Energy White Paper

Submission Cover page

Name:                 Frank Topham

Address:            GPO Box 3916 Sydney NSW 2001

Organisation:     Caltex Australia Limited

Phone number: 02 9250 5357

Email address:   ftopham@caltex.com.au

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Caltex submission on Energy White Paper discussion papers

June 2009

 

Overview

Caltex welcomes the opportunity to provide its views on the key issues that should be addressed in the Energy White Paper in relation to the supply and use of liquid petroleum fuels.  These issues are:

• maintenance of the viability of oil refining in Australia
• development of sustainable biofuels
• reduction of greenhouse gas emissions from vehicles.

Energy security is an emerging strategic issue. Over the coming decades the developing world's growing demand for petroleum products will create increased competition to secure supply of these products.  Without a viable refining industry Australia will be exposed to the risk of less reliable fuel supply in addition to the loss of the economic value added to the Australian economy.

The dominant threat to Australian oil refining is not international competition but the current proposals for an emission trading scheme, which fail to fully maintain international competitiveness.  Oil refining is a crucial link in the supply chain for petroleum products; the chain would not be strengthened by the removal of one of its links.  

Caltex believes alternatives to conventional refined petroleum products will be increasingly important to reduce greenhouse gas emissions and increase energy security. While conventional fossil fuels including refined products will remain dominant over the next few decades, alternatives will make a relatively small but significant contribution and energy policy should support this diversification of energy supply.

In Caltex's view, reliable, affordable and secure energy supplies are critical to Australia's continuing economic prosperity.            

Specifically, Caltex advocates an energy policy framework that includes:

• full maintenance of international competitiveness for oil refining under an emission trading scheme, for example through 100% allocation of free permits under the CPRS until international competitors face the same carbon costs, or the equivalent maintenance of competitiveness under an alternative emission trading scheme design;
• implementation of the taxation arrangements for liquid fuels including biofuels outlined in the 2004 energy white paper, supplemented if necessary by additional transitional assistance for the development, production and distribution of sustainable biofuels
• Implementation of a package of measures to reduce the carbon intensity of road vehicles including carbon efficiency targets, financial incentives for consumers of fuel and vehicle manufacturers, and other measures to reduce transport emissions through improved public transport and land use planning.

Further information on these three policy proposals is contained in this submission, largely extracted from recent material published by Caltex.

In addition, "Energy effects everyone: the coming challenges for business" a presentation by Caltex's CEO in October 2008, is attached to this paper.  The presentation and accompanying slides provide an overview of Caltex's views on a number of energy issues and the challenges ahead.

Caltex's business

Caltex is a refiner and marketer of petroleum products in Australia, with operations in all states and territories. It has an estimated market share of more than 30 per cent of the major transport fuels (petrol, diesel and jet fuel) supplied nationally. It has a branded petrol market share of about 16% nationally (excluding Woolworths co-branded sites), although sites at which Caltex sets the price account for only 5% of petrol sales.

Caltex accounts for around 35 per cent of Australia's oil refining capacity. It owns and operates two of Australia's seven operating oil refineries - at Kurnell in Sydney and Lytton in Brisbane. Between them, the Caltex refineries have the capacity to process 244,000 barrels (about 39 million litres) of crude oil per day.

Caltex produces mostly high-value transport fuels which contribute to the growth of the economy and provide significant employment. The two refineries directly employ 874 Caltex employees and around 550 contractors. These numbers can escalate when there is major maintenance and project work, escalating by a further 1,200 workers to bring the total number employed to about 2,600.

Caltex refineries will spend an average of $100 million per year over the next three years on capital expenditure and approximately $60 million per year on the major maintenance projects that are required regularly in all oil refineries.

Maintenance of the viability of oil refining in Australia

The Australian oil industry exists to supply quality fuels safely and reliably to customers.   While competition from refineries overseas is an ongoing challenge, the proposed Carbon Pollution Reduction Scheme (CPRS) could make some local refineries unviable.  If there was a level playing field, Australian refineries could remain competitive but this would require substantial changes to the CPRS.  Caltex's views on the CPRS are set out in its submission to the Senate Select Committee on Climate Policy.

If there was a substantial reduction in Australian refining capacity, Australian-grade fuel could become harder to obtain and premiums for Australian grade fuel could increase, depending on the rate at which Asian countries moved to fuel standards similar to Australia. Freight costs could increase if importers had to place orders with refineries outside Asia, for example from the Middle East.

