The Economic Impacts of the Clean Energy Future on Queensland

The economic impacts of the Clean Energy Future on Queensland

22 August 2011

Impact of a carbon price on the Queensland economy

Contents

Acronyms ...... i Executive summary ...... i 1 Background ...... 1 1.1 Limitations of the analysis ...... 2 2 Underlying assumptions ...... 4 2.1 Macroeconomic assumptions ...... 4 2.2 Electricity generation ...... 5 2.3 Intermediate input productivity ...... 6 2.4 Energy efficiency ...... 7 2.5 Policy scenarios ...... 7 2.6 Framework of the analysis ...... 10 3 CGE modelling results ...... 15 3.1 Medium price scenarios ...... 15 4 Comparison with previous Commonwealth Treasury modelling ...... 21 4.1 Key differences in the modelling approach ...... 21 4.2 Key differences in results ...... 22 5 Other scenarios ...... 25 5.2 Delayed global action scenarios...... 27 5.3 Reduced commodity price scenario ...... 28 6 Queensland coal sector ...... 29 6.1 Industry snapshot ...... 29 6.2 Cost structure ...... 30 6.3 Price forecast ...... 34 6.4 Demand side analysis ...... 35 7 The LNG sector ...... 45 7.1 Industry snapshot ...... 45 7.2 Industry pressures...... 47 7.3 Costs and emissions ...... 48 7.4 Price forecast ...... 49 7.5 Carbon price risk ...... 50 8 Heavy transport ...... 53 8.1 Industry snapshot ...... 53 8.2 Industry pressures...... 55 8.3 Carbon price risks...... 58 9 Agriculture ...... 63 9.2 Carbon price issues ...... 64 10 Other Tier 2 industries ...... 66

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10.1 Tourism ...... 66 10.2 Cement ...... 68 10.3 Steel ...... 68 Limitation of our work ...... 70 Charts

Chart 3.1 : Carbon prices in Australia, real $A, 2010 prices ...... 17 Chart 3.2 : Queensland GSP, billion $A, real 2010 prices ...... 19 Chart 6.1 : Coal cost by mine location (USD/t 2008) ...... 31 Chart 6.2 : Average metallurgical FOB cost component (2008 USD/t) ...... 32 Chart 6.3 : Metallurgical FOB Mine Cost (2008 USD/t) ...... 34 Chart 6.4 : Thermal FOB Mine Cost (2008 USD/t) ...... 34 Chart 6.5 : Export coal price forecasts ($A/t real, 2010-11) ...... 35 Chart 6.6 : Australian coal export forecast (PJ) ...... 37 Chart 6.7 Australian forecast of thermal coal electricity generation (GWh) ...... 37

Chart 6.8 : Metallurgical FOB mine cost — emissions intensity of 0.3 CO2-e/t ...... 41

Chart 6.9 : Metallurgical FOB cine cost — emissions intensity of 0.1 CO2-e/t ...... 42

Chart 6.10 : Metallurgical FOB mine cost — emissions intensity of 0.5 CO2-e/t ...... 42

Chart 6.11 : Thermal FOB mine cost — emissions intensity of 0.3 CO2-e/t ...... 43

Chart 6.12 : Thermal FOB mine cost — emissions intensity of 0.1 CO2-e/t ...... 43

Chart 6.13 : Thermal FOB mine cost — emissions intensity of 0.5 CO2-e/t ...... 44 Chart 7.1 : New global liquefaction projects ...... 45 Chart 7.2 : LNG netback price (AUD/GJ)...... 50 Chart 7.3 : Cost vs price estimate — High cost case scenario ...... 51 Chart 8.1 : Total employment and share of gross value added ...... 53 Chart 8.2 : Breakdown of business size in Queensland ...... 54 Chart 8.3 : Indicative cost structure across transport subdivisions ...... 56 Chart 8.4 : Indicative income structure across transport subdivisions ...... 57 Chart 8.5 : Brisbane wholesale diesel prices ...... 60 Chart 8.6 : Average fuel price movement and carbon price impact ...... 60 Tables

Table 2.1 : Australian macroeconomic assumptions (%) annual average growth ...... 4

Deloitte Access Economics Impact of a carbon price on the Queensland economy

Table 2.2 : State macroeconomic assumptions (%) annual average growth ...... 5 Table 2.3 : Macroeconomic assumptions, international regions, annual average growth ...... 5 Table 2.4 : Electricity generation technology shares (%) ...... 6 Table 2.5 : Improvements in intermediate input efficiency ...... 6 Table 2.6 : Assumed carbon prices, core policy scenario ...... 9 Table 2.7 : Industry assistance for trade exposed emissions intensive industries ...... 10 Table 2.8 : Sectors and Regions in DAE-RGEM ...... 11 Table 3.1 : Queensland electricity sector output index — medium global versus core policy ... 16 Table 3.2 : Macroeconomic outcomes for Queensland: medium global action v core policy .... 18 Table 3.3 : Selected macroeconomic results (% deviation*) ...... 20 Table 3.4 : Macroeconomic impacts on Queensland and Australia, % deviation from medium global action ...... 20 Table 4.1 : Selected macroeconomic results (% deviation*) ...... 23 Table 5.2 : Macroeconomic outcomes for Queensland, medium global action v. core policy ... 26 Table 5.3 : Selected macroeconomic results (% deviation*) ...... 26 Table 5.4 : Selected macroeconomic results (% deviation*) ...... 27 Table 5.5 : Selected macroeconomic results (% deviation)...... 28 Table 6.1 : Queensland nominal coal rail haulage capacities and expansion (Jan 2008)...... 30 Table 6.2 : Average FOB cost component and standard deviation ...... 32 Table 6.3 : Key proposed coal projects in Queensland ...... 38 Table 7.1 : LNG pipeline projects in Queensland ...... 47 Table 8.1 : Transport industry input output table ...... 58 Table 8.2 : Fuel consumption and emissions for vehicle type ...... 59 Table 8.3 : Illustrative impact of carbon price on road freight ...... 59 Table 9.1 : Agricultural production, Queensland, 2009-10 ...... 63 Table 9.2 : Gross value of production, Queensland, 2009-10 ...... 64 Table 9.3 : Agricultural emissions, 2007 ...... 64 Table 10.1 : Visitors to Queensland, 2010 ...... 66 Figures

Figure 2.1 : Illustrative dynamic simulations using DAE-RGEM ...... 14 Figure 3.1 : Deviations from baseline versus medium global action ...... 16 Figure 5.1 : Assumed carbon prices under various scenarios ...... 25

Deloitte Access Economics Impact of a carbon price on the Queensland economy

Acronyms

ABARE Australian Bureau of Agriculture and Resource Economics ABS Australian Bureau of Statistics BCM Billion cubic metres CES Constant Elasticity of Substitution CGE Computable General Equilibrium

CO2-e Carbon dioxide equivalent CPRS Carbon Pollution Reduction Scheme DAE Deloitte Access Economics DAE-RGEM Deloitte Access Economics’ Regional General Equilibrium Model DCCEE Department of Climate Change and Energy Efficiency DWT deadweight tonnage EITE Emissions Intensive Trade Exposed FOB free on board GDP Gross Domestic Product GNI Gross National Income GSI Gross State Income GSP Gross State Product GTAP Global Trade Analysis Project GTEM Global Trade and Environment Model HES Household Expenditure Survey LNG liquid natural gas LTM Deloitte’s Long Term Model MRET Mandatory Renewable Energy Target MPCCC Multi Party Climate Change Committee PCI Pulverised coal injection PPM Parts per million REC Renewable Energy Certificate RET Renewable Energy Target

Impact of a carbon price on the Queensland economy

Executive summary

The Australian Government’s recently announced Clean Energy Future policy proposes a broad-based carbon price to be introduced from 1 July 2012. The package establishes a national carbon price and expands renewable energy, energy efficiency and land use policies and programmes, with legislation expected to be passed by Parliament in late 2011. A range of assistance measures for industry was also announced within the policy package, principally for emission intensive trade exposed businesses, and has been factored into the analysis. The scheme is directed at meeting a national emissions reduction target of at least 5% below 2000 levels by 2020 and a longer term target of 80% below 2000 levels by 2050.

At the same time as the scheme was announced, economic modelling was released by the Commonwealth Treasury in support of the policy package. This modelling did not incorporate detailed State level impacts.

In this context, Deloitte Access Economics was commissioned by Queensland Treasury to undertake a range of quantitative modelling of the economic impacts of the main aspects of the Clean Energy Future plan on the Queensland economy.

Key aspects of the carbon price policy

The Australian Government has indicated that approximately 400-500 companies will be directly liable for the carbon price (around 110 of these companies operate solely in Queensland). Generally, a threshold of 25,000 tonnes of direct CO2-e emissions will apply for determining whether a facility will be covered by the carbon pricing mechanism.

For the three financial years to 30 June 2015, the carbon price will be fixed, starting at $23 per tonne of emissions and rising by 5% per annum in nominal terms. From 1 July 2015, the carbon price is to be set by the market. Commonwealth Treasury has projected the nominal world carbon price, in the 2016 financial year, to commence at $29 per tonne.

For the first three years of the flexible price period ‘safety valves’ will be built into the system to avoid extreme carbon price fluctuations. The carbon price ceiling will be set at $20 above the expected international price, rising by 5% per annum in real terms. The price floor will be at $15, rising by 4% per annum in real terms.

During the three year fixed price period, the number of carbon permits on the market will be equivalent to that which Australian businesses require to meet their regulatory obligations. Under the flexible price period, the number of permits will be limited by the prescribed annual carbon pollution cap. Businesses will have the option to buy either domestic or credible international carbon permits to meet their obligations, with the carbon price to be determined by these market trades.

Industry sectors covered by the scheme

The industry sectors covered by the price mechanism are stationary energy, industrial processes, fugitive processes (other than decommissioned coal mines), non-legacy waste

Deloitte Access Economics i Impact of a carbon price on the Queensland economy

and limited coverage of the transport sector. Agriculture and land use emissions are excluded.

Transport fuels are excluded from the scheme directly, but domestic aviation, marine, rail and certain other transport fuels will have an indirect carbon price (a ‘carbon price equivalent’) applied to them through reductions in fuel tax credits or an increase in excise charges (as for domestic aviation).

A carbon price will not apply to household transport fuels, light vehicle business transport and off-road fuel use by the agriculture, forestry and fishing industries. From 1 July 2014, the Government will look to establish a carbon price for heavy transport on-road liquid fuel use.

However, even if businesses do not have a direct carbon price liability, they will be impacted by the indirect flow-through of the carbon price. This flow-through impact will vary between industries and products. Due to the high carbon cost some businesses may face and potential difficulties in passing this cost on to consumers the Commonwealth Government has proposed a wide reaching support package to be implemented during the three year fixed price period.

Industries which are emissions intensive and exposed to international trade are to receive assistance. Highly intensive activities are to receive 94.5% of their permits at no cost, with moderately intensive activities receiving 66%. Approximately 50 activities are expected to be eligible for free permits under the assistance package.

The Commonwealth Treasury was asked to model the impacts of the main features of the Clean Energy Future, in particular, the likely social and macroeconomic implications of the carbon price. The Commonwealth Treasury modelling results are set out in the Strong Growth, Low Pollution, Modelling a Carbon Price1 report. More detailed information on the carbon price policy and related support and green energy initiatives, is contained in the Australian Government’s Climate Change Plan, Securing a clean energy future2.

Household compensation

In conjunction with the introduction of a carbon price, various household compensation measures will also be provided. These include tax cuts and increases in pensions, allowances and benefits. The household compensation measures are a significant component of the policy approach, accounting for more than half of the carbon taxation revenue collected.

Economic modelling

The modelling was carried out using Deloitte Access Economics’ in house computable general equilibrium (CGE) model, DAE-RGEM. The economic modelling assumptions underpinning this analysis have been aligned, where possible and in the time available, to

1 The Treasury of the Australian Government, Strong growth, low pollution: modelling a carbon price, http://www.treasury.gov.au/carbonpricemodelling/content/report.asp, 2011. 2 Commonwealth of Australia, Securing a clean energy future: The Australian government’s climate change plan, http://www.cleanenergyfuture.gov.au/clean-energy-future/our-plan/, July 2011.

Deloitte Access Economics ii Impact of a carbon price on the Queensland economy

assumptions in the recently released modelling undertaken by the Commonwealth Treasury. However, precisely replicating the Commonwealth Treasury modelling was not the aim of this analysis.

Where differences in the announced policy and the Commonwealth Treasury modelling exist, the analysis adopts the parameters from the announced policy. For example, the Commonwealth Treasury modelling assumes a starting price of carbon of $20 t/CO2-e where as the announced policy is based on a $23 t/CO2-e starting price. The modelling presented in this report is based on a $23 t/CO2-e starting price.

In terms of the two main elements of the compensation measure, assistance to emissions intensive and exposed sectors and household compensation, the modelling only accounts explicitly for the former. This is consistent with the approach undertaken by the Commonwealth Treasury.

While our modelling includes the key features of the Commonwealth Treasury modelling, it does not include details of some of the announced policy initiatives such as the iron and steel package, the assistance to coal mines and the $10 billion Clean Energy Finance Corporation. These elements were not included because it is unclear, at this stage, what the detail of the initiatives will be. The design of these packages will be important in terms of managing the transition in some sectors as well as pursuing additional policy goals.

Summary of results

Core policy scenario

Under the ‘core policy’ scenario, Australia participates in what is described as ‘medium global action’ in reducing emissions. Under this scenario, all regions undertake to stabilise concentrations of greenhouse gases at 550 ppm CO2-e by around 2100. The reference case for this scenario is taken to be the ‘medium global action’ scenario excluding participation from Australia.

The ‘core policy’ scenario is projected to result in lower economic growth in Australia and Queensland relative to the reference case due to the imposition of a carbon price. The carbon price increases energy costs, which in turn flows through to industrial production costs and consumer prices. This encourages producers and consumers to generally shift from carbon-intensive fossil fuel to alternatives which, exclusive of a carbon price, have historically been more expensive forms of energy. These effects tend to dampen economic activity, resulting in a decline in economic growth.

The projected reduction in economic activity over time is generally related to the level of the domestic carbon price, meaning over time the impacts on economic growth tend to increase. For example, at 2020 with a carbon price of $33t/CO2-e Queensland GSP is expected to be 2.76% lower than the reference case (or medium global action scenario), while at 2050 it is 4.11% lower.

The adverse impacts of the Clean Energy Future policies are projected to be higher in Queensland compared with the Australia-wide results. For example, Queensland GSP declines by 2.76% relative to the ‘medium global action’ levels at 2020 under the ‘core policy’ scenario, while Australian gross domestic product (GDP) is projected to decline by

Deloitte Access Economics iii Impact of a carbon price on the Queensland economy

2.20%. This is because the Queensland economy is more concentrated in industries that are relatively more adversely affected by a carbon price because of their higher emissions intensity, particularly in mining and minerals processing.

Ambitious global scenario

Under the ‘ambitious global’ scenario, all regions undertake to stabilise concentrations of greenhouse gases at 450 ppm CO2-e by around 2100 (compared with 550ppm under the ‘core policy’ scenario). The reference case for this scenario is taken to be the ‘ambitious global action’ scenario excluding participation from Australia.

The reduction in economic activity is related to the size of the domestic carbon price. Accordingly, the higher carbon prices assumed in the ‘ambitious global’ scenario result in relatively higher economic costs compared with the ‘core policy’ scenario. At 2020, Queensland’s GSP is projected to be 4.37% lower than the reference case, while at 2050 the reduction is 10.61%.

Delayed global action

Under the ‘delayed action’ scenario, there is reduced international action on greenhouse emissions, including limited availability of international emissions permits.

The projected reduction in GSP is lower in the longer term driven by the relative competitiveness impacts between major economies and Australia. By delaying action in the United States and China, these countries face a more difficult structural transition once a carbon price is established. Conversely, in Australia there is a more gradual transition to carbon pricing which lowers adjustment costs.

Reduced commodity prices

Under the ‘reduced commodity price’ scenario, all regions including Australia undertake to stabilise concentrations of greenhouse gases at 550 ppm CO2-e by around 2100 under materially lower commodity prices (approximately 30%) from that assumed in Treasury modelling.

The analysis shows that a moderation in expected long term commodity prices has little effect on the results compared with the ‘core policy’ scenario.

That said, the analysis does demonstrate Queensland’s exposure to commodity price growth in terms of the State’s economic prospects.

Differences from previous Commonwealth Treasury estimates

The modelling results presented in this report differ from the recently released Commonwealth Treasury modelling at the macroeconomic level, although they are of a similar magnitude as the previous modelling the Commonwealth Treasury undertook for the Carbon Pollution Reduction Scheme (CPRS).

A key difference is that the aggregate macroeconomic impacts are lower in the recently released Commonwealth Treasury modelling than the analysis presented in this report. For example, the projected reduction in GDP in the latest Commonwealth Treasury analysis is

Deloitte Access Economics iv Impact of a carbon price on the Queensland economy

0.3% at 2020 (from the ‘medium global action’ scenario) compared with a 2.2% reduction GDP in this analysis.

The primary difference between the two modelling exercises is due to the level of domestic abatement particularly in the period to 2020 from the two modelling exercises. The level of domestic abatement is 8.5% from reference case levels at 2020 in the Commonwealth Treasury modelling. Emission abatement in our modelling is 22% from reference case levels at 2020. This means that the marginal cost of abatement in the recent Commonwealth Treasury modelling is higher than our modelling.

