CMI Sofassstware Tool Manual20140909

www.climateworksaustralia.org +61 3 9902 0741 1

Carbon Decision Making and Risk

Management:

TOOL MANUAL

Version 2.0


Contents

Disclaimer .................................................................................................................................... 3

Getting started ........................................................................................................................ 6

Summary .................................................................................................................................. 7

Manual ..................................................................................................................................... 9

Inputs ....................................................................................................................................... 9

1. Company Characteristics.............................................................................................. 9

2. Liability Calculation .................................................................................................... 11

3. Make Options ............................................................................................................. 13

4. Buy Options ................................................................................................................ 15

Scenario testing ..................................................................................................................... 19

5. Parameter Definitions ................................................................................................ 19

6. Scenario Definition ..................................................................................................... 22

Scenario testing application .................................................................................................. 24

Outputs .................................................................................................................................. 27

7. Exposure Summary .................................................................................................... 27

8. Project Evaluation ...................................................................................................... 29

9. Portfolio selection ...................................................................................................... 32

10. Portfolio Visualisation ................................................................................................ 34

11. Portfolio Evaluation ................................................................................................... 36

12. Summary .................................................................................................................... 41

Acknowledgements ................................................................................................................... 43


Disclaimer

This Carbon Decision Making and Risk Management Tool (Tool) and the accompanying report

Carbon Decision Making and Risk Management: A Guide for Business (Guide) has been

prepared by Baker & McKenzie, ClimateWorks Australia, Climate Mundial (AFSL No 428196)

and Seed Advisory (the Authors) for the Carbon Market Institute (CMI) as an informational

tool only and is not an offer to sell or solicitation to buy any financial product nor the

provision of financial services or financial advice. While this Tool and Guide may make

reference to various financial products no such reference should be taken to be an

endorsement of such product by CMI, the Authors or any other person.

The Authors attempt to provide accurate and complete information obtained from reliable

sources, however, they make no warranties or representations, express or implied, as to

whether information provided in this Guide is accurate, complete or up-to-date. In particular,

users should be aware of the following key limitations:

The Tool assists users to identify the optimum emission unit portfolio based on

economic selection criteria. It therefore relies upon forward curve information - on

emission unit and energy prices - for its accuracy, which are all inputs added by the

user.

The portfolio of make and/or buy options is only considered with respect to economic

considerations and the Tool does not adjust the results according to other criteria,

such as risk. The main risks to be considered are discussed qualitatively in this Guide.

The user should therefore be fully aware of these limitations and, where further accuracy is

required, the user shall seek its own professional advice.

CMI, and the Authors where relevant, retain all rights (including copyrights, trademarks,

patents as well as any other intellectual property rights) in relation to all information

provided in this Tool (including all texts, graphics and logos). You may not copy, download,

publish, distribute or reproduce any of the information contained in this Tool and Guide in

any form without the prior written consent of CMI or the appropriate consent of the owner.

CMI and the Authors make no representation and give no advice in respect of any financial,

investment, tax, legal or accounting matters in any jurisdiction including the suitability of the

financial products to investors. Neither CMI, the Authors nor any of their agents or

subcontractors shall be liable for any direct, indirect, special, incidental, consequential,

punitive, or exemplary damages, including lost profits (even if CMI or the Authors are advised

of the possibility thereof) arising in any way from, including but not limited to: (i) the

information provided in this Tool; (ii) the modification or misuse of information in this Tool; or

(iii) claims of third parties in connection with the use of this Tool. This exclusion of liability is

also made for the benefit of directors and employees of CMI or the Authors.


The Tool and Guide have been prepared without taking account of your objectives, financial

situation or needs. Consequently, before acting on the information in the Tool and Guide,

you should consider the appropriateness of the information in view of your own objectives,

financial situation and needs.

As noted above, the Tool and Guide Tool do not constitute legal advice. CMI and the Authors

encourage you to seek your own professional advice to find out how the Clean Energy Act

2011 and other applicable laws apply to you, as it is your responsibility to determine your

obligations.

The user should be aware of the following assumptions and limitations when using the Tool:

A company is able to aggregate the total liability across facilities up to five facilities

but it is not designed to accommodate complex group structures and scenarios.

Where a company has multiple facilities and has altered its liability arrangements

through JVs, OTNs, LTCs or establishing a separate entity to hold all liability either:

(i) substitute total corporate liability into facility box; or (ii) need to seek specialist

legal/commercial advice.

All liability and expenses are worked on a number of tonnes liability converted to

permit numbers and financial estimates in AUD.

All amounts are in nominal pre-tax Australian dollars.

The tax effectiveness of various options and models is beyond the scope of this advice

and users of this Tool should refer to the Guide on Tax and Accounting Treatment and

seek professional advice.

Focus is on direct (scope 1) emissions re: liability and where this liability exists at

law. Added to this is then additional exposure through carbon cost pass through

arrangements.

Liability is analysed over a 10 year assessment period from the year entered at the

start of the Tool.

The Authors will not advise in any detail on the tax, transfer pricing and financial risk

issues that arise.

The Tool assists users to identify the optimum emission unit portfolio based on

economic selection criteria. It therefore relies upon forward curve information - on

emission unit and energy prices - for its accuracy, which are all inputs added by the

user.

