Cover story: Why emissions trading must provide a level playing field for Australian refineries

Refineries could be less competitive

About a quarter of Australia’s petroleum products are imported, mostly from Asian refineries. Australian refineries must compete against these imports so prices for refined petroleum products are based on the cost of importing, known as import parity.

The price of carbon permits for fuel must be highly transparent ... and matched cent for cent to the excise reduction

From 2010, Australian refineries will bear a “carbon cost” through having to purchase permits for their greenhouse gas emissions. Most of their international competitors will not have to bear such carbon costs for many years because the countries in which they are located will not have emissions trading schemes. Australian refineries will have to absorb the carbon costs from Australia’s Carbon Pollution Reduction Scheme because their refinery gate prices are set at parity with the imports from these countries without carbon costs.

If the scheme is implemented as proposed in the green paper, Caltex’s two oil refineries could in total face extra costs of around $90 million per year (at a carbon cost of A$40 per tonne of carbon dioxide emitted). This means Caltex and other Australian refineries will be much less competitive against imports from Asian and other overseas refineries. Caltex believes the scheme should be designed to avoid this loss of competitiveness.

Nothing will be achieved if a badly designed scheme results in Australian production of petroleum products being replaced by imports. There will be no global environmental benefit and Australia will lose skilled jobs, investment and technology. Greenhouse gas emissions will simply be created in Asia instead of Australia. And Australia’s security of supply of petrol, diesel and jet fuel will be seriously weakened.

Caltex must buy permits for customers’ emissions ... then pass on the cost

In addition to the permits that Caltex must purchase for its own emissions, mainly from refining, the Carbon Pollution Reduction Scheme will require liquid fuel suppliers like Caltex to purchase permits for their customers’ greenhouse gas emissions then pass on the cost at the pump. This means that Caltex will be the largest purchaser of carbon permits in Australia, approaching 10 per cent of the market. The four major oil refining and marketing companies will purchase over 25 per cent of the permits available, mainly for their customers’ emissions. Caltex believes t he design of the scheme should avoid imposing high risks and costs on fuel suppliers for the purchase of permits to cover customers’ emissions. The scheme should also provide for large customers to purchase their own permits for emissions from liquid fuels.

The scheme as proposed in the government’s green paper will do very little in the near term to cut the annual 115 million tonnes of carbon dioxide emissions from Australia’s use of petroleum products, because the carbon cost at the pump will be offset “cent for cent” by a reduction in excise, at least initially.

Carbon costs on Australian refineries should not increase faster than for overseas competitors.

The full excise offset means there will be no incentive to reduce petroleum consumption.

There is public concern over high fuel prices and a Petrol Commissioner has been appointed to monitor fuel prices. The price of carbon permits for petroleum products must be highly transparent so motorists can be assured they are paying “cent for cent” at the pump the same carbon cost that oil companies pay for the motorists’ permits. Caltex does not want oil companies to be regarded as profiting from the Carbon Pollution Reduction Scheme. The scheme must be designed to ensure the price paid by oil companies for permits is exactly matched “cent for cent” to the excise reduction to assure motorists they are not being overcharged for carbon costs.

The scheme is also unlikely to have much longer term impact on consumption of petroleum products. A carbon price of $40 per tonne of carbon dioxide – 10 cents per litre of petrol – is estimated to reduce carbon emissions from transport fuels by about 3 to 5 percent, far short of what’s required to meet Australia’s long term target of reducing total emissions by 60 per cent in 2050 relative to 2000.

So if the emissions trading scheme will not substantially reduce emissions from transport, what will? The answer is a gradual shift in fuel consumption from conventional hydrocarbon fuels like petrol and diesel to electricity and alternative fuels (see following story). Refined petroleum products will be around for decades but Australia’s production of petroleum products is already less than demand, hence the growing level of imports. Alternative fuel sources with lower carbon emissions can replace some of these refined product imports. Long term shifts in fuel supply will also create new business opportunities.