The reduction in domestic abatement shown in the latest Commonwealth Treasury modelling, and subsequent increase in reliance on international permit purchases, implies a significant reduction in the impact of the policy response as measured by GDP. Put simply, the lower the level of domestic abatement, the smaller the economic impacts will be in terms of the flow on effects to production, investment and employment.

Of course, as with all modelling, there are a number of other differences between DAE- RGEM and the Commonwealth Treasury modelling framework such as: Baseline emissions growth is different across the two modelling frameworks. This implies that the abatement effort required to achieve a predetermined abatement target is higher in this analysis compared with the Commonwealth Treasury modelling. The speed of adjustment in the labour market differs across the two models. While they have similar structures, the parameters chosen by the Commonwealth Treasury imply the labour market returns to full employment faster in MMRF compared with DAE-RGEM. In other words, the Commonwealth Treasury modelling assumes the economy adjusts relatively quickly and resources, mainly labour, are reallocated in response to carbon pricing. Indeed, as labour is a key factor of production this represents a significant difference between the two modelling approaches.

Industry analysis

Specific analysis of selected emissions-intensive industries in Queensland was also undertaken to complement the economy-wide modelling of a carbon price. The industries examined included coal, LNG and road transport.

Among other factors, industry analysis examined the likely impact of different carbon price outcomes, the level of exposure to world markets and relevant forward investment and commercial considerations.

Coal sector

The Queensland coal sector is heavily dominated by the production of metallurgical coal for export. The key long term global driver for metallurgical coal is growth in rapidly industrialising Asian markets which is resulting in strong demand for steel-making raw materials.

On the back of this global demand, the Queensland coal sector (and its supply chains) has been rapidly expanding capacity over recent years. New production capacity has predominantly been in large capital-intensive, open-cut mines, which currently comprise around 85% of Queensland's coal output. Importantly, these mines are typically less

Deloitte Access Economics v Impact of a carbon price on the Queensland economy

emission intensive, and are unlikely to be eligible for industry assistance, but the precise emissions profile of new projects is not known.

Queensland coal miners, especially for metallurgical coal, are some of the lowest cost producers in the world. Even under relatively high carbon price outcomes, and given robust export prices, production margins are likely to be high.

Global demand conditions are supportive at present and are expected to persist over the much longer term. However, even without a carbon price impost, it is likely that not all proposed projects would proceed — either cancelled completely or significantly delayed — given other commercial factors and variables.

While the fugitive emissions profile for prospective coal projects is not known, on the basis of current production and cost factors, there does not appear to be substantial risk of large reductions in capacity investments from a large range of carbon price outcomes. Rather, it is the demand side factors over the longer term which are most critical.

Liquefied natural gas (LNG)

A number of very large LNG projects are expected, committed and under construction in Queensland, however the industry has yet to commence production.

While carbon emissions from LNG production vary by project, prices are expected to be above long run marginal costs for most facilities and LNG projects are likely to remain profitable (particularly given assistance to the industry covering 50% of annual carbon emissions). This aligns with recent project announcements.

Given the level of competition between global LNG exporters, the ability for Australian producers to pass on the additional cost imposts from a carbon price to overseas customers is expected to be extremely limited (especially given the long term nature of supply contracts). Overall, the impost of the carbon price is likely to be fully absorbed by producers.

Reliability is also a key issue underpinning long term supply arrangements (which commonly cover periods of greater than 10 years). In this regard, Australian LNG projects have some competitive advantages in that Australia has a favourable sovereign risk profile, especially compared to other key LNG producers.

On the basis of this advantage, coupled with the long term contracts underpinning LNG projects, the carbon price is unlikely to have a substantial adverse impact on the Queensland LNG sector and its forward investment plans. Other commercial issues, including technical supply issues with coal seam gas and escalating costs of construction, are likely to be far more significant investment factors for the sector.

Road transport

Deloitte Access Economics vi Impact of a carbon price on the Queensland economy

On the basis of available cost information across the sector, a carbon price applying to the fuel inputs of heavy road transport operators is unlikely to add considerably to their overall cost structure. Any potential cost impacts should also be considered in the context of changes in the price of fuel. Indeed, the additional costs from a carbon price are likely to be within the scale of fuel price increases already observed in the market over recent years.

However, there are reasons to suggest that cost impacts from a carbon price may be more acute than indicated by analysis. Profit margins are already tight in the industry and there are likely to be limited opportunities for many operators to pass through these costs to customers. Where this occurs, the additional impost will reduce their profitability. For smaller operators which dominate the industry, the commercial impacts could be more pronounced as they tend to have fewer avenues for reducing overheads and securing network efficiencies.

This is likely to drive some network productivity improvements in which trucks operate within a wider and integrated ‘door to door’ network, as opposed to small freight companies or owner operated trucks. Crucially, this has been a trend in the industry over some years with the emergence of vertically integrated freight companies. Such structural responses may intensify if operating margins come under further pressure from a carbon price. This may lead to further consolidation in the industry.

Concluding comments

Economic modelling provides a valuable tool for assessing policy changes such as that proposed by the Commonwealth Government. The analysis presented in this report will be compared, rightly, with that produced by the Commonwealth Treasury and the differences noted. In a policy context, these differences shed light on the key mechanisms for consideration in the debate.

In this case, the modelling presented in this report which is based on DAE-RGEM suggests a greater adverse economic impact on the Queensland and Australian economies in the short term (ie to 2020) than the Commonwealth Treasury modelling.

The analysis serves to highlight how core assumptions and parameters adopted in the modelling framework heavily influence the expected macroeconomic consequences. In particular, assumptions governing the timing for large trading nations to agree to concrete emissions reductions actions (and the cost of abatement in these countries), the extent of labour market flexibility and the speed of technology advancement and deployment are critical factors governing impacts on the economy, irrespective of the precise domestic abatement task.

In the context of major policy deliberations, including the myriad of details still required to bed down the carbon price scheme and supporting initiatives announced by the Government, alternative perspectives, such as those presented in this report, have an important role to play.

Deloitte Access Economics

Deloitte Access Economics vii Impact of a carbon price on the Queensland economy

1 Background

On 10 July 2011, the Prime Minister announced the details of Australia’s proposed carbon pricing mechanism as part of its Clean Energy Future policy package, a set of policy measures designed to reduce Australian greenhouse gas emissions and to encourage a ‘cleaner’ energy sector. The package has been negotiated by the Multi-Party Climate Change Committee, which was established in September 2010 to explore options for implementing a carbon price. The Clean Energy Future package establishes a carbon price and expands renewable energy, energy efficiency and land use policies and programmes. The Commonwealth Government expects the legislation to be passed by Parliament in late 2011.

Under the proposed carbon policy, around 400-500 of the biggest emitters in Australia will need to buy and surrender to the Government a permit for every tonne of carbon emissions they produce. Only emitters that release over 25,000 tonnes of direct carbon emissions (i.e. first-hand emissions produced through internal business operations) will be taxed. This mechanism, coupled with the green energy policies, aims to achieve a high level emissions reduction target of 5% below 2000 levels by 2020 and 80% below 2000 levels by 2050.

Due to the high carbon cost some businesses may face and potential difficulties in passing this cost on to consumers, the Commonwealth Government has proposed a wide reaching support package to be implemented during the three year fixed price period.

The Commonwealth Treasury was asked by the Government to model the impacts of the main features of the Clean Energy Future, in particular, the likely social and macroeconomic implications of the carbon price. The results of the Commonwealth Treasury modelling were released in the Strong Growth, Low Pollution, Modelling a Carbon Price3 report on 10

3 The Treasury of the Australian Government, Strong growth, low pollution: modelling a carbon price, http://www.treasury.gov.au/carbonpricemodelling/content/report.asp, 2011.

Deloitte Access Economics 1 Impact of a carbon price on the Queensland economy

July 2011. For more detailed information on the carbon price policy and related support and green energy initiatives, refer to the Australian Government’s Climate Change Plan, Securing a clean energy future4.

Against this background, Deloitte Access Economics was commissioned by Queensland Treasury to undertake a range of quantitative modelling of the economic impacts of the main aspects of the Clean Energy Future plan on the Queensland economy. Modelling of the impacts was carried out using Deloitte Access Economics’ in house computable general equilibrium (CGE) model, DAE-RGEM.

Industry analysis

Analysis of specific key industries has also been undertaken at a high level. The focus of the analysis was to examine some of the potential ‘real world’ effects and commercial implications (such as the ability to pass through any additional costs from a carbon price) which cannot be fully captured within a formal macroeconomic modelling framework.

Two tiers of industries have been examined: Tier I industries — coal, LNG, road transport This analysis provides an economic profile of these industries and its cost structures. A core focus has been to examine how costs and investments are likely to be affected by a carbon price, the scope to minimise cost imposts and the implications of changes to global markets. Tier II industries — agriculture, tourism, EITEs (minerals processing) Analysis of these Tier II industries has been undertaken at a higher level. It sets out the level of emissions intensive inputs used within the industry and the composition of businesses. Broader strategic issues are discussed for these sectors alongside the profiles. 1.1 Limitations of the analysis

The economic modelling assumptions underpinning the analysis in this report have been aligned, to the extent possible, to the recently released modelling undertaken by the Commonwealth Treasury. Where differences in the announced policy and the Commonwealth Treasury modelling exist, the analysis adopts the parameters from the announced policy. For example, the Commonwealth Treasury modelling assumes a starting price of carbon of $20 per tonne where as the announced policy is based on a $23 per tonne starting price. The modelling presented in this report is based on a $23 per tonne starting price.

While this modelling includes the key features of the Commonwealth Treasury modelling, it does not include details of some of the announced policy initiatives such as the iron and steel package, the assistance to coal mines and the $10 billion Clean Energy Finance Corporation. These elements were not included because it is unclear, at this stage, what

4 Commonwealth of Australia, Securing a clean energy future: The Australian government’s climate change plan, http://www.cleanenergyfuture.gov.au/clean-energy-future/our-plan/, July 2011.

Deloitte Access Economics 2 Impact of a carbon price on the Queensland economy

the detail of the initiatives will be. The design of these packages will be important in terms of managing the transition in some sectors as well as pursuing additional policy goals.

In terms of the CGE modelling, DAE-RGEM has a similar structure to the models used by the Commonwealth Treasury however, as with all models, there are differences in underlying data, parameters and assumptions which means replicating the Commonwealth Treasury analysis is not possible.

Deloitte Access Economics 3 Impact of a carbon price on the Queensland economy

2 Underlying assumptions

The modelling in this report is underpinned by a ‘Business-As-Usual’ (BAU) projection. This projection represents economic growth conditions in the absence of the major policy changes under consideration.

The BAU scenario runs over the period 2004 to 2050 and is based on a set of input assumptions made about: economic growth; population and employment growth; electricity generation; energy efficiency; and some existing greenhouse policies and measures.

The Commonwealth Treasury modelling report provides a detailed discussion of assumptions used in the reference case to underpin that modelling. To the extent possible, these BAU assumptions have been adopted in this analysis. These assumptions are discussed below. 2.1 Macroeconomic assumptions

Key macroeconomic assumptions for Australia are shown in Table 2.1, including assumed economic growth (real GDP), employment and labour productivity. These assumptions are presented at the State and Territory level in Table 2.2. Economic and population growth is higher in Queensland and Western Australia compared with other regions of Australia. This relatively rapid expansion is primarily driven by high levels of resource based investment and increasing minerals exports.

Table 2.1: Australian macroeconomic assumptions (%) annual average growth

Employment Lab. Productivity Real GDP 2010s 1.6 1.4 3.0 2020s 1.1 1.6 2.6 2030s 1.0 1.6 2.6 2040s 0.9 1.6 2.5 Source: Commonwealth Treasury (2011)

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Table 2.2: State macroeconomic assumptions (%) annual average growth

NSW VIC QLD SA WA TAS NT Gross state product 2010s 2.5 2.7 3.6 2.1 4.3 2.0 3.8 2020s 2.5 2.5 2.9 1.6 3.0 1.9 2.8 2030s 2.7 2.5 2.8 1.9 2.6 2.1 2.8 2040s 2.4 2.3 2.6 1.8 2.4 1.9 2.9 Population 2010s 1.1 1.4 2.1 1.0 2.0 0.7 1.5 2020s 1.0 1.3 1.8 0.9 1.7 0.5 1.4 2030s 0.9 1.0 1.5 0.7 1.4 0.3 1.3 2040s 0.8 0.9 1.3 0.6 1.3 0.2 1.3 Source: Commonwealth Treasury 2011

The macroeconomic assumptions for the international regions are also based on those used in the Commonwealth Treasury modelling. Table 2.3 provides a summary of the macroeconomic assumptions for the international regions in DAE-RGEM, showing strong expected growth for the developing regions particularly China and India over the period to 2020. There is, however, a notable reduction in Chinese economic growth over the period 2020 to 2030. Economic and population growth across developed economies are considerably lower than developing countries, particularly in Japan and the European Union (EU).

Table 2.3: Macroeconomic assumptions, international regions, annual average growth

GDP Population 2010-2020 2020-2030 2010-2020 2020-2030 China 8.47 3.72 0.27 -0.17 Japan 1.15 0.45 -0.12 -0.48 Korea 4.34 3.46 0.97 0.53 India 7.99 6.31 1.26 0.74 North America 2.46 1.94 0.79 0.61 EU 1.77 1.33 0.19 0.01 Rest of World 4.48 4.12 1.68 1.32 Source: Commonwealth Treasury 2011 and United Nations, 2011 2.2 Electricity generation

The assumptions in the reference case about electricity sector fuel or technology play an important role in determining the overall emissions intensity of each region and hence their response to a carbon price. The assumptions are sourced from electricity modelling undertaken by Deloitte Access Economics. This modelling includes key existing policies about the technologies employed in future generation capacity such as the 2% Mandatory Renewable Energy Target (MRET) and the 20% expanded renewable energy target (RET).

Deloitte Access Economics 5 Impact of a carbon price on the Queensland economy

Table 2.4 provides a summary of technology shares for Queensland. The table shows the continuing predominance of coal fired generation in Queensland due to plentiful and easily accessible coal reserves, with a slowly rising share of gas fired power.

The impact of the RET policy can be seen in the significant increase in renewable capacity over the period to 2020. However, renewable energy in Queensland is not expected to reach 20%. This is because, over the immediate period, there is greater potential for new renewable projects outside of Queensland, especially in South Australia and Tasmania. Achieving the RET target occurs mainly at the expense of coal fired generation. Without a carbon price, coal generation declines to 2020 but it remains the dominant technology in Queensland and the rest of Australia.

Table 2.4: Electricity generation technology shares (%)

Coal Gas & oil Hydro Other renew 2012 2020 2012 2020 2012 2020 2012 2020 Queensland 86.1 75.1 13.1 19.1 0.7 0.9 0.0 4.9 Source: Deloitte Access Economics 2.3 Intermediate input productivity

In addition to the GDP and population assumptions, a set of intermediate input efficiency assumptions are used in the Commonwealth Treasury modelling. These are carried over to the modelling in this report and applied to relevant international economies at an average of 0.5% a year for all Australian regions.

Table 2.5: Improvements in intermediate input efficiency

Annual average (%) United States 0.3 European Union 0.2 China 0.4 Former Soviet Union 0.7 Japan 0.2 India 1.0 Canada 0.2 Indonesia 0.5 South Africa 0.7 Other south & East Asia 0.3 OPEC 0.5 Rest of World 0.5 Source: Commonwealth Treasury 2011

Deloitte Access Economics 6 Impact of a carbon price on the Queensland economy

2.4 Energy efficiency

In line with the Commonwealth Treasury modelling, a general energy efficiency improvement of 0.5% a year is assumed across all regions and industries. For some industries (including transport, iron and steel, non-metallic minerals, non-ferrous metals, chemicals, rubber and plastics), the energy efficiency gains vary across time and between regions, from the 0.5% average. 2.5 Policy scenarios

The following scenarios are considered in the analysis. Medium Action scenarios, incorporating: • Medium Global Action: All regions apart from Australia undertake to stabilise concentrations of greenhouse gases at 550 ppm CO2-e by around 2100 (this scenario forms the reference case for the ‘core policy’ scenario and the ‘delayed global action’ scenario discussed below). • Core Policy Scenario: Australia participates in the medium global action. Ambitious Action scenarios, incorporating: • Ambitious Global Action: Regions apart from Australia undertake to stabilise concentrations of greenhouse gases at 450 ppm CO2-e just beyond 2100 (this scenario forms the reference case for the ‘high price’ scenario discussed below). • High Price Scenario: Australia participates in the ambitious global action. Delayed Global Action Scenario: Models carbon price impacts with reduced international action on greenhouse emissions, including limited availability of international emissions permits. Reduced Terms of Trade scenarios, incorporating: • Reduced Terms of Trade Scenario reference case: All regions apart from Australia undertake to stabilise concentrations of greenhouse gases at 550 ppm CO2-e by around 2100 under materially lower commodity prices (approximately 10%) from that assumed in core Commonwealth Treasury modelling. • Reduced Terms of Trade Scenario: All regions including Australia undertake to stabilise concentrations of greenhouse gases at 550 ppm CO2-e by around 2100 under materially lower commodity prices (approximately 30%) from that assumed in core Commonwealth Treasury modelling.