The portfolio of make and/or buy options is only considered with respect to economic

considerations and the Tool does not adjust the results according to other criteria,

such as risk. The main risks to be considered are discussed qualitatively in this Guide.

The Guide is based on the regulatory and policy framework in force at the time of

preparing the Guide. However, the regulatory and policy framework is constantly

evolving and those matters that must be taken into account in making any decision

will change from time to time.


With the linking of Australia's Carbon Pricing Mechanism to other schemes there is an

increase in the influence that the rules and regulations of those schemes have on

meeting liabilities under the Australian scheme. For example, while Australian entities

can purchase European Union Allowances (EUAs) for compliance purposes in 2015,

there are a range of regulatory restrictions that affect their use which need to be

considered external to the model.

The user should therefore be fully aware of these limitations and, where further accuracy is

required the user shall seek their own professional advice.


Getting started

System requirements:

PC with CD Rom drive

Microsoft Excel version 2007 or later

Setup:

The tool will open in Microsoft Excel 2007 or later.

Open Microsoft Excel and ensure that Macros are enabled

File > Options>Trust Centre > Macro Settings > Enable All Macros


Summary

This Tool is designed to assist organisations manage the costs, risks and uncertainties of

participating in the carbon market. Using the framework of the Tool, users define their

liability under the Carbon Pricing Mechanism (CPM) and identify key make options (in house

emission reduction projects) and buy options (purchase of permits) towards managing that

liability. The tool uses this information to evaluate all options against common assessment

criteria and presents a risk management analysis to inform the decision making process.

The Tool allows users to evaluate their carbon management options to develop an optimal

portfolio of actions to manage their exposure by:

analysing single projects or the entire portfolio of actions against key evaluation

criteria

providing outputs such as abatement composition, compliance cost curve, exposure,

capital expenditure and annual cash flows

assessing risk through flexible scenarios defined by the user

The performance of a companys carbon management strategy will be dependent on a

number of variables that may be highly uncertain at the time of assessment. Variables such as

the price of different carbon units, price of energy fuels, the delivery and cost of different

abatement options and the companys emissions profile will all affect the cost of the

management strategy but are subject to many risks and uncertainties detailed in step 3 of the

Guide. To allow the user to better understand the risks of carbon management, the Tool

allows users to group these parameters into three different scenarios. The Tool will then

present project and portfolio assessment data in each of these scenarios for the user to

investigate performance under various conditions.

The Tool allows users to enter emissions and make options data at a facility level. However,

all buy option strategies and portfolio assessment are presented at a whole of company level,

so that strategies will be evaluated on their ability to manage cost and risk across the

company.

This Manual references 3 types of cells within the Tool which have been colour coded for ease

of reference as follows:

Data entry cells: e.g. cell D16

Automated entry cells: e.g. cell D16

Pick from dropdown menu: e.g. cell D16

A summary of how data flows within the Tool is presented on the following page.


Company Data Input of main financial data to

contextualise the outputs of the Tool

Liability Calculation Input or calculation of

emissions from energy use data and fugitive/process emissions

Make Options Identification of projects to reduce the entitys overall

liability

Buy Options Identification of options to purchase permits to cover

remaining liability

Scenario Parameters Define potential future movements in the parameters affecting project and portfolio

performance

Scenario Definition Assigning parameters defined in Scenario Parameters to investigate the impact of

uncertainties on projects and the portfolio

Exposure Summary Calculation of total liability,

gross exposure and net exposure

Project Evaluation Analyse key assessment metrics

over time for each make and buy option identified

Portfolio Selection Selection of preferred make and buy options to manage the cost

and risk of the liability

Portfolio Visualisation Graphs all selected make and

buy options on a cost curve for easy comparison and analysis

Portfolio evaluation Assessment of key financial impacts and risk

from implementing the selected portfolio

Legend

Input sheets

Scenario sheets

Output sheets

Summary Key findings of the analysis for management

reporting


Manual

Inputs

1. Company Characteristics

As a first step, users will enter the key company attributes that will lay the foundation for the

analysis throughout the tool.

The Company Characteristics tab allows users to enter the names and locations of up to five

facilities. The entry of basic financial benchmarks will enable the comparison of an entitys

carbon price exposure alongside key financial metrics required for effective decision making.

INPUT STEPS:

I. Analysis definition Enter the first year of analysis. This date will flow through to all

sheets within the tool and set the primary year of the assessment period (10 years).

You can test this by altering the date in cell D12 and observing how the tool

automatically changes the assessment period in the Financial Benchmarks section

below (cell D30 to M30).

Now enter the companys discount rate in cell D14. This sets a default discount rate

which affects all subsequent tool calculations where a project specific discount rate is

not specified.

II. Facility definition Enter the names of up to five facilities and select their locations

from the drop down menu.

III. Financial Benchmarks users have the option of entering the companys key financial

data such as gross profit ($), gross margin (%), annual capital expenditure ($), and

annual operating expenditure ($). By entering this data, users will be able to

benchmark the impact of carbon exposure on some of the key indicators of company

performance. Although these fields are not mandatory, if left uncompleted, some

analysis functions of the tools outputs will be limited.

