MPF53 FINANCE

“Review the proposed Carbon Pollution Reduction Scheme (CPRS) in Australia and critique its impact on financial management decisions”

BY Xiao Nie

Yang Song

Date: 20th April 2010

Introduction

In today’s society, all countries in the world will experience climate change in coming decades because of increasing carbon pollution (climate change 2007). In order to reduce the carbon pollution, ETS and CPRS will be proposed in the world wide and Australia. This essay is to focus on revising the proposed carbon pollution reduction scheme and point out its impact on financial management decision. In the first place, there is a brief summary about the CPRS scheme in detail. In the second place, there is an analysis about major and minor financial management decisions. In the final place, the impacts of CPRS on its financial management decision will be raised. All in all, the conclusion is a summary of the aim of the essay and how to achieve this aim.

The CPRS scheme

The emissions trading scheme (ETS) in Australia is called Carbon Pollution Reduction Scheme (CPRS). Australia is very vulnerable to the effects of climate change. They recognize that human activity is causing the climate change and also Australia is one of the biggest polluters on a per capita basis.

The CPRS will help reduce Australia’s carbon pollution by putting a price on carbon for the first time in Australia’s history. The carbon price means that goods that are emissions intensive to produce will generally become more expensive, and that emissions intensive activities will cost businesses more.

The main driver of the Government's plan to reduce Australia's greenhouse gas emissions is the Carbon Pollution Reduction Scheme (CPRS). This is an emissions trading scheme which will use a cap and trade mechanism. The cap - an upper limit on the country’s carbon pollution that will be reduced in future years - achieves the environmental outcome. The ability to trade ensures that pollution reduction opportunities throughout the economy are harnessed which reduces the economic cost of meeting our ambitious carbon pollution reduction targets.

The CPRS is an emissions trading scheme with two key features: a “cap” which places a limit on the total amount of ‘carbon pollution’, and the ability to “trade” by businesses in sectors that are covered by the scheme.

The CPRS only applies to businesses which are in “covered” sectors: stationary energy (mainly electricity generation), transport (the oil, gas and petrol suppliers), industrial processes (large manufacturing operations, aluminum and other energy intensive metals or other products), waste (landfill and other waste-management facilities), fugitive emissions (oil and gas production, mining).Businesses who are in the CPRS will have a “cap” applied at a facility level where they own (and operate) facilities that have direct emissions of 25,000 tonnes of CO2~e per year of more. (Direct emissions from the facility are those which are produced at that facility and are not those relating to purchased electricity.)

The Target of the scheme is to cut greenhouse gases by 5-25 percent below 2000 levels by 2020, depending on what other countries commit to. Australia will auction most of its permits. The scheme plans to curb competitiveness impacts by making permits free for companies that depend on exports, and by having a carbon price cap of a$10 per tonne for the first year (Reuter’s news 2010). One the 《CPRS White paper brief notes》which has released by the commonwealth government on the 28th Dec ,2008.It has outlined the framework of CPRS. “The target of The White Paper outlines three fixed targets commencing at 109% of 2000 levels in 2010/11 and declining by one percentage point a year to 107% of 2000 levels in 2012/13. The remaining fixed targets for 2013/14-2014/15 will be announced in early 2010. The Government has also announced a “gateway” of a 5-15% reduction of emissions relative to 2000 levels by 2020.” These three targets would result an decline in the carbon pollution around 10 million tones per year in 2012/13, if we just assume the CPRS excludes only agriculture.

An example for IFSA (Investment and Financial Services Association) is of the view that the design of an emission trading scheme should facilitate market efficiency and integrity and minimize uncertainty, along with the economy-wide costs of reducing emissions (Beaman 2008).

For example, in personal household section, The Carbon Pollution Reduction Scheme (CPRS) will change the prices of the goods and services that all households use. Goods that are emissions intensive to produce will generally become more expensive. This is consistent with the intent of the CPRS to motivate people to change their behavior and use products which are fewer emissions intensive to produce. Ultimately, this will assist in reducing Australia’s emissions. He Australian Carbon Trust Pledge Fund

The Government is setting up the Australian Carbon Trust and it will include an Energy Efficiency Pledge Fund to help households and businesses take action on climate change and directly contribute to lowering Australia’s carbon pollution levels.
The fund will be launched in 2010 and updates will be provided on our website and through our email alerts.