2.5.1 Medium global action scenario

The ‘medium global action’ scenario is a climate change scenario where all regions apart from Australia undertake emissions abatement. The target for abatement is to stabilise concentrations of greenhouse gases at 550 ppm CO2-e by around 2100.

All the assumption, settings and features of this scenario are the same as the ‘core policy’ scenario except that Australia does not impose a carbon price over the projection period to 2030. The years of entry for the international regions are the same as the ‘core policy’

Deloitte Access Economics 7 Impact of a carbon price on the Queensland economy

scenario. Since Australia has no carbon price, there is no assistance package for EITE industries, no transport fuel exemptions and no buy back of coal fired generation capacity.

Finally, as with the Commonwealth Treasury modelling the ‘medium global action’ scenario becomes the reference case against which the ‘core policy’ scenario is measured. Hence in following chapter, results are often expressed as being relative to the reference case, meaning relative to the ‘medium global action’ scenario.

2.5.2 Core policy scenario

The ‘core policy’ scenario is based on Australia introducing a domestic carbon price in 2012- 13 for three years before transitioning to carbon trading scheme in 2015-16. When the carbon trading scheme starts the prevailing Australian carbon price will be the domestic dollar equivalent of the global carbon price.

In this scenario, when Australia starts emissions abatement 2012-13, the EU and Japan concurrently have an emissions abatement scheme in place. In later years, other regions join the trading scheme: North America and Korea at 2015-16; China and India at 2020-21; and the rest of the world at 2025. As regions enter the scheme their carbon price is set to the global price.

Carbon prices

The carbon prices applied in the ‘core policy’ scenario are those announced in the Clean Energy Future report, namely: 1 July 2012 - 1 July 2013: Fixed price nominal $A23.00/t 1 July 2013 - 1 July 2014: Fixed price nominal $A24.15/t 1 July 2014 - 1 July 2015: Fixed price nominal $A25.40/t A nominal world price in 2015-2016 of $A29/tonne, or a real price of $US28/tonne in 2010 prices. 2020 real global price of $US33/tonne ($A29/tonne) – 2010 prices. 2050 real global price of $US100/tonne ($A131/tonne) – 2010 prices. The announced policy states over the first three years the domestic carbon price will increase in real terms at 2.5%. The nominal figures above grow around 5% suggesting an assumed rate of inflation to 2.5%. Hence, for this modelling, the nominal carbon prices for the first three years and the 2015-2016 global price (in $A) are converted to 2012-2013 real prices. Then, also assuming 2.5% inflation from 2010, all carbon prices are converted to 2010 real prices (Table 2.6).

Deloitte Access Economics 8 Impact of a carbon price on the Queensland economy

Table 2.6: Assumed carbon prices, core policy scenario

$A/t nominal $A/t real (2012- $A/t real $US/t real (announced) 13) (2010 prices) (2010 prices) 2012-2013 23.0 23.0 21.9 2013-2014 24.2 23.6 22.4 2014-2015 25.4 24.2 23.0 2015-2016 29.0 26.9 25.6 28.0

2020 29.0 33.0 2050 131.0 100.0 Source: Treasury modelling and DAE estimates assuming 2.5% inflation

Converting the Australia nominal prices to 2010 real prices and comparing this to the $US 2010 prices presented in the Commonwealth Treasury reports reveals the likely exchange rate assumptions in the Commonwealth Treasury modelling. At 2015-16, the exchange is assumed to be $A1.09 and appreciating to $A1.14 in 2020, it then depreciates to $A0.76 by 2050.

It should be noted that Commonwealth Treasury modelling used a different set of carbon prices in the early, fixed price years since modelling was completed before the final policy details were announced.

Carbon trading

In line with the Commonwealth Treasury modelling, the ‘core policy’ scenario assumes that carbon trading commences in 2015-16 with an allowed upper limit of 50% of abatement purchased from international regions. In the modelling, this constraint is non-binding.

Compensation: Emission-intensive trade-exposed activities

An important aspect of the ‘core policy’ scenario is assistance provided to trade exposed emissions intensive industries. The ‘core policy’ scenario modelling has implemented an assistance package similar to Commonwealth Treasury modelling. The key features of the assistance package are: 94.5% coverage for the mostly high exposed; 66% coverage for others; Liquefied Natural Gas (LNG) rate of assistance is changed to 50%; Iron and Steel is increased to 94.5% comparers to a lower rate for previous CPRS modelling; Rate of assistance is reduced 1.3% a year; and The scheme is phased out over 5 years starting in 2022. Table 2.7 provides a summary of the rates of assistance for industries in DAE-RGEM. It should be noted that the ‘other non-ferrous metals’ is a highly aggregated industry that includes some sub sections that are covered by the assistance scheme, particularly zinc (which is relevant to Queensland). A consequence is that the industry impacts for other ‘non-ferrous metals’ are potentially slightly overstated in the early years of the simulation.

Deloitte Access Economics 9 Impact of a carbon price on the Queensland economy

Table 2.7: Industry assistance for trade exposed emissions intensive industries

% share of emissions LNG 50.0 Petroleum and Coal products 66.0 Non Metallic Minerals 74.0 Iron and Steel 94.5 Alumina 66.0 Aluminium 94.5 Other non-ferrous metals 0.0 Source: Treasury modelling of CPRS-5 with Government White paper (2009) adjusted rates An important aspect of the assistance package is that all regions that undertake emissions abatement have the same scheme in place. Regions not undertaking emissions abatement do not have a scheme until they commence emission abatement. A consequence of this is that Australian industries are not assisted more than other regions.

Compensation: Households

This form of compensation has not been explicitly modelled in this exercise. Rather, permit revenue is returned to States and Territories in a lump sum fashion based on emissions. In other words, the greater a particular State’s purchase of domestic permits, the greater the share of carbon permit revenue returned to the State.

Transport fuels

In the ‘core policy’ scenario as in the Commonwealth Treasury modelling report, there is no direct carbon price for transport fuel use by households over the projection period to 2030.

Fuel use for other road transport is tax free until 2014-2015, and then taxed at a reduced rate to account for a range of exemptions such as for light vehicles and tradesmen. 2.6 Framework of the analysis

Deloitte Access Economics has undertaken a range of quantitative modelling of the economic impacts of a carbon price. This modelling is based on the application of a computable general equilibrium (CGE) model to examine the broader economy-wide impacts of abatement policies, as well as specific analysis of likely sectoral outcomes.

The CGE model used is Deloitte Access Economics’ in house CGE model called DAE-RGEM.

DAE-GEM is a large scale, dynamic, multi-region, multi-commodity computable general equilibrium model of the world economy. The model allows policy analysis in a single, robust, integrated economic framework. This model projects changes in macroeconomic

Deloitte Access Economics 10 Impact of a carbon price on the Queensland economy

aggregates such as Gross Domestic Product, Gross State Product, Gross National Income , Gross State Income, employment, export and import volumes, investment and private consumption. At the sectoral level, detailed results such as output, exports, imports and employment are also produced.

Base data

The base data of the model is derived from the Global Trade Analysis Project (GTAP) which produces a global database for general equilibrium modelling used by across a large research community. The Australian component of the database is provided by the Productivity Commission, and is based on Australian input-output tables produced by the Australian Bureau of Statistics.

The model is primarily based on input-output or social accounting matrices, as a means of describing how economies are linked through production, consumption, trade and investment flows. For example, the model considers: direct linkages between industries and countries through purchases and sales of each other’s goods and services; and indirect linkages through mechanisms such as the collective competition for available resources, such as labour, that operates in an economy-wide or global context.

DAE-RGEM is based on Version 7.0 of the GTAP database with a 2004 base year. The sectoral and regional detail in the model is summarised in Table 2.8. Of course, not all sectors represented in the model are relevant to Queensland — brown coal, for example. The model does contain a LNG sector, however, given the base year is before Queensland’s LNG sector will be developed, there is no representation of this in the scenarios. While this would ordinarily be seen as a deficiency in the analysis, it does accord with the Commonwealth Treasury modelling in this instance.

Table 2.8: Sectors and Regions in DAE-RGEM

Number Sectors Number Regions 1 Crops 1 New South Wales 2 Livestock 2 Victoria 3 Other Agriculture 3 Queensland 4 Fishery and Forestry 4 South Australia 5 Brown Coal 5 Western Australia 6 Thermal Coal 6 Tasmania 7 Metallurgical Coal 7 Northern Territory 8 Crude Oil 8 China 9 Condensate 9 Japan 10 Natural Gas 10 Korea 11 LNG (no industry for Qld) 11 India 12 Bauxite 12 North America 13 Other minerals 13 EU 14 Processed foods 14 Rest of the World 15 Lumber and Wood Products

Deloitte Access Economics 11 Impact of a carbon price on the Queensland economy

16 Petroleum and Coal Products 17 Chemicals, rubber and plastics 18 Non-metallic minerals products 19 Iron and Steel 20 Alumina 21 Aluminium 22 Other Non-ferrous metals 23 Paper products, publishing 24 Motor Vehicles and Parts 25 Electronic Equipment 26 Other Manufacturing 27 Water 28 Electricity Generation 29 Gas Distribution 30 Construction 31 Trade 32 Air Transport 33 Water Transport 34 Land Transport 35 Communications 36 Other Business Services 37 Govt. Services 38 Other Services

Feature specific to climate change modelling

DAE-RGEM has been developed principally for analysing climate change response policy. The industry detail allows for comprehensive accounting for greenhouse gas emissions at the State and Territory levels. This data is calibrated to the latest greenhouse gas inventory numbers published by the Department of Climate Change.

Apart from emission accounting, DAE-RGEM has been developed to allow for energy substitution possibilities in response to the pricing of carbon. The model contains two production structures. The first applies to all industries apart from electricity generation. In these industries, products in each of the energy bundle (coal, gas, petroleum products and electricity), primary factor bundle and intermediate input bundle are combined using constant elasticity of substitution (CES) technology. The energy-factor bundle is formed from a CES combination of the primary factor bundle and the energy bundle, and is combined in fixed proportions with the intermediate input bundle. Depending on the value of the substitution elasticities at the various production nodes for an industry sector, substitution is possible between the four energy inputs and then between the energy bundle and the primary factor bundle. The structure does not, however, permit substitution between intermediate inputs and primary factors or the four energy inputs.

The production structure for electricity generation is based on a ‘technology bundle’ approach developed by ABARE (2006), although modified in DAE-RGEM. For the electricity

Deloitte Access Economics 12 Impact of a carbon price on the Queensland economy

sector, the model accounts for six generation technologies: brown coal, thermal coal, gas, oil, hydro, nuclear (not in Australia) and other renewables. Electricity generators choose their pattern of technologies by minimising costs in response to changes in relative prices using a CES production function. However, each technology in the bundle uses inputs in fixed proportions to output.

This treatment of electricity is an attempt to bridge the gap between the general equilibrium modelling framework and ‘bottom-up’ electricity models. ‘Bottom-up’ models are engineering-based, linear programming models that take energy/electricity demand as given and determine the least-cost technology mix to satisfy a given level of demand. While these ‘supply side’ models are not suited to estimating the economy-wide impacts of imposing a carbon price, they are often used to inform general equilibrium models of the responses to carbon pricing in the electricity sector (as is the case in this analysis).

Dynamics

DAE-RGEM is a recursive dynamic model that solves year-on-year over a specified timeframe. The model is then used to project the relationship between variables under different scenarios, or states, over a predefined period. This is illustrated in Figure 2.1. This shows the reference case scenario which forms the basis of the analysis. The model is solved year-by-year from time 0, which reflects the base year of the model (2004), to a predetermined end year (in this case, 2030). Thus, the reference case in this example is a state of the world where only existing greenhouse policies and measures operate.

The variable represented on the vertical axis of Figure 2.1 could be one of the hundreds of thousands represented in the model ranging from macroeconomic indicators such as real GDP to sectoral variables such as the export of coal. In the figure, the percentage changes in the variables have been converted to an index (= 1.0 in 2005) and are projected to increase by 2030.

Set against the reference case scenario is a ‘scenario projection’. This scenario represents the impacts of imposing a carbon price, for example, on stationary energy, which results in a new projection of the path of the variable over the simulation time period. The impacts of the policy change are reflected in the differences in the variable at a point in time. It is important to note that the differences between the reference case and policy intervention scenario are tracked over the entire timeframe of the simulation.

Deloitte Access Economics 13 Impact of a carbon price on the Queensland economy

Figure 2.1: Illustrative dynamic simulations using DAE-RGEM

5.0

Reference case 4.0

3.0 Policy response

2.0

1.0

2005 2010 2015 2020 2025 2030

Deloitte Access Economics 14 Impact of a carbon price on the Queensland economy

3 CGE modelling results 3.1 Medium price scenarios

The ‘medium global action’ scenario is based on a co-ordinated global action (excluding Australia) to achieve a 550 ppm CO2-e environmental outcome. This scenarios forms the reference case against which the ‘core policy’ scenario is examined.

As such, the ‘core policy’ scenario results are presented as deviations from the ‘medium global action’ scenario in the same year.

This methodology replicates the Commonwealth Treasury analysis as closely as possible given publicly available information, mostly contained in the Strong Growth, Low Pollution report.

Two points are important in interpreting results: The baseline scenarios represent a world where all countries other than Australia adopt carbon pricing policies over time. Under these conditions there is ‘carbon leakage’ from the rest of the world to Australia (for example, as emissions intensive activities are increasingly located in Australia to minimise emissions prices applying in other jurisdictions). Modelling in this assumed environment will therefore indicate larger economic changes than if the comparison was made to a baseline where there was no world carbon mitigation policies and Australia had reduced relative advantages in emissions intensive activities. A stylised example is highlighted in Figure 3.1 which shows a smaller policy deviation (A) from a lower reference case (Deviation A) than a higher one (Deviation B) which represents a different world policy environment. The results represent deviations from a counterfactual baseline scenario in that year. That is, a deviation of 10% in 2020 does not represent a fall in industry output from present levels, rather it indicates a reduction in output growth rate over time which leads to the industry having 10% lower output than it would have in the absence of Australian carbon pricing policies. This is highlighted in Table 3.1 which shows an index of output of the Queensland electricity sector in the medium global and core policy scenarios (as modelled in this analysis). Despite a deviation against the reference case, the sector continues to grow in absolute terms (albeit at a lower rate) and is over three times as large in 2050 as in 2010.

Deloitte Access Economics 15 Impact of a carbon price on the Queensland economy

Figure 3.1: Deviations from baseline versus medium global action

A Value

Time

BAU Core Global Core Policy

Table 3.1: Queensland electricity sector output index — medium global versus core policy

2020 2030 2040 2050 Medium Global 1.43 1.96 2.66 3.61 Core Policy 1.30 1.74 2.39 3.29 Implied deviation (%) -9.0 -11.1 -10.1 -8.7 Note: (2010 output = 1) Source: Deloitte Access Economics estimates

Carbon prices

The carbon price prevailing in each region and globally is a key determinant of the estimated macroeconomic and sectoral impacts. A summary of carbon prices for the ‘core policy’ scenario in real (2010) Australian dollars is presented in Chart 5.1. For the first three years the carbon price in Australia and Queensland is set at fixed rate, increasing 2.5% a year in real terms. In the fourth year of the scheme, carbon prices for Australia and Queensland will be market determined (subject to some transitional parameters), with the establishment of a global emissions trading scheme.

Deloitte Access Economics 16 Impact of a carbon price on the Queensland economy

Chart 3.1: Carbon prices in Australia, real $A, 2010 prices

140

120

100

2013 2017 2019 2021 2023 2027 2029 2031 2033 2037 2039 2043 2047 2049 2015 2025 2035 2041 2045

Medium scenario $AU2010

Source: Based on Commonwealth Treasury (2011)

The international carbon price profile in the Commonwealth Treasury analysis, consistent with the Hotelling rule5, grows at an assumed 4% per annum. By 2020, the carbon price in Australia is expected to be $A33.0/tonne CO2-e and the price reaches $A131/tonne CO2-e by 2050. Macroeconomic results The ‘core policy’ scenario is also projected to result in lower economic growth in Queensland relative to the medium global action scenario (Table 3.2). The carbon price increases energy costs, which in turn flows through to industrial production costs and consumer prices. This encourages producers and consumers to generally shift from carbon- intensive fossil fuel to alternatives which, exclusive of a carbon price, have historically been more expensive. These effects tend to dampen economic activity, resulting in a decline in economic growth. The projected reduction in economic activity measured by real gross state product (GSP) over time is related to the carbon price. This means that over time the impacts on economic growth tend to increase as the carbon price escalates in real terms. For example, at 2020 with a carbon price of $US33, Queensland GSP is expected to be 2.76% lower than under the medium global action case. In 2050, with a carbon price of $US100, Queensland GSP is projected to be 4.11% lower than under the medium global action scenario.

Other key macroeconomic indicators follow a similar trend to GSP. Employment and investment each decline as a result of the carbon price. Employment declines relative to the reference case by 0.75% at 2020. Over the longer term, the employment effects are mitigated to some extent as the labour market returns to previous rates of employment. This is a result of lower growth in wage rates.

5 The Hotelling rule is a principle in resource economics which explains the growth in the price of finite resources. Consistent with the rule, the price of emissions increases over time at the real interest rate from a specified starting level.

