Brokers part of a carbon fog

It's early days after the Clean Energy Futures package, and the brokers are releasing their analyses. As a client of Macquarie and CommSec, I've only received and been able to review theirs. If they are indicative, investors may not be being as well served on this issue as they would normally expect.

First, a little background. Five years ago, when the first 'impact of a carbon price' analysis was undertaken by Elaine Prior at Citibank, it was a simple, but then very useful, analysis. If a company emitted 1 million tonnes of greenhouse gas emissions (CO2-equivalent or "CO2-e”), and the price was $25/tonne, then the company's liability was $25 million, and its EBITDA would be that much less. Of course, nobody believed that would be the actual effect, because the company could reduce emissions, or secure permits in other cheaper ways, or get some compensation, or pass on some of the cost. But it was a useful apples-for-apples analysis.

Carbon price impact analyses may have advanced since then, but it would pay to be sure. Macquarie's sector analyses simply quote the company's emissions, multiply it by the rising carbon price, and take away the top-line scheme compensation. No further company reactions are considered. The idea that firms operate in a complex system and respond dynamically to material price signals is not yet orthodox, nor is the idea that the culture of firms and their capability to respond differ markedly.

Take the steel sector analyses. Using the above arithmetic, Macquarie declares that BlueScope earnings for the year ending June 30, 2013 will be down $34 million, and OneSteel's will drop $25 million. While it notes that the companies will receive $300 million in compensation over five years from the Steel Transformation Plan, it does not take that into account in its EBIT conclusions. This exclusion is unlikely to be an oversight; more likely to be a deliberate choice, on the basis of uncertainty over how the $300 million will be applied.

However, the amount of the Steel Transformation Plan – $60 million per year – is not coincidental. It matches the nominal losses of BlueScope and OneSteel. The government has compensated them for those nominal losses for five years.

If BlueScope did anticipate a $34 million per annum (or 7 per cent) drop in EBIT, it would be obliged to declare it to the market. Has it? No. Quite the contrary.

BlueScope's ASX release declares that the Steel Transformation Plan "materially reduces the overall cost of the carbon tax on BlueScope”. It confirms that the $300 million "will be split approximately 60 per cent to BlueScope Steel and 40 per cent to OneSteel based on an agreed production/emissions formula”.

OneSteel's ASX release similarly states that "our concerns about the adverse impacts of the proposed carbon tax on our competitive position have been recognised and substantially addressed”.

Macquarie's overall Clean Energy Futures analysis, a separate paper, seems more informative. It recognised that "the short-term impact of carbon pricing is relatively muted”, was concerned about the uncertainty of the carbon price in 2015–20 and its effect on longer-term investment planning, and otherwise kept to the pricing and investment implications. It seems typical of the objective view of carbon price proposals that financial market researchers have offered over the past decade.

Not so CommSec's overall analysis. This was a real eye-opener. The chief economist of Australia's largest broker could not have released a more political document if it were written by Tony Abbott's press secretary.

First, the chief economist declares himself a climate sceptic: "The United Nations climate change conference in December may not renew the Kyoto agreement on carbon emissions. Simply, there has been a re-assessment of the climate change theory. While the Clean Energy Future documents warn of global warming and point to a similar situation in Australia, long-run figures from the Bureau of Meteorology indicate that the gradual upward trend in temperatures has occurred for almost 150 years. The risk is that Australia ends up leading the world on an issue whether [sic] there is less agreement on the right response.”

The Bureau of Meteorology as evidence against the climate change "theory”? The Bureau has been absolutely unequivocal on this, declaring with CSIRO time and again that climate change is happening, and that it is anthropogenic.

The only re-assessment being done by scientists advising the UN Framework Convention on Climate Change is to conclude that the climate risks are getting worse and worse. The 1997 Kyoto Protocol will not be renewed, and was never going to be, because it is now fourteen years old and is not nearly strong enough to meet those risks.

After some further comments on international climate policy (disagree, happy to discuss, no room here), Commsec's economist puts a view on how ineffective the scheme might be: "The aim of the tax is to increase the price of goods produced by carbon-intensive industries and thus change behaviour of consumers and businesses. But ... if consumers are no worse off, and in fact many are better off, then you don't have the incentive to change behaviour.”

Here, the economist is on ground closer to his field of expertise. However, he may be misinformed, because the policymakers are not pricing carbon as a direct incentive to change behaviour. So, as covered in an earlier article (A carbon price with compo can work, April 14) and again by The Sydney Morning Herald's Ross Gittins this week, compensation is irrelevant to the carbon price's effectiveness.

A carbon price triggers the availability and adoption of low-emission technology, regardless of compensation. When high-emission products and services become marginally more expensive, then low-emission or energy-saving solutions become that much more cost competitive. They become that little bit more attractive for investment. As investment flows, the scale of production increases and distribution channels improve. As prices to consuming firms and households then fall and margins for suppliers rise, there is further investment in the low-emission technologies. Further innovation results, continuing the cycle. Consumer firms and households will have more low-emission choices for whatever their current activity, and can spend their compensation there or anywhere else they choose.

The CommSec note finishes with this list of "implications for investors”, which might draw the following responses:

– A repeat of the Bureau of Meteorology verbal (Enough said, though I'm not sure why the report repeated it as an "implication”).
– "The government gives the impression that it has created the perfect tax. But if it was that easy and painless then governments would have done it years ago.” (Easy and painless? No one claims that. A necessary and sound investment? Discuss.)
– "The budget bottom line is worse off by $4.3 billion.” (Is that over one year, or four?)
– "Foreign investors will continue to be cautious on investing in Australia.” (The RBA has seemed very pleased with levels of foreign investment, given the global situation.)
– "The Australian dollar is unlikely to be significantly impacted.” (Agreed.)
– "The extent of change and uncertainty for the coal and steel sectors as well as manufacturers will lead to a softening of investment support in the short term.” (Little wonder, with this type of advice adding to the confusion, though in the very short term Peabody has been unconcerned.)
– "Electricity and gas are inelastic goods, meaning that substantial changes in prices lead to only small changes in demand.” (Demand-side policy measures continue in addition to the carbon price mechanism. It's the substitution between low- and high-emission energy sources that's the key issue here.)
– "Any increase in the headline rate of inflation makes the Reserve Bank nervous.” (The RBA may see through the one-off impact, just as it did with the much higher one-off GST impact.)

The performance of the ASX 200 this week has been dominated by international factors, but there's no doubt that Monday's losses carried a significant element of carbon price reaction. When in time investors consider more complete advice, they may consider even that modest reaction overdone.

Josh Dowse is an independent consultant on sustainable business and investment. www.dowse-csp.com.au