Company Characteristics

Liability calculation

Make options

Buy options

Parameter Definition

Scenario Definition

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Figure 1: (Company Characteristics Tab, Cells B9 E38) The Company Characteristics tab

Enter the names of the facilities for analysis

(Optional) Enter key financial metrics to benchmark carbon exposure against company performance

Set the first year of the assessment period


2. Liability Calculation

On the second tab, users will enter their emissions data to calculate both direct and indirect

liabilities. Direct emissions are those covered by the CPM that will incur a carbon liability

under the scheme (refer to page 17 of the Guide for a discussion of direct liability). Indirect

emissions are those that are not covered by the scheme but nonetheless will effectively incur

a cost of carbon passed through from a supplier (e.g. electricity use where the carbon price is

paid by the generator but passed through to the consumer). For a detailed explanation of the

determination of liability, see page 10 of the Guide.

Important: For each facility, users have the option of entering emissions data in either one of

two ways:

OR

INPUT STEPS:

1. Enter company emissions data through one of two options

i. Option 1 enter aggregate expected emissions data into the Emissions A section of

the tab for each facility (separating direct and indirect1 emissions) for each year of the

assessment period. Repeat this process for each facility.

OR

ii. Option 2 enter energy use into section B1, fugitive & process emissions into section

B2 and other emissions into section B3 at each facility.

a. For energy use data, enter fuel use in GJ and select any one of seven fuel

types and select the relevant emissions factor from the drop down menu (the

tool will automatically calculate emissions for this energy use). Entry of

indirect liability data is optional but will allow analysis of the indirect impacts

of the carbon price on energy that is not directly covered by the scheme.

b. Enter any data for fugitive and process emissions in tCO2e

1 Indirect emissions data is optional.



Make options

Buy options


Scenario Definition

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Option 1 For users who have a detailed understanding of the direct and indirect emissions, users can simply enter aggregate emissions data (both

direct and indirect liability)

Option 2 For users requiring a more detailed view of

theirs emissions profile, users can enter data describing their energy use (by each fuel type),

fugitive process emissions data and other emissions data.


c. Enter any other emissions that are not captured in the above categories. This

is a catch all group for irregular emissions sources.

2. Enter EITE assistance (if applicable) if you are an entity that undertakes an emissions-

intensive trade-exposed (EITE) activity as prescribed under the Regulations and receive

free carbon units under the Jobs and Competitiveness Program, enter the number of

permits (in tCO2e) in the green shaded cells of section 3 of the tab for each facility. For a

detailed explanation of the eligibility under the EITE scheme, see page 20 of the Guide.

3. Summary this table provides a liability snap shot of the entered data for each facility (no

data entry required)

Figure 2: (Liability Tab, Cells B11 to I33) The Liability Calculation tab

Option 1: Enter aggregate total Scope 1 and Scope 2 emissions here

or enter direct and indirect emission by fuel type here (Option 2)

Choose energy types and emissions factors from the drop down menus


3. Make Options

In meeting their carbon liability, companies can either reduce their internal emissions

through make options or source permits from outside the company through buy options. In

the Make options tab, users enter the project costs and abatement volume under the

following categories:

Energy efficiency

Cleaner Energy

Fugitive/process emissions

Other projects

Up to twenty projects can be entered in each of the four categories. These can be assigned to

any of the five facilities defined earlier in the tool.

INPUT STEPS:

I. Select the facility where this project is located from the drop down menu.

II. Give the project a unique name for reference within the Tool

III. Enter the project lifespan in years (this is typically from project commencement until

it is decommissioned or until the date in which the impacts of the projects are no

longer material to business decisions).

IV. Enter capital amortisation in years. This will change the number of years over which

capital is spread across the project. This may be the same period as the project

lifespan although it may change depending on company policies.

V. Enter the cost of capital for each project. This may vary from project to project

depending on the different financing options and risk level of each project.

VI. From the drop down, select whether the project reduces direct or indirect emissions.

In the case of energy efficiency, the fuel type saved is selected from the list from one

of the seven options, alongside the emissions intensity (from the NGERS guidelines).

Operation and capital expenditure data can be entered alongside other cost data to

fully characterise the project reference case2.

VII. Enter uncertainty parameters these parameters allow users to investigate the

performance of the project if the project cost or the amount of emissions reductions

(called project delivery in the tool) is uncertain. Users enter the percentage

2 The reference case refers to the most likely outcome for the project under consideration; variability in

these outcomes can be tested using the scenario analysis feature.



Make options

Buy options


Scenario Definition

Enter the facility name and location using the drop down menu

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variation above or below the reference case for testing in the scenario analysis to

reflect the projects individual risk characteristics.

After entering this key data for each make option project, the tool will automatically generate

key financial assessment metrics in the Project evaluation tab. In this tab, the tool will

calculate project NPV and IRR enabling the user to evaluate the viability of the projects (see

page 26).

Figure 3: (Make Options, B14 to K49) The Make Options Tab

Make options categories:

Energy Efficiency, Cleaner Energy, Fugitive/Process

emissions and Other

Setting these parameters allows testing of uncertainty of cost and abatement in different scenarios (for each year in the assessment

period)


4. Buy Options

Buy Options refers to the purchase of eligible permits accepted under the CPM to meet the

companys liability. The tool accommodates two purchasing strategies the spot purchase of

permits and the contracted purchase of permits.