Deloitte Access Economics 17 Impact of a carbon price on the Queensland economy

Table 3.2: Macroeconomic outcomes for Queensland: medium global action v core policy

Med. Global Action Core Policy % deviations 2020 GSP, $ million 346,774 337,195 -2.76 growth from 2010 42% 38% Employment, ‘000 FTE 2,810 2,789 -0.75 growth from 2010 22% 21% Investment, $ million 107,300 100,951 -5.92 growth from 2010 38% 30% 2050 GSP, $ million 811,186 777,826 -4.11 growth from 2010 232% 218% Employment, ‘000 FTE 4,491 4,471 -0.45 growth from 2010 95% 94% Investment, $ million 324,989 308,522 -5.07 growth from 2010 319% 298% Source: Deloitte Access Economics

A key feature of the ‘core policy’ scenario analysis is that the imposition of a carbon price tends to impact more heavily on capital (and hence investment) than on labour. This is because over the early phases of the scenario, investments in energy intensive activities (largely outside those emission intensive trade exposed sectors) are not undertaken.6 Over the longer term, however, the impact on investment is expected to attenuate as new capital investments are able to be more effectively reallocated into productive (less emissions intensive) areas of the economy and investment in more energy efficient forms of plant and machinery. Macroeconomic results in context

To put these macroeconomic results into context it is worth noting the projected pattern of state and national output over time under both scenarios. While the projected impacts on Queensland GSP are significant compared to the reference case at a given point in time, all scenarios indicate continued strong economic growth over the projection period.

For example, Queensland economic growth is expected to be 3.02% a year on average from 2012 to 2050 in the ‘medium global action’ scenario, while in the ‘core policy’ scenario, the growth rate is expected to be 2.90%. A similar pattern occurs nationally, with reference case growth in GDP projected to average 2.71% a year, whilst under the ‘core policy’ scenario, annual growth falls to 2.61%.

6 In addition, under the ‘medium global action’ reference case there is some additional investment undertaken in Australia that no longer occurs.

Deloitte Access Economics 18 Impact of a carbon price on the Queensland economy

Chart 3.2: Queensland GSP, billion $A, real 2010 prices

900000

800000

700000

600000

500000

400000

300000

200000

2010 2014 2016 2018 2022 2024 2026 2030 2032 2034 2038 2040 2044 2046 2048 2012 2020 2028 2036 2042 2050

Medium global action Core policy scenario

Source: Deloitte Access Economics

Comparison to Australia-wide results

The economic impacts of the Clean Energy Future policies are projected to be slightly amplified in Queensland compared with the Australia-wide results. For example, Queensland GSP declines by 2.76% relative to the ‘medium global action’ levels at 2020 under the ‘core policy’ scenario; while Australian gross domestic product (GDP) is projected to decline by 2.21% (see Table 3.4).

The main reason for a relatively higher impact on Queensland compared with the Australia- wide result is related to a relatively high reduction in investment in the short term (to 2020). Under the reference case, Queensland (together with Western Australia) is projected to grow faster than the national average, with much of this growth based on investment in mining and minerals processing which become less competitive under a carbon price (despite some EITE assistance). While this effect moderates over time, the reduction in the productive base of Queensland in the early years has greater long term effects for the State.

Deloitte Access Economics 19 Impact of a carbon price on the Queensland economy

Table 3.3: Selected macroeconomic results (% deviation*) 2020 2030 2040 2050 Queensland Real GSP -2.76 -3.66 -3.86 -4.11 % growth from 2010 38 83 142 219 Employment -0.75 -0.78 -0.47 -0.45 % growth from 2010 21 43 67 94 Real investment -5.92 -6.55 -5.21 -5.07 % growth from 2010 30 86 170 298 Real wages -3.85 -4.94 -4.83 -4.47 % growth from 2010 12 28 48 73 Australia Real GDP -2.21 -3.01 -3.43 -3.84 % growth from 2010 32 70 119 181 Employment -0.60 -0.64 -0.49 -0.50 % growth from 2010 14 28 44 60 Real investment -4.95 -5.59 -5.11 -5.25 % growth from 2010 34 90 169 286 Real wages -3.12 -4.07 -4.23 -4.19 % growth from 2010 14 32 55 83 Results are presented as percentage deviations of the Core Policy Scenario relative to the Medium Global Action scenario

Table 3.4: Macroeconomic impacts on Queensland and Australia, % deviation from medium global action

2020 2050 Queensland Australia Queensland Australia GSP / GDP -2.76 -2.21 -4.11 -3.84 % growth from 2010 38 32 219 181 Employment -0.75 -0.60 -0.45 -0.50 % growth from 2010 21 14 94 60 Investment -5.92 -4.95 -5.07 -5.25 % growth from 2010 30 34 298 286 Emissions -21.39 -22.76 -28.46 -33.12 Carbon price, $A 2010 33 33 131 131 Source: Deloitte Access Economics

Deloitte Access Economics 20 Impact of a carbon price on the Queensland economy

4 Comparison with previous Commonwealth Treasury modelling

The economic modelling assumptions underpinning the analysis in this report have been aligned, to the extent possible, to the recently released modelling undertaken by the Commonwealth Treasury.

In terms of the modelling, DAE-RGEM has a similar ancestry to the models used by the Commonwealth Treasury. However, as with all models, there are differences in underlying data, parameters and assumptions which mean replicating the Commonwealth Treasury results is not possible. Indeed, the results of the ‘core scenario’ presented in the previous section represent a significant diversion from the current Commonwealth Treasury analysis at the macroeconomic level.

Differences between model results are expected, as the Commonwealth Treasury note in their recent analysis:

The wide range of estimates from published studies reflect the uncertainty about mitigation costs. Studies differ owing to different policy assumptions, model parameters and technology availability and cost assumptions. In addition, cost estimates are strongly affected by emission levels in the global action scenario (which varies across studies) as this determines the scale of economic restructuring required to achieve any given emission reduction goal. (p. 90)

This section compares the differences between DAE-RGEM and the MMRF model results and, to the extent possible, explains differences between the two results. Other previous analysis undertaken by the Commonwealth Treasury is also considered in the analysis. 4.1 Key differences in the modelling approach

While DAE-RGEM and MMRF are underpinned by similar assumptions there are some key differences. At a high level, the modelling undertaken by the Commonwealth Treasury: Is based on more bottom-up detailed modelling than that utilised by DAE-RGEM. While the modelling presented in this report is underpinned by a detailed electricity model, the agriculture and forestry and road transport modules utilised by the Treasury (or an equivalent) have not been adopted in this analysis; Has different sectoral detail although the key sectors in mining, electricity and minerals processing align well; and Has different international regional detail although key trading partners in both developed and developing countries align well.

Deloitte Access Economics 21 Impact of a carbon price on the Queensland economy

However, these differences are not likely to be significant in terms of producing different results. A key difference is that the Commonwealth Treasury modelling is based on a suite of models, but centres on two computable general equilibrium (CGE) models called MMRF and GTEM. These two models are linked as documented (see p. 146):

The MMRF takes world market conditions as given. This means it does not determine endogenously the prices Australia faces in world markets, nor does it project the changes that may occur in demand for Australian exports. GTEM determines such prices and quantities, aggregated over all other regions. This requires care to ensure the world demand curve determined within GTEM is appropriately linked with MMRF.

The Commonwealth Treasury also explains that the linking of these two models is a source of uncertainty (see p. 146):

While input assumptions are harmonised as much as possible across GTEM and MMRF, the projections in these models for Australia are not identical. The differences arise primarily from the different structures of the models, and these differences reflect the uncertainty surrounding modelling estimates.

DAE-RGEM incorporates each State and Territory of Australia in a global economic framework. As a result, the uncertainties around linking two models with different input assumptions are removed from the analysis presented in this report. 4.2 Key differences in results

The modelling results presented in this report differ substantially from the recently released Commonwealth Treasury modelling at the macroeconomic level, although they are of a similar magnitude as the previous modelling the Commonwealth Treasury undertook for the Carbon Pollution Reduction Scheme (CPRS).

Table 4.1 presents a summary of the key differences which shows that in the short term the current Commonwealth Treasury analysis forecasts very little impact on Australian economic output (measured by gross domestic product) in 2020 compared with both the DAE-RGEM results and the previous CPRS-5 scenarios. This is despite both the DAE-RGEM and CPRS-5 scenarios being based on similar assumptions.

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Table 4.1: Selected macroeconomic results (% deviation*)

2020 2050 GDP/GSP Treasury -0.3 -2.8 DAE-RGEM -2.2 -3.8 CPRS-5 -1.2 -3.7 Emissions Treasury -8.5 -45.9 DAE-RGEM -21.4 -28.6 CPRS-5 -24.4 -59.6 Carbon price Treasury 29 131 DAE-RGEM 29 131 CPRS-5 35* 115*

Results are presented as percentage deviations of the Core Policy Scenario relative to the Medium Global Action scenario except for the CPRS-5 scenario * $AU2005

Differences from previous Commonwealth Treasury estimates

The results in Table 4.1 clearly show that the current Commonwealth Treasury modelling implies a significant decline in the economic impact of the abatement effort as measured by GDP compared with the CRPS-5 modelling released two years ago.

The primary reason for this is that there is a significant increase in the reliance of international permit trading under the recent Commonwealth Treasury modelling compared with both the CPRS-5 modelling and the DAE-RGEM modelling.

This implies that the marginal cost of abatement in the recent Commonwealth Treasury modelling has risen substantially compared with the previous modelling. This is clearly demonstrated in the level of domestic abatement relative to international permit purchases. Under the ‘core policy’ scenario in the recent Commonwealth Treasury modelling, domestic abatement is 8.5% from reference case levels at 2020. International permit purchases are 94Mt. Under the previous CPRS-5 modelling, domestic abatement was 25% from reference case levels with 46Mt being purchased internationally. The DAE- RGEM results are similar to those produced in the previous Commonwealth Treasury modelling at 2020.

The reduction in domestic abatement shown in the latest Commonwealth Treasury modelling implies a significant reduction in the impact of the policy response as measured by GDP. The lower the domestic abatement effort implies considerably lower flow-on effects to production, investment and employment. For example, for relatively similar carbon prices, the projected reduction in GDP in the latest analysis is 0.3% from the reference case at 2020, compared with 1.2% in the previous analysis and 2.2% in the DAE- RGEM.

A number of other differences between the modelling frameworks are also contributing to differences in the results. These differences include:

Deloitte Access Economics 23 Impact of a carbon price on the Queensland economy

A change in the reference case scenario to incorporate global action rather than no global action is likely to be driving some of the difference. As discussed in the previous section, the latest Commonwealth Treasury modelling states that this incurs a cost on the Australian economy. Under the ‘medium global action’ scenario, Queensland and Australia are projected to benefit compared with losses under the latest Commonwealth Treasury modelling. This means the percentage differences from the reference case in this analysis will be larger than the latest Commonwealth Treasury modelling. The parameterisation of the labour market differs across the two models. While they have similar structures, the parameters chosen by the Treasury imply the labour market returns to full employment faster in MMRF compared with DAE-RGEM. In other words, the Commonwealth Treasury modelling assumes the economy adjusts relatively quickly and resources, mainly labour, are reallocated in response to carbon pricing. Indeed, as labour is a key factor of production this represents a significant difference between the two modelling approaches. • On this point it is important to note that the MMRF has been used in the past with parameters that have generated long term changes in employment. For example, in a report commissioned by the Allen Consulting Group in 2006 for the Business Roundtable on Climate Change, Deep Cuts in Greenhouse Gas Emissions, long run employment reduction was estimated to be 22,000 jobs in 2050 under an early action scenario compared with 271,000 jobs under a delayed action scenario

Deloitte Access Economics 24 Impact of a carbon price on the Queensland economy

5 Other scenarios

The high price scenario mimics the methodology adopted by the medium price scenario, with the key difference being an increased global carbon price profile in order to target a 450 ppm global environmental outcome by 2100 instead of the 550 ppm CO2-e outcome targeted by the medium price scenario. The difference between the carbon price profiles faced by Australia is shown in Figure 5.1.

Figure 5.1: Assumed carbon prices under various scenarios

300

250

200

150

100

2013 2017 2019 2021 2023 2027 2029 2031 2033 2037 2039 2043 2047 2049 2015 2025 2035 2041 2045

Medium scenario $AU2010 Ambitious scenario $AU2010

Source: Commonwealth Treasury

Table 5.2 provides a summary of the macroeconomic impacts of the ‘ambitious policy’ scenario, expressed as deviations from the ‘ambitious global action’ scenario, together with the absolute levels of these variables in both scenarios at 2020 and 2050.

As previously noted the reduction in economic activity is related to the size of the domestic carbon price. At 2020 with a carbon price of $US68 Queensland GSP is expected to be 4.37% lower than baseline, while 2050 with a carbon price of $US204 the GSP is 10.61% lower than baseline. The carbon price is the key difference between this scenario and the medium action scenario – and it is thus unsurprising to see that for approximately twice the carbon price the percentage changes to GDP are approximately twice as large in terms of deviations.

Deloitte Access Economics 25 Impact of a carbon price on the Queensland economy

Table 5.2: Macroeconomic outcomes for Queensland, medium global action v. core policy

Ambitious baseline Ambitious policy % change 2020 GSP, $ million 347,432 332,267 -4.37 growth from 2010 42% 36% Employment, ‘000 FTE 2,808 2,780 -1.03 growth from 2010 22% 20% Investment, $ million 108,184 98,744 -8.73 growth from 2010 39% 27% Emissions, Mt -29.36 2050 GSP, $ million 823,866 736,437 -10.61 growth from 2010 237% 202% Employment, ‘000 FTE 4,506 4,446 -1.34 growth from 2010 95% 93% Investment, $ million 342,004 284,829 -16.72 growth from 2010 341% 267% Emissions, Mt -40.20 Source: Deloitte Access Economics As a result of the increase in carbon prices, the macroeconomic impacts of the high price scenario are greater than the core price scenario as can be seen from Table 5.3, although the relativity of results between Australia and Queensland are similar. Table 5.3: Selected macroeconomic results (% deviation*) 2020 2030 2040 2050 Queensland Real GSP -4.36 -7.92 -10.23 -10.61 % growth from 2010 36 76 128 202 Employment -1.03 -2.47 -1.78 -1.34 % growth from 2010 20 40 65 93 Real investment -8.73 -20.25 -19.96 -16.72 % growth from 2010 27 61 132 267 Real wages -5.71 -9.12 -11.41 -10.82 % growth from 2010 10 23 39 64 Australia Real GDP -3.73 -6.96 -9.23 -9.68 % growth from 2010 30 64 107 168 Employment -0.92 -2.20 -1.65 -1.26 % growth from 2010 14 26 42 60 Real investment -8.07 -19.13 -19.38 -15.87 % growth from 2010 31 65 132 257 Real wages -4.95 -8.23 -10.49 -10.33 % growth from 2010 12 27 46 73 Results are presented as percentage deviations of the High Price Scenario relative to the Ambitious Global Action scenario Source: Deloitte Access Economics estimates

Deloitte Access Economics 26 Impact of a carbon price on the Queensland economy

5.2 Delayed global action scenarios

The main impact of the delayed global action scenario is a result of different international competitiveness effects relative to the core policy scenario. By delaying action in the United States and China, these countries are not subject to the same emission abatement effort and, as a result, emission intensive economic activities in these regions secure a competitive advantage in the short term. To meet a comparable environmental outcome the carbon price profile is increased slightly once full trading commences, with the international carbon price growing at the same rate of 4% as the other scenarios, but with an international carbon price in 2050 of $US105 rather than $US100.

The results of this scenario indicate marginally smaller Australian macroeconomic impacts than the core policy scenario. As observed in the results of other simulations there is a relatively larger macroeconomic impact in Queensland than in Australia.

Table 5.4: Selected macroeconomic results (% deviation*)

2020 2030 2040 2050 Queensland Real GSP -2.76 -3.56 -3.75 -4.03 % growth from 2010 38 83 143 222 Employment -0.75 -0.72 -0.43 -0.42 % growth from 2010 21 43 67 94 Real investment -5.91 -6.20 -4.92 -4.80 % growth from 2010 30 87 173 307 Real wages -3.84 -4.80 -4.67 -4.31 % growth from 2010 12 28 49 76 Australia Real GDP -2.21 -2.95 -3.36 -3.80 % growth from 2010 32 70 120 185 Employment -0.59 -0.62 -0.50 -0.50 % growth from 2010 14 29 44 61 Real investment -4.93 -5.32 -4.89 -5.04 % growth from 2010 34 91 172 295 Real wages -3.12 -3.92 -4.07 -4.05 % growth from 2010 14 32 56 86 Source: Deloitte Access Economics estimates

The results demonstrate the long run impacts of an early ‘lock-in’ of emissions intensive industry in those regions that choose to delay. The impacts of the carbon pricing policy with international delay on Australian industry are almost identical to those experienced in early years under the core policy scenario; however, local industries in the long term enjoy a degree of early mover advantage in the longer term. As can be seen however, the results when compared against the core policy scenario are not fundamentally different — suggesting that the pattern of entry of foreign regions as modelled does not make a significant difference to domestic adaptation costs in the short term (assuming marginal changes to the international permit price).

