Executive Summary

Overview of key points

1. About 30% of Australia's petroleum products were imported in the last financial year, mainly 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.

2. 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 emission trading schemes. Even though import parity prices will not change, Australian refineries will have to absorb the carbon costs from Australia's Carbon Pollution Reduction Scheme (CPRS) because their refinery gate prices are set at parity with the imports from these countries without carbon costs. Trade-exposed industries can't pass on carbon costs to customers because of import or export competition - oil refining is therefore trade exposed.

3. If the CPRS 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 CPRS should be designed to avoid this loss of competitiveness through the issue of free permits to emissions-intensive, trade-exposed industries such as oil refining until overseas competitors face the same carbon costs.

4. Nothing will be achieved if a badly designed scheme results in Australian refineries closing and 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. Australia's security of supply of petrol, diesel and jet fuel will be seriously weakened.

5. In addition to the permits that Caltex must purchase for its own emissions, mainly from refining, the CPRS 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 the design of the CPRS 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.

6. The CPRS 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. The full excise offset means there will be no incentive to reduce petroleum consumption. Even in the longer term, a $40/tonne carbon price with no excise offset would likely reduce petrol demand by only 1.3 million tonnes. As a result, emissions from petrol (and other liquid fuels) would continue to grow in the absence of substantial technological change.

7. Caltex recognises the impact of high oil prices on households and businesses and the rationale for the government's excise offset commitment. In order to ensure delivery on the government's "cent for cent" commitment, the price of carbon permits for petroleum products must be highly transparent and should be exactly matched to the excise reduction to assure motorists they are not being overcharged for carbon costs. Caltex proposes a mechanism in this submission that would enable an exact matching of carbon price and excise offset to occur.

8. 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. However, by imposing a tight cap on its emissions ahead of competitor countries, Australia may create a price for carbon that makes its oil refineries uncompetitive.

9. 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.

10. 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. 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. Revenue as defined in the Green Paper is the wrong measure - other measures such as emissions divided by value added (equal to earnings before interest, tax and depreciation, plus employee costs) would be more appropriate to measure the financial impact of carbon costs.

11. Australia can take an international leadership position in policies to reduce carbon emissions but until there is global commitment to emission reduction Australia's emission reduction trajectory should be modest and ensure a low carbon price initially. This would allow unintended outcomes to be indentified and corrected before irrevocable business decisions are taken.

Other comments on Green Paper issues

12. Emitters above the CPRS threshold ("large end users") should have the ability to acquire permits for their emissions from liquid fuels and acquit these annually to the CPRS regulator. However, a CPRS with both upstream point of obligation and large end user liability could not be implemented by 2010 because of the time required to make the necessary accounting system changes once CPRS design and regulation is completed. Such a CPRS design could be phased in. In the attachment to this submission, Caltex proposes a simple and robust set of rules that can be regulated to allow end user liability to operate, including appropriate treatment of non-fuel users of liquid fuels.

13. The ACCC Petrol Prices Commissioner will want to monitor the impact of carbon prices on the market. Under emission trading, carbon pricing will not be transparent as there cannot be any agreement between suppliers on methodology for carbon pricing and methodologies would vary. The problem of carbon price transparency and monitoring would be eliminated by Caltex's proposal for an excise offset mechanism. If this proposal (or some similar mechanism) is not adopted, transparency could be increased by frequent permit auctions: in essence, a weekly carbon auction in which there is substantial participation by liquid fuel suppliers could provide a benchmark carbon price for ACCC price monitoring, although there should be no restriction on pricing of the carbon in market prices.

14. In relation to an upstream point of obligation for liquid fuels, there should be a weekly auction of permits if Caltex's proposal for an excise offset mechanism is not adopted. If a permit auction was held at annual or six-monthly intervals, there is no way Caltex could fund the purchase of more than a small fraction of the permits it would need at the auctions. Caltex's current debt level is about $600 million and this debt could not be increased to $2.3 billion as would be required for an annual auction because of constraints on debt and equity raising. The net effect of financial intermediaries purchasing permits for resale to fuel suppliers would be to reduce the return to government from auctions, increase the return to shareholders of the financial institutions (including overseas shareholders) and limit the recycling of auction revenue to households and for other uses by about $200 million pa compared to weekly auctions in which fuel suppliers could fully participate.

15. The Green Paper proposes to apply the existing GST legislation to transactions relating to permits and any derivatives of permits. This creates complexity and unnecessary compliance costs. The Government's policy objectives could be met and these problems avoided by making all transactions relating to permits and their derivatives GST free.

16. The Green Paper has proposed new provisions of the income tax law to deal with the income tax treatment of transactions associated with permits. According to the proposed rules, a deduction will effectively be available when a firm sells or surrenders its permits. This will encourage Caltex to defer the purchase of permits until sometime closer to the date of surrender and will have implications for permit auctions, the secondary market and the stability of the carbon price. Alternatively, the proposed methodology will encourage Caltex to buy permits and surrender them as soon as practical. A solution to these problems is to ensure the deduction for permits is obtained at the point when permits are purchased.

17. The Green Paper does not deal with the potential for stamp duty being levied on transactions with permits. If dealings with permits are subject to stamp duty of up to 5.5% of unencumbered value, Caltex may have an additional cost of $97M pa as it must purchase permits for its own emissions and those from its customers' use of purchased fuels.

Download the full submisssion