COMMENT by Rebecca Howard, of BusinessDesk
New Zealand's listed dairy companies don't argue the need to reduce agriculture emissions, but could the cost eat into investor returns?
Analysts say the risk is minimal but warn
of challenges down the track given a likely lift in carbon prices and a greater volume of emissions the sector eventually must stump up for.
They also see Synlait Milk and Fonterra as more exposed than A2 Milk.
The Interim Climate Change Committee report, released this month, recommended agricultural emissions be priced through the emissions trading scheme at processor-level as soon as feasible, ideally from 2020.
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If implemented, Fonterra and Synlait – not to mention other dairy processors like Westland Milk – will pay for on-farm emissions until the tools needed to charge for individual farm emissions are developed.
Agricultural emissions have been excluded from the ETS in the absence of commercially viable technologies to help farmers reduce biological greenhouse gas emissions, to varying degrees of success.
But what does that mean for processor profits?
For Fonterra, this involves about 19.8 million tonnes of global on-farm carbon dioxide equivalent, while for Synlait it involves about 755,583 tonnes.
If the processors paid for 100 per cent of those emissions at a carbon price of $25 a tonne, Fonterra would face a hefty $495 million bill while Synlait would pay a more modest $19 million.
Fonterra's revenue topped $20 billion in the year to July 31 but it reported a net loss of $196 million. Synlait's revenue was $879m in the same period and net profit was $74.6m. Either way, the minnow looks better placed.
However, thanks to the Government's free allocation of emissions units for the sector, it will initially only involve 5 per cent of that total.
The ICCC estimates that, at 95 per cent free allocation, the agriculture sector would initially bear a cost of about $50 million per annum – a level it estimates will shave just 1 cent off the farm-gate milk price.
Nigel Brunel, OMF's director of institutional commodities, said OMF was currently transacting about 1.25 million tonnes of carbon a month through its desk alone.
"Five per cent is 2 million tonnes of carbon a year – we do half that every month. It's nothing," he said. "The impact is negligible."
Brunel acknowledged, however, the carbon price would be likely to increase.
While currently capped at $25 a tonne, the Government has said the fixed price option will be gone by December 31, 2022 at the latest.
There are a wide range of estimates – both national and international - of just how high the carbon price needs to go for New Zealand to achieve net zero emissions by 2050.
The Productivity Commission has said prices need to rise to at least $75 a tonne of carbon dioxide equivalent and possibly top $200 a tonne over the next three decades.
However, Brunel said as soon as the price headed over $40, $50 or $70 a tonne, "things are going to come out in that space to reduce emissions, because all of a sudden it is cost effective to do so".
He also said, however, the 5 per cent was the "thin edge of the wedge," and would increase over time.
ASB Bank rural economist Nathan Penny also said costs were likely to "rise materially" in the long term as carbon prices rise and the cost of mitigating emissions push higher.
There might not be a significant jump in carbon prices until 2030 "but it is coming, so we need to think about it now."
He also warned reaching the targets might reduce New Zealand's competitiveness if other countries didn't follow suit, which would in turn erode the sector's long-term value.
Harbour Asset Management's Oyvinn Rimer said of listed companies, processors Fonterra and Synlait were more exposed than milk marketer A2, which sourced the bulk of its product from Synlait but also had supply arrangements with Fonterra.
While processors were widely expected to pass on the cost of emissions through a lower farm-gate milk price, they could also pass some on to their customers, potentially driving up costs for the likes of A2 Milk.
However, at 5 per cent and at the current price, "I don't think it moves the dial for A2," Rimer said.
In an extreme situation where Synlait passed on the entire cost to A2, it would be "a drop in the ocean" to a company that generates $1.5 billion of revenue, he said.
And even if it did pass on that cost, Belinda Moore, research analyst for Morgans, said "A2 Milk is good at increasing its selling prices".
The market has been pretty clear in picking favourites among dairy players. A2 has steadily chalked up new records and dragged Synlait along for the ride, while Fonterra has languished near its all-time low.
In the case of extra regulatory risk, it's probably better to be on top than bottom.