Carbon Trading: Get set for a change in climate

We’ve all heard the old joke: what did the man say when he walked into a bar? Ouch!

Perhaps he was focused on the here and now of getting a drink and forgot to lift his eyes to see what was coming.

Our previous articles in Money Management have focused on the ‘here and now’ challenges of complying with legal obligations. In this article, we lift our eyes to the not too distant future, to a world of trading in carbon emissions, renewable energy and water rights, and ask what challenges and opportunities will exist for financial services businesses.

There is much about the coming regimes that is unclear, including exactly when they will be introduced and exactly how they will look. Admittedly, that’s not great fodder for action plans and ‘to do’ lists at this stage.

However, there are certain common features in the proposed regulation of carbon, energy and water that we can understand now, and that will provide us with valuable information for strategic planning.

Those who think now about coming opportunities and keep their eyes on the landscape in an informed way could do very well.

One can summarise the whole financial services industry as one that collects money from people who do not need it today and gives it to people who do need it today, and charges a fee on the way through. The money that is collected is invested in either debt or equity in the form of ownership of some form of property or a productive enterprise.

Property is a scarce resource that is desirable to own, and a system of title has been developed to regulate the ownership and distribution of it.

The belated recognition of the impact of carbon emissions produced by industrial development on the climate and environment is about to result in the rationing of carbon emissions.

For the first time, the right to produce carbon emissions will be a scarce resource that is desirable to own. It will be a new form of property, which can be bought and sold on a market. It is something that can be invested in, and that must mean opportunities for the financial services industry.

Similarly, the increasing move to renewable energy is creating new property rights and opportunities for productive enterprise.

Who has heard of an REC?

REC stands for Renewable Energy Certificate. It’s effectively a form of electronic currency created by the Renewable Energy (Electricity) Act 2000.

An REC has a value, which is determined by the market, and can be traded between registered persons. It may be traded separately from the physical electricity in an REC market.

Even householders have the capacity to generate renewable energy — for example, by installing solar panels in their roofs. Any excess over their actual use can be sold back into the grid.

All this adds up to new property rights and new markets, and if there aren’t opportunities in there for the financial services industry, we’re just not thinking hard enough.

As with anything that has a fluctuating value dependent on the forces of supply and demand, a market will develop for derivative products based on the underlying value of a unit of carbon emission or a unit of energy.

Opportunities will be created for the development of new financial products and consequent opportunities for advisers with the appropriate expertise.

There will be a need for new technologies and infrastructure that will be securitised and invested in via managed investment schemes and a host of other ways.

Of course, in marketing such opportunities, we need to be mindful of obligations under the Trade Practices Act and the Australian Securities and Investments Commission (ASIC) Act not to be misleading and deceptive.

The Australian Competition and Consumer Commission (ACCC) has already taken enforcement action in relation to several “green claims” that use words or phrases like ‘environmentally friendly’, ‘carbon neutral’ and ‘low emissions’ and has released guidelines in a publication, Green Marketing and the Trade Practices Act, which is available from the ACCC website.

Similar principles will apply in relation to the promotion of ‘green’ financial products and the ASIC Act.

There will also, of course, be challenges.

We are all carbon emitters. We need to learn to think in a world where, for the first time, carbon production comes at a cost.

Large carbon emitters will have to buy credits from those that produce less.

The regime will bring another layer of reporting. Most immediately, commercial property owners will have reporting obligations under the National Greenhouse and Energy Reporting Act 2007 (Cth).

It will impact on choices we make about the type and location of office buildings we inhabit, the amount and source of the power we use, whether we have carbon offset programs (eg, planting trees for which we can claim carbon offset credits), our transport and that of our staff to and from the office and so on.

Some of these decisions, such as entering into a long-term lease of premises, we may be making now without any thought about the future cost of carbon emissions associated with the premises.

Last March, the Government announced that Australia would have a carbon emissions trading scheme in place by 2010.

While there have been some recent rumblings about whether or not 2010 is still realistic in light of the financial crisis, it is likely that some type of carbon emissions trade scheme will be introduced within the life of your next lease.

The challenges

Of course, the challenges are there for the designers and regulators of the schemes as well.

The success of the schemes will depend on establishing an environment that is attractive to lenders and equity seekers.

The designers will set parameters, such as annual targets, that will directly impact on the price and the predictability of the price of the new property rights (whether they are RECs or carbon offsets).

These will be important factors to lenders and those looking to purchase equity when making their decisions.

Banks will need to consider revaluing their mortgage books and fund managers their property portfolios having regard to the impact of the carbon emissions of the building or land. Commercial buildings have been estimated to produce 8.8 per cent of Australia’s total greenhouse emissions.

It is likely that these emissions will adversely impact the value of these buildings and that buildings designed with ecologically sustainable principles in mind will become relatively more valuable.

The relative cost of things will change depending upon the level of carbon emissions produced in the chain of production. The relative pre-carbon costs of steel, glass and aluminium will change once the cost of carbon emissions is introduced.

The total of the energy that goes into producing something during every stage of the process (‘the embodied energy’) will now be measured and impact on the price of the particular item.

Production techniques that are viable now may not be cost effective post-carbon trading. Conversely, some techniques that are not viable now may become so post-carbon trading.

While this brave new world may seem too radical to be real, it is real.

Europe has already started moving down this road. Governments are working on legislation and the establishment of regulators. Irrespective of what you think about the science of climate change, regulatory change is coming.

Although short-term responses to economic conditions may (or may not) hold back the tide for a brief moment, the tide is advancing inexorably. Don’t be washed away. There is good work to be done and real money to be made. It is those who are informed, innovative and just a bit ahead of the pack that will make it.

There is money to be lost — and it is those who are not informed and who are caught out that will lose it. And then there will be the majority of us who just struggle on with another lot of compliance, doing what we have to in order to survive. Where will you be?

We’ll endeavour to keep you up-to-date as Australia’s response to climate change takes shape and the regulatory requirements become clearer.

Grant Holley is a partner at Holley Nethercote Commercial Lawyers, www.holleynethercote.com.au.