Spot purchase of permits By buying on the spot market the company pays the going market

rate at the time the decision to purchase permits is made. In this strategy the company is

exposed to market risks, such as the risk of the price changing. The tool allows the analysis of

spot purchase of the following four permit types:

Australian Carbon Units bought through either government auction or secondary

market. This is the default credit purchase in the tool. Quantitative limits can be

placed on the other 3 permit types available.

ACCUs Australian Carbon Credit Units (generated through the Carbon Farming

Initiative)

Permits from linked trading schemes EUAs from the European Union trading

scheme or

Kyoto units (which include Certified Emissions Reduction units (CERs), Assigned

Amount Units (AAUs) and Removal Units (RMUs)).

For further discussion on these permit types, please refer to page 28 of the Guide.

INPUT STEPS (spot purchases):

I. Enter the maximum percentage of liability (after the make options) that can be

covered through the purchase of ACCUs in each year of the assessment period. This

will be limited by legislative limits and company policies. Note: the spot purchase

timeline has 20 years for analysis which will recognise annual constraints in each year

while allowing for flexibility around the analysis start date. It is not necessary to

enter data years outside of the tools 10 year analysis period. The user should

understand the limitations of these markets as they may take time to mature. It may

take some years of scheme operation before a secondary market for ACCUs becomes

functional.

II. Enter the percentage of liability that will be covered through the purchase of

international permits in each year of the assessment period. The tool automatically

recognises the regulatory constraints on the use of these units. For instance, the use

of international units is limited to 50% of the total liability during the first five years of

the floating price period of the CPM.



Make options

Buy options


Scenario Definition

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Spot purchase calculation: The tool will automatically select the lowest cost permits for each

year based on the permit prices set out in the parameter definition tab. The tool will then

buy the lowest cost units up to the maximum buying and regulatory limits set out above

until the entire liability is covered.

Contracted purchase of permits defines fixed forward price contracts where the permit

price is negotiated in advance as opposed to a spot price that is variable over time. The

contracted delivery of permits can be entered over the time series, alongside upfront and

annual payments as per the contractual arrangements. Similar to the Make options tab,

scenario testing allows fluctuations in the delivery of units or costs to be included in the

analysis over the assessment period. Users can, for example, include the risk of default or

under delivery of permits from the project developer as well as foreign currency fluctuations

affecting contract price.

INPUT STEPS (contract purchases):

I. Enter the contract name and select the permit type (from the drop down menu),

contract life (years) and cost of capital (%).

II. Enter the contracted delivery of permits over the assessment period in cells I43 to

R43.

III. Enter upfront and annual payments as per the contractual arrangements over the

time series. Year 1 is the first year of the contract as defined on the portfolio

selection tab.

IV. Set up the uncertainty parameters and include estimates of the high case and low

case values as a percentage of the reference case. These parameters allow the user

to investigate the performance of the project subject to uncertainty in the contracts

cost or delivery of emissions reductions.

V. Repeat the above process for each purchase contract.


Figure 4: (Buy Options, Cells B4 M29) Spot purchase of permits in the Buy Option Tab

Figure 4b: (Buy Options, Cells B30-L52) Contracted purchase of permits in the Buy Option Tab

Purchase of units from government auction is automatically calculated based on other

inputs

Maximum use of international permits defined by legislative

limits and user preferences

Enter the potential variation in the number of units delivered and contract

costs over the assessment period for risk assessment

Enter the costs associated with each purchase option for the calculation of key assessment

metrics


Scenario testing

5. Parameter Definitions

There are multiple parameters that will influence the performance of the carbon

management strategy, many of which are highly uncertain. The risks and uncertainties

associated with these parameters are discussed further in Step 3 of the Guide. These are in

addition to inherent uncertainties associated with projects listed as make options and any

contracted buy options. The tool allows users to examine the performance of the strategy

under different scenarios by defining three combinations of these parameters into scenarios.

The scenario testing is an important step in understanding the risks and uncertainties

affecting the carbon management strategy. Accordingly, the tool allows the user to

investigate the impacts of different parameter values on each of the make or buy options

over the analysis period.

This approach to setting the variables can be used across the following parameters:

Direct emissions

Indirect emissions

EITE Assistance

Changes to Australian Carbon Unit price

CFI ACCU price

EUA Price

Kyoto price

Price of all seven energy types at each facility

INPUT STEPS:

The reference case for direct emissions, indirect emissions and EITE assistance are calculated

based on inputs in the liability calculation.

I. The user is required to enter reference case estimates for the price of various carbon

permits and the cost of the different energy prices. For guidance on likely future

carbon prices, please refer to carbonmarketinstitute.org.

II. The user then enters estimations of variance around the central estimate (or

reference case) using either of two methods:



Make options

Buy options


Scenario Definition

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OR

III. Enter the percentage variation on the reference case for the parameter of interest.

This can be used to model parameter variations against the central estimate over the

assessment period. This approach is appropriate where variance is likely to be

uniform throughout the analysis period. For the % variation cases, variation below

the reference case should be entered as a negative e.g. -10% and variation above the

reference case should be entered as a positive e.g. 10%

IV. Repeat for other parameters of interest

OR

V. Enter the tailored case data for the parameter of interest. This approach might be

useful to describe a particular event, for instance the closure of a particular facility.