In the industry section, the proposed scheme will directly affect companies that emit more than 25,000 tonnes of greenhouse emissions each year. The effect of the scheme will be most noticeable in the increased cost of energy. Companies will either pass on increased costs or reduce their profits. Increased costs will flow on down the supply chain and may influence consumer choices. Businesses can lower the cost of carbon permits by helping to lower the demand for energy. The Climate Change Action Fund has been set up to assist business in the transition to a low carbon economy. Early estimates suggest that the CPRS will directly affect around 1,000 businesses in Australia which business emit more than 25,000 tonnes of carbon each year. Each affected company will be responsible for monitoring emissions and reporting on them to the scheme regulator by 31 October each year. The government has proposed that those organizations emitting more than 125,000 tonnes will need to have their emissions independently assured by third-party assessors (Energy save 2010).

By introducing a carbon price, however, the CPRS will affect many more businesses indirectly through increased costs. The Government has made a commitment to provide assistance to businesses through the Emissions-Intensive Trade-Exposed Assistance program, the Electricity Sector Adjustment Scheme and the Climate Change Action Fund.
In order to assist small businesses and businesses in some rural and regional industries, the Government is committed to cutting fuel taxes on a cent-for-cent basis to offset the initial price impact on fuel as a result of the CPRS.

The various challenges involved in implementing the scheme are the global economic crisis, areas of climate change and national securities. Also there are some arguments on CPRS from some politicians in Australia typically the same politicians who argue that human activity is not contributing to climate change – claim that what we do at home does not matter in the international climate negotiations. The assertion is that because Australia's emissions are less than those of other countries, such as the United States and China, what we do at home is irrelevant (Speech to the 5th Australia-NZ Climate Change and Business Conference 2009).

Some challenges are also from Australia coal association, because they think the scheme Damages to Australia’s number one exporter. Unfair treatment in the White Paper Australian coal will lose international competitiveness Cumulative effect of the Global Financial Crisis increased royalties and the CPRS, if it stands will be: Reduced investment; Job losses; Damage to regional communities (Hillman 2009).

For instance,

Furthermore, The Australian Government will provide assistance to the coal-fired electricity generation sector through the Electricity Sector Adjustment Scheme (ESAS) to help the transition to a low emissions economy under the Carbon Pollution Reduction Scheme (CPRS). The electricity generation sector accounts for up to 34% of Australia’s annual emissions figure and is heavily reliant on coal fired power stations. The industry sector will play a pivotal role in the prospective Carbon Pollution Reduction Scheme (CPRS) to be launched in July 2011. The CPRS will impose a carbon cost on all fossil fuel-fired generators. The most emissions intensive generators may be constrained in their ability to pass on these costs, leading to a decline in their asset values. Recognizing these effects, the Government established the ESAS to manage a smooth transition to a lower carbon electricity generation sector while maintaining security of supply, promoting stable energy contracting markets and supporting investor confidence in our energy market.
Ongoing investment in lower emissions generation is essential to maintain energy security in a carbon constrained future. The ESAS guards against risks of supply disruptions and supports the investor confidence necessary to deliver new investment and long-term energy security

Financial management decision

The financial manager acts in the shareholder’s best interests by making decisions that increase the value of the shares. The appropriate goal for the financial manager can thus be stated quite easily: The goal of financial management is to maximize the current value per share of the existing shares (Ross 2007).

The CPRS will not achieve its aim unless investors commit to undertake the necessary investments in new technology and infrastructure. Investors have indicated that they will be wary about making such large and long lived investments if the profitability of these investments is subject to a world in which rules and regulations are uncertain. This is particularly the case when many of these potential investors regard the proposed compensation arrangements as inadequate. Although some dispute these claims, they have not yet been tested under any comparable scheme in the world (since the European Emissions Trading Scheme provided more substantial compensation). Given the critical importance of a reliable electricity supply at a time when Australia needs to commit to significant new investment in supply for the first time in many years, it will be important to have practical policies in place to ensure investors will commit to the development of new capacity (Frontier Economics 2009).

