Stream 2.2

Evaluating supply chain exposure from carbon pricingMarc Newson Nathan RoostPartner DirectorErnst & Young Ernst & Young

What is the ‘carbon’ being priced

Type of gas Sources Lifetime (years)

GWP % of 590mt

Carbon Dioxide (CO2)

Burning fossil fuels (coal, oil, natural gas) – 65%; and deforestation – 35%

100 1 82.7%

Methane (CH4) Rice paddies, ruminants, landfills, swamps

12 21 10.0%

Nitrous oxide (N2O) Fertilisers, explosives, burning vegetation

120 310 5.6%

Perfluorocarbons(PFC)

Aluminium and semi-conductor production

6500-9200

1.7%Hydrofluorocarbons(HFC)

Refrigeration, air-conditioning

140-11,700

Sulphurhexafluoride (SF6)

Electricity dist., magnesium & semiconductor prod’n.

23,900

At ambient temperatures, 1 tonne of CO2 fills a typical 3 bedroom house

1

H1: Supply chain exposure from carbon pricing is determined by your culture and not a new price impost

Ability to adapt

PO

OR

GO

OD

HIGH LOW

PASSIVEEXPOSED

RISK MITIGATOR

OPPORTUNIST

Impact of carbon price

2

Carbon scenarios

A

Everyone pays

Everyone can play

Consumers do respond

Bigfoot is my Frankenstein

Virtue as a weapon

Supp

ly c

hain

the

mes

How we can explore this

B C D

3

A. We will have to buy permits to emit carbon fromJuly 2012

$

2009 2012

Cost ofdoing

business

Cost ofdoing

business

withcarbonpermitcosts

Carbon permit prices will be determined by marketdemand and government policy

4

$

B. We are significantly exposed to increased input costs as a result of a carbon price from July 2011

Goods & Services

INPUT costs increase per tonne output

PLUS direct energy costs increase

Energy Market

New permit cost changes energy costs

EnergyIntensiveProduct Market

Energy costs increase per tonne output

PLUS new permit cost

Creates new carbon permit cost

Carbon Market

$

$

5

C. We use energy in our business, costs are increasing, but these increases are relatively small

23.40 22.15

78.7593.65100.00

200.00

300.0019

55

1959

1963

1967

1971

1975

1979

1983

1987

1991

1995

1999

2003

Wholesale electricity price -$/MWh

Avg Qld Electricity Price (Nominal Dollars)1955 price escalated at full CPI

Increase of only 44 % of CPI using 1955 base

Source: AGL data 6

D. We are committed to carbon neutrality as part of our corporate social responsibility

Yahoo purchased offsets from hydropower in rural Brazil and wind turbines in India because “…investing in a clean power project here seemed critical and timely…..only recently, the village school was powered by a small diesel generator – dirty, noisy, threatening to young lungs, and not very reliable”

Totalemissions

In-houseabatement

Offset remaining emissions through acquisition of credits at $5 to $7/tonne

t/CO2e

Source: Yahoo quote from ‘Forging a Frontier’ by Ecosystem Marketplace and New Energy Finance 7

Status ScopeCarbon scenarios

We are committed to carbon neutrality as part of our corporate social responsibility

Current ?

We use energy in our business, costs are increasing, but these increases are relatively small

Current 5,000,000+

We will have to buy permits to emit carbon from July 2011

Proposed 170 + (~1000 sites)

We are significantly exposed to increased input costs as a result of a carbon price from July 2011

Proposed ?

D

C

A

B

8

Everyone pays

9

Our electricity supply is the most economically challenged

Source: AGL data 10

Emis

sion

s(t

onne

s pe

r $

mill

ion

of r

even

ue)

6000

4000

2000

8000

10000

Electricity

supply

Aluminium

Beef cattle

Cement and lim

eSheep

Dairy cattle Pigs

Black coal

Ceramic products

Alumina

Gas supply

Cost of electricity by fuel source

$40

$80

Black c

oal

Brown co

al

Gas C

C

Landfill

Gas

Gas tu

rbine

Geoth

ermal

Nuclear

Wind

Mini Hyd

ro

Biomas

s

Generation cost ($/MWh) – no carbon price included

0.2

0.6

1.0

1.4CO2 intensity

(t/MWh)

