pwc.com.

au

Carbon pricing Implications for the Mining sector

August 2011

Key features and impacts of The Plan on the Mining sector:

Reduction targets
The Australian Governments Clean Energy Future Plan (The Plan) commits Australia to a reduction target of at least 5 per cent from 2000 levels by 2020 and 80 per cent below by 2050. Meeting this target will require abatement of at least 159 million tonnes CO2-e by 2020 Any entities with facilities with covered emissions above 25,000 tonnes CO2-e will have a liability to surrender carbon units. The government estimates that approximately 500 heavy emitters will be obligated to surrender units under the scheme. Around 100 of these are expected to be miners. The starting carbon price for each tonne of CO2, to be introduced on 1 July 2012, is $23. This will rise (in real terms) to $24.15 in 2013 and to $25.40 in 2014. As of 1 July 2015, a flexible carbon price will be introduced. This will include a transitional price cap and floor. Fuel Tax Credit Scheme reduction: 1 July 2012 30 June 2013: 6.21 cpl for diesel, fuel oil 5.52 cpl for petrol 3.68 cpl for LPG acquired inclusive of excise 1 July 2013 30 June 2014 6.521 cpl for diesel, fuel oil 5.796 cpl for petrol 1 July 2014 30 June 2015 6.858 cpl for diesel, fuel oil 6.096 cpl for petrol 4.064 cpl for LPG acquired inclusive of excise 1 July 2015 30 June 2016 (move to flexible price period)

Who is liable?

Carbon price starting points and evolution to a flexible price Fuel excise

Fuel Tax Credit changes determined six-monthly based on average carbon 3.864 cpl for LPG acquired inclusive of excise price over previous six months

Transitional assistance for emissionsintensive tradeexposed (EITE) sectors

Organisations conducting emissions-intensive trade-exposed (EITE) activities will receive an estimated $9.2 billion in transitional assistance over the first three years of the Jobs and Competitiveness Program. The initial rates of transitional assistance have been set at two levels, these are intended to reduce by 1.3% each year. The average industry rates are: 94.5% For highly emissions intensive activities (e.g. aluminium smelting, integrated iron and steel production and flat glass production) 66% For moderately emission intensive activities (e.g. polyethylene production and tissue paper production) The operation, the impact and the economic and environmental efficiency of the Jobs and Competitiveness package will be reviewed. Productivity Commission inquiries are to be conducted in the lead up to flexible price (12 months to 30 June 2015) with further reviews during the first six months and 18 months of flexible pricing. Following this, there will be regular five year reviews. These reviews will consider an extensive range of factors including if windfall gains have occurred and what future rates of EITE assistance should be provided. Changes that will have a negative effect on the assistance rates will not come into effect for three years from the announcement. Importantly, activities directly associated with mining are not eligible for transitional assistance.

Fugitive emissions

Fugitive emissions refers to the emission of greenhouse gases, most commonly methane, which occurs during coal mining. In some instances technology exists to assist in limiting the release of these gases. Gassy mines already in operation will benefit from the Coal Sector Jobs Package, but such assistance will not be available for mines not already in operation. There are significant issues in relation to the data accuracy of fugitive emissions for coal mines, with the range of uncertainty in the National Greenhouse and Energy Reporting (NGER) default factors being 50%. Liable entities are likely to focus effort on achieving improved measures.

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For more information, please contact:

Over the course of the last year, global economic and political trends have changed the mining industry. In Australia miners are grappling with a looming Minerals Resource Rent Tax (MRRT), skill shortages and a high Australian dollar, which all serve to increase operational costs. In this document we explore the potential impacts the mining industry faces in Australia following the release of the Clean Energy Future Plan and Exposure Draft of the Clean Energy Bill 2011. Firstly, we have outlined industry reactions following the announcement. This is followed by an in depth Q&A with PwCs Energy, Utilities & Mining Leader, Michael Happell, which provides insight into how The Plan could actually affect Australian mining operations. You can also find the accounting implications of the introduction of a price on carbon and key next steps to ensure you and your organisation can be proactive in your response. Indeed, responding now will help to ensure you are well placed with the transition to a carbon price economy. If you have any questions or would like assistance working through the carbon price response strategies for your organisation, please contact any of the PwC representatives in this document.

Michael Happell Partner Energy, Utilities & Mining Leader michael.happell@au.pwc.com (03) 8603 6016