Financial Management is the efficient and effective planning and controlling of financial resources so as to maximize profitability and ensuring liquidity for an individual(called personal finance), government(called public finance) and for profit and non-profit organization/firm (called corporate or managerial finance). Generally, it involves balancing risks and profitability.

The financial manager undertakes the three decisions the first is investment to determine the total amount of assets needed by a firm hence closely tied to the allocation of funds.
Two type of investment decisions namely: • Capital Investment decisions re: large sums, non routine, longer term, critical to the business like purchase of plant and machinery or factory • Working Capital Investment decisions re: more routine in nature, short term but are also very critical decisions like how much and how long to invest in inventories or receivables

Second one is Financing After deciding on the amount and type of assets to buy, the financial manager needs to decide on HOW TO FINANCE these assets via the sources of fund
Financing decisions for example: • Whether to use external borrowings/debts or share capital or retained earnings • Whether to borrow short, medium or long term • What sort of mix – all borrowings or part debts part share capital or 100% share capital
The needs to determine how much dividend to pay out as this will directly affects the financial

Third one is Dividend decisions which is about ASSETS MANAGEMENT DECISION

Once assets have been purchased and appropriate financing ar secured, it now involve the efficient and effective management of current assets like cash inventories & receivables so as to maximize returns and minimize the risk of liquidity.
Example of assets management decision like

• Extension of credit term to increase sales • To hold more stocks or on a longer term

In trying to meet the firm’s objective of maximizing the value of equity, with this in mind, it does not matter whether the business is a proprietorship, a partnership or a company. For each of these, good financial decisions increase the market value of the owner’s equity and poor financial decisions decrease it.

Figure: the interrelationship of the decision made by a financial manager (Ross 2007)

Source (----------------( objectives(-----------------( use

Of funds of funds

Cash flows in = cash flows out

New
Funds + funds = asset acquisition + dividends From and expense Operations

F investment D
Financing decision dividend
Decision decision

The three types of financial management decision are also called Capital budgeting, Capital structure, and Working capital management.
Capital budgeting is the process of planning and managing a firm's long-term investments. The key to capital budgeting is size, timing, and risk of future. Cash flows is the essence of capital budgeting
Capital Structure refers to the specific mixture of long-term debt and equity the firm uses to finance its operations. There are two main questions when looking at the capital structure
Working Capital Management refers to a firm's short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. This is more of an everyday activity.

In contrast, the major decision of the financial management decision is Investment and capital budgeting decisions, and the minor decision is Working Capital Management.

Potential impact of CPRS on financial management decisions

Those potential impact and issues are about Uncertainty in the future such as policy, costs, cash flows, investments and Trade off in cost benefit at different time periods such as Confirmed higher costs in the short ‐term in return for potential higher benefits in the long –term

For instance some potential impact will be influence on agriculture The Australian Governments Carbon Pollution Reduction Scheme (CPRS) will commence in 2010. Agricultural emissions are likely to be included in the scheme from 2015 (Ford 2009).

However the major impacts will be in coal mining and coal fired electricity, which is a scheme that puts a price on emissions. Putting a price on emissions means that we are giving big business a real incentive to clean up their act and help protect the future of tens of thousands of jobs across Australia’s coal industry (Maher 2010). Moreover, there were a number of significant changes made to the scheme in November 2009 after Malcolm Turnbull negotiated with Prime Minister Kevin Rudd. These changes included huge increases in compensation for polluting industries, including the coal and aluminum smelting industries.$4 billion is now proposed for the manufacturing sector and $1.5 billion is now proposed for electricity generators.

The negative impacts on coal industry from Australia coal association (2009) is to make job losses and reduced investment. But the facts from coal hard facts (Maher 2010) is about The Australian coal industry will have a lot more jobs in 2020 than it does now – at least 10,000 more and up to 16,000 more. And that’s with the CPRS. The allegations of large job losses are a big lie. The projection of large job increases comes from the very same reports that the coal companies are using to claim job losses.

