CLIMATE SPECTATOR: Killing manufacturing with kindness

Our failure to hold manufacturing to strong environmental standards is undermining Australia’s long-term competitiveness.

Climate Spectator

At present the news is dominated by stories of closures or potential closures of major manufacturing facilities. Aluminium smelters, oil refineries, car manufacturers, the list goes on. Much of the attention is focussed on the impact of the high Australian dollar or the carbon tax. But in many respects these closures are inevitable and entirely foreseeable.

These plants have been a product of tariff walls or government subsidies and are seen by their parent companies as assets to milk, rather than innovative businesses to foster and grow. Unfortunately multiple Australian governments have been complicit in this strategy of milking Australia. This is because they have failed to insist that these plants meet world’s best practice environmental standards. And they have kept energy costs artificially low through a range of subtle subsidies.

How would upholding higher environmental standards help competitiveness?

At their essence strict environmental standards and higher energy costs force businesses to run tighter ships (or build tighter ships in the case of motor vehicles). You simply can’t meet world’s best environmental standards through creaking and rusting old assets. Instead you have to invest in plant and technology to enable greater monitoring and control over production processes to meet sterner tolerances. These plants have higher levels of energy-efficiency, less waste and produce higher quality products.

This idea that strict environmental standards might spur innovation and therefore aid competitiveness was identified by Michael Porter, an economist at Harvard Business School, back in 1991 (see this webpage for further information). Porter is not some crazed greenie, he wrote the seminal books in business strategy, Competitive Strategy and The Competitive Advantage of Nations, which are compulsory reading in just about any University MBA course taught around the world.

I’ll provide three examples that illustrate this point which are prominent in the news at present: Oil refining, motor vehicle manufacturing, and aluminium smelting.

Oil Refining

The best years for Australia’s oil refineries are well behind them. Largely built in the 1950s and ‘60s behind tariff walls, they are sub-economic scale and use outdated plant. In global benchmarking studies these plants rate in the bottom quartile on energy efficiency. They are on borrowed time versus their far more modern and more efficient competitors in Asia. The only things keeping them alive are:

1) a slight difference in costs between shipping crude and shipping refined product to Australia; and

2) the fact that closure of plants would require the owners to pay hefty environmental clean-up costs.

Consistent with my prediction back in April 2010, Shell announced they would close the Clyde refinery and they are refusing to guarantee the future of their Geelong refinery. Caltex is also considering the future of its oil refinery operations.

We’ve treated these refineries with kid gloves, failing to introduce fuel standards that have been in effect in Europe and Japan for a considerable time. To meet these tighter fuel standards the refineries would need to invest to upgrade their plants to more modern technology. This led some to threaten plant closures and consequently government dragged its feet.

This meant Australian car buyers were denied access to more advanced and fuel-efficient motor vehicles, particularly diesels, until only the last few years. City dwellers have also had to put up with dirtier air because motor vehicles are unable to achieve lower pollution levels without cleaner fuel. And guess what – oil refineries have shut down anyway because without substantial new investment, they’ll continue to be uncompetitive.

Car Manufacturing

The Australian motor vehicle industry is basically a group of clever people who have one of their hands tied behind their back by head-offices in Detroit and Tokyo. For these head-offices Australia is not a source of innovation, it is a dumping ground for second-hand technology. Australian governments have enabled this to happen by refusing to introduce emission standards on Australian cars that have been in place for five to ten years in other developed countries. This, combined with poor fuel quality standards, has meant Australian car manufacturers have specialised themselves into a dying niche of inefficient motor vehicles that are unable to survive rising oil prices.

The tragedy of it all is that the people in these companies are capable of better things. A neighbour of mine, a design engineer at one of the Australian car manufacturers, related a sad story to me that illustrates this point. The CEO of his company addressed the staff a few years ago to announce that the company was in severe financial stress. High oil prices had led buyers to turn away from the Australian-made car in favour of more fuel-efficient imported alternatives. At this point a frustrated engineer pointed out to the CEO that ‘Blind Freddy’ could have seen this coming nearly five years ago. He lamented to the CEO that over that period they had engine design and development equipment sitting idle. This could have been used to develop a highly fuel efficient diesel engine and ensured the ongoing viability of the Australian car. After the CEO had left, this staff member was told that he should refrain from speaking to the CEO like that in future, even though every one of the staff agreed with him.

Aluminium Smelting

Australia’s aluminium smelting sector is largely a product of misguided state government industry policy to ‘add value’ to our mineral resources. Aluminium smelters have great appeal to politicians because in one foul swoop they get to cut ribbons on two impressive structures – a power station and a smelter. This has led multiple Australian state governments to offer aluminium companies long-term electricity supply contracts at prices well below cost. Over the past few decades these subsidies have added up to several billion dollars at a cost of tens of thousands of dollars each year per job created.

The problem for Australia is that aluminium smelting is not some high-value, sophisticated industry with high barriers to entry. Any tin pot dictatorship can build itself an aluminium smelting industry if it’s prepared to provide heavily subsidised electricity, and unfortunately many stupidly do. In their anxiousness to don hard hats and reflective vests, politicians around the globe have induced massive over-capacity in aluminium production. In such circumstances Australia’s aluminium smelters were only going to last as long as the electricity subsidies. These are coming to an end for Alcoa’s Point Henry in 2012 and Rio’s Bell Bay sometime shortly after. Bell Bay is particularly at threat because of its old age and sub-economic scale.

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In Germany, one of the few developed countries in the world that still has a thriving manufacturing sector, businesses don’t see environmental controls as a hindrance, they see them as a spur for smarter engineering. The Germans realise that you can’t sustain prosperity by trying to compete against China in finding the lowest input costs. You’ll only succeed through doing the things that China can’t.