Longer term, Asia may also struggle to keep up with demand, leaving countries like Australia that are short on refining capacity vulnerable to disruption of supply from overseas.

Australia has sufficient crude oil to supply roughly 60 per cent of its domestic needs. While it has refineries, it is within the power of the government to ensure that at least some of our fuel requirements can be provided from our own crude oil run in our own refineries if international cooperation broke down.

Refineries add security to the supply chain by providing a reliable base load supply.   Established import supplies and terminal stocks can then be used to optimise the supply chain between refining and imports and respond to planned and unplanned shutdowns.  In contrast, relying on an import supply chain that takes up to two months to get finished product to market would create greater risk of supply disruptions with potentially serious economic impacts on fuel users.

Local refiners will not remain viable if regulatory and tax burdens become too great.

Refining faces a number of challenges including increased competition from large new refineries in the region. New refineries in India, China, Korea, Vietnam and Indonesia will seek to buy the crudes that Caltex has traditionally bought from the region, increasing demand and reducing available supply. New Middle East refineries will also be looking to export into the region. These refineries will be designed for heavy sour crudes but will compete for the regional light sweet crudes which have diminishing availability.  Some new refineries are designed for local crude (e.g. in Vietnam).

The new Asian refineries will affect Singapore refiner margins and therefore profitability of Australian refiners.  

Refining is a competitive low margin business and policies that impose additional costs on the business threaten longer term viability.  The CPRS for example will impose costs of between $25-$40 million per year on Caltex's refining business, costs which cannot be passed on to customers.   Imposing costs on refining which cannot be passed on limits the capital available for local refining to invest in projects that increase productivity.

Development of sustainable biofuels

Transport in Australia, as in much of the world, is highly dependent on petroleum-based fuels, with alternatives accounting for only three per cent of total fuel consumption. Road travel contributes 89 per cent of total transport greenhouse gas emissions. Higher prices associated with tightening oil supply should see a move towards the greater uptake of biofuels and synthetic fuels with lower life cycle emissions.

Policy on alternative transport fuels must be formulated and implemented in the context of transport policy generally and the broader context of energy and environmental policy.

The introduction of emissions trading alone is unlikely to significantly change fuel use in the transport sector. Even a A$100/tCO₂e permit price would only increase the cost of fuel by around A$0.25/L, which is significantly less than the impact of oil price movements in the four years to 2008. Nevertheless, there is likely to be a steady shift toward lower emission fuels and vehicles.

In the next ten years it is projected that use of electricity, diesel, liquefied petroleum gas (LPG) and compressed natural gas (particularly in freight) will expand, particularly if there is an abrupt decline in the availability of international oil supplies. Only these among the non-conventional fuels have the capacity to expand their availability into the transport market in a relatively short time frame due to existing production and distribution infrastructure. However, some of these fuels will take considerable time to be fully commercialised.

Longer term, beyond 2020, advanced biofuels that limit competition with food production, hydrogen and synthetic fuels derived from gas and coal (using carbon capture and storage) are also expected to come into use once production infrastructure has had sufficient time to scale up. The extent of their use will depend on primary fuel prices and government emission targets.

Caltex supports the development of a market-driven, sustainable biofuels industry based on consumer confidence, reliable supply and competitive prices. It looks to a commercial "win-win" for producers and marketers in an industry that is economically, environmentally and socially sustainable.

With these caveats in mind, the company foresees a biofuels business that continues to expand. While there is no prospect of biofuels replacing all fossil fuels, Caltex believes there is potential for these products to occupy a larger portion of the market than its current small percentage.

From a policy principles perspective, Caltex supports a fuel tax system that:

• is efficient, equitable and simple
• is practical and workable and minimises compliance and administration costs for business and governments
• supports clarity, consistency and stability in policy settings relevant to the petroleum industry.

The taxation of all fuels should be consistent and neutral so that consumers can make informed decisions about fuel choice.  Consistent with this view, Caltex supports energy content as an appropriate and neutral basis for taxing fuels.  Further, Caltex does not oppose the introduction of excise for alternative fuels.

However, significant investments and business plans have been made on the basis of the current fuel tax policy framework including the 2004 white paper and, if there are to be any changes, they should not result in any existing or committed projects (at the date of any policy change) being made worse off.

