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Carbon get it

Feature Articles

Cite as: (2008) 82(6) LIJ, p. 38

Many industries will be at risk if they do not prepare for the forthcoming carbon market.

By Ross Blair

Australia will have a carbon market by 2010. It is reasonable to predict that this will be part of an emissions trading scheme including legislation capping the emission of carbon as well as regulations to enforce sustainability principles. A key requirement of itscheme would be that major carbon emitters must acquit emission permits to balance their carbon emissions. Major carbon emitters would include the likes of fossil fuel energy suppliers, large companies, airlines, transport companies and dairy and beef farmers, although some categories may initially be excluded. Emission permits would be issued up to the level of the cap and sold to the highest bidders. Carbon offsets would likely be issued to those who sequester CO2 and retain it for a lengthy specified term. These would also be saleable and their inclusion likely to soften the market’s impact. The progressive lowering of the cap to meet international commitments would then cause demand to increase, supply to diminish, and the price start to climb. It would continue climbing until major carbon emitters reduce their emissions or go out of business.

Pending this result, major carbon emitters will pass the additional cost on to their purchasers. This is the key element in the scheme because it causes that cost to flow on into the cost of all goods and services. It follows that although fossil fuel energy suppliers will be able to pass on the cost for a time, it will not be too long before their customers look elsewhere for their energy supplies or adopt ways of reducing their reliance on carbon-based energy.

Embodied energy

To most of us, all this means is that the petrol and electricity we use will become dearer – pretty simple really. But to those concerned with the economics of business, such a rise in the cost of “operational energy” is only the tip of the iceberg. To manufacturers, builders, and developers and many others, a far more concerning issue is the effect a rising carbon market will have on the cost of what we refer to as “embodied energy”. It is this cost that will have the greatest effect on the competitiveness of the goods, buildings and developments they have to sell.

An understanding of what effect a carbon market will have on business needs to begin with knowing what embodied energy is all about. It is the total of the energy that goes into the making of a material, or of things, that are made with materials. It includes the energy used both directly and indirectly in making a material or thing, stretching back to the mining or obtaining of raw materials. It extends to the energy consumed in making the equipment used in every process of that chain, as well as to transportation and the operation of all the businesses that contribute to the processes involved in making the material or thing. Simply, embodied energy can best be defined in the following way: “The energy, the cost of which (however small) eventually finds its way into the cost of a material or a thing that is made with materials, constitute collectively the embodied energy in that material or thing”.

Effect on costs

The next step is to recognise that cost increases in energy resulting from the operation of a carbon market will not apply uniformly to the cost of goods or services. This is because the quantity of embodied energy in any of those goods or services is likely to differ from that in the other goods or services of the same range. However, in respect of a whole range of goods or services there is already an ability to make reasonably accurate predictions. Assume a prevailing carbon market price of Au$40 per tonne of CO2. Based on that price, the cost of steel would increase over its pre-carbon market price by approximately 20 per cent. This would include not only the energy involved in smelting, rolling and other processes, but also in mining and transporting the iron ore. Similarly, the cost of concrete would increase by about 11 per cent. The cost of glass would rise by approximately 15 per cent and the cost of aluminium by approximately 30 per cent. As against these, the cost of plastics would increase by only about 6 per cent. It should also be noted that the figure of Au$40 a tonne for CO2 is low. The highest estimate (provided some years back by the Australian Bureau of Agricultural and Resource Economics (ABARE)) is Au$180 per tonne which was considered excessive at the time, but is currently receiving greater support. It should also be noted that some industries have already developed the means to claw back some of the predicted price increases.

Positive reaction

Whatever the percentage increases may be, however, their level even at a low carbon price makes it clear that manufacturers, builders and others need to look now at the materials they are producing and using to assess the likely future costs of their products or things. They should also be making the same calculations in respect of the materials and things produced by their competitors, both actual and potential.

Prudent manufacturers, builders, developers and others should also start reducing their product’s carbon level or turn to an alternative product that already has a satisfactory level. They should also review processes, patents and ideas previously rejected because they were not cost-effective. Their time may at last have arrived. Right across the board, those whose businesses are threatened by energy cost changes need to understand why those changes are occurring and adapt to them as best and as quickly as they can.

This article assumes that the methane emissions of cattle will result in dairy and beef farmers being included as major carbon emitters. Some dairy farmers took advice given to them six years ago to plant trees in order to provide offsets. They are now potentially in a position, with legal adjustment, either to take the higher price for dairy products that the application of cap and trade will create, or to join with others in a similar position to market their dairy products as carbon neutral, or trade in their carbon offsets. Such is the result of prompt action taken on the basis of good advice. Australia is about to enter a period of unprecedented change that will need the highest levels of innovation for businesses to survive.

A further step towards achieving a full understanding of how a carbon constrained economy will operate is simply to apply normal market principles. For example, if traditional building materials are priced out of the market, other materials will replace them and designs will change to accommodate this. You can follow some of this by visiting http://www.carboncostcalc.com where we have started to look at materials and design from an embodied energy perspective. Whether this causes McMansion to be superseded by Smarthouse remains to be seen, but the driving force of whatever changes occur will undoubtedly be the carbon emission and offset market.

