Turnbull has delivered business certainty – but the future looks ugly: Kohler

Australia’s business community at least has some certainty now. It might be of impending doom, but at least it’s certain.

It turns out Malcolm Turnbull really is a man of conviction – rather than a politician – and he really is following through on his statement that he won’t lead a party that doesn’t support emissions trading.

But there are enough senators in the Liberal party who either agree with him or aren’t ready to change leaders yet to get the CPRS through parliament.

If Turnbull weren’t leader, he and the other true believers among the Liberals would just be crazy floor-crossers.

But he is leader, which means that his Shakespearean murder on the steps of the Senate has become the main story about Australia’s premature, pre-Copenhagen emissions trading legislation. (Malcolm Caesar no doubt said to Andrew Robb yesterday, as his former climate change spokesman stabbed him: “Et tu, Brute?”)

The real story, meanwhile, has been lost. It is that businesses will have a new input cost the year after next that will start at $10 per unit for 12 months and then a year later move to the international price, whatever that might mean.

The Government is assuming $26 per unit (permit) in 2012, or $US28.89 based on an exchange rate of US90c, but business should make their up own mind about that. The bureaucrats actually have no idea.

In any case the Government’s assumptions have been manipulated to achieve a political outcome. They even deliberately left the assumed exchange rate the same for household compensation in the recent mid-year economic and fiscal outlook, while raising it for everything else, thus providing a $5.5 billion kitty as cheese in the mousetrap for Turnbull and his negotiator Ian Macfarlane, which worked perfectly, slamming down on their necks yesterday.

The assumed international price of $US28.89 a permit (for one tonne of carbon dioxide) may or may not be correct in two years’ time and the exchange rate could be anything at all.

What’s more, there is no prospect of an international market in carbon emissions permits coming out of the Copenhagen meeting next month, and no sign of when that might happen. It might be sometime in 2010, but who knows?

The current spot price on the European Climate Exchange is €12.64 euros, or $A20.59, but independent forecasts of the price in a few years range from $US30-40.

That depends entirely on how other countries end up compensating their electricity generators with free permits.

Europe over-compensated them to guarantee supply, and the permit price crashed to a few euro cents as the generators dumped their excess certificates on the market for cash, before recovering after the overhang cleared.

Australia is under-compensating the electricity sector and playing the odds that even if their owners lose all their equity, as some will, the power stations will keep operating – either under bank control or new owners.

All things being equal, that would drive the price very high. Opening the Australian scheme to international permits changes that equation and simply makes the price subject to the exchange rate and US and Chinese electricity compensation rather than demand and supply within Australia.

As we have been pointing out in Business Spectator, this is a risky game. The two biggest polluters – International Power and TRUenergy – are warning of receivership and sovereign risk, and the Victorian Premier John Brumby is getting slightly hysterical about the possibility of supply outages for which he will be blamed.

Australia is also under-compensating coal miners – to the tune of $10 billion or so, they say – and transferring the cash saved from them and the electricity generators to low and middle-income households in the form of cash compensation.

This is a deliberate strategy by the Rudd government to buy re-election in 2013 through taxing the profits of coal miners and electricity generators.

Also, by low-balling the assumed carbon price, they are potentially understating revenues by up to $10 billion in the forward estimates. If the price turns out to be $35 for the 2013 federal budget, they will be swimming in cash for the election that year.

The 2010 re-election plan was handed to them by Malcolm Turnbull’s passion for emissions trading, and his decision to choose that over leading a united party to an election fought over climate change.

There will probably be a new leader in time for that election, and the coalition will eventually unite against the CPRS, but the damage along the way and the fact that the leader in 2009 did support the legislation, will make it unelectable next year at least.

Meanwhile business people should treat the politics as a spectator sport and get on with preparing for buying carbon emission permits as a cost of doing business.

It will be very challenging – a new cost that will be subject to two simultaneous volatilities: an internationally traded price and the exchange rate. And don’t forget there is no sign of an international trading scheme yet, and therefore no sign of a decent derivatives market through which to hedge your exposure.

The carbon permit price seems to have a 92 per cent correlation to the oil price at this stage, so that part of this new cost looks like being roughly as volatile as crude oil.

As with oil, you can’t recover every movement in the global price unless you sell a product whose price can change every day. And businesses don’t buy oil on the spot market anyway – they buy petrol or diesel or other oil-based products whose prices change more slowly than crude oil.

The spot market for carbon permits is likely to change every day, and hedging via the carbon futures market will become very important. The alternative is to use your profit margins as a buffer.

And all of that only works if and only if you have pricing power. If you compete with imports, your margins will be squeezed and you will have to put your hand out to the government as a “trade-exposed” business, although that’s only if you’re “emissions intensive” as well, and therefore come under the EITE – the emissions intensive trade exposed industry assistance scheme.

If you’re just a little business trying to get by in a tough market, with not much pricing power, you are in strife.

You might want to get out now.

This article first appeared on Business Spectator.