Production of biofuels in Australia is currently supported by production incentives from the Australian Government which effectively negate the excise costs of ethanol and biodiesel, providing competitive pricing for the product, the intention of which is to incentivise consumer uptake. Current legislation proposes a phasing out of this tax concession, which in practice is likely to discourage further investment in the industry and reduce the price competitiveness of biofuels, which is currently the primary mechanism for consumer takeup.

On current policy settings, the incentives for blending these fuels will deteriorate from 2011 and any relative advantage to biofuels from the proposed CPRS will not fully offset this increased excise burden. As such, there may be a case for financial assistance to alternative fuels in order to overcome barriers to development that would address energy security, environmental or industry development objectives.  Such transparent assistance e.g. subsidies or grants, could also address any adverse consequences arising for existing or committed projects arising from any fuel tax changes.  For example, biofuels should continue to receive tax concessions at the same level as currently expected on the basis of the 2004 Energy White Paper, including the 50% discount on energy content (adjusted if necessary for the effect of the CPRS).  Additional assistance might be provided for more advanced biofuels and supply chain infrastructure.

Caltex is concerned that legislation provides for the phasing in of full rates of excise (i.e. 38.14 cpl) on ethanol and biodiesel over five years starting July 2011.  In addition, Caltex is concerned that the implementation of a biodiesel blend standard could remove the tax break afforded to B20 blends, with sever adverse consequences for the biodiesel industry.

Reduction of greenhouse gas emissions from vehicles

Carbon prices would do little to change motorists' consumption behaviour. The necessary changes to reduce greenhouse gas emissions will come mainly from new vehicle technologies, with carbon prices having little impact on this technological change. Once new vehicle technology becomes economic drivers will switch from fossil fuels to electric vehicles and vehicles using other renewable non-fossil fuels, including biofuels. The focus of policy has to be on reducing emissions from consumption of liquid fuels, not their production, as emissions from use of liquid fuels are about 20 times emissions from production in Australian refineries.

Significantly higher future oil prices will have a greater impact than carbon prices as drivers seek to reduce the costs of running their cars and seek ways to achieve greater energy efficiency. For example, an increase in oil prices of US$50 per barrel is equivalent to a carbon price of about A$170 per tonne of carbon dioxide[1] and such an oil price increase seems quite plausible once the global economy resumes reasonable growth. Taxes also play a part in driving vehicle efficiency as evidenced by the significantly greater fuel efficiency of European vs US vehicles due at least in part to much higher fuel prices.

While the CPRS will play a role in addressing climate change, carbon prices will have very little impact on fuel demand because it is fairly inelastic with respect to price and taxes are already high. In order to reduce the emissions from vehicle use in Australia, it is necessary to examine vehicle technology, new fuel sources and non-price measures such as improved public transport, infrastructure and urban design. Australia can benefit from the experience of other countries, with the European Union an example of achieving reductions through complementary measures. Transport is not part of the EU emissions trading scheme.

The 12 million passenger vehicles in Australia constitute 77% of the fleet. The average age of the passenger vehicle fleet in 2007 was 9.7 years, with about 20% more than 15 years old. In recent years, the composition of new passenger vehicle sales has changed significantly, with a marked increase in the sale of smaller cars.

It is widely accepted that the elasticity of fuel use with respect to petrol prices is very low in the short term, as vehicle owners often have limited opportunity to change travel patterns or switch to more fuel efficient vehicles. The demand for road transport tends to respond slowly to changes in the price of fuel.

The CPRS is expected to provide a cost effective approach to reducing CO₂ emissions on an economy wide basis but will not have a significant impact on emissions from transport. Governments in Australia have implemented a range of measures aimed at reducing CO₂ emissions from transport including National Average Fuel Consumption targets, the Alternative Fuels Conversion Program and government biofuels measures. The impact of these measures is estimated to be 1.8 Mt CO₂-e per annum over the Kyoto period and 5.0 Mt CO₂-e in 2020. As a percentage of total road transport emissions these projected savings are small, representing 2% in 2010 and 4% in 2020.

Modelling for the Future Fuels Forum projected that a greater shift toward public transport, rail and sea freight and lighter vehicles could, by 2050, reduce kilometres travelled by 30 per cent and greenhouse gas emissions by 17 per cent.         