Investment and capital budgeting is the financial decision which has got a link with CPRS. Because it is the process of planning and managing a firm's long-term investments, the key to capital budgeting is size, timing, and risk of future. Therefore, as a long term, future industry the coal real job numbers which MMA used a reference scenario commissioned by the mining industry that reflects a pre-CPRS jobs forecast. The National Institute of Labour Studies 2008 report for the MCA “The Labour Force Outlook in the Australian Minerals Sector 2008-2020” forecast that coal mining jobs would grow from 35,800 in 2008 to 54,700 in 2020. That’s a huge 53% increase in jobs in the “reference case”.
Deducting forecast job losses from the CPRS for each of the three reports from this reference scenario shows that employment not only grows in coal mining, it grows strongly.

Furthermore, the case of Xstrata is another example to illustrate those jobs of coal will grow in the future, which is one of Australia’s largest coal companies. While strongly campaigning against the CPRS and claiming that some of its own mines are at risk, it has been buying coalmines and announcing major infrastructure investments. Since late 2007 – when a CPRS was the policy of both the then Coalition Government and the Australian Labor Party – Xstrata has purchased 3 coal mines and projects worth almost $2 billion announced a 10 year $800m rail freight contract with Pacific National, bought its own set of coal trains (a first for any coal company) for $120 million and commenced planning for a new $1 billion coal port in Queensland. Xstrata is not the only one to do so , every major company Australian coal industry has announced aggressive expansion plans to take advantage of rapidly increasing demand from China and India and other rapidly industrializing nations The real story here is simple – with or without a CPRS, the Australian coal industry is growing. And jobs will grow with it (Maher 2010).

Therefore the impact of CPRS on financial management decisions will maximize the current value in the future as well as meet our international obligations to reduce our emissions under the Kyoto Protocol.

Conclusion

In conclusion, the aim of this essay is to review the proposed carbon pollution reduction scheme (CPRS) detailed in Australia and analysis the impact of CPRS on financial management decisions especially the investment capital budgeting decision. The focus of this essay is to present the impact via an analysis of coal industry. It can be achieved by the supporting of those investors and proper government legislations

References

Australian coal association, Ralph Hillman, 2009, Emissions Trading –risks to jobs, regional economies and investment in the Australian Coal Industry, Retrieved on 11th of April http://www.australiancoal.com.au/resources.ashx/Publications/32/Publication/A073E6D374FA11304F6902542E454F0C/General_present_on_CPRS.pdf Beaman Lucinda, 2008, IFSA supports carbon pollution reduction scheme, Retrieved on 15th of April http://researchpro.deakin.edu.au:50080/ebsco-web/ehost/pdfviewer/pdfviewer?vid=2&hid=113&sid=2e39a8bb-d29a-4b2b-9117-27b79021707a%40sessionmgr112

Climate change 2007, shaping a global solution, Retrieved on 13th of April http://www.climatechange.gov.au/government/international.aspx Energy save, The University of Sydney, 2009, Retrieved on 18th of April http://www.energysave.energyaustralia.com.au/carbon_emissions__and__you/learn/4.0_key_questions/4.3_carbon_questions/im_a_large_business_-_how_will_the_cprs_affect_me Frontier Economics, 2009, The economic impact of the CPRS and
Modifications to the CPRS, retrieved on 16th of April http://www.nickxenophon.com.au/campaigns/15/Frontier%20Economics%20CPRS%20Exec%20Summary.pdf

Maher Tony, CFMEU Mining and Energy Union, Coal Hard Facts, 2010, Retrieved on 17th of April http://www.cfmeu.com.au/storage/documents/Coal_Hard_FactsReport171109.pdf Ross, S, Thompson, S, Christensen, M, Westerfield, R and Jordon, B 2007, Fundamentals of Corporate Finance, 4th end, McGraw Hill, Sydney.

Senator the Hon. Penny Wong, Speech to the 5th Australia-NZ Climate Change and Business Conference, 2009, Retrieved on 11th of April http://www.climatechange.gov.au/minister/wong/2009/major-speeches/August/sp20090825.aspx Thomson Reuters 2010, FACTBOX – Carbon trading schemes around the world , Retrieved on 10th of April
http://sites.thomsonreuters.com.au/carbon/2010/02/factbox-carbon-trading-schemes-around-the-world/