Source: AGL data 11

The price of a carbon changes the merit order

$40

$80

Pre

car

bon

Gas C

C

Geoth

ermal

Black c

oal

Gas tu

rbine

Brown co

al

Nuclear

Wind

Mini Hyd

ro

Biomas

s

0.2

0.6

1.0

1.4Generation cost ($/MWh) with $25/t carbon price imposed

CO2 intensity (t/MWh)

Source: AGL data 12

Black c

oal

Rising investment in low carbon energy assets

13Source: New Energy Finance

2004 2005 2006 2007 2008

$50bn

$100bn

$150bn

Representing10% of global energy infrastructure spend

68%growth

58%growth

59%growth

5%growth

$40

$80

$120

Generation

Distrib

ution

TransmissionRetail

Regulatory

Total (ex CO2)

Total (incl CO2)

Unit cost ($/MWh)

But at $25/t the average end-user price

increases by 25%

At $25/t, wholesale prices increase by 50%

Through electricity pricing everyone pays!

Source: AGL data 14

BUT, by 2012 we will be used to this…..

NSW 22% increase on 1 July 2009QLD 30% increase over 2007-2010 VIC 20% increase over 2007-2010WA 25% increase on 1 July 2009 (112% over 3 years)SA 22% increase in 2004 and 17% 2007-2009

UK 26% increase in 2008 alone!!

15

…..and this is before an ETS and carbon permit pricing!

Everyone can play

16

Will these price increases be enough to effect change?

Source: International Energy Agency estimates of abatement sources to stabilise emissions at current levels by 2050 17

End-use efficiency

Biofuels in transport

Fuel mix in buildingsand industry CCS in

industry

CCS in fueltransformation

Coal to gas

Power generation

Nuclear

Carbon Capture & Storage (CCS)

Renewables

Generation efficiency

18

Cos

t-ef

fect

ive

ener

gy

redu

ctio

n po

tent

ial

60%

40%

20%

80%

Residentia

l

property

Commercial

property Mining

Everyone can play – the most cost-effective energy initiatives are in our homes

Source: Adapted from Council of Australia Governments –National Framework for Energy Efficiency

Agricultu

re

Manufacturing

Constructio

n

Electricity

supply

Investments with 8 year payback or less

Of these, the following have a 4 year payback or less

It’s not just about energy emissions ….. other industries will be exposed to carbon pricing from direct emissions

19Source: AGL data

Emis

sion

s (k

t)

6000

4000

2000

8000

Steel production

Cement productio

n

Aluminium production

Refrigeratio

n

Agricultu

ral liming

Synthetic ru

tileproductio

n

Lime productio

n

Limesto

ne use

Civil aviatio

n

Note: road transport equates to 71,000kt of which 45,000kt is from passenger cars

Example industries

However, for these industries the cost impact of a carbon permit can be drowned out

Source: UK data from Cairneagle

Aluminium

ConcreteSteel

Steel (recyclce

d)

Aluminium (recy

cled)

17%

3%

9%

14%

21%

Per

cent

age

incr

ease

per

ton

ne

of o

utpu

t (b

ased

on

$40/

t)

14%

5%

10%

% fabricationcosts

21%20%

Inputcosts

Rawsteel

Shipbuilding

14%

3%

10%

% fabricationcosts

23%20%

Inputcosts

Rawsteel

Steel cans

20

Overall, a modest carbon price on its own is unlikely to change consumer behaviour

Source: UK data from Carbon Trust, Cairneagle

Incr

ease

in U

K c

onsu

mer

sp

end

(bas

ed o

n $4

0/t)

10%

20%

£600bn

HolidaysRecreation, culture, restaurants & hotelsCommunication

Alcoholic drink, tobacco & narcotics

Financial and other servicesHousehold goods & services

Rent & maintenanceOther utilities

Clothing etcFood & drink

Public transport & vehicle purchases

Health & hygiene

Education

Private transport fuelElectricity

Domestic fuel (home heating)

Annual UK consumer spend, £bn

3%

21

Typical CPI

Consumers do respond

22

What lenses do we apply to better understand consumer behaviour?