A combination of measures is likely to achieve better results than any single measure. It is also worth noting that while short term gains are possible in terms of influencing purchasing decisions, the 10 to 15 years it takes for new vehicles to become dominant in the vehicle fleet means that it will take considerable time to achieve significant change to the greenhouse gas emissions of the vehicle fleet from the introduction of new vehicle technologies and/or some fuels.

Caltex believes that changes in vehicle technology will be the key to reducing emissions, together with greater reliance on alternative fuels.

Caltex proposes the following package of measures:

• Take motorists and light commercial vehicles out of the CPRS while retaining carbon liabilities for heavier vehicles (see Caltex submission to Senate Economics Committee inquiry into the CPRS bills for details)
• Monitor carbon efficiency (in grams/kilometre) against a set of voluntary targets that are comparable to other countries.
• Provide incentives to consumers to purchase the most fuel efficient vehicles available from manufacturers in Australia, Europe, the US and other regions through a "feebate" scheme that provides "cashbacks" for low emission vehicles, funded by fees on higher emission vehicles.
• Provide grants for research, development and demonstration of low emission vehicles and low carbon fuels, including biofuels, tailored to developing Australian manufacturing capability and fuel distribution infrastructure
• Other policies including consumer education, improved public transport and road management, and better urban planning to reduce transport emissions.

Appendix 1 (includes speech notes, followed by presentation slides)

Energy affects everyone: the coming challenges for business

CEDA CEO Vision Series

Sydney, 23 October 2008

 

Mr Desmond King
Managing Director & CEO, Caltex Australia Limited

CHART 1 - ENERGY affects everyone: the coming challenges for business

Energy affects everyone.  The use of energy is so pervasive in our personal and working lives and the economy that we barely think about it until we pull up at the petrol pump or pay the electricity bill.  Energy is delivered to us easily and efficiently. But for many people in poor countries, energy is scarce and expensive.  For these people, access to energy brings a better life.

The world is heavily reliant on fossil fuels to maintain our lifestyles and to lift others out of poverty. Oil in its various forms is a very versatile fuel that is used in almost every part of the economy from households to heavy industry, from agriculture to commerce.  It moves people around, heats their homes and fuels their machines.

 ENERGY CONSUMPTION BY REGION

North America and Europe dominated energy demand in the second half of the 20th century but this chart shows developing countries will dominate growth in the first half of this century, particularly the developing countries of Asia. This shift is fundamentally affecting energy supply/demand and energy trade.

But energy consumption in the form of fossil fuels is a large part of the climate change problem.  We all face threats from climate change with scenarios that vary from serious to disastrous.  We must all be part of a global solution that greatly reduces greenhouse gas emissions while maximising economic growth.  Carbon pricing and other regulatory interventions to address climate change will fundamentally reshape energy supply and demand.

There is another major factor affecting our future - limited oil supply.  It is generally accepted that oil demand will outstrip conventional oil supply in the foreseeable future, leading to higher oil prices or even oil price shocks if supply is very tight.  This often goes under the heading of "peak oil". 

OIL SUPPLY SOURCES

This chart is from Chevron, which is not a "peak oil" theorist.  Nevertheless, it shows conventional crude oil supply flattening off by about 2020 and increasing reliance on the Middle East, Africa and the former Soviet Union.  Over half the world's proven oil reserves are in the Middle East. The chart on the right shows the rapid increase in oil supply from unconventional sources, including extra heavy oils, tar sands and biofuels.

We are likely to experience a shortfall in conventional crude oil supply versus the trend in oil demand sometime in the next two decades, although the exact timing is the subject of debate. 

OIL PRICES

As this chart reminds us, we recently experienced unprecedented high oil prices in nominal dollars per barrel and about the same price in real, inflation adjusted terms as the first oil shock. It should be noted, however, that the data used in the chart is from a few months ago and there has now been a drop in oil prices to around US$70 or A$100 per barrel which is still historically high. We can't ignore what the market is telling us, which is to reduce our reliance on crude oil.

Global energy supply

ENERGY BY SOURCE

This chart shows the world is heavily dependent on fossil fuels for energy supply in the form of coal, oil and gas.  Conventional biofuel use is substantial but also not sustainable in many countries because of depletion of natural resources.  This dependence will be very difficult to change because of rapid growth in the developing world led by countries like China, India, Brazil and Indonesia and the current cost of switching to alternative energy sources such as nuclear and renewables. This chart is one of the Shell global energy scenarios that shows continued high dependence on fossil fuels despite a huge switch to renewables to address climate change.