Some businesses and professions are at greater risk than others in a world where prices will change largely on the basis of a carbon market and the ability of businesses to understand and adapt to that change. Qualified valuers, land managers, property developers, real estate agents and others in the property industry will be at high risk. This is primarily because they are already making judgments that come into effect some time after 2010 and consequently they need to know very precisely what changes are likely to affect those judgements.

Some existing issues

Not all the risks of a carbon market, however, are those associated with the changing cost of materials and designs. For example, in the area of property law the changes will be vast but can arise
from different, but related, causes. The forestry rights proposed in 1995 for the Forestry Rights Act 1996 and their derivatives, the carbon sequestration rights of 2002, will be expanded to include a diverse range of new “land use change” carbon sinks to capture and retain carbon. This, in turn, will necessitate the creation of a sizeable number of diverse registrable carbon offset rights which are legally similar to carbon sequestration rights, and which provide the necessary legal basis for tradeable carbon offsets and their management and verification.

Those involved in rural property and their lawyers will need to understand that carbon offsets and carbon offset rights are transferable and mortgageable. Provisions for their protection are, or will be, binding on the owners of land and of those attachments to land, such as trees, in which the carbon offsets and carbon offset rights “reside”. Those provisions will remain in operation to preserve the captured carbon for very lengthy periods, probably 100 years at least. The ability to lawfully terminate the carbon offset rights of a carbon sink will, at the very least, necessitate acquitting carbon offsets equalling all the carbon offsets previously traded in respect of that sink. The use of carbon offsets will, I believe, become the means by which the human race will regulate the climate of the planet, even to the extent of simulating the alternate warming and cooling necessary to continue developing species. Carbon offset law will become a new area of legal practice including its export internationally as the most appropriate law on the subject.

Overview of change

We are likely to experience many changes in business arrangements that today seem cut and dried. The climate across Australia will change more rapidly and more remarkably than we have previously envisaged, leaving some areas storm ravaged, flood prone and uninsurable, while previously green and lush cities will come to look increasingly drought ravaged. “Land use change” requirements seem likely to be imposed in respect of new developments, housing subdivisions and roads in order to balance the carbon emissions their construction causes. Carbon offsets will become expensive but necessary in the case of building and other proposals likely to cause excessive carbon emissions. Rates, taxes and other charges will increasingly be linked to the achieving of environmental outcomes. Regulations will follow in the wake of carbon inroads that result from the operations of the carbon market just as has occurred in Europe. Owners of businesses and their mortgagees, insurers, employees, customers, shareholders and others will be interested in these and similar issues and look to the legal profession for much of the advice and protection they will require.

Some legal issues

Members of the legal profession will need to have a knowledge of how a carbon market is likely to affect their clients. As with valuers, they will be constantly asked for advice on issues with commercial impacts beyond the introduction of such a market. Some of those issues are set out below. These should be considered in the light of the changing circumstances that a carbon market will produce.

  • Many people have invested, or are considering investing in, community-title-owned high-rise buildings that will eventually be revealed to be greenhouse lemons requiring urgent and costly remedial environmental refurbishment (RER). What do you say to a unit owner who has invested in a poorly designed high-rise requiring RER which is being resisted by a small group of absentee owners with sufficient numbers to block the proposal and what do you say to his mortgagee?
  • You act for an insurance company that wants to know whether the operations of a carbon market are likely to have any effect on its replacement value insurance business or its contents insurance business which offers “new for old”.
  • A community-based renewable energy developer seeks advice on funding options for a new source of energy production, but is unable to convince potential investors or lenders of the derivative benefits.
  • You specialise in town planning and you begin to realise that the carbon market is going to reverse a large number of the principles that have underpinned the precedents you rely on.
  • You act for a company whose directors need to know what they should advise shareholders in respect of the company’s exposure to increased energy and other costs after 2010.
  • You act for a bank that wants advice as to if and when it should review its mortgage book on the basis of the introduction of a carbon market.
  • The litigation section of your firm asks for your input on the question of the quantum of damages (or restitution) in a commercial or other dispute.
  • A land developer would like your advice as to whether to build now or after the carbon market opens and whether it should refurbish an existing but substantial building or demolish and reconstruct from scratch.
  • Your client seeking a loan in Europe is required to demonstrate how it proposes to lower its CO2-e emissions to permanently avoid the carbon market impact.

Conclusion

The issues listed above are, of course, merely examples of what the legal profession will be confronted with. Practitioners in the various areas of law to which these issues relate will be able to flesh out and develop the problems they contain in the context of a changing world of carbon constraint. Some of the issues are not new, but the commencement of a carbon market will accentuate them; others will not occur until the economic impacts of a carbon market begin to be felt.

The legal profession is well placed to become early adaptors and advisers on a myriad of issues that will arise as a result of an economic price being put on the emission of carbon gases. I encourage you to consider and debate these issues to help our governments develop appropriate incentives, mechanisms and controls for the future security of our planet.

ROSS BLAIR is special counsel, McKean Park Future Law Team.

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