VI. Repeat for other parameters of interest

Figure 5: (Parameter Definitions, Cells C20- P47) The Parameter Definitions tab

Enter default high and low case scenarios using %

variation or

Method 1: % Variation Where the variable is a fixed % above or

below the central estimate across the assessment time frame

Method 2: Tailored Where data can be manually entered in a point in time (for instance, to describe the closure of

a particular facility during a particular year)

enter tailored data to describe fluctuations over the assessment

period


6. Scenario Definition

In the second scenario testing tab, the user will define two scenarios to compare the

performance of make and buy options against the reference case.

The reference case scenario is automatically pre-filled based on the parameters entered into

the parameter definition tab. This scenario represents the most likely scenario based on

the data entered by the user. For the two additional scenarios, the tool also allows for the

selection of a group of parameters (for instance to describe a pessimistic or optimistic case)

or the selection of just one parameter to allow for sensitivity (for instance, the movement of

the Australian Carbon Unit price).

All parameters defined in the parameter definition tab are presented in Column C.

Different scenario testing objectives will direct the combination of these parameters included

in each scenario. See page 20 of this manual for three examples of scenario testing.

INPUT STEPS:

I. Review your objectives for scenario testing and select an appropriate case for each

parameter to include in the scenario.

II. Under Scenario 2 (column G) on the Scenario Definition tab, select a case for each

parameters from the drop down menu.

III. Repeat this process for Scenario 3 (in column I).

IV. The Parameter Visualisation tool on this tab allows for easy review of the cases

selected for each parameter to ensure that these meet scenario testing objectives.

V. The selection of cases for scenario testing will be automatically applied to the results

tabs.



Make options

Buy options


Scenario Definition

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Figure 6: (Scenario Definition, A1 I42) The Scenario Definition tab

Select combinations of parameters (entered in the previous tab) from the drop down menus


Scenario testing application

There are many risks and uncertainties that will affect a companys carbon exposure, as detailed in step 3 of the Guide. Many of these uncertainties, such as future policy changes to the scheme will be difficult to predict, however these may have significant impacts on the overall cost of the carbon management strategy. In order to understand these risks and uncertainties the scenario testing feature of the Tool allows the user to investigate and quantify their potential impacts to assess the need for further risk management. Three examples of scenario testing that may help liable entities understand their liabilities are detailed below. Scenario Testing Example 1: Sensitivity of projects and contracts to changes in the carbon price. The scenario testing feature of the Tool can focus on the impact of one specific parameter on individual projects or contracts. One example of this application is to test the performance of an individual project or contract under different carbon price scenarios.

1. Enter cost, emissions reductions and permit delivery into the relevant Make option or Buy option tab.

2. In the Parameter definition tab, enter the most likely carbon price for the Australian Carbon Unit price parameters - Reference case

3. Use either Cost of Australian Carbon Unit - High case or one of the tailored cases to define a high carbon price.

4. Use either Cost of Australian Carbon Unit - Low case or one of the tailored cases to define a low carbon price.

5. In the Scenario definition tab, set all parameters in Scenario 2 apart from Australian Carbon Unit price to Reference Case. Set the Australian Carbon Unit price to the high price defined in step 3.

6. Set all parameters in Scenario 3 apart from Australian Carbon Unit price to Reference Case. Set the Australian Carbon Unit price to the high price defined in step 3.

7. In the Project evaluation tab, select the project for analysis. The tool will calculate the NPV, IRR, Payback period, Payoff, Cash flow and capital requirement in each scenario.

Scenario Testing Example 2: Upper and Lower Limits of Carbon Exposure For some companies, while carbon exposure may not pose a material risk to operations under reference case assumptions, it could have severe impacts if worst case scenarios eventuate. Users can use the scenario testing feature to examine potential downside case and investigate the potential financial impacts if these scenarios eventuate. An example of a worst case scenario analysis is presented below.

1. Enter financial, liability, make option and buy option data into the Tool as described in steps 1 to 4 of this manual

2. Enter base case assumptions for carbon unit prices and energy prices throughout the 10 year analysis period for the Reference case in the Parameter definition tab


3. Use one of the four other cases to describe a pessimistic case for each parameter. This can be achieved by selecting a % above or below the reference case or by entering data into one of the Tailored Cases.

4. Use another case to describe an optimistic scenario. 5. In the Scenario definition tab of the tool, group all pessimistic cases into "Scenario

2" and all Optimistic cases into Scenario 3 as shown in the figure below. Reference cases are automatically grouped in the Reference Case Scenario.

6. Analyse the impacts of these risks and uncertainties on the overall cost of carbon management and on individual projects in the results tabs. These tabs are described further in steps 7 to 12 of this Manual.

If the upper limit of carbon exposure exceeds the companys capacity to manage this cost effectively, the carbon management strategy should be reviewed for improved mitigation of these risks. Note: Many parameters entered into the Parameter definition tab will be interdependent, for example different carbon permit prices which are linked through various domestic and international markets. These dependencies should be considered when setting scenarios for analysis. Scenario Testing Example 3: The Impact of Scheme Repeal on Individual Projects or Contracts The Tool can be used to analyse the potential impact of repeal risk discussed on page 53 of the Guide on a single project or the whole portfolio of options in a companys carbon management strategy.