Growth in developing countries has serious consequences for greenhouse gas emissions, which makes global agreement on reducing emissions imperative.  This is probably a familiar story but let me illustrate it with two charts.

WORLD OIL CONSUMPTION

This chart shows growth in world oil consumption from 2004 to 2008.  China and other developing countries dominated growth.  The developed countries of the OECD reduced their oil use over the period.

OIL USE AND GDP

This chart relates oil use to economic output, or GDP.  You can see the way that oil use per unit of GDP in the US, Australia and Japan is high but has flattened off.  China and India have much lower incomes and lower oil use per unit of GDP.  If these countries tried to increase their use of oil to the level of developed counties, the supply would not be available. 

It seems likely there will be global agreement by 2010 on reducing growth in greenhouse gas emissions, even though highly imperfect and differentiated between countries.  Australia and other developed countries will commit to substantive action.  This may not result in deep emission cuts or high carbon prices initially but the evolving nature of the climate change threat seems likely to drive all governments to more stringent action over the next decade.  Private and public investments that are made now must take account of this likely outcome. Customers, shareholders and regulators are increasingly looking for evidence of corporate readiness for the changing environment.

This raises the question of whether Australia should be planning an emission trading scheme when there is a global economic crisis and possibly a recession. Our view is that a scheme should be put in place as soon as it can be properly designed but its implementation should take account of economic conditions and international climate change negotiations.

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.  A scheme with a fixed price could be an alternative to a market-determined price while an international agreement is negotiated, then implemented, to provide a level playing field.

We need to remember that Australia can't go it alone.  Even if Australia massively reduced its emissions, there would be almost no discernable change in global concentrations of greenhouse gas emissions and no change to global warming or rising sea levels.  All the world's major emitters need to take substantial action to reduce emissions or, in the case of the poorest countries, reduce their growth in emissions.

The energy picture for Australia is similar to the world.  We depend on coal, oil and gas.  Coal is mainly for electricity generation, which in turn supplies residential, commercial and industrial uses, gas supplies similar end uses and oil is mainly for transport.

If Australia is to meet its target of a 60 per cent reduction in greenhouse gas emissions by 2050 relative to year 2000, radical changes in energy supply and demand will be necessary.  Note that a 60 per cent reduction relative to year 2000 is a 77 per cent reduction relative to business as usual emissions in 2050. 

That's the good news.  The bad news is that Professor Garnaut has advised we need about a 90 per cent reduction of greenhouse gas emissions in 2050 relative to business as usual.

Australian energy supply and greenhouse gas emissions

AUSTRALIAN GHG REDUCTION SCENARIOS

This chart is from the final report of the Garnaut Review.  The 60% line shows progress towards the Government's target of a 60% reduction in emissions.  The 80% line is what would be required for Australia to play its part in stabilising the global atmospheric concentration of greenhouse gases at 550 parts per million.  Professor Garnaut regards this as the necessary international target to avoid dangerous climate change, The 90% line is what would be required to stabilise the atmospheric concentration of greenhouse gases at a more satisfactory 450 parts per million.

Leaving aside nuclear power, the only way Australia can meet its 2050 target or more stringent targets is through heavy reliance on low-carbon electricity and biofuels.  Both climate change and the oil market are driving us in the same direction: greater efficiency in use of liquid fuels and diversification of supply.

AUSTRALIAN TRANSPORT EMISSIONS

This chart from the Garnaut report shows transport emissions are fairly flat through the middle of the century in the 550 ppm scenario.  This is the result of substantial usage of fossil fuels over the next 40 years, followed by almost complete electrification of transport in the second half of the century to help achieve the 550 ppm target.  All this assumes effective international agreement and we must act in concert with the rest of the world.

ELECTRICITY GENERATION BY TECHNOLOGY

Caltex recently participated in the Future Fuels Forum led by CSIRO, which generated a number of scenarios of fuel supply through to 2050. We have selected some charts from this study to illustrate our points.  These charts are broadly consistent with the Garnaut report.

There are many sources of low carbon electricity including solar thermal, wind, geothermal, wave, biomass, photovoltaic and hydro that are suited to various applications and locations and should be allowed to compete for market position.  Coal and natural gas with carbon capture and storage will play an important transitional role until stringent targets and high carbon costs reduce their viability.