Risk to emissions-intensive, trade-exposed industries

Australia has many industries that are emissions-intensive and trade-exposed, so-called EITE industries, including oil refining. Emissions intensive means the costs of their carbon emissions under an emission trading scheme will have a material impact on their cost structure and profitability. Trade exposed means they can’t pass on carbon costs to customers because of import or export competition.

Most of these industries could remain competitive in a carbon-constrained world if there was a level playing field, so that carbon costs for Australian industries increased in line with overseas competitors. However, by imposing a tight cap on its emissions ahead of competitor countries, Australia may create a price for carbon that makes many EITE industries uncompetitive. This process of imposing carbon costs and effectively shifting emissions and industries overseas is known as carbon leakage – and it makes no sense for Australia.

How has the government ended up in the situation of imposing large costs on the exporting and major import-competing manufacturing industries that underpin Australia’s prosperity?

The permits problem

For the answer we need to look at the way the green paper proposes permits should be issued. Emissions-intensive trade-exposed industries, excluding agriculture, will account for about 40 per cent of the emissions covered by Australia’s emission trading scheme. However the government has decided that only 20 per cent of permits for these emissions will be allocated free to EITE industries and the other 20 per cent will have to be purchased. This means free permits will only be half the number required to create a level playing field against imports.

This 20 per cent allocation is even more inadequate than it appears, as many industries including oil refining are not defined by the green paper to be emissions intensive so would receive no free permits at all.

Flawed equation

Anyone who has been to an oil refinery and seen the huge amounts of energy consumed in heaters, compressors and pumps would realise they are energy intensive, hence emissions intensive.

The problem lies with the way the green paper defines emissions intensity: emissions divided by revenue, which is the total value of petroleum products and includes crude oil purchase costs. Most people would understand revenue to mean the dollars received from turning crude oil into petroleum products (which in oil industry jargon is the gross refiner margin). Revenue as defined in the green paper is the wrong measure. It would be more appropriate to measure the financial impact of carbon costs by measures such as emissions divided by value added (equal to earnings before interest, tax and depreciation, plus employee costs). Other emissions intensity criteria related to financial impact may also be appropriate.

Some people might argue that carbon costs on refining are necessary to create incentives to improve energy efficiency and reduce greenhouse gas emissions. However, the high cost of energy today creates a huge incentive for Caltex to cut carbon emissions, so adding more costs through having to buy emissions permits would not create any additional incentive to cut emissions. Annual fuel costs at Caltex’s refineries are about $400 million out of total costs of about $800 million. Carbon costs would amount to a huge new tax on Australian oil refineries.

Creating a level playing field

Australia can take an international leadership position in policies to reduce carbon emissions but until there is global commitment to emissions reduction Australia’s emissions reduction trajectory should be modest to ensure a low carbon price.

Oil refining is a tough, competitive business with low average margins in which the key to success is controlling costs. Australian oil refineries are competitive with overseas counterparts but even low carbon prices would have a significant impact on competitiveness.

The emissions trading scheme must maintain the competitiveness of Australia’s emissions-intensive trade-exposed industries until overseas countries take comparable action on carbon costs for their industries. Carbon costs on Australian refineries should not increase faster than for overseas competitors.

In practice, this means an initial 100 per cent free allocation of permits to emissions-intensive trade-exposed industries with a formula for eligibility that realistically measures the financial impact of carbon costs and achieves broad industry eligibility. Once overseas competitors have comparable carbon costs so there is a level playing field internationally, all permits can be auctioned.

Caltex seeks no special treatment. Its refineries can be competitive in a carbon-constrained world and help maintain Australia’s security of supply of petroleum products. Caltex supports the introduction of an emissions trading scheme for Australia and other strategies to reduce greenhouse gas emissions – but they must provide a level playing field for oil refining and other emissions-intensive trade-exposed industries.

 

 

 

 

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