$5 $10

FitShock absorption

No child labourBreathability

Sole durabilityNo dangerous working conditions

Ankle supportWeight

Brand (Nike)

Dollar value of product features

Australian responses only (n=162)

Source: data from AGSM and US Energy Information Association 23

CSR lenses

Economic lenses

Short-run energy demand is in-elastic in end-use sectors:• long-lived capital equipment limits options• limited fuel switching capability• willing to absorb the price increases to maintain lifestyle• unattractive attributes of energy saving devices• incomplete information on energy use / savings

24

Can’t be a premium product – cost, convenience, affordability, reliability all come first

50%

100%

Would actively seek low carbon products if as cheap/convenient

Willing to pay more for products that help me minimise my footprint

Source: LEK Consulting and Tesco, 2008

Information partially fills the gap and language is critical

25

“Renewable” – industry expert language

“Alternative” – implies lifestyle change

“Green” – too political

“Clean” – favoured, but reliability of ‘clean energy’ is questioned (when compared to fossil fuels)

“Carbon” - ?

Incentives to mitigate transaction costs and bounded rationality are key

$

Pre-ETS Post-ETS(Scenario A)

Post-ETS(Scenario B)

Cost ofenergy

Cost ofenergy

NEWcost ofenergy

Avoided carbon

costIncentives:government funding; new carbon assets

Cost ofenergy

26

Carbon cost

Cost of energy saving

initiatives

Consumers responding: household solar PV growth since $8000/kW rebate in June 2007

27

2000 2001 2002 2003 2004 2005 2006 2007 2008

1000

2000

3000

4000

kW

Bigfoot is my Frankenstein

28

“Design for recycling” is already here, but what are the hidden carbon implications……

Boot sill coverEasy removal for recycling

All materials labeledThis enables easy sorting by type

Back panel of front seatEasy removal for recyclingPyrotechnic Devices

Designed for easy neutralisation prior to dismantling

DrainingOperating fluids positioned for easy access and drainage

29

….. is your globalglobal carbon footprint going to be your Frankenstein?

Carbon value-at-stake (typically disclosed)

Carbon value-at-stake (typically hidden)

House build

er

60%

20%

% of

ope

rati

ng

prof

it (g

loba

l)

Retail

er

Water

utility

Building m

at.

Chemica

ls

Food

Reasons why:

• Impacts outside business boundaries ie supply chain

• Free allocation of permits

• Lack of carbon regulations in many countries

• Management awareness

• Ability to pass costs through to consumers

Source: analysis by Cairneagle (based on $40/t price by 2013) 30

The majority of your product emissions might not be your direct carbon liability

Production& purchase

Electricitygeneration

Transmission& distribution Consumption

Gas processing activities

Gas-fired electricity generation

Gas leaks from pipelines

Use of gasbycustomersSo

urce

Pro

duce

dga

s /

elec 1.1

MtCO2e

Pur

chas

edga

s /

elec

1.3 MtCO2e

1.9 MtCO2e

9.1 MtCO2e

1.4 MtCO2e

34.6 MtCO2e

0MtCO2e

0MtCO2e

Source: Origin Energy 31

“End-to-end” value chain engagement and collaboration

Procure supplies Consumers Disposal

RecycleDistributeManufactureRawmaterials

Raw material producersWalkers logistics & network planning

Potato & corn producersSunflower / vegetable oil manufacturersCorrugated cardboard manufacturers

Walkers engineeringWalkers plant managementWalkers energy managementWalkers’ waste management partner

Walkers network strategic planning

Walkers marketing

Walkers recycling consultantsWalkers’ waste management partner

32

Enterprise carbon

emissions

Design & Plan

Procurement & Sourcing

Material selectionComponent modularityTiming of customisationLifecycle emissions

Supplier location / distanceSupplier carbon outputSupplier collaboration

Operations

Marketing & Customer

Energy usageEnergy sourceShipment size and frequencyTransported distanceTransport modeInventory holding / replenishment policiesWarehouse management