DISTANCE TRAVELLED BY ENGINE TYPE

As this chart suggests, road vehicles will need to transition towards electricity to reduce carbon emissions.  And electricity will need to transition towards fuels other than coal and gas.  The carbon prices necessary to make this all happen ramp up to about A$80 per tonne of carbon dioxide in 2025 then decline to $40 to $60 per tonne by 2040. Oil prices increase from US$80 per barrel to US$100 per barrel by 2030 in real terms.

As the chart shows, internal combustion engines will be around for a long time yet.  They may use petrol or diesel with some proportion of biofuels and they may become more efficient through use of hybrid technology, but pure electric vehicles or even plug-in hybrids will remain relatively expensive over the next few decades.  This is why the market for fossil fuels for transport is projected to hold up well over coming decades.

AUSTRALIAN TRANSPORT FUEL CONSUMPTION

This chart looks at transport fuel consumption in more detail.  Beyond fuel for transport, there is fuel growth in other sectors, notably diesel for mining. Biofuels like ethanol and biodiesel will be important in transport applications where electricity is impractical.

As an oil company, Caltex has a focus on the future of liquid fuels as that is the core of our business.  Caltex is also the largest convenience store retailer in Australia and this is a growing part of our operations. 

Over the next several decades, Caltex will continue to evolve our fuel marketing operations.  Caltex is the leading fuel supplier in Australia and a leading marketer of biofuels blends.  To retain our position as the leading fuel marketer over the next decades we will likely be greatly increasing the amount of biofuels sold.

20 per cent of Australia's greenhouse gas emissions come from the use of liquid fuels including petrol, diesel and jet fuel. Reducing reliance on fossil fuels (including oil) means all fuel users must cut usage of conventional petroleum products over the next 40 years and gradually replace them with low-carbon, sustainable forms of energy.  Alternative, lower carbon energy sources will help meet the growing demand for fuel across the Australian economy and reduce fuel imports.

Oil refineries will also continue to provide substantial volumes of conventional liquid fuels, even in 2050. In the CSIRO scenarios, these fuels are blended with ethanol and biodiesel and net petrol and diesel consumption remains high.

AUSTRALIAN PRODUCT DEMAND

The long term outlook for fuels is consistent with Caltex's outlook for Australian demand growth through 2020.  The outlook is shown in this chart.  While petrol demand will be flat, we see diesel increasing at about 4% per year and jet fuel at 3 to 4% per year.  This is consistent with the time it will take for climate change policies to be agreed and fully implemented internationally and for climate change policies to have a substantial impact on fuel demand in Australia.  It also reflects the strong growth in Australia's economy.

ADVANCED VEHICLE TECHNOLOGIES

Conventional vehicles will dominate for many years but new technologies are starting to evolve.  This starts to show the technological feasibility of large reductions in transport emissions but the costs of these vehicles will remain relatively high.  We are already seeing the start of this shift with mass-produced petrol-electric hybrid cars, which will lead the way to vehicles that rely partially or completely on renewable, mains-based electricity. Alternative liquid fuels with a smaller carbon footprint will also play a role, and will include biofuels from sustainable feedstocks, synthetic petrol and diesel and hydrogen. Natural gas and LPG are already used as transport fuels.

These technologies will be made more economic by higher oil prices as conventional crude oil sources fall short of demand. Already, billions of dollars are being invested by vehicle manufacturers globally to avoid being left behind in the race for new technologies. Billions more are being invested by energy companies in ways to make new forms of liquid fuels and construct plants to produce them.

What about carbon prices?  The answer is that carbon prices will have very little impact on oil demand because prices and taxes are already high.  For example, an increase in oil prices of US$50 per barrel is equivalent to a carbon price increase of A$160 per tonne of carbon dioxide.  That's the kind of increase we experienced earlier this year.

A carbon price of A$40 per tonne of carbon dioxide, which is what we might expect in the next decade, the price of petrol would increase about 10 cents per litre.  That would reduce greenhouse gas emissions from use of petrol by only 1.3 million tonnes in the long term out of a total of 46 million tonnes of emissions from the use of petrol.  In other words, fuel demand is very unresponsive to carbon prices.  Most of the emission reduction will come from the supply side through changes to vehicle technology and fuel supply.

CALTEX IS NO.1

You may be thinking the future will become increasingly challenging for oil refining and marketing.  However, the changes I have discussed will take place over an extended period relative to the life of current investments.  History shows that very few companies survive unchanged for 50 years let alone 100 years.  Caltex has been present in Australia in various corporate guises since the RW Cameron company in 1900 so we know about change.  The key to success is the ability to adapt to changing times.  So what are the facts?

