Australia’s Taxing Matter

By Roger Conrad • March 27, 2013 • Pacific Digest

At first glance, Australia seems an extremely unlikely place to implement a carbon tax. But since July 1, 2012, the resource-rich country has levied a price of AUD23 per ton of emissions.

That levy is slated to rise by 5 percent a year until July 2015, at which time the fixed rate will convert to a floating price linked to Europe’s emissions trading platform. Price increases after that will also be limited by a pollution “cap,” to prevent unexpected spikes.

At the time of passage, Australia’s opposition Liberal Party called it a “toxic tax” that would cost jobs and raise every family’s cost of living without helping the environment. Liberal leader Tony Abbott went so far as to say Australians could be “100 percent certain” there would be no carbon tax if they returned his party to power.

To be sure, the initial price of AUD23 per ton was set higher than, for example, the AUD8.70 to AUD12.60 a ton in Europe at the time. And it’s not hard to imagine dramatic economic consequences for a country so dependent on producing natural resources and historically reliant on coal-fired electricity.

A mid-2012 study funded by the Australian Research Council forecast a haircut of 0.68 percentage points from Gross Domestic Product (GDP) growth, a 0.75 percentage point rise in consumer prices, and a 26 percent boost in electricity prices as a result of the tax. The prospective payoff: a 12 percent cut in emissions, as the country shifts from coal to wind and other energy sources.

As it’s turned out, there have been some unforeseen shocks from the tax, such as an alleged 400 percent rise in the price of refrigeration gas in some areas. And the impact on the environment is debatable. Otherwise, the effect has been considerably more benign than many feared.

The Australia Competition and Consumer Commission (ACCC), for example, reports a 9 percent to 10 percent boost in energy bills as a result of the tax. That’s “about what we expected” according to ACCC Chairman Rod Sims, who also cited the tax impact for the Australian Treasury as in line with expectations.

As for the broad economy, the Reserve Bank of Australia reported this week that global conditions have improved “significantly” for the country. Fourth-quarter 2012 growth was hardly robust, but is coming in well ahead of previous estimates, and the markets no longer expect to see a cut in interest rates in the near future to prop up the economy.

That’s considerable resiliency in the face of, among other things, a soaring Australian dollar, which makes exports less competitive. The country has also suffered from continued economic weakness in Europe and uncertainty in China. As for inflation, Australia’s Consumer Price Index is holding steady at 2.2 percent, well within the government’s long-stated 2 percent to 3 percent target range.

The tax still has its critics. “The carbon tax is contributing to a record number of firms going to the wall with thousands of employees being laid off and companies forced to close factories that have stood for generations,” charges an editorial in one leading Australian newspaper. The Australian Chamber of Commerce and Industry asserts, “It defies logic to adopt a policy which even the Treasury acknowledges will lower our standards of living and be harmful to national productivity.”

Intra-party battles within the Labor government itself over the tax were rumored to be part of the recent leadership challenge to Prime Minister Julia Gillard. And while Gillard did survive, Liberal party politicians are still pledging to axe the tax should they regain power.

As for the Australian public, opinion on the tax remains roughly split. That’s in contrast to greater support for Labor’s tax on mining company profits, despite the fact that it too has been criticized for raising much less money than expected. It’s also considerably less popular than the ongoing effort to build a government-controlled National Broadband Network.

Blaming the carbon tax as the sole cause of weakness in Australian manufacturing is, of course, somewhat disingenuous. Mainly, it ignores the Australian dollar’s rise from barely 60 US cents in late 2008 to a current level of USD1.04. That’s an effective increase of 73 percent in the cost of Australian goods and services versus those produced in the US.

Moreover, China manages its currency appreciation versus the US dollar. Consequently, the decline in Australian competitiveness against its most important trading partner has been almost as severe. And Australian dollar appreciation has been dramatic against other Asian currencies, including countries where it has budding economic relations, such as India.