Deloitte Access Economics 27 Impact of a carbon price on the Queensland economy

5.3 Reduced commodity price scenario

Commodity prices in the ‘medium global action’ scenario remain relatively strong over time. This scenario is based on a ‘medium global action’ scenario with lower commodity prices. Under this scenario, commodity prices by approximately 30% lower over the period to 2050 in the baseline.

Given the carbon price remains the same, the estimated impacts are very similar to the ‘core policy’ scenario albeit the economic impacts are slightly higher. This is because lower commodity prices serve to increase the use of commodities such as coal in a relative sense. In other words, higher commodity prices serve the purpose of a carbon price over the reference case which act to reduce the relative use of commodities such as coal. With that effect weaker under the reference case in this scenario, the carbon price has a relatively larger impact on production which, in turn, increases the adverse economic impacts on Queensland.

Table 5.5: Selected macroeconomic results (% deviation)

2020 2030 2040 2050 Queensland Real GSP -2.87 -3.79 -4.01 -4.36 % growth from 2010 40 71 103 130 Employment -0.85 -0.81 -0.51 -0.51 % growth from 2010 22 32 37 36 Real investment -6.36 -7.11 -5.67 -5.72 % growth from 2010 30 57 98 138 Real wages -4.02 -5.28 -5.18 -5.06 % growth from 2010 12 27 48 73 Australia Real GDP -2.29 -3.07 -3.53 -4.05 % growth from 2010 33 59 84 104 Employment -0.67 -0.65 -0.53 -0.56 % growth from 2010 15 19 19 13 Real investment -5.23 -6.00 -5.65 -6.14 % growth from 2010 35 61 96 130 Real wages -3.25 -4.30 -4.50 -4.68 % growth from 2010 14 32 55 83 Source: Deloitte Access Economics estimates

Deloitte Access Economics 28 Impact of a carbon price on the Queensland economy

6 Queensland coal sector 6.1 Industry snapshot

Queensland produces approximately 55% of Australia’s saleable black coal. In 2009-10 coal production reached a record 206Mt of saleable coal, with approximately 87% of this coal being exported. Queensland is the world’s largest seaborne coal exporter. Of exported coal, around 68% comprised metallurgical coal with the remaining 32% thermal coal.

Japan is Queensland’s biggest export market, accounting for approximately 30% of all exports, while China is the second biggest importer receiving 16% of exports.

There were 57 mines operating in 2009-10, of which 44 are open-cut mines and 12 are underground. About 85% of raw production in Queensland was from open-cut mines.

Recent mine developments include the Lake Vermont, Middlemount and Clermont Mines in the Bowen Basin. In 2010, there were 28 advanced export coal projects under development (with mining lease either been granted or under application), with the potential for black coal resources totalling over 10,000 Mt.7

Queensland’s coal inventory

A large proportion of coal reserves are located in the Bowen Basin, with approximately 65% of reserves estimated to be in that basin. Shallow open-cut coal accounts for 55% of reserves, while deeper underground coal makes up the remaining 45%. Thermal coals represent 65% of the inventory and metallurgical coal 35%. The Bowen Basin contains almost all of the identified metallurgical coal resources. Approximately 40% of the coal inventory occurs at or within close proximity to operating mines.

A map of Queensland coal reserves is provided in Attachment A.

Coal rail and port network

Export coal is transported to the ports via the rail network. There are four major ports with six coal export terminals. Export terminals include Abbot Point (capacity 200,000dwt), Dalrymple (capacity 230,000dwt), Hay Point (230,000dwt), RG Tanna (220,000dwt), Barney Point (150,000dwt) and Fishermans Island (90,000dwt).

Total rail coal haulage capacity is approximately 242 Mt per annum (not including the Northern Missing Link or Surat Basin rail link). System capacities are shown in Table 6.1.

7 ‘Queensland’s coal – mines and advanced projects’, June 2010

Deloitte Access Economics 29 Impact of a carbon price on the Queensland economy

Table 6.1: Queensland nominal coal rail haulage capacities and expansion (Jan 2008)

Haulage Capacity Mt/a Rail system 2009-2010 Newlands system 20 Northern Bowen Basin – Port of Abbot Point Goonyella system 118-131 Northern and central Bowen Basin – Port of Hay Point Blackwater system 64-68 Central and southern Bowen Basin – Port of Gladstone Moura system 17 Southern Bowen Basin – Port of Gladstone West Moreton system 6 Surat and Clarence Moreton Basins – Port of Brisbane Total 225-242 Source: Department of Mining and Safety 6.2 Cost structure

Mines have considerably different cost structures. Chart 6.1 shows the average FOB cost by mine location, underground versus open-cut and metallurgical versus thermal coal. Thermal coal is generally less expensive to produce than metallurgical coal.

Metallurgical coal is currently only mined in the Bowen Basin. The average cost of production does not differ significantly within the basin, with north, central and southern mines averaging around $50/t. However, within the metallurgical coal mines, the costs between mines can vary quite significantly. For example, costs for open-cut mines in the north Bowen Basin range from $38/t to $73/t.

Deloitte Access Economics 30 Impact of a carbon price on the Queensland economy

Chart 6.1: Coal cost by mine location (USD/t 2008)

80.00 Metallurgical 70.00 Thermal Max - Metallurgical 60.00 Min - Metallurgical 50.00

40.00

30.00

FOB CostFOB (USD $/t 2008) 20.00

10.00

0.00 OC UG OC UG OC OC OC OC

Bowen - Bowen - Bowen - Bowen - Bowen - Callide Clarence- Surat North North Central Central South Moreton

Note: Dollar values are in $US 2008. Source: Deloitte analysis

Cost components

Table 6.2 shows the breakdown of costs for selected metallurgical coal mines. It should be noted that the information presented does not include all mines, hence the average cost may not match the analysis presented in Chart 6.1.

The analysis shows royalty, freight and port loading costs are similar across mines. The main differences lie in labour and mining and processing costs. This is more evident in examining the standard deviation of costs in Table 6.2. The standard deviation for royalties, freight and port loading costs are all within 0-1, whereas for labour and mining and processing costs, the standard deviation ranges from 3 to 6.

Labour costs range from $5/t up to $21/t, and mining and processing costs range from $13/t to $27/t.

Deloitte Access Economics 31 Impact of a carbon price on the Queensland economy

Chart 6.2: Average metallurgical FOB cost component (2008 USD/t)

Port Loading 30 Freight

20 Royalties FOB CostFOB (US $/t) Mining & Processing 10 Labour

0 OC UG OC UG OC

Bowen - Bowen - Bowen - Bowen - Bowen - Central Central North North South

Note: Dollar values are in $US 2008. Source: Deloitte analysis

Table 6.2: Average FOB cost component and standard deviation

Average Cost (FOB USD/t) Standard deviation Bowen - Bowen - Bowen - Bowen - Bowen - Central North South Central North OC UG OC UG OC OC UG OC UG Labour 7 13 13 18 13 3 3 5 3 Mining & 15 22 20 22 19 3 3 6 4 Processing Royalties 6 7 7 7 6 1 1 1 0 Freight 8 8 6 6 6 0 0 1 1 Port Loading 3 3 3 3 3 0 0 1 1

Note: Dollar values are in $US 2008. Source: Deloitte analysis

Emissions intensity

The average emissions intensity8 of Queensland mines in 2009 is:

0.077 CO2-e/t Open-cut

0.021 CO2-e /t Underground

8 Department of Climate Change and Energy, Efficiency National Greenhouse Gas Inventory, calculated using fugitive emissions for coal mining divided by raw production.

Deloitte Access Economics 32 Impact of a carbon price on the Queensland economy

Queensland coal mines have lower emissions intensity in comparison to mines in New South Wales. The average emissions intensity in NSW in 2009 was 0.045 CO2-e /t for open- cut mines and 0.214 CO2-e /t for underground mines.

Due to their higher level of fugitive emissions, the carbon pricing scheme will impact gassy underground mines the most, with open-cut and non-gassy mines less affected (ignoring any government measures to mitigate these effects).

International comparison

Chart 6.3 and Chart 6.4 compare the FOB mine cost in Queensland with the cost in other states and countries for 2008. Conversion from 2008 to current dollars has not been undertaken as although cost increases in Australia can be estimated (the producer price index for material used in coal mining suggests a total increase of approximately 10% over 2008 to 2011), the cost increase for other coal producing countries is unknown and subject to some uncertainty. Escalating production costs for these countries may result in misleading results. Additionally, only relative increases between countries are relevant for determining the positioning in the supply curve. While costs are now higher in Queensland compared with 2008, it is unlikely that there will be large movements in relative costs among countries in this period.

The metallurgical coal costs show Queensland’s mine costs are the lowest in the world, with Queensland mines dominating world supply. Indeed, Queensland mines comprise almost 50% of global export supply in 2008.

Queensland does not have as large a share of thermal coal exports. However, the majority of the thermal coal exported is within the lowest 50% of all mines.

Queensland is a very low cost and globally dominant coal exporter. Assuming a very high emissions intensity of 0.1 CO2-e/t, Queensland coal mines are likely to be highly competitive under most carbon price scenarios. For instance, a carbon price of $100/t is estimated to add about $10/t to the FOB cost of coal.

Taking the strong bargaining position of larger exporters (especially in the metallurgical coal market), the Queensland coal industry is not expected to be materially affected with a domestic carbon price (within normal ranges).

Deloitte Access Economics 33 Impact of a carbon price on the Queensland economy

Chart 6.3: Metallurgical FOB Mine Cost (2008 USD/t)

HCC

200 180 160 PCI

140 SSCC 120 100

80 USD $ / tonne / $ USD 60 40 20 0 0 10 20 30 40 50 60 70 80 90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 2008 Global Metallurgical Market Supply (Mt) QLD NSW Canada China Russia E Indonesia NZ Mongolia Vietnam USA Russia W Poland Venezuela South Africa Colombia Mozambique

Chart 6.4: Thermal FOB Mine Cost (2008 USD/t)

100 90 80 70 60 50

40 USD $ / tonne USD 30 20 10 0 0 50 100 150 200 250 300 350 400 450 500 550 600 2008 Global Thermal Coal Supply (Mt) QLD NSW Indonesia China Vietnam Russia E Canada W South Africa Colombia Venezuela Russia W USA Poland

Note: Dollar values are in $US 2008. Source: Deloitte analysis 6.3 Price forecast

International coal prices continue to increase despite other commodities scaling back. Metallurgical coal has almost doubled in price, climbing from just above US$80/t to more than US$160/t today. This can be tracked to a few key influences: Metallurgical coal demand continues to grow. Steel intensive emerging markets are expected to ramp-up in non-OECD countries. Coal-fired power generation is expected to underpin demand for thermal coal. Supply shortages. Acute shortages in key consuming nations like India and China combined with weather and logistics related supply bottlenecks in key exporting countries like Australia.

Deloitte Access Economics 34 Impact of a carbon price on the Queensland economy

India’s domestic coal industry is struggling to keep pace with rising demand. India is turning to imports as far away as the US, Russia and Australia. India is actively seeking to become involved in the Australia coal market. There have been several recent transactions involving Indian acquisitions of Australia coal assets (i.e. Griffin Coal, Galilee). There continues to be record investment in Australian coal mines and coal infrastructure.

In work undertaken for the Australian Coal Association, ACIL Tasman forecasts that the export coal price will drop over the next five years, in particular for metallurgical coal which is forecast to drop from $250/t in 2011-12 to $177/t by 2015-16. Thermal coal prices remain more stable, only dropping from $120/t to $95/t by 2015-16. These commodity price projections are consistent with terms of trade forecasts from Deloitte Access Economics.

The Commonwealth Treasury forecasts a higher price rise in 2011-12 compared with the ACIL Tasman forecasts, with a similar price reduction trajectory. Prices under the Commonwealth Treasury forecasts reach a plateau later, in 2019-20, rather than in 2015-16 in the ACIL Tasman forecasts. From 2019-20 the price trajectory is forecast to be similar.

However, these prices still remain significantly higher than the FOB mine cost, where the average cost for metallurgical mines is $53/t and thermal mines is $38/t. As such, Queensland coal exports are likely to remain competitive should these somewhat softer market conditions eventuate.

Chart 6.5: Export coal price forecasts ($A/t real, 2010-11)

300 ACIL export thermal coal ACIL export coking coal 250 ACIL weighted price Treasury Modelling 200

150

100 A$/treal 2010/11 prices 50

Source: ACIL Tasman ‘Impact of Proposed Carbon Price on Black Coal Mining’, June 2011 6.4 Demand side analysis

The Queensland coal sector is dominated by the production of metallurgical coal for export. The key long term global driver for this coal is growth in rapidly industrialising Asian

Deloitte Access Economics 35 Impact of a carbon price on the Queensland economy

markets which is resulting in strong demand for steel-making raw materials. China’s steel consumption is forecast to increase by 6% to 664mt in 2012 underpinned by growth in the infrastructure and housing sectors.

China increasingly relies on imports for its hard metallurgical coal requirements, with consumption outpacing growth in domestic production. Demand for high quality metallurgical coal is expected to grow substantially in the medium term as China’s steel sector adds more integrated steelworks with large furnaces that require metallurgical coal that is low in ash and sulphur and with high viscosity.

Coal imports to Japan are also expected to support near term prices for both metallurgical and thermal coal. Imports of metallurgical coal (from all destinations) are forecast to increase by 13% to 59mt in 2012 as steel production increases to support the rebuilding of damaged housing and infrastructure following the recent natural disaster. Further, there is expected to be strong demand for thermal coal with switching to coal fired electricity to address the loss of nuclear generation capacity.

The IEA World Energy Outlook highlights that a decline in coal-generated power in OECD countries will be more than offset by growth in Asia. Demand from China, India and Indonesia is expected to account for 90% of coal demand growth through to 2035. That said, there are significant risks for prices (both in thermal and metallurgical coal) associated with the close linkages to industrialisation in Asian economies. Any interruption in growth in these economies would likely have a large and rapid impact on many commodity prices.

The ABARE’s ‘Australian Energy Projections to 2029-30’ show coal exports are projected to increase over the next 20 years from 8000 PJ in 2011-12 to 12000 PJ in 2029-30, corresponding to approximately 450 Mt of coal (see Chart 6.6).

The projected annual growth rate of 2.4% is built on expectations that global demand for coal will continue to increase in the period to 2030 as a result of increased demand for electricity and steel-making raw materials, particularly in emerging market economies in Asia. Black coal exports will be supported by the expansion of infrastructure and mining capacity in New South Wales and Queensland over this period.

Deloitte Access Economics 36 Impact of a carbon price on the Queensland economy

Chart 6.6: Australian coal export forecast (PJ)

Source: ABARES ‘Australian Energy Projections to 2029/30’, March 2010

Chart 6.7 shows a forecast of generation in Australia by generator type under the carbon pricing scheme proposed by the Commonwealth Government. The forecast is undertaken using the DAE Long Term Model (LTM) which models the Australian electricity sector over 2010-2050 incorporating a generation investment and dispatch optimisation.

Generation from coal is expected to decline as the carbon price rises. However from 2035, generation from coal with carbon capture and storage (CCS) is expected to increase, with the overall impact leaving coal generation with a stable share of dispatch.

Chart 6.7 Australian forecast of thermal coal electricity generation (GWh)

500000 450000 400000 350000 Renewables 300000 Gas and Oil 250000 Gas CCS 200000 Coal CCS

Generation (GWh) 150000 Brown Coal 100000 Black Coal 50000

2012 2036 2039 2042 2045 2048 2015 2018 2021 2024 2027 2030 2033

Source: Deloitte analysis

Deloitte Access Economics 37 Impact of a carbon price on the Queensland economy

Queensland supply forecast

The Queensland coal sector (and its supply chains) has been rapidly expanding capacity over recent years. New production capacity has predominantly been in large capital- intensive, open-cut mines. (About 85% of Queensland's coal output comes from open-cut mines.)

Key advanced coal projects in Queensland include: BHP Billiton Mitsubishi Alliance’s $1.6 billion development of the Daunia metallurgical coal mine BHP Billiton Mitsubishi Alliance’s US$900 million to extend the Broadmeadow metallurgical coal mine Jellinbah Resources' $200 million expansion of the Lake Vermont thermal coal mine

In terms of projects which are currently being planned but yet committed, the majority comprise (typically less gassy) open-cut projects (see Table 6.3). However, the emissions intensity of these projects is not known. With projects in relatively early stages of commercial assessment, the form of coal production (ie open-cut or underground) may also be subject to change.

Table 6.3: Key proposed coal projects in Queensland

Project Company Expected start-up New capacity Drake Coal project Drake Coal 2012 6 Mt Qcoal/JFE Steel Byerwen Coal project 2012 10 Mt metallurgical Corporation Colton Northern Energy 2012 0.5 Mt metallurgical Macarthur 3.6 Mt metallurgical Middlemount (stage 2) 2013 Coal/Gloucester Coal ROM Wilkie Creek Peabody Energy 2013 7.7 Mt thermal Caval Ridge (Peak BHP Billiton Mitsubishi 2013 5.5 Mt metallurgical Downs expansion) Alliance (BMA) Collinsville open cut Xstrata 2013 6 Mt Washpool coal project Aquila Resources 2013 2.6 Mt Grosvenor 4.3 Mt hard Anglo Coal Australia 2013 underground metallurgical Woori Cockatoo Coal 2013 3-4 Mt PCI and thermal Wonbindi Cockatoo Coal 2013 3 Mt PIC and thermal Source: ABARES

Commercial response

There are a range of uncertainties on the future path of coal prices on which investment decisions are based. The long term direction of coal prices is expected to remain elevated underpinned by robust demand from large Asian economies, notwithstanding some moderation from near term peak prices as supply catches up with demand.