Growth in petrol demand in Australia is about zero. However, diesel is continuing to grow strongly because of demand from road transport, mining, construction and agriculture.  Jet fuel, which is a kind of light diesel fuel, is also growing strongly.  In recent years this has increased diesel prices globally relative to petrol and these global prices are the basis for prices in Australia.  The impact of current global economic conditions and the crude oil price will have an impact on the demand for petroleum products in the shorter term and refining margins in the short term will be soft as more refining capacity comes on stream in the next 12-18 months. 

Australia's imports of petroleum products last financial year were 30% of total sales and this figure will increase substantially over time, if only because of growing diesel and jet fuel demand.  However, large low cost Asian refineries which have the competitive advantages of: lower labour costs; less regulation; and closer proximity to growing markets mean no new refineries will be constructed in Australia.  Refining is a tough business at the best of times, like many manufacturing industries.  Competitive pressures could mean some of Australia refineries will close but many of Australia's refineries, perhaps all, could be competitive in the long run. 

What the refining industry needs is a level playing field, not an emission trading scheme that imposes a large carbon cost on Australian refineries, while our international competitors bear no carbon costs.  This would not reduce global emissions from use of oil, just relocate Australia's refinery emissions to Singapore and other Asian countries.

In addition, it does not help Australia's oil security of supply to take some of the links out of the supply chain and place reliance solely on supply from overseas refineries instead of a combination of local and overseas production. 

We have been building our marketing operations for a number of years now. We have successfully developed a business that focuses on the distribution and marketing of petroleum products with a flexible supply chain that includes value-adding refining operations and imports.  This provides a greater focus on marketing operations that are less vulnerable to carbon prices and import competition while maintaining refining assets that can take advantage of any upturns in the refining business cycle.  It contrasts with a traditional oil industry model that focuses on refining with a marketing operation to sell the refinery production.  Marketing sales growth should be strong, even in a carbon-constrained world, because of the strong links between diesel and jet fuel sales and Australia's economic growth.

The marketing-focused model is part of our business evolution.  It keeps us aligned with a world in which carbon prices, oil prices and demand-side technologies are all changing within the timeframes of current investments.  Caltex is investing in new and upgraded terminals around Australia to increase flexibility and meet increased diesel demand from Australia's resource industries and other customers.  We have also acquired wholesale operations that fit our marketing objectives. 

Caltex is also diversifying its fuels portfolio with investments in terminals and service stations to sell biofuels blends to retail and commercial customers.  Biofuels can have much lower life-cycle greenhouse gas emissions than petrol or diesel but the challenge is to produce them sustainably from non-food crops. Research on these second-generation biofuels is well advanced and should be commercialised within the next decade.  Sustainable biofuels are likely to play a relatively small but still significant role as a future fuel for internal combustion engines, including petrol-electric and diesel-electric hybrids. 

Because Caltex's refinery production is significantly less than its sales of petroleum products, a reduction in demand for refined petroleum products translates into lower imports, not lower refinery production for Caltex.  As Caltex does not make any refiner margin on imports, the impact on sales is only on the marketing side of the business.  However, growth in biofuels and LPG sales can help offset the loss in sales of petrol and diesel.  The growing convenience retailing business also helps to diversify revenue away from conventional transport fuels into area that have much less carbon sensitivity and our substantial holdings of strategically located real estate at service stations sites provides further long term flexibility for evolution of marketing operations.

Climate change policy issues

THE STAR

No discussion these days can be complete without discussing Australia's greenhouse gas emission trading scheme, the Carbon Pollution Reduction Scheme.  This is hardly surprising because the potential impacts on emissions-intensive, trade-exposed industries like oil refining are so significant. This chart shows the cover of our most recent Caltex magazine, which is available on our web site.

Oil refining operates on small margins on average over the business cycle and, given the capital-intensive nature of the business, faces very high carbon mitigation costs expressed as dollars per tonne of emissions abated.  As a result, almost all carbon costs will require the purchase of permits rather than the undertaking of  emission reduction projects.  High costs for carbon emission permits would threaten the viability of the Australian oil refining industry.

