelling disguised this negative employment impact by burying away in the back pages a decline in real wages across a number of the emission target scenarios.

It is important to note that our study probably the above study substantially underestimated the real economic impact on SMEs as firstly, it assumes the very low electricity price increase estimated by Treasury, and secondly, it ignores the flow on impact of higher energy prices on other production inputs apart from direct energy consumption. The carbon price impact may vary from deterioration in employment levels, to foregoing expansion opportunities, through to precipitating plant closures. However, this will depend upon the severity of the escalating carbon price. Such is the scale and lack of uniformity in relation to the carbon price impact on middle ranking and small businesses, it is not possible to design an appropriate and efficient compensation arrangement to properly deal with the major adjustment task that is likely to occur.

Australian manufacturers are of course already facing extreme stress as the Australian dollar reaches an all-time high against the US dollar. As we know the Australian dollar has appreciated more than 17 per cent against the US dollar over the past year and the market is expecting the Australian dollar to appreciate further and remain elevated in the near future due to the terms of trade boom as well as the large interest rate differentials between Australia and most other advanced economies.

An additional cost impost in the form of a carbon tax amplifies the competitive pressure on Australian manufacturers, especially SMEs. According to the Reserve Bank, manufacturing only contributed 11 per cent to the Australian total share of exports and the sector as a whole contracted over the past 12 months. Industry is concerned that a unilateral carbon pricing scheme as proposed by the Government will unnecessarily exacerbate the adjustment pressured difficulties currently faced by the manufacturing sector.

It is also apparent that the imposition of harsh regulatory decisions throughout Australia which are rewarding for the most part inefficiently operated government owned network businesses will make the imposition of an additional carbon tax even more onerous. For example in 2011-12, electricity prices are expected to increase further by:

  • VIC: between 2.5% and 7%, following a 12-19% increase in 2009-10
  • SA: 13% following a 6.9% increase from January 1, 2011 and a 5.6% rise from July 2010
  • WA:     5%, following a 22% increase in 2010-2011

Conclusion

  1. In the absence of an international agreement Australia should not impose a carbon tax
  2. In this context real market mechanisms delivered through technology and efficiency should be the cornerstone of our response rather than big stick approaches
  3. Our manufacturing companies and workforce are going through enough adjustment pressures in a re-balancing economy -  a carbon tax will only intensify this
  4. Finally a unilateral carbon tax will worsen our already flagging productivity performance and hence lead to a lower our standard of living – a point Professor Garnaut acknowledged last week in his final report

Thank you.