1. To investigate the impact of scheme repeal on the carbon management strategy follow steps 1- 2 of Example 2 above.

2. To simulate scheme repeal, use a tailored case in the Parameter definition tab for Direct emissions parameters. Direct emissions (Emissions covered by the scheme) would drop to 0 after the scheme is repealed.

3. Use another tailored case for Australian Carbon Unit price parameters to simulate the drop in the carbon price after the scheme is repealed. Refer to Figure 7 below for examples of direct liability and carbon price cases where the scheme is repealed in 2015.

4. In the Scenario definition tab select the Reference case for all parameters in Scenario 2 apart from your tailored cases for Direct emissions and Australian Carbon Unit price. Select the Tailored cases from steps 2 and 3 of this example to describe the repeal scenario.

5. Analyse the impacts of scheme repeal on the overall cost of carbon management and on individual projects in the results tabs. These tabs are described further in steps 7 to 12 of this Manual.


Figure 7: Scheme repeal cases in the Scenario


Outputs

7. Exposure Summary

After the user has completed the (orange) data entry tabs, the tool will populate the yellow

results tabs. The first results tab analyses the companys exposure to the carbon price based

on the data inputs.

First, the gross exposure represents the amount the company will be required to pay to meet

the liability by buying permits at the defined carbon price in each scenario in nominal dollar

terms. The gross exposure represents the cost of carbon management before free permits

and the pass-through if all permits are bought at the spot permit price.

Second, all free EITE permits received through Government assistance are displayed. The

gross exposure after assistance is then calculated as the direct and indirect inherent exposure

less the free permit allocation.

Third, pass through can be set on a year by year basis as a percentage of the gross exposure

for each scenario. These all add up to create the net exposure which is calculated as the gross

direct and indirect exposure less the free permit allocation and the pass through.

OUTPUT STEPS:

I. Review the Facility threshold summary at the top of this tab. This summary highlights

the emissions over the facility thresholds of the CPM after implementing all make

options identified. Any years where emissions can be reduced below the threshold

are highlighted in green.

II. Review the Exposure summary of the reference case in the blue shaded cells (F70 to

O73). This table displays the direct and indirect liability in tCO2e and cost in nominal

dollars. Comparing these results to the outputs for the two other scenarios shows

the potential variation in exposure under the conditions defined in the Scenario

Definition tab.

III. For emission intensive trade exposed business (EITE), review the amount of forecast

assistance (if any) across the assessment period.

IV. Assess net exposure (gross exposure after free permits and pass through) by setting

the pass-through rate. This can be set to different rate across the assessment time

frame and across scenarios offer a lot of flexibility in analysis.

V. Review the total exposure under each scenario.

Exposure Summary

Project Evaluation

Portfolio Selection

Portfolio Visualisation

Portfolio Evaluation

Summary

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Figure 7: (Exposure Summary, Cells B49 - I86) The Exposure Summary tab

Output tables showing the exposure for each of the three

defined scenarios

Estimation of the ability to pass through the costs of meeting the

carbon liability

Graph of direct and indirect exposure throughout the

assessment period


8. Project Evaluation

Projects (identified in the Make option tab) can be analysed individually, across each of the

three scenarios. The tab includes a summary of the key financial metrics for the selected

project (payback, NPV, internal rate of return) with visualisations of project pay off and net

cash flow over the assessment time frame.

Net project payoff is the difference between the cost of carbon calculated for the project and

the spot carbon price. For example, if the project can reduce liability at a levelised cost of $10

per tCO2e and the spot carbon price is $25 per tCO2e, the project payoff for this year will be

$15 per tCO2e. Users can also investigate the performance of the project in the different

scenarios and calculate a weighted average performance, based on the users assessment of

the likelihood of each scenario. In addition, users can investigate the impact of delaying the

start date of each project on financial performance to determine the optimal timing of

projects. Follow the steps below to investigate the relative value of each project under

consideration.

OUTPUT STEPS:

I. Select project of interest from the drop down tab in cell D11.

II. Choose the projects year of implementation. Changing the year of implementation in

this tab will only affect calculations on this page. After deciding on the optimal year of

implementation from the project analysis, enter the desired start year for the project

on the Portfolio Selection tab.

The tool will generate the following outputs to evaluate the performance of the project:

a. Net present value (NPV) - The NPV represents the sum of all cash flows of the project

or contract considering the capital and incremental operating costs, as well as the

benefit in direct carbon emission reductions, priced at the carbon price in each

scenario. These cash flows are discounted at the project or contract specific cost of

capital. The NPV is calculated using all cash flows throughout the 10 year analysis

period and calculates a terminal value to represent all cash flows after this period

until the end of the projects lifespan. The terminal value calculation assumes that the

cash flows in the tenth year are representative of all cash flows from then until the

end of the lifespan. You can choose to remove the terminal value from the NPV

calculation by setting project life to 10 years

b. Internal Rate of Return (IRR) - The IRR refers to the annual rate of return (% p.a.) of

the project and can be used to measure and compare the profitability of projects.