Deloitte Access Economics 38 Impact of a carbon price on the Queensland economy

Based on supportive demand and price conditions, coal production margins are currently high. However, future investment decisions are based on the costs of additional capacity (that is, marginal costs) rather than the production costs of existing coal operations.

As resources become more marginal in terms of reduced mineral or energy content, greater distance from supply chains, or through rising extraction and development costs, they will become increasingly sensitive to changes in expected future coal prices.

It is these potential higher cost developments which would be most affected by the carbon price, which would effectively add an extra layer of costs and reduce potential margins. The assistance package for the coal sector announced by the Australian Government does not assist new mines or expansions of existing mines. There have been limited public statements from coal companies following release of the Australian Government’s carbon price policy.

The most material costs for coal producers from a carbon price would be expected to occur through on-site energy use, transport of coal (especially for very remote deposits), and fugitive emissions. The relative composition of these costs is subject to considerable uncertainty and will vary by project. Coal producers have stated that there exist some opportunities to manage fugitive emissions (ie through greater flaring), and some Commonwealth funding assistance will be available in this area, but these are unlikely to drastically reduce their underlying emissions liabilities.

International risk

Many Queensland coal producers are diversified resource companies with a global portfolio of projects. These producers make investment decisions based on the relative returns available in different countries. The carbon price and associated uncertainties could increase risks and costs of investing in Australia and make projects in other jurisdictions more attractive.

The materiality of this issue is difficult to gauge, especially in light of uncertainties over the precise impacts of climate policy and other issues like the Mineral Rent Resource Tax.

Carbon price risk

The Commonwealth Government has committed to providing assistance to the coal mining sector through the Coal Sector Jobs Package. The package will provide assistance over six years to the most emissions-intensive coal mines, with eligible coal mines including mines that had emissions in 2008-09 of at least 0.1t CO2-e per tonne of saleable coal. The majority of coal mines in Australia (including Queensland) have low emissions; however, there are a small number of highly emissions intensive underground mines that will face a significant carbon cost. The Australian Government has estimated that without any assistance, low, medium and high fugitive emission mines will face a cost of $1.40, $7.20 and $25 per tonne of coal produced respectively. In response $1.3 billion has been pledged to the Coal Sector Jobs Protection Package over six years to the most emissions intensive coal mines.

Deloitte Access Economics 39 Impact of a carbon price on the Queensland economy

As shown in the above cost analysis, the average emissions intensity of mines in Queensland is below this 0.1t cut-off. It is likely that most mines in Queensland will not receive assistance as their emissions intensity is already very low.

Queensland metallurgical coal is the lowest cost in the world and accounts for 50% of export supply, while thermal coal costs are still among the lowest 50% of coals in the world. Coal export prices are expected to decline from their current high levels over the next 20 years. However even with a carbon price of $100/t, export prices are forecast to be higher than the cost of mining coal.

Demand for Queensland coal is predominantly export focused. As the dominant world producer of metallurgical coal, Australian/Queensland producers tend to have some capacity to transfer added costs to customers. This ability is much more limited in thermal coal markets where far greater supply balance exists between coal producing countries exists.

The analysis has assumed a limited ability for producers to pass on additional costs to coal customers.

Should there be significant global action to price emissions, global demand may moderate over the longer term in response to higher prices. In thermal coal markets, a drive to low emission energy production may soften demand (especially if carbon capture and storage technologies are delayed or are not cost effective). These demand impacts could be less material for metallurgical coal given Australia’s market position and that raw material substitution opportunities for steelmaking are more limited.

The charts below illustrate the competitiveness under a carbon pricing scheme of metallurgical and thermal coals respectively. An emissions intensity of 0.3 CO2-e /t for all Australian mines has been assumed. However, it is understood that the majority of mines will have emissions intensities below this, with the average emissions intensity in Queensland being 0.077 CO2-e /t for open-cut mines and 0.021 CO2-e /t for underground mines.

Additionally, there are indications that fugitive emissions comprise a relatively small component of total emissions costs, with indirect emissions from electricity, diesel fuel usage, transport and port costs contributing a significant share to total cost increase under a carbon scenario. It is difficult to determine the precise impact of these other cost factors, with considerable variations likely across projects (for example, depending on the methods of production). These factors have been incorporated into the analysis via the average emissions intensity factor. This parameter, which likely represents an upper case of actual emissions profile, is considered to encompass these additional production process emissions.

Modelling has been conducted using an emissions intensity of 0.3 CO2-e /t as representing a generic gassy coal mine in Queensland, noting that emissions from most coal mines are likely to be significantly below this. Sensitivities at 0.1 CO2-e /t and 0.5 CO2-e /t have also been performed. These are shown in Chart 6.9 to Chart 6.13.

The grey dashed lines shown in the charts below compare this cost outcome with the low end of the price estimate forecast by ACIL Tasman, corresponding to 136 USD/t in 2023/24

Deloitte Access Economics 40 Impact of a carbon price on the Queensland economy

(170 AUD/t at 0.8 exchange rate) for metallurgical coal and 70 USD/t in 2023/24 (87 AUD/t at 0.8 exchange rate) for thermal coal. An additional price line at 30% below the ACIL Tasman estimate has also been included.

The following implications are indicated by the analysis on metallurgical coal:

Under the 0.3 CO2-e /t scenario, all metallurgical coal mines in Queensland remain below ACIL Tasman’s long term price forecast of 136 USD/t.

There is a small likelihood that if a mine has an emissions intensity of 0.3 CO2-e /t it will exceed the low long term price of 95 USD/t. With this emissions intensity, the mine faces the risk of being displaced by international suppliers.

At 0.1 CO2-e /t all mines are below the low long term estimate of coal prices.

At 0.5 CO2-e /t some mines may have costs which exceed the low long term estimate of price, however all mines are below the ACIL Tasman long term forecast of price.

It is likely that a mine with a carbon price of 0.5 CO2-e /t will move up to the top end of the merit order, hence facing the risk of being displaced by international suppliers.

Most mines will have emissions intensities significantly lower than 0.1 CO2-e /t and, accordingly, overall industry impacts are considered to be lower than depicted in the modelling.

Chart 6.8: Metallurgical FOB mine cost — emissions intensity of 0.3 CO2-e/t

Note: Assumes emissions intensity of 0.3 CO2-e/t and a $100 t/CO2-e carbon price

Deloitte Access Economics 41 Impact of a carbon price on the Queensland economy

Chart 6.9: Metallurgical FOB cine cost — emissions intensity of 0.1 CO2-e/t

Note: Assumes emissions intensity of 0.1 CO2-e/t and a $100 t/CO2-e carbon price

Chart 6.10: Metallurgical FOB mine cost — emissions intensity of 0.5 CO2-e/t

Note: Assumes emissions intensity of 0.5 CO2-e/t and a $100 t/CO2-e carbon price

The following implications are indicated by the thermal coal analysis: The long term estimate of thermal coal prices is approximately half that of metallurgical coal.

At 0.3 CO2-e/t, carbon costs may almost double the costs of some mines.

It is likely that a mine with an emissions intensity of 0.3 CO2-e /t will have production costs which exceed the low forecast of long term prices. However there is still a high probability costs will be below the ACIL Tasman long term forecast of 70 USD/t.

At 0.3 CO2-e/t it is likely a mine will move significantly up the merit order and hence face the likelihood of being displaced by other suppliers.

Deloitte Access Economics 42 Impact of a carbon price on the Queensland economy

At 0.5 CO2-e/t it is likely the FOB cost will exceed the long term price forecast. A mine with this emissions intensity will move to the top end of the merit order and is likely to be displaced by other suppliers.

Again, most mines will have emissions intensities significantly lower than 0.1 CO2-e/t and will therefore have impacts lower than depicted in the modelling.

Chart 6.11: Thermal FOB mine cost — emissions intensity of 0.3 CO2-e/t

Note: Assumes emissions intensity of 0.3 CO2-e/t and a $100 t/CO2-e carbon price

Chart 6.12: Thermal FOB mine cost — emissions intensity of 0.1 CO2-e/t

Note: Assumes emissions intensity of 0.1 CO2-e/t and a $100 t/CO2-e carbon price

Deloitte Access Economics 43 Impact of a carbon price on the Queensland economy

Chart 6.13: Thermal FOB mine cost — emissions intensity of 0.5 CO2-e/t

Note: Assumes emissions intensity of 0.5 CO2-e/t and a $100 t/CO2-e carbon price

Conclusion

Global demand is at present supportive, and these conditions are expected to persist over the much longer term. However, even without a carbon price, it is likely that not all proposed projects would proceed — either cancelled completely or significantly delayed — given other commercial factors and variables.

While the fugitive emissions profile for prospective coal projects is not known, on the basis of current production and cost factors, there does not appear to be substantial risk of large reduction in investment from a large range of carbon price outcomes. Rather, it is the demand side factors over the longer term which are most critical.

The analysis has generally been conservative. It has used a carbon price of $100 per tonne for scenarios and this is not likely to be reached until well past 2030 when international trading is operating. In addition, it has modelled relatively high emissions intensities for coal production.

However, one important caveat is that the analysis has been based mainly on existing cost and competition structures for Queensland coal producers. New developments may be higher (or lower) cost than the existing cost structure. Some parts of the industry argue future costs will be higher. In addition, the relatively high coal prices at present may bring forward unexpected new international supply. These factors have not been explicitly modelled because of their uncertainty.

Deloitte Access Economics 44 Impact of a carbon price on the Queensland economy

7 The LNG sector

A number of very large LNG projects are expected, committed and under construction in Queensland. The projects being developed in Queensland have been underpinned by relatively long term supply contracts together with equity commitments made by customers. In part, this may mitigate many of the commercial risks concerning changed global demand for natural gas. 7.1 Industry snapshot

A large share of new global LNG capacity is being developed in Australia, principally in Western Australia and using coal seam gas in Queensland (see Chart 7.1).

Chart 7.1: New global liquefaction projects

Brazil

US/Canada

Russia

Iran

Angola/Nigeria

Indonesia/PNG

Australia

0 20 40 60 80 100 120 bcm/year Under construction Proposed

Source: Deloitte

The Queensland LNG industry, which is being developed as a major gas export hub in Gladstone, is supplied by coal seam gas from the Surat and Bowen basins. Approximately 250,000 PJ of gas reserves exist in these basins on current assessments and it is expected these reserves will be sufficient to meet both domestic natural gas and export-oriented requirements over coming decades.

Deloitte Access Economics 45 Impact of a carbon price on the Queensland economy

Current LNG Projects in Queensland

A summary of key Queensland LNG projects is set out below.

Queensland Curtis Island LNG (QCLNG) — Committed

QGC, a subsidiary of BG Group, proposes to build a LNG facility on Curtis Island. The facility will contain two LNG trains with a combined capacity of 8.5 million tonnes of LNG per year. The facility will be able to accommodate an expansion up to 12 million tonnes per year. Natural gas is to be sourced from gas extraction facilities in the Surat basin. A 540km pipeline will transport the natural gas to the LNG facility. The project is expected to cost $15 billion. QGC have agreements to supply China, Chile and Singapore. Final investment approval was undertaken in October 2010.

Gladstone LNG (GLNG) — Committed

Santos, Petronas, Total and KOGAS are developing the GLNG project, valued at approximately $16 billion. The LNG facility will feature two trains with a combined capacity of 7.8 million tonnes per year. A pipeline will transport gas from Santos reserves in the Bowen and Surat basins to Curtis Island for liquefaction. The gas will be sold to Petronas, Total and KOGAS. Construction for the GLNG project started in May 2011. First production run is expected in 2015.

Australia Pacific LNG (APLNG) — Committed

The APLNG project is a joint venture between Origin Energy, ConocoPhillips and Sinopec. Natural gas will be sourced from Origin Energy’s reserves in the Bowen and Surat basins. ConocoPhillips will operate the LNG facility. Sinopec will purchase 4.3 million tonnes of LNG per year. The APLNG project will involve a LNG facility located on Curtis Island, linked to a 450km pipeline to the gas reserves. The facility will have two LNG trains with a combined capacity of 9 million tonnes of LNG per year. The facility will be able to accommodate expansion to 18 million tonnes of LNG per year. Final investment decision has recently been confirmed, with operation of the LNG facility proposed in 2015.

Curtis Island LNG — Final investment decision pending

The Shell/PetroChina facility will be located on Curtis Island. Gas will be supplied by production facilities via pipelines from Surat and Bowen basins. The plant will feature two trains capable of supplying approximate 8 million tonnes per year in output. The facility is to accommodate up to 16 million tonnes of output. The project is targeting final investment decision in 2012.

Fisherman’s Landing LNG — Proposal

Liquefied Natural Gas Ltd (LNG Ltd) proposes to construct a smaller LNG facility at Fisherman’s Landing, Gladstone Port. The facility will include one LNG train with 1.5 million tonnes LNG per year capacity. The facility will accommodate an additional 1.5 million tonne train if desired.

Deloitte Access Economics 46 Impact of a carbon price on the Queensland economy

Energy World — Proposal

Energy World proposes to connect coal seam gas resources from the Cooper basin in central Australia, through Bowen and Surat basins. Two LNG facilities, at Abbott Point and Hay Point, are envisaged. The facilities are expected to accommodate up to 2 million tonnes of LNG production per year.

Southern Cross LNG — Proposal

Impel (Southern Cross LNG) proposes to construct an open-access LNG terminal on Curtis Island near Gladstone. The LNG plant would have capacity of 0.7–1.3 million tonnes per year. Impel also proposes to build an open access, 400km long pipeline (the Southern Cross Gas Pipeline) to Gladstone.

The ownership structure and capital cost of the four most advanced LNG projects is shown in Table 7.1.

Table 7.1: LNG pipeline projects in Queensland

Capex Production Project Owner Ownership ($US billion) target Origin Energy 42.5% 14 (Stage 1) Australia Pacific LNG ConocoPhillips 42.5% 2015 6* (Stage 2) Sinopec 15% BG Group 93.75% Queensland Curtis LNG CNOOC 5% 15 2014 Tokyo Gas 1.25% Santos 30% Petronas 27.5% Gladstone LNG 16 2015 Total 27.5% Kogas 15% Shell 50% Curtis Island LNG 20 2017 PetroChina 50% *Approval pending 7.2 Industry pressures

Despite the generally strong outlook for the Queensland LNG sector, a number of pressures and uncertainties exist.

World demand

LNG in particular is experiencing strong world demand for natural gas, especially from rapidly industrialising Asian economies. Much of the growth in demand is driven by a switch to gas fired electricity generation.

Demand uncertainties centre on how Japan responds to the Fukushima nuclear power disaster. There are expectations that this response will involve a reassessment of the role

Deloitte Access Economics 47 Impact of a carbon price on the Queensland economy

of nuclear power in Japan, driving significant increases in Japanese demand for natural gas (perhaps in the order of 10-12 mtpa).

Global supply issues

Underpinning the increase in global gas demand is substantial investment in gas infrastructure. This includes pipelines, storage facilities, interconnectors, upstream development and LNG liquefaction, regas terminals and shipping.

Queensland LNG production is higher cost than other major exporting countries. Qatar is currently the world’s largest supplier of LNG, with much of its production exported to North America. However, recent extraction and production of shale gas in North America has had an impact in subduing export demand for LNG, effectively displacing LNG from Qatar. As a result, excess supply of LNG from Qatar may be directed to Asia, potentially lowering gas prices in the region and squeezing project economics.

Increasing development costs

Due to the current status of the Queensland LNG industry, the main decision facing proponents is whether or not to commit to the large capital costs associated with constructing a LNG liquefaction facility. In Queensland, the costs of establishing an LNG liquefaction facility, and adjoining pipelines, may be higher than expected due to increasing construction costs (ie steel input costs) and skilled labour shortages. These pressures have already been evidenced in current Australian resource developments. Cost over-runs and slippage of development schedules represent substantial risks to projects, especially given the considerable scale of investment.

The price of LNG is closely related to the price of oil (on an energy equivalent basis). Consequently, if the price of oil declines, the price of LNG will fall as well. On this basis, it has been estimated that most new LNG projects will become unviable if the oil price falls below US$60 per barrel. Despite fluctuations in the oil price, the International Energy Agency believes the oil price is likely to remain above US$80 per barrel in real terms over the next two decades. 7.3 Costs and emissions

Capital and operating costs

Operating costs for Queensland LNG projects are estimated to be between $2/GJ – 2.50/GJ.9 The cost includes well operating costs, labour costs, transportation costs and pipeline costs. Liquefaction and refrigeration costs may add an additional 10% to this cost.

Emissions intensity

Carbon emissions from LNG production vary from project to project. Differences in emission intensities can result from the amount of CO2 contained in the field gas, whether

9 Deloitte analysis

Deloitte Access Economics 48 Impact of a carbon price on the Queensland economy

the LNG is sourced from coal seam gas or conventional natural gas, and the efficiency of the LNG liquefaction facilities.

