Introduction

The emergence of an emissions trading scheme [“ETS”] in 2010 signals recognition of a need for our economy to move to a polluter-pays regime.

There will be value impacts – indeed this is what is intended as a consequence of an ETS.

Governments of most developed and developing nations have seen the need to limit the production of greenhouse gases in order to curb the impact of global warming.

The method most widely accepted as the most effective means to achieve this objective is via a user-pays system – in this instance, frequently referred to as a polluter pays system.

Fairly obviously, those who pollute most will be required to pay most. Shareholder value will be destroyed in some sectors and by individual companies. Some companies will create vast shareholder wealth. Yet others will profit enormously in the short term and then die.

Climate Capital’s carbon valuation model is a solution available to all companies, funds managers, asset consultants and investors seeking to understand the potential value impacts of ETS introduction and how management decisions can be employed to influence value outcomes.

How much value might my company lose?

If your company currently has any carbon footprint, there will be a cost to your business from 2010 in the form of some combination of:

1. The need to acquire carbon offsets under an ETS;

2. Implement mitigation strategies

3. Voluntarily abate emissions

A key question is whether the competitive positioning of your business and the relative effectiveness of your mitigation strategies will enable all or any of the costs of mitigation and offsetting to be passed on to customers.

If the answer is “no”, then the cost of mitigation and offsetting (and abatement) will be met by equity holders.

The need for an ETS

Governments of the world have responded to the scientific and popular belief that the predicted climate change outcome should be averted. The response is largely to move to a polluter-pays regime, in most cases favouring an ETS.

Accepting this base-line reminds us that some segments of our economy are larger consumers or destroyers of the environment than others. Fairly obviously, industries such as fossil fuel extraction and conversion into energy (e.g. transport, property) are among the worst offenders.

Corporate life in a post-ETS world

Features of a post-ETS world are likely to be:

• A self-assessment regime whereby polluters determine their carbon footprint and a compliance assurance systems developed by the regulator to monitor the quality of self assessment processes

• Offsetting (abatement) will increasingly be regarded as nothing more than a “get out of jail free” card

• Incentives for effective implementation of mitigation plans

• Pollution “havens” will emerge in much the same way as tax havens – with the same ultimate outcomes

• Demand elasticities will change in unexpected ways as customers assess their preparedness to endorse (through higher prices) environmentally efficient businesses

• Some “offensive” industries (such as fossil fuel extraction) will prosper in the near term due to political expediency and the simple supply/ demand affects resulting from technology inertia

• Tariff and other forms of protection may be employed to mitigate against the affects of wealth re-distribution within an economy such as Australia

A business which is environmentally unsustainable is most likely financially unsustainable.

Emissions Trading: Impacts on your company’s value

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Level 23, COMALCO Building , 12 Creek Street, Brisbane Qld 4000 AustraliaTel: +61 409 553 335 info@climatecapital.com.au www.climatecapital.com.au

The aim of the carbon valuation model is not only to identify the likely range of potential value impacts but, more importantly, provide the insight into the actions and decisions which management can take to manage the value impact.

The carbon valuation model simulates a range of variables which impact the anticipated incremental cashflows arising as a function of the cost of carbon offsetting, mitigation and/or voluntary abatement. Allowance is made for revenues from the sale of offsets arising from (e.g.) bio-sequestration.

There are some key valuation parameters:

• Demand elasticity – how much of the cost can be passed on to customers?

• Policy framework – will the business be positively or negatively impacted by government policy?

• The extent to which the capital markets have already captured some level of carbon cost into current valuations

• Rate of mitigation change – how fast can the business respond to the need to re-shape its purchasing, logistics and core processes?

• The initial carbon price and rate of carbon price increase change – how will the market for carbon offsets behave?

• The amount of “free” pollution which the ETS provides us from its inception and the rate of decay to the eventual sunset

• Cost of technologies to assist in changing core business processes

• Cost of mitigation – what will the process change implementation cost the business? Will the cost be more or less than the cost to offset?

• What is the likely impact on input costs of ETS introduction (i.e. what is the “carbon intensity” of inputs)?

• Revenue opportunities arising from environmentally sympathetic offerings

What we would like to know is how much value might be destroyed or created as a consequence of the introduction of an ETS and how the business can respond to its GHG emissions.

Strategies for the post-ETS world

In many cases, the impact of a variable is dependant upon the resolution of key uncertainties – such as the initial carbon price and the behavior of that price over time. This uncertainy is incapable of resolution. So what can management do to exploit the knowledge that it is one of the most important variables?

Several strategies are available.

A focus is needed on insulating the business from volatility in carbon prices and developing operating flexibility which minimizes the impact of extremes in outcomes. This is the core of the real option thinking which pervades the oil exploration and pharmaceutical drug discovery industries where uncertainty is omnipresent.

The carbon valuation model examines each of the key drivers of carbon value explicitly – including the shape and behaviour of curves which describe underlying business responsiveness to management decisions such as mitigation strategy implementation.

Checklist for management action

The carbon simulation and valuation model has demonstrated that management action can be taken when some basic preparation is complete. The checklist includes:

1. Assess the business’s carbon footprint

2. Consider the likely relationship between input costs and footprint

3. Estimate the likely impact on input costs of ETS introduction

4. Estimate the realistically achievable carbon reduction from a well-executed mitigation strategy

5. Fully-cost the mitigation strategy, ensuring that both capital and operating expenditures are considered

6. Research and test the likely demand elasticity of the customer base

Conclusion

For most businesses, the impacts on value of an ETS are far from trivial and require urgent consideration in order to preserve management flexibility in the face of potentially dislocational or transformational change.

Preserving and creating value in a post-ETS world