That’s a big reason why we’ve skewed our Australian Edge Portfolio to companies that aren’t as affected by currency appreciation. But whether Australia’s carbon tax survives will depend on whether the opposition coalition retakes parliament in the upcoming elections on Sept. 14.

Change You Can Count On

However, there has already been a substantial shakeup in the country’s energy sector. And it’s unlikely to be significantly rolled back, even if Labor is defeated and the carbon tax nixed.

For one thing, the country’s electricity generators have all but given up trying to build coal-fired power plants. According to Bloomberg New Energy Finance, Australian wind energy is 14 percent cheaper to build and operate than a new baseload coal plant and 18 percent cheaper than a new natural gas-fired facility. And that’s before including the added expense of a carbon tax.

Even solar power is cheaper in some parts of the country, such as sun-drenched Western Australia. And technology is expected to significantly drive down the cost of renewables by the end of the decade. Coupled with lower-than-anticipated levels of electricity demand, that’s put pressure on wholesale prices. And the upshot is building and financing new coal-fired power plants has become an expensive risk companies and lenders are increasingly reluctant to take.

There’s still very much a market for Australian coal. But it’s increasingly outside the country. The same is true for the country’s bounty of natural gas, which is about to be unlocked as several major liquefied natural gas projects come on stream in the next couple years.

The typical gas-fired power plant emits less than half the CO2 of an equivalent coal plant. And its operational flexibility makes it the easiest way to back up renewables, whose output is subject to weather-related variability.

That continues to be a major plus for Australian Edge Conservative Portfolio member APA Group (ASX: APA, OTC: APAJF) and the country’s other pipeline companies. And gas-focused producers such as AGL Energy Ltd (ASX: AGK, OTCL AGLNY) are benefitting as well.

By contrast, the country’s coal miners have suffered, including some of the largest such as BHP Billiton Ltd (NYSE: BHP) and Peabody Energy Corp (NYSE: BTU). These companies could wind up big beneficiaries if the Labor Party is indeed ousted this year.

Their greatest strength, however, is they’ve proved their ability to adapt to the carbon tax, and in BHP’s case to the mining tax as well. And Australian carbon tax or no, what they have in the ground will be in demand as global energy needs ratchet up, particularly in the giant emerging economies to their north.

The Roundup

The first takeaway from a glance at the Australian Edge Portfolio tables posted on the website is how few Conservative Holdings still trade below our buy targets. The second is how many Aggressive Holdings still do.

That dichotomy reflects investors’ continued focus on stocks they deem “safe,” and general aversion to anything with a perceived high level of risk. And in this case, risk is anything to do with natural resources.

Our view remains that the resource picks are values at these prices. That includes BHP Billiton Ltd (ASX: BHP, NYSE: BHP) and Rio Tinto Plc (ASX: RIO, NYSE: RIO), which have both taken hits to share prices recently. This week, Rio was forced to take a write-down on a project in Mongolia, owing to unresolved issues on royalties. BHP, meanwhile, appears to be suffering mainly from worries about China, but is also embroiled in a dispute over electricity prices in South Africa.

But as we pointed out in the Portfolio Update in our March issue, the key is that these companies as well as the vast majority of our picks are still raising dividends. That’s the best possible sign that any company’s payout is safe, its finances strong, and business plan is on track. And those in turn are our primary criteria for keeping them in the Portfolio.

New buyers should observe our buy targets when building a position. It never pays to chase rising stocks. And remember that prices can change quickly in US dollar terms, as these stocks are priced in Australian dollars.

Here’s where to find discussion of earnings for AE Portfolio companies, most of which just reported fiscal 2013 first-half results. Some posted results for 2012, while others report on completely different schedules. We’ve included the next reporting dates for those companies. Please consult the Portfolio tables at www.AussieEdge.com for current advice.

Conservative Holdings

Aggressive Holdings

Stock Talk

Comments Guidelines

Add New Comments

You must be logged in to post to Stock Talk OR create an account