Exposure Summary

Project Evaluation

Portfolio Selection



Summary


The method of calculation for the IRR requires at least one positive and one negative

net annual cash flow from the project. Projects with only negative or positive cash

flows will return NA. If the cash flows change sign more than once throughout the

assessment period technically there is more than one IRR. The tool will only give one

value that is closest to the projects cost of capital

c. Payback Period - The Payback period represents the first year in which cumulative

cash flows become positive. This metric is commonly used to describe the length of

time required for the project to return the initial capital cost of the project. The tool

will calculate the payback period as the first year in which the cumulative cash flows

from the project is greater than 0. Negative cash flows after the initial payback

period will not affect the calculation.

d. Net Project Payoff -Net project payoff is the difference between the cost of carbon

calculated for the project and the spot carbon price. For example, if the project can

reduce liability at a levelised cost of $10 per tCO2e and the spot carbon price is $25,

the project payoff for this year will be $15. The cells turn green when the project

delivers abatement at less than the carbon price and red when it delivers abatement

at greater than the carbon price.

e. Net project cash flow This is the sum of all expenses including capital, operating and energy costs, excluding the benefits from the carbon price (not considered as a cash flow). This table is also formatted to provide a quick visual guide to periods with negative cash flows.

f. Capital Expenditure- This chart shows the total capital expenditure required on the project in each year.

Figure 8a: (Project Evaluation), Cells A1- P41) The Project Evaluation tab

Analysis of key financial metrics (IRR, NPV and payback period) for

each project in each scenario


Figure 8b: (Project Evaluation, Cells B42-O81) The Project Evaluation tab

Analysis of project payoff, annual cash flows and capital expenditure in each scenario over the assessment period

Enter the probability of each scenario to evaluate the weighted average payoff.


9. Portfolio selection

After evaluating the projects individually (on the Project Evaluation tab), we can now assess

how the various projects perform in a portfolio context. This process of comparison will assist

in devising and optimising a portfolio strategy to meet the calculated liability.

On this tab, users can define preferences for how projects can be ranked. This prioritises the

most important measures of a projects performance using user defined ranking parameters.

These include:

Net annualised abatement cost ($/tCO2e)

Net annualised pay off ($/tCO2e)

NPV ($)

Capital requirement ($)

Average annual opex ($)

For instance, if an organisation is particularly capital constrained, the user might rank the

capital requirement parameter highest. A companys preference for one over another will

typically reflect its usual approach to financial analysis. The tool will then rank each project in

the portfolio based on its performance against this assessment criteria in a single year snap

shot.

The final section presents a summary of the volume of abatement delivered by the portfolio

across the assessment period.

OUTPUT STEPS:

I. Select the scenario from the drop down menu (cell K12) and the analysis year (enter

start data into cell K14).

II. Define your portfolio of projects based on the assessment on the Project evaluation

tab. This is done by choosing which projects are to be implemented (under the drop

down yes/no) and the year of implementation (using the drop down menu in

Column L).

III. Prioritise the assessment criteria in the five options by allocating a percentage value

in the green shaded cells (note this must add to 100%).

IV. Review how the ranking of the projects change under the defined conditions and

different scenarios in each analysis year.

V. Review how this portfolio performs across the ten year assessment time frame in the

section below.

Exposure Summary

Project Evaluation

Portfolio Selection



Summary


VI. Repeat this process using the other scenarios to evaluate the performance of the

portfolio performance under different parameter forecasts.

Figure 9a: (Portfolio Selection, Cells A1- T118) The Portfolio Selection tab

Figure 9a: (Portfolio Selection, Cells B131- N251) The Portfolio Selection tab

Based on the analysis in the Project Evaluation tab, optimise the portfolio of options by selecting which projects to include and when to implement them

Users rank projects based on preferred

criteria

Assess the performance of the portfolio over the assessment

period under each scenario


10. Portfolio Visualisation

The tab provides a visual representation of the various emission reduction options in a

liability cost curve.

Each box on the cost curve represents an individual option to either reduce emissions or

purchase permits to cover the carbon liability. The width of each box represents the liability

abated by the option in tCO2e. Added up, the width of all boxes on the cost curve represents

the total liability that can be met over the assessment time frame.

The height represents the average cost of abating/offsetting one tonne of emissions in the

analysis year from implementing that option. Options that fall below the horizontal axis offer

financial savings even before considering the cost savings from reducing carbon liability. This

tab provides a quick and easy comparison of the annual levelised carbon cost of options in

the selected year and scenario.

This graph groups opportunities by type (e.g. energy efficiency, cleaner energy, fugitive

emissions and the different buy options) through colour coding. This visualisation provides a

succinct graphical representation of the portfolio, in any year, in any scenario.

OUTPUT STEPS:

I. Select scenario of interest using the drop down menu in cell F5.

II. Enter the year of assessment.

III. Hit draw

Exposure Summary

Project Evaluation

Portfolio Selection



Summary


Figure 10: (Portfolio Visualisation, Cells J5-X25) The Portfolio Visualisation tab

The tool generates a liability cost curve based on

the portfolio of options selected previously. Each make and buy option is represented by a box on

the curve.

The height of each box represents the cost per

tonne of CO2e.