Brand image changesPackagingDownstream emissionsRecyclability / re-useability / disposability

Agreeing the areas which can make a difference

33

2007 carbon footprint 2009 carbon footprint

Over 85g of CO2 Less than 80g

of CO2

Reduced footprint of bag of Walkers crisps

Breakdown of 7% carbon footprint reduction

Manufacturing gas consumptionManufacturing electricity consumptionLightweight corrugated boxesPotato TransportOther

41%

37%

11%

5% 6%

Total savings of up to 9,200 tCO2-e

Communicating the results to customers and shareholders

34

Benefits can quickly become evident across a portfolio of business units or locations

Site B

Indicative benefits

Site C

Supply chain & capital issuesEnergy efficiency

Site A

Energyefficiency

Supply chain & capital issues

ØIncreased fuel efficiencyØNewer aircraft

ØNew fuels (in long term)ØGround activities and

other support servicesØRoute configurationsØInvest in low-carbon

economy

Aviation example:

Source: Adapted from Cairneagle 35

Virtue as a weapon

36

$

Pre-ETS Post-ETS(By default)

Post-ETS(By design)

Cost ofproduct

NEWcost ofproduct

NEWcost ofproduct

Avoided carbon

costNEW carbon

assets

Cost ofproduct

37

Carbon costs hidden in

supply chain

Cost of carbon

reductioninitiatives

‘By default’ or ‘By design’ - which approach will your customers and shareholders expect?

Price: 50c80kg CO2 pa

New carbon assets – their value can be greater than the value of the underlying product

New asset: $6

Price: $10006 MWh pa

New asset: $1500PLUS rebate: $1600

Current proposition

Price: $420kg CO2 pa

Low-carbon proposition

Price: $30002 MWh pa

38

Hot

wat

erLi

ghti

ng

Example: double glazing3.9 tonnes saving from high-spec window p.a. (25 year life of windows)

Energy/carbon saving across 100 homes 9,750 tonnes

Value @ $24.50 per tonne $239,000

PLUS improved Green Star/ABGN rating = improved tenancy, rental income and divestment value

New carbon assets – application in the property sector

Example: energy efficient lamp5 watts/m2 saving for 4000 hours of usage p.a. (10 year life of bulb)

Energy/carbon saving across 100 homes 4,750 MWh

Value @ $24.50 per certificate $104,500

Note: assumed CO2 intensity of electricity (0.9t/MWh)Sources: Accurate data and Isaacs, 2007 39

Responding to supply chain exposure

40

Emerging key messages

Everyone pays Carbon pricing will result in increased energy costs – something we all use

Everyone can play Energy efficiency is the low hanging fruit for all of us

Consumers do respond While information helps, consumers will require financial incentives to change behaviour

Bigfoot is my Frankenstein For business, there is large value-at-stake hidden in the supply chain

Virtue as a weapon New asset classes can provide a competitive advantage

41

ü

ü ü ü

ü ü

Carbon scenariosA

Supp

ly c

hain

the

mes

B C D

42

Where could an ‘ability to adapt’ provide you with a strategic advantage over the next 2 to 5 years?

ü

ü

ü

ü

Everyone pays

Everyone can play

Consumers do respond

Bigfoot is my Frankenstein

Virtue as a weapon

“By design” or “By default”

A. We will have to buy permits to emit carbon from July 2012 B. We are significantly exposed to increased input costs as a result of a carbon price from July 2011C. We use energy in our business, costs are increasing, but these increases are relatively small

“By design” or “By default” Contract review

Consumer incentives

Substitution of inputs

43

Thank you

Nathan Roost is an executive director in the Advisory Services team and has over 10 years experience in supply chain projects around the world, specifically in strategic sourcing, procurement, vendor management, operational planning, logistics strategy and post merger integration. He has managed engagements across numerous industries and has also worked for Cap Gemini Ernst & Young, Wyeth Pharmaceuticals and ICG Commerce.

Dr Marc Newson is a partner in the Climate Change & Sustainability Services team and for the last 11 years has been enhancing aspects of performance through environmental efficiencies, corporate governance controls and behaviours, corporate social responsibility, research and analysis, business development and associated change management implications.

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