Emissions from LNG production arise primarily from the following:

Fugitive emissions associated with the extraction of natural gas — venting of CO2 and escape of natural gas during pipeline transmission. Emissions due to the combustion of natural gas to drive the liquefaction process — approximately 10% of the natural gas feed is consumed in this process. Emissions released during transport to export destinations (these emissions are taxed).

A joint report by McLennan Magasanik Associates and KPMG Econtech for the Queensland 10 Government estimates the average emission factor for LNG to be 0.57 t CO2-e/t LNG , 11 while ACIL Tasman estimates the emission factor to be as high as 0.71 t CO2-e/t LNG , albeit for conventional gas based LNG projects

There are some indications (for example, the Grattan Institute) that technological advancements will significantly reduce the carbon intensity of proposed LNG plants in Queensland. The GLNG project currently under construction expects to emit 0.35 t CO2-e/t 12 LNG while the QCLNG project which is committed expects to emit 0.24 t CO2-e/t LNG. However, it is noted these estimates may only cover the liquefaction process and therefore may understate the true emissions intensity of the LNG production process. 7.4 Price forecast

Intelligent Energy Systems (IES) completed a study in January 2011 for the AEMO on fuel costs in Australia. IES examined the LNG price and determined a range of possible outcomes as is illustrated in Chart 7.2. A range of scenarios (A to E) was examined as described below: Scenario A: Fast rate of change, high growth, high carbon price Scenario B: Uncertain world, high growth, low carbon price Scenario C: Modest rate of change, medium growth, medium carbon price Scenario D: Independent climate action, low growth, high carbon price Scenario E: Slow rate of change, low growth, low carbon price

By 2030, the LNG netback price is forecast to range from $8/GJ in the uncertain world scenario up to $20/GJ in the fast rate of change scenario.

10 MMA 2009, “Queensland LNG Industry: viability and economic impact study” 11 ACIL Tasman 2008, “The CPRS and the LNG Industry: An assessment of the impacts” 12 Grattan Institute 2010, “Restructuring the Australian economy to emit less carbon”

Deloitte Access Economics 49 Impact of a carbon price on the Queensland economy

Chart 7.2: LNG netback price (AUD/GJ)

Source: ‘Review of Fuel Costs, a report to AEMO’, IES January 2011 7.5 Carbon price risk

Under the announced carbon price scheme, LNG projects are only required to acquire carbon credits equivalent to 50% of their annual carbon emissions. To evaluate the potential carbon risk to LNG projects, the cost structures of four projects which are currently under development have been examined. A high cost scenario has been evaluated, with the following assumptions: Capital cost: Annualised over 30 years at a discount rate of 9.7% Operating cost: Assumed at the high end of cost estimates at $2.75/GJ Emissions cost: Assumed to be $100/t, however only 50% of costs are included. Emissions rate is as per the MMA estimate of 0.57 t CO2/t LNG Price: Assumed at the low end of IES estimates at $8/GJ by 2030 Assistance rate: Assumed to continue at 50%, however this is subject to review in 2015

Under this high cost scenario (see Chart 7.3), the price is still above the long run marginal cost of the LNG facilities. Hence, even under a carbon price of $100/t, LNG projects are likely to remain profitable. This aligns with recent project announcements.

Deloitte Access Economics 50 Impact of a carbon price on the Queensland economy

Chart 7.3: Cost vs price estimate — High cost case scenario

$450 $450

$400 $400

$350 $350

$300 $300

$250 $250 Carbon Cost ($100/t)

$200 $200 Operating Cost ($2.75/GJ)

Cost (AUD/t)Cost Annualised Capex ($/t/yr) $150 $150 Price ($8/GJ) $100 $100

$50 $50

$0 $- APLNG QLD Curtis Gladstone Curtis Island LNG LNG LNG

Commercial response

Given the competition between LNG exporters, the ability for Australian producers to pass on the additional cost imposts from a carbon price to overseas customers is expected to be extremely limited (especially given the long term nature of supply contracts). Overall, the cost of emissions from a carbon price is likely to be fully absorbed by producers.

There appear to be some opportunities to reduce the emissions intensity of LNG production. These include utilising more efficient gas turbines to run compressors and generate power, as well as capturing more waste heat from production. However, it is not clear how much of this technology response has already been factored into LNG project development plans (and costs), and therefore incorporated within existing emissions intensity profiles.

The impact of the carbon price will add to the level of investor uncertainty in the sector but this may not be sufficient to deter existing projects from proceeding, which is in line with recent project announcements. However, given project costs are unambiguously rising, through shortages of skilled labour and specialist contractors and higher materials costs, it is not unreasonable to expect that some of the currently proposed LNG projects may be cancelled or postponed. Indeed, some gas resources may be consolidated into other LNG projects.

Conclusion

The impact of the carbon tax is therefore likely to be minimal in relation to the costs of LNG production (especially considering the policy shielding provided at the earlier phases of the proposed carbon price scheme).

Deloitte Access Economics 51 Impact of a carbon price on the Queensland economy

Supply reliability is also a key issue underpinning long term supply arrangements (which commonly cover periods of greater than 10 years). In this regard, Australian LNG projects have some competitive advantages in that Australia has a favourable sovereign risk profile, especially compared to other key LNG producers.

On the basis of this advantage, coupled with the long term contracts underpinning LNG projects, the carbon price is unlikely to have a substantial adverse impact on the Queensland LNG sector and its forward investment plans. Other commercial issues, including technical supply issues with coal seam gas and escalating costs of production, are likely to be far more significant investment factors for the sector.

Deloitte Access Economics 52 Impact of a carbon price on the Queensland economy

8 Heavy transport 8.1 Industry snapshot

The transport sector has steadily increased as a share of the Queensland economy, from 4.5% in 1990 to 5.9% in 2010 (see Chart 8.1). This largely reflects the increased transport intensity of production and distribution activities, and more fragmented supply chains. A few different factors are important in driving the broader freight task: There is increasing centralisation of production as well as increased product variety. Trade intensity is also expanding, with corresponding increases in the movement of goods — due to, for instance, the rise of low cost manufacturing in centres like China. There has also been a broader uptake in just-in-time inventory management — with more firms recognising that carrying large inventories ties up space, resources and cash. Importantly, this type of operational management, which has spread from just car manufacturers to retailers, hospitals and grocers, generally means more freight being moved around as it is required. Greater levels of internet retailing are also driving the freight task. Online retailers by definition possess national (if not international) reach and involve a heavy freight requirement.

Chart 8.1: Total employment and share of gross value added

Total employed persons % Share of QLD GVA

120,000 6.0%

5.8% 100,000 5.6% 80,000 5.4%

60,000 5.2%

5.0% 40,000 4.8% 20,000 4.6%

4.4% 1997 1999 2001 2003 2005 2007 2009 2011 Employed persons Share of GVA

Source: ABS Cat No. 5220.0 and ABS Cat No. 6202.0

Overall, transport is a high employment industry, the eighth largest in Queensland, accounting for approximately 110,000 workers or 6.1% of the total workforce (as at May 2011).

Deloitte Access Economics 53 Impact of a carbon price on the Queensland economy

Road freight transport

The types of goods traditionally transported by road in Queensland are containerised commodities, manufactured goods and livestock. Primary activities include: road freight transport service long haulage service road vehicle towing furniture removal service; and truck hire service.

A large number of smaller enterprises

Business size and market concentration differs across the wider transport industry (see Chart 8.2). The road freight sector is dominated by small and medium enterprises. Self- employed and contractors represented about 67% of enterprises in 2008-09, down from 74% in 2003-04

This decline is attributed to the highly competitive nature of the industry. Due to relatively low barriers to entry and a large number of (generic) suppliers, price competition between operators is keen. This is reflected in low profit margins within the sector and limited ability to pass on added costs to customers. Traditionally the road freight transport sector has seen profit margins ranging between 3% and 7% (ABS 2010).

Chart 8.2: Breakdown of business size in Queensland

Air freight transport

Water freight transport Non employing Small (1-19) Medium (20-199) Rail freight transport Large (200+)

Road freight transport

0% 20% 40% 60% 80% 100%

Source: ABS Cat No. 8165.0

Deloitte Access Economics 54 Impact of a carbon price on the Queensland economy

8.2 Industry pressures

Cost pressures

Given the clear differences in modal technologies across the transport sector, there is considerable diversity in relevant cost structures (see Chart 8.3).

For road transport, the largest single cost component is labour, at approximately 28% of total costs. Emissions intensive inputs are also significant cost elements of road transport. Most directly, oil and petrol comprise around 14% of total costs. However, there is also an important emissions component in the freight and cartage cost component (about 17% of costs) which involves other distribution and delivery inputs.

A few factors determine the fuel (and emissions) intensity of road freight operations. These include the type of vehicle(s) operated and the loads carried. However, unlike for rail freight, the average per kilometre road freight cost is relatively constant with respect to distance (ignoring differences between forward and back-haul rates). It is the weight related factors which tend to be more significant.

There are variations in estimates of overall fuel costs for road transport. Some estimates are that fuel accounts for 10% to 40% of total costs, with the proportion of costs accounted for by fuel tending to be at the higher end for smaller transport businesses. It should be noted that these costs will be driven by the price of fuel, which can vary markedly over the short term, mainly in response to international economic factors.

The illustrative analysis below has been based around an average fuel cost contribution of 20% which is considered to be a reasonable indicator of the potential impact of a carbon price on road transport operations.

Increases in crude oil prices have placed pressure on operating margins across road freight service providers. As competition between road freight providers is vigorous and firms have weaker bargaining leverage with customers, businesses have been forced to absorb most or all of these cost increases. Going forward, the extent to which oil prices will increase total expenses is also dependant on any offsetting effects from the persistence of the strong Australian dollar.

Deloitte Access Economics 55 Impact of a carbon price on the Queensland economy

Chart 8.3: Indicative cost structure across transport subdivisions

100% Other expenses 90%

80% Purchases

70% Other transport and motor vehicle running expenses 60% Repair and maintenance 50% expenses

40% Petroleum products and other fuels

30% Rent, leasing and hiring of transport and motor vehicles 20% Freight, cartage, delivery and 10% transport expenses Labour costs 0% Road freight Rail freight Water freight Air freight transport transport transport transport

Source: ABS Cat No. 8155.0

Competitive responses

Strong competition within the industry, coupled with the large number of small enterprises, has put substantial pressure of industry profit margins. This has highlighted the dependence on scale as a determining factor for profitability and as a result there has been some consolidation in the industry.

A key factor in ensuring scale in road freight operations has been the use of secured contracts. Market participants have also expanded into integrated logistics and warehousing services. Such investments are considered to assist in retaining and winning secure contracts in the future.

However, there is also the competitive pressure that increases in price efficiency across other modes of transport will alter the relative cost of transportation through the real freight rates charged. This may cause demand to shift between transport modes. Analysis by BITRE (2009) found that rail infrastructure investments could lead to contracts being transferred from road freight to rail to harness the economies of scale in the latter, especially for less time dependant and longer distance freight tasks.

Demand pressures

The predominant source of income for freight transportation lies in its role connecting economic activities — the transportation of goods produced by others.

As can be seen through the income breakdowns below (see Chart 8.4), freight transport is heavily influenced by economic activity in industries which require mass goods transportation services. Consequently, performance in freight transport is affected by the following up-stream industries:

Deloitte Access Economics 56 Impact of a carbon price on the Queensland economy

manufacturing; wholesale and retail trade; construction; agriculture; and mining.

Any long term downturn in these industries will adversely impact demand for freight services across transport modes.

Chart 8.4: Indicative income structure across transport subdivisions

100%

90% Other income

80% Income from other services 70%

60% Income from other transport services 50%

40% Income from passenger fares

30% Income from transporting goods 20% not produced or sold by the business 10% Sales of goods 0% Road freight Rail freight Water freight Air freight transport transport transport transport

Source: ABS Cat No. 8155.0

Table 8.1 shows inter-industry transaction flows between the wider transport industry and other industries in Australia. In particular, as shown, the transport sector is heavily exposed to activity in the retail and wholesale trade and manufacturing sectors.

For example, over the period 2006-07, around $15.1 billion of transport services were sourced by the retail and wholesale sectors. Though similar figures are not available for Queensland, it is assumed that the relative importance of these sectors in terms of transaction shares is similar.

It should also be noted that the data does not reflect the more recent mining boom that would increase the value of transactions between the mining and transport industry. However, mining and other bulk commodities are predominantly undertaken by rail rather than road transport.

Deloitte Access Economics 57 Impact of a carbon price on the Queensland economy

Table 8.1: Transport industry input output table

Agriculture Mining Manufacturing Construction Retail and wholesale trade $M $M $M $M $M 1989-90 1409 2455 10517 1229 8921 2000-01 1209 1837 12271 2924 9214 2004-05 1355 2262 12888 2487 5267 2005-06 1688 3277 14735 5015 12603 2006-07 2482 3551 15942 5980 15110 Source: ABS Cat No. 5209.0, Deloitte Access Economics calculations 8.3 Carbon price risks

The wider transport industry is the fourth largest source of Queensland’s greenhouse gas emissions. According to the 2009 State and Territory Greenhouse Gas Inventory, transport contributed 10.4% of Queensland’s total emissions profile. About 85% of these emissions are generated by road transport (both passenger and freight).

The Australian Government announced the trucking and road freight industry will be exempt from a direct carbon price until July 2014. Instead, pending agreement between the Multi-Party Climate Change Committee, transport fuel will be taxed through changes to the fuel tax credits system between July 2012 and July 2014. Under the plan, the industry’s fuel tax credits will decrease each year as the carbon price rises. This means that in July 2012, diesel fuel tax credits will fall 6.21 cents per litre, consistent with the initial carbon price of $23 per tonne. Similarly, in July 2014, the diesel fuel tax credits received by trucking operators will fall 6.86 cents per litre, matching the planned 2014-15 carbon price of $25.40 per tonne.

The scheme is only applicable to vehicles with a gross vehicle mass greater than 4.5 tonnes, namely heavy rigid and articulated freight carrying trucks, with lighter commercial and passenger vehicles excluded. Figures from the 2010 Australian Motor Vehicle Census suggest there are around 119,000 vehicles in Queensland to which this will apply.

Impacts on costs

The emissions profile for the three main classes of road freight vehicles, based on the relative cost structure in the broader industry, is set out in Table 8.2.

Detailed information on the cost profiles of short and long haul road freight operations is not readily available. More general publically available cost information has been used, incorporating data on freight distances and fuel efficiency assumptions.

A major uncertainty relates to the actual consumption of fuel for different road freight operations. Key factors will be vehicle technology, operating patterns and network scale. Diesel fuel is expected to remain the dominant fuel source over the medium term and the analysis was based on this fuel type. Given these factors, this analysis should be considered indicative and representing the potential magnitude of the impact of a carbon price impost on road transport businesses.

Deloitte Access Economics 58 Impact of a carbon price on the Queensland economy

Table 8.2: Fuel consumption and emissions for vehicle type

No. of Fuel Total Total diesel Total vehicles in efficiency distance consumed emissions Queensland (l/km) travelled (l) (t) (1000 km) Light commercial vehicles 653,400 0.14 7,190,352 4,179,008 10,029,619 Rigid trucks 100,232 0.28 1,345,281 1,855,560 4,453,344 Articulated trucks 18,899 0.53 1,175,941 2,825,451 6,781,082 Note: Based on 0.0024t of carbon emitted per litre of diesel, Fuel Tax Legislation Amendment (Clean Energy) Bill 2011. Light commercial vehicles are excluded from the carbon price scheme. Source: ABS, BITRE, Deloitte Access Economics estimates

Table 8.3: Illustrative impact of carbon price on road freight

Medium price Low price scenario scenario High price scenario ($23 t/CO2-e) ($50 t/CO2-e) ($100 t/CO2-e) Cost of carbon price per vehicle Light commercial vehicles $83 $180 $359 Rigid trucks $207 $451 $902 Articulated trucks $1,824 $3,965 $7,930 Total cost of carbon price on Queensland transport sector Light commercial vehicles $53,979,000 $117,347,000 $234,693,000 Rigid trucks $20,793,000 $45,201,000 $90,403,000 Articulated trucks $34,468,000 $74,931,000 $149,862,000 Total $109,240,000 $237,479,000 $474,958,000 Note: Light commercial vehicles are excluded from the carbon price scheme. Source: Deloitte Access Economics estimates

As indicated by the analysis (see Table 8.3), a carbon price applying to the fuel inputs of road transport operators is unlikely to add considerably to their overall cost structure. With a $23 t/CO2-e carbon price, there is a potential cost impact per year of around $200 for rigid trucks and $1,800 for larger articulated trucks. Based on a fuel cost of around $1.40 per litre, this could add about 3.8% to the fuel costs of road transport operators. On the basis of strong competition between transport operators, there is expected to be limited opportunities for many enterprises to pass on these cost increases to their customers.

Sensitivity analysis has been undertaken with different carbon prices, representing a broad range of potential price outcomes. With a high carbon price of $100 t/CO2-e, the annual impact for rigid and articulated trucks could be in the order of $450 and $4,000 respectively.

Deloitte Access Economics 59 Impact of a carbon price on the Queensland economy

Light commercial vehicles are presently excluded from the carbon price scheme. However, the potential impact on the costs for these vehicle operations has been shown for indicative purposes.

These potential cost impacts should also be considered in the context of changes in the price of fuel. Indeed, the additional costs from a carbon price are likely to be within the scale of fuel price increases already observed in the market over recent years (see Chart 8.5 and Chart 8.6). Over the previous eight years, average annual changes in the nominal wholesale price of diesel have been significant, at around 28 cents per litre.