The width of each box represents the volume of emissions

reductions (For make options) or the amount of the liability covered

(for buy options).


11. Portfolio Evaluation

This tab is used to examine key financial information and performance of the portfolio

defined earlier in the tool. The tab is divided into the following sections:

Portfolio composition - The section contains visualisations of the portfolio composition (make

and buy) over the assessment time frame and how the portfolio performs in meeting the

exposure. The composition table presents a breakdown and the contribution of each project

in meeting the overall exposure. In the output field, the darker the cell is shaded, the greater

that projects contribution is to meeting the overall liability. This figure shows when the

portfolio is highly dependent on a specific project.

The tool will also identify excess purchase of permits that may occur in the analysed

scenarios. This will occur when contract purchase of permits exceeds the buy strategy for the

particular permit type. The tool will highlight cells in yellow when the buy strategy results in

excess purchase of permits.

Risk management provides an overview of the portfolio composition in each project

category and displays the total number of permits that are sourced directly from carbon

markets at a spot price. These permits will be exposed to movements in carbon markets,

increasing the risk to exposure. This visualisation allows the user to quickly identify potential

exposure to market risk.

Cost composition displays the cost of carbon per year in the reference case scenario for all

make and buy options. The table also presents the average cost of carbon for each year of

analysis.

Capital requirement Presents the total capital costs of projects for each year of analysis

allowing users to assess the magnitude of capital expenses and the potential impact on

capital budgeting.

Cash flow analysis Presents operating and capital cash flows from the defined carbon

management strategy for each analysis year.

Exposure Summary

Project Evaluation

Portfolio Selection



Summary


OUTPUT STEPS:

I. Review the portfolio composition and assess the contribution of each project in

meeting the overall exposure. Identify those options which are contributing a

significant portion to your portfolio and consider the implications and risks.

II. Now examine the excess permit visualisation (see figure 11b). Do any of the

scenarios deliver an excess of permits in the first few years of the assessment time

frame?

III. Examine the risk management visualisation. In the case of example depicted in Figure

11c, the output clearly demonstrates that majority of the exposure come from a

strategy heavily dependent on unhedged EUAs in the floating price period (beyond

2015). An example of this is presented in Figure 11c.

IV. Review the costs for meeting the liability for each year and assess the trends in the

total net annualised cost of meeting liability over time. See Figure 11d.

Figure 11a: (Portfolio Evaluation, Cell B10 P42) The Portfolio Evaluation tab

Figure 11b: (Portfolio Evaluation, Cell C150 J171) Examining excess permit options

Portfolio composition: Displays the

relative contribution of each project to

meeting obligations

Periods with proportionally high cash flow are shaded

darker.

Indicates excess purchase of permits above the threshold


Figure 11c: (Portfolio Evaluation, Cell B172 P219) Examining risk management options

Figure 11d: (Portfolio Evaluation, Cell B222 K255) Carbon cost per year assessment

The proportion of the liability met with options that are protected from

movements in market prices are presented in green (Hedged)

The proportion of the liability met with options that are

exposed to movements in market prices are presented

in shades of red (Unhedged)

Review the cost of the make and buy options and assess the trends in

the total net annualised cost of meeting liability over time

The average cost of carbon across all options is presented on the line

graph on the secondary axis


Figure 11e: (Portfolio Evaluation) Examining capital requirements

Figure 11f: (Portfolio Evaluation) Examining cash flow

The trends in the total net cost of meeting liability in each year (not annualised)

The summary of cash flow covers both operating and

capital expenditure


12. Summary

This tab provides the final output and report that can be communicated to stakeholders and

management for decisions making, providing a high level view of the exposure, the portfolio

composition, and the overall costs of implementing the portfolio strategy.

OUTPUT STEPS:

I. The exposure summary and portfolio composition are automatically prefilled from

earlier sections of the tool. This data is presented in a simple and succinct tabular

format.

II. Baseline costs these are now benchmarked against company characteristics

entered earlier. This enables the user to see their exposure as a percentage of gross

profit, capital expenditure as a percentage of capital budgeted and the operating

expenditure profile over time. See Figure 13b.

III. Risk assessment - shows the impact of the selected variables in each scenario on the

costs of the carbon management strategy. The impacts on liability and cash flows are

shown for each year of the analysis period.

Figure 13a: (Summary, Cells A1 M37) The Summary tab

Exposure Summary

Project Evaluation

Portfolio Selection



Summary

Summarises the strategy formulated to meet obligations under the CPM


Figure 13b: (Summary, Cells B65 X100) The Summary tab

Figure 13c: (Summary, Cells B121, N157) The Summary tab

The exposure, capital costs and operating costs are all compared to the entitys key financial statistics defined at the beginning of the process

The net cost of the strategy is shown in each scenario as compared to the reference case


Acknowledgements

The authors would like to acknowledge the following people and organisations for their help in

the production of this tool:

Andrew Grant, CO2 Australia

Brendan Lim, Net Balance

Damien Lockie

John Marsden, Marsden Jacobs

Gujji Muthuswamy and Michael Ward, Monash University

John Tomac, PricewaterhouseCoopers

Kris Viller, City Smart

Andrew Webster, Macquarie Group

Documents

CMI Sofassstware Tool Manual20140909