Caltex's submission on the government's green paper sets out the impact on the EBIT from Caltex's refining operations.  We believe the current criteria under the green paper are flawed as oil refining does not qualify for any free allocations of carbon permits despite being highly energy intensive, hence emissions intensive.  As a result, a scenario based on gross refiner margins since 2000 shows that carbon costs would reduce refining EBIT by one third.  This period included both very low and higher refiner margins. 

Management and boards have to manage what is before them.  In the bottom half of a business cycle, carbon costs for refining could consume 100% of EBIT as the costs would not be recoverable.  That would be a formula for shutting down operations.  Similar outcomes are faced by many industries, as the recent report by the Business Council of Australia showed.

But before everyone panics, the Carbon Pollution Reduction Scheme is far from finalised and we have considerable faith in the commonsense of government to devise a sensible scheme.

Professor Garnaut suggests assistance to emissions-intensive, trade-exposed ("EITE") industries should reflect their long term international competitiveness in a world where overseas competitors bear the same carbon prices.  I believe most of Australia's emissions-intensive, trade-exposed industries could be competitive in a carbon-constrained world that has a level playing field versus offshore competitors.  What is needed is assistance to bridge the time gap until competitors also have carbon costs and we have that level playing field.

PURPOSE OF CPRS

One of the key issues relating to the CPRS is its fundamental purpose. Is the CPRS (a) a kind of tax to raise revenue for green projects, or (b) a way to change the relative prices of goods and services according to their greenhouse gas emissions?  The answer is (b).  The Government says "the scheme is intended to deliver abatement, and not to adversely affect the distribution of income and wealth".  It also says "every cent raised...will be used to help households...and business adjust to the impact of the scheme". This goes to the heart of the issue of assistance for emissions-intensive, trade-exposed industries.

It also raises the question of where funding for R&D and industry adjustment schemes should come from.  Publicly funding for R&D is important and Caltex supports government assistance for R&D where private funding would be inadequate.  There is also a case for adjustment schemes where companies or communities would be disproportionately affected by climate change policies.  However, Australia has a long history of funding these activities from the budget and it is hard to see why climate change requires a different approach.  We believe all the revenue from the sale of permits should be recycled to households and businesses, not diverted to other uses.

COST IMPACTS OF CPRS

At $20 per tonne and about 500 million tonnes of emissions liable for permits in the first year of the scheme, about $10 billion is flowing to the government.  However, no-one outside the Cabinet has seen any calculations on the distribution of permit revenue.

This chart shows the major sources of emissions in the Australian economy.  Electricity generation is the largest and most of its carbon permit costs will be passed through to consumers.  Other forms of stationary energy are next, which includes a lot of emissions-intensive, trade exposed industries including oil refining and metals manufacturing.  These industries can't pass on their permit costs.  Transport is also large but over half of this is private motorists, who will have any increase in fuel prices due to carbon credits fully offset by a reduction in excise for the first three years of the scheme.

Emissions-intensive trade-exposed industries, what are now called EITE ("eaty") industries, will contribute about 40% of permit revenue.  That 40% is excluding agriculture. By their nature, as trade exposed, EITE industries can't pass on price increases due to carbon costs so they don't have an impact on households or other businesses.

However, the green paper proposes only 20% of permits would be allocated free to EITE industries - that's just half of the permits they are required to hold for their emissions.

This 20% shortfall in EITE assistance appears to constitute to a $2 billion per annum redistribution from EITE industries to the rest of the economy.  Where is this money going?  Are the benefits of its expenditure greater than the long-term cost to Australian industry in terms of lost investment, jobs and skills? An explanation is needed of how the $10 billion of permit revenue is being distributed.

Greater assistance to EITE industries in the form of free permits will not increase the burden on the rest of the economy.    First, the government says its intention is that CPRS revenue will be fully recycled to avoid redistributing income or wealth so recycling EITE permit revenue back to EITE industries will ensure revenue neutrality for those industries.  Second, the free allocation of permits will have no effect on the incentive for EITE industries to reduce emissions.  This is due to the way in which the amount of free permits for a particular activity will be calculated.

Conclusion

CONCLUSION

• Climate change and oil supply/demand will fundamentally change the long term business environment.
• Caltex's business continues to evolve.
• Sound climate change policy decisions are critical for the viability of Australian industries.

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. 

We need to remember that Australia can't solve the global problem alone when it comes to climate change.  However, climate change is a good example where, with the right scheme, Australia can help lead the world to a better future without disadvantaging the Australian economy.