Chart 8.5: Brisbane wholesale diesel prices

cents/l 200

180

160

140

120

100

80 2004 2005 2006 2007 2008 2009 2010 2011

Note: Wholesale diesel prices at Brisbane terminal (nominal). Source: Australian Institute of Petroleum

Chart 8.6: Average fuel price movement and carbon price impact

cents/l 160 140 120 100 80 60 40 20 0 2004 2005 2006 2007 2008 2009 2010 2011 Brisbane average Annual price range

Note: Wholesale diesel prices at Brisbane terminal (nominal). Bars show indicative impact of $23 t/CO2-e on price of diesel fuel at $1.40 litre. Source: Australian Institute of Petroleum, Deloitte Access Economics estimates

Deloitte Access Economics 60 Impact of a carbon price on the Queensland economy

Impacts could place additional pressure on industry

There are reasons to suggest that cost impacts from a carbon price may be more acute than that indicated in the analysis.

Profit margins are already tight in the industry and there are likely to be limited opportunities for many operators to pass through these costs to customers. Where this occurs, the additional impost will reduce their profitability. For smaller operators which dominate the industry, the commercial impacts could be more pronounced as they tend to have fewer avenues for reducing overheads and securing network efficiencies.

Road transport has an important function linking sectors of the economy, ie moving agricultural and manufacturing products to market. While the overall freight task has been trending upwards in line with more fragmented production patterns, the introduction of a carbon price may well lead to some moderation in demand for freight services by other industries — especially those most directly impacted by a carbon price themselves.

Because of the way in which the carbon price policy has been designed, with light commercial vehicles excluded (at least initially) from the scheme, some substitution into these vehicles may occur. However, this would be expected to be limited because, in most cases, larger and smaller road vehicles are not direct substitutes. The largest vehicles are able to cost effectively transport greater loads over longer distances, whereas smaller vehicles operate more flexibly within the urban road network over shorter distances (eg delivering freight to direct end-users and retail outlets). A carbon price, at least over the ranges expected, would not be expected to fundamentally alter these inherent modal advantages.

There may also be some substitution from road freight to rail as a result of a price on emissions. It is difficult to distinguish how much substitution is likely in light of other modal shift drivers, such as reforms to road pricing (eg mass-distance charging) which tend to make rail more viable for certain freight tasks and investments in intermodal hubs to alleviate road network congestion. This substitution effect is likely to be most relevant for heavy rigid and articulated trucks where there is more direct competition in the freight market.

Risks and uncertainties

Road transport is the dominant form of transporting most freight in Queensland and Australia, principally in the non-bulk and time-sensitive freight task. The sector is characterised by low profit margins, mainly driven by the high level of competition between operators and relatively low entry barriers. The opportunities for many operators to pass through any additional operating costs to customers (eg food retailers) is considered limited.

Historically, growth in road freight growth has been supported by robust productivity growth. Average heavy vehicle productivity (average load per truck km) has primarily increased through use of larger vehicles (eg B-doubles). But there is a limit to the size in which trucks can safely operate on the road network.

Deloitte Access Economics 61 Impact of a carbon price on the Queensland economy

There are a range of uncertainties regarding the extent to which technology advances can be incorporated to reduce emissions and drive efficiencies over the medium to long term. Some of these opportunities will be more readily available to larger logistics or freight forwarding companies, rather than owner operators or smaller freight businesses.

The ability of road transport operators to switch into low emissions fuels, like biodiesel and electric may be constrained. Long haul operations, which are currently undertaken by rigid and articulated trucks, are likely to be unsuitable for electric power applications. Further, operators will be somewhat limited by current capital investments, whereby new technology applications can be practically adopted once capital reaches the end of its economic life and requires renewal.

Beyond actual truck technologies, there is likely to be more pressure to optimise the overall efficiency of logistics networks. A key factor will be to minimise the extent in which trucks operate at below full freight capacity (eg for back haul operations). This is likely to drive some network efficiencies in which trucks operate within a wider and integrated ‘door to door’ network, as opposed to small freight companies or owner operated trucks.

Crucially, this has been a trend in the industry over some years with the emergence of vertically integrated freight companies. Such structural responses may intensify if operating margins come under further pressure from a carbon price. This may lead to further consolidation in the industry.

Deloitte Access Economics 62 Impact of a carbon price on the Queensland economy

9 Agriculture

The agriculture industry employs around 73,000 workers and contributes 2.5% of Queensland GVA. The Queensland agriculture industry is dominated by small and medium businesses. This is highlighted by an ABS 2009 count of businesses by state that found 97% of businesses in the agriculture industry employed less than 200 workers. This industry composition implies that the ability to pass on increased costs to consumers may be limited.

Further, agricultural production is highly export focused, especially for higher value agricultural crops and livestock (see Table 9.2). Many products trade on world markets and producers are essentially price takers.

Agriculture has been excluded from the carbon price and farmers will therefore not be required to pay for emissions from livestock or fertiliser use. However, the price of some other farming inputs (such as electricity) may increase. In total it is estimated that the share of agriculture inputs procured from emissions intensive sectors is approximately 22%.

The carbon price will also not apply to off-road fuel use by the agriculture, fisheries and forestry industries. Business transport will face an effective carbon price on use of transport fuels from 2012-13 through a reduction in their fuel tax credits. However, businesses in agriculture, fisheries and forestry are exempt from these reductions in credits. From 2014-15, pending agreement by the MPCCC, the fuel tax credit arrangements will apply to the heavy on-road vehicle industry. This may have implications for agricultural transport such as road trains for transporting livestock.

Assistance will be provided to food processors due to the high exposure to energy costs in this sub sector. The Australian Government is also proposing to create a $200 million Food and Foundries Investment program aimed at reducing the impact of a carbon price by focusing on energy efficiency. Additionally this industry will not face a carbon price for off- road fuel use or on light vehicles used to transport agricultural output.

Table 9.1: Agricultural production, Queensland, 2009-10

Commodity Area (‘000 ha) Production (‘000 t) Sugar cane 370.5 29,330.1 Cereals for grain 1375.2 2394.1 Legumes for grain 124.9 145.8 Crops and pastures for hay 118.2 n.a. Oilseeds n.a. n.a. Cotton 87.6 138.4 Linseed n.a. n.a. Peanuts (in shell) n.a. n.a. Tobacco n.a. n.a. Source: Queensland Government 2011

Deloitte Access Economics 63 Impact of a carbon price on the Queensland economy

Table 9.2: Gross value of production, Queensland, 2009-10

Top 10 Commodities GVP ($m) Cattle and calves 3,228.70 Sugar cane 1,316.20 Fruit and nuts 1,045.40 Vegetables 868.8 Cereals for grain 499.4 Poultry 358.5 Nurseries, flowers and turf 327.8 Cotton 301.1 Liquid whole milk 296.2 Pigs 230.9 Source: Queensland Government 2011 9.2 Carbon price issues

Relative emissions

In 2007, agricultural emissions made up 16.3% of Australia's emissions (Australian Government, 2010). These emissions are mostly methane and nitrous oxide and volumes are largely influenced by the size of the beef herd. A breakdown of the relative emissions from agricultural sources is shown in the table below.

Table 9.3: Agricultural emissions, 2007

Source Emissions Percentage of (Mt CO2-e) agricultural emissions (%) Enteric fermentation in livestock 57.6 65.3 Manure management 3.5 3.9 Rice cultivation 0.2 0.2 Agricultural soils 15.0 17.0 Savannah burning 11.6 13.1 Field burning of agricultural residues 0.3 0.4 Total 88.1 100.0 Source: Australian Government 2010

Carbon credit opportunities

While a carbon price will not apply to agricultural emissions, agricultural producers will be able to create tradable emissions credits. The Carbon Farming Initiative is a carbon offset scheme which provides opportunities for farmers and land managers to generate (Kyoto- compliant) credits which can be sold to other businesses to meet their emissions liabilities (subject to a 5% limit during the fixed price period of the carbon price scheme).

Notably the actions allowable under the scheme are broad, indicating that producers across a wide range of agricultural activities will potentially be able to benefit from new commercial opportunities.

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Actions which can generate credits include: reforestation and revegetation; reduced methane emissions from livestock digestion; reduced fertiliser pollution; manure management; reduced pollution or increased carbon storage in agricultural soils; savannah fire management; native forest protection; forest management; reduced pollution from burning of stubble and crop residue; reduced pollution from rice cultivation; reduced pollution from legacy landfill waste; and other methods of reducing pollution and increasing carbon storage as developed in the future.

Commercial response

The Carbon Farming Initiative provided for under the carbon price scheme is likely to deliver additional opportunities for agricultural producers to generate new sources of revenue and reduce their emissions intensity, despite the sector not being included under the carbon price scheme. Indeed, because the agricultural sector generates a significant proportion of emissions, the opportunities for carbon sequestration and adoption of less emissions-intensive land use patterns may deliver significant upside potential for the sector.

While the sector is characterised by a large number of family operated farms, industry production is concentrated in larger commercial farms. An ongoing trend in the industry has been to secure productivity gains through greater scale economies (and diversification). These enterprises may also have greater ability to generate tradable carbon credits, especially early in the commencement of the scheme when carbon offset markets in Australia are still being developed.

There are likely to be some upfront capital investments required to secure the emissions abatements necessary to obtain certified credits. Such investments are more likely to be undertaken in larger agribusinesses which tend to have greater levels of capital availability and are often more receptive to adopting larger scale innovative changes. Over time, the most cost effective abatement practices (should they prove commercially viable) may filter down into smaller farms as they become more widely accepted and possibly involve lower costs and risks.

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10 Other Tier 2 industries 10.1 Tourism

The broader Queensland tourism industry employs about 220,000 workers and contributes around $7.8 billion to the state economy, including $3.8 billion in export earnings (Tourism Queensland, 2010). While the tourism industry is not directly covered under a carbon price scheme, substantial secondary impacts will be faced from parts of the economy which are affected by the carbon price.

Tourism-linked sectors mainly include retail trade, accommodation, food and beverage services and air travel, which account for 85% of tourism output. It is anticipated that costs for the retail trade and accommodation sector will increase due to rising energy costs for building owners.

In 2010, a total of 53 million trips were taken to Queensland, including international, domestic overnight and domestic day trips. This equates to more than 415 million visitor nights spent in the state. Of the domestic visitors, more than 20 million — or around 40% — of these trips were intrastate trips undertaken by Queenslanders.

Table 10.1: Visitors to Queensland, 2010

Visitor type Visitors total Visitor nights Holiday visitors International 2,048,160 39,799,980 1,259,510 Domestic overnight 16,581,760 71,207,610 7,020,000 Domestic day 34,704,570 34,704,000 16,249,690 Total visits to Queensland, 2010 53,334,490 415,711,590 24,529,200 Source: TRA

Notably, the air travel sector accounts for 16% of tourism related expenditure. Hence the Australian Government’s planned aviation fuel tax increase of 157% (from 3.56 cents to 10.16 cents per litre by 2014-2015) will have a significant impact on the sector. For example, small businesses that use light air or helicopters will face substantial cost increases, while Australia’s large airlines will also face higher costs. The majority of these costs are expected to be passed on to consumers leading to a likely reduction in demand for air travel and associated tourism goods and services.

However the most substantial influence of the carbon price on tourism will be through the increase in cost of domestic air travel. This may impact on the behaviour of tourists and potential tourists in two main ways: It becomes relatively more expensive for domestic tourists to visit parts of the country via air travel. This may lead to some substitution of air travel for car travel, as the price of petrol will be exempt from the carbon price. This will particularly affect those tourist destinations that are not geographically close to large population centres, such as tropical North Queensland.

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While the exclusion of international flights means that the cost of visiting Australia will not increase per se, it will influence the cost of making multi-stop visits to Australia. As a result, visitors may reduce the number of places visited while in Australia owing to the cost of domestic flights. This is more likely to affect visitation to Queensland among those who arrive in Australia at a gateway outside of Queensland and would likely need to travel to Queensland on a domestic flight. Some of these affected visitors may elect to avoid travelling to Australia altogether, while others may simply visit fewer regions as part of their holiday.

However not all visitors to Queensland have flexibility of destination that would allow them to change their plans. In particular, business travellers and those visiting friends and relatives are likely to be committed to a particular destination and therefore are not readily able to alter their plans to visit Queensland rather than another destination.

Instead, it is the more price-sensitive holidaymakers who may be swayed by the increased cost of domestic flights. Holidaymakers account for 61% of all international visitors to Queensland, comprising 42% of all domestic overnight visitors and 47% of all domestic day visitors.

Because the cost of international flights is unaffected by the carbon price, those international visitors to Queensland who arrive in Australia through a Queensland gateway are unlikely to be dissuaded from visiting the state by the carbon price (although it may reduce the number of regions visited, for example a holidaymaker who arrives at Cairns Airport may be less likely to take a domestic flight to visit Brisbane). As a result, it is anticipated that the main constraint of the carbon price on international tourism in Queensland will be among holidaymakers who arrive at a gateway outside of Queensland.

Of all international visitors to Queensland in 2010, some 588,000, or 12% of the total, were holidaymakers who arrived in Australia outside of Queensland. This represents, in a sense, the upper scale of visitors who may potentially be dissuaded from visiting Queensland as a result of the carbon price. However, it is unlikely that all of these visitors will be price- sensitive enough to avoid their trip, with many likely to simply absorb the price increase or cut their spending in other areas. Further, more than two-thirds of this total arrived in Sydney, and the domestic air trip between Sydney and southern Queensland destinations could be substituted for other, carbon price-avoiding mechanisms, such as car travel.

Car travel is also a potential substitute for many domestic travellers, in particular those who are making intrastate trips from elsewhere in Queensland. Air travel is used by relatively fewer domestic holidaymakers to Queensland — around 28% of overnight visitors and fewer than 1% of day visitors, largely due to the fact that an overwhelmingly large share of these are local Queenslanders who are not travelling long distances. Overall, just under two million domestic overnight trips in 2010, and just 42,000 domestic day trips, utilise air transport and may be considered of a potentially susceptible to the price increases from the carbon price.

However, of these leisure trips involving air transport, 410,000 overnight trips and 15,000 day trips were undertaken by Queenslanders. If these travellers were to substitute trips involving flights for trips by motor vehicle to avoid the price, they are overall just as likely to travel within Queensland as previously, albeit to a potentially different destination. This reduces the potential number of trips lost to 1.55 million domestic overnight trips, or just

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27,000 day trips. As with international visitors, however, the true figure will most likely be well below this level, as some domestic travellers will not be sufficiently price-sensitive to change their plans on the basis of the carbon price increase. 10.2 Cement

The cement industry comprises of a few large producers that service domestic markets. The majority of cement imports into Australia are from Asia Pacific countries which currently have no carbon pricing plans. As there are few barriers to entry for cement imports, the industry is very much trade-exposed.

The industry is also highly emissions intensive, with the manufacture of cement in Australia 13 producing around 700kg CO2-e per tonne of cement production . Therefore, a carbon price of $23 per tonne from 1 July 2012, if fully applied to the industry, would have a sizeable direct impact on costs and result in a reduction in competitiveness in the domestic market.

However, the impact of the carbon tax is expected to be minimal in the short-term due to the Jobs and Competitiveness Program shielding 94.5% of the industry. This is particularly important for cement - which has a limited ability to reduce emissions intensity in the cement industry - as the emissions intensity is driven by the chemical composition of the product.

The demand for cement is predominantly from the construction industry, both industrial and housing. Any increase in the cost of cement, and the price pass through to manufacturers and consumers, could generate some substitution away from cement in which other less emissions-intensive materials are used. For example, some substitution may be seen between concrete roof tiles and steel sheet roofing should the price of concrete roof tiles increase relative to steel sheet roofing. However, given the high levels of shielding and import competition, it is expected any cost pass through from cement producers and substitution effects would be limited, especially over the shorter term. 10.3 Steel

The steel industry has similar characteristics to the cement industry in that a few large producers service domestic markets, for example BlueScope Steel. The majority of steel imports into Australia are from Asian countries which currently have no carbon pricing plans. As there are few barriers to entry for steel imports, the industry is very much trade- exposed. Indeed, the import penetration of more complex fabricated products has increased over recent years, particularly given the strength of the Australian dollar. For example, there has been significant utilisation of large scale modular steel components for mining and LNG projects.

The industry is also highly emissions intensive in both the production of raw steel and subsequent fabrication processes. A carbon price would therefore be expected to have a sizeable direct impact on costs, and result in a reduction in competitiveness in the domestic

13 Australian Cement Industry Statistics, Cement Industry Federation, 2009

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market. However, the impact of the carbon price — at least over expected ranges — is expected to be minimal in the short-term due to the Jobs and Competitiveness Program shielding 94.5% of the industry. This level of assistance is particularly important the steel industry, which in addition to high production costs, also faces significant pressures from imports.

Like the cement industry, the demand for steel is predominantly from the construction industry as well as heavy engineering (mining and gas investments). Any increase in the cost of steel products may see a substitution to other building materials (or imports) where these are available. This would be heavily dependent on the relative price of steel to other materials after accounting for the carbon price. However, any price pass through from the production of raw steel is expected to be minimal due to the level of shielding and import competitions faced in the domestic market.

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