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Industry reaction

comments from across the sector

Despite enjoying record profits in 2010, Australian mining is an industry that has come under increasing cost pressure in recent years. Following the announcement of the Federal Governments 10 July 2011 climate change plan, Securing a Clean Energy Future, market reactions throughout the mining sector have echoed a common sentiment relating to the industry absorbing an additional cost burden. Indeed many have argued that the result of the introduction of a price on carbon will endanger the competitive advantage currently enjoyed by the major miners courtesy of Australias proximity to emerging Asian markets most notably China.
Rio Tinto has been one of the most vocal of the major miners, calling the carbon price mechanism an unfair tax on Australian exporters. BHP Billiton has historically supported action on climate change, however, CEO Marius Kloppers also noted concern that Australias international competitiveness could be harmed, potentially affecting investment in Australia moving forward. Anglo Americans Head of Metallurgical Coal, Seamus French also voiced concern over the future of Australian coal investment projects, arguing that the tax bill on fugitive emissions alone will account for more than 75 per cent of revenues to be raised from the coal industry. The Minerals Council of Australia (MCA) has argued that the introduction of this legislation is a dangerous experiment with the Australian economy. In fact, many across the industry are concerned that the carbon price puts jobs at risk, future investment in exploration in jeopardy and erases a global competitive advantage, which has underpinned the Australian economy for years. If this was the case, Australians would not see the real impact of mining investment going offshore for 5-10 years. The industry is also concerned about the uncertainty around the economic flow through effects from suppliers. Some have argued that 1 July 2012 start date for The Plan is in fact too early and a softer approach is needed to ensure a smooth transition to a carbon economy. In this document, Michael Happell, PwCs Energy, Utilities & Mining sector leader, outlines the key issues faced by the mining industry if a carbon price is successfully introduced into the market.

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Steel
The sector is characterized by capital intensive infrastructure, high energy consumption and exposure to international trade. Analysts have kept a close eye on the sector in relation to the previous incarnations of the Carbon Pollution Reduction Scheme (CPRS) and related proposals. Under the plan the steel sector is to receive two assistance packages in addition to the EITE transitional assistance available for other defined activities: Steel Transformation Plan (STP) $300m over four years for investment and innovation. Based on a self assessment applicable to entities that meet qualifying threshold of >500,000 tonnes of production of crude steel in FY2009-10 (Bluescope, OneSteel) A 10% increase in the allocative baseline for EITE assistance from 2016/17 for specified steel making activities. The result of this is that in 2016/17 entities conducting these activities will receive >98% of their permits at zero cost. Year 2012/13 2013/14 2014/15 2015/16 2016/17 2017/18 2018/19 2019/20 % of Permits provided as assistance (Steel) 94.5 93.3 92.1 90.9 98.6 97.4 87.4 86.2

These packages will shield the sector from the high potential imposts of the carbon price. Deutsch Bank AG estimates the impact at -3.3% NPAT for OneSteel in FY13 and -9.3% NPAT for Bluescope in the same period.

Coal
Government analysis concludes that an average non-gassy mine will incur additional costs of around $1.40 per tonne of production. For gassy mines that release of fugitive emissions, this cost will rise to between $7.4 and $25 per tonne of saleable coal. As gassy mines have limited abatement options, the government is proposing the Coal sector jobs package. This will provide $1.264bn over six years for gassy mines, based on historic emissions intensity per tonne of saleable coal. Threshold of 0.1tCO2-e/tonne of production 18 mines in NSW, 7 in Queensland are expected to be eligible Rate of assistance up to 80% Existing mines only, expansion projects are excluded Scheme to be administered by Department of Resources, Energy & Tourism A further package of $70m is provided for the Coal Mining Abatement technology Support. This is to be on a co-contribution basis.

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Q&A
with Michael Happell, PwCs Energy, Utilities & Mining Leader
Q:  The MCA has said The Plan will impose massive costs for no material environmental dividend. How exactly are miners being hit so hard with the introduction of a carbon price?
We have identified a number of additional costs that miners are most concerned about: 1. fugitive emissions from coal mines 2. rising energy costs 3. a lack of transitional assistance for mining activities, despite being predominantly an export focussed sector 4. the reduction of the fuel tax credit scheme 5. the accumulation impact, taking into account the proposed Minerals Resource Rent Tax (MRRT) and the strong Australian dollar.

Q:  How will the reduction in the Fuel Tax Credit Scheme impact the industry?
The plan features significant changes to the existing fuel tax credit and excise regimes, which are a core part of the carbon price proposals. Specific to mining, fuel tax credits previously available for non-gaseous fuels (such as petrol and diesel), which are used off-road for burning/generating heat or in internal combustion engines for off-road activities, will be reduced by an amount equal to the carbon price. More simply, mining has not been excluded from the discounting of fuel tax credit (FTC) rates. The agriculture, fishing and forestry sectors, in comparison, have been excluded from the discounted rates and therefore retain the full value of the FTC. In preparation for these changes, impacted businesses may need to implement significant systems changes to capture the revised excise and fuel tax claiming rates, in order to report and recover the correct amount to/from the Australian Taxation Office. When Australia moves to a flexible carbon price in 2015, the fuel tax rates will change every six months, placing an added burden on systems. The changes in the fuel tax/excise claiming rates should also be factored into the projected costs of fuel in feasibility studies.

Q:  How are increases in energy prices likely to impact mining businesses? With this in mind, what should miners be thinking about to prepare for this cost?
The increased cost of electricity and diesel is renewing the sectors focus on energy efficiency. Identifying where an operation consumes energy and what steps can be taken to reduce consumption are an immediate step that businesses can take. Prioritising reduction efforts is a real challenge, especially for long lived, complex operations. With limited capital available the key is to develop a consistent financial model which will enable efficiency savings to be identified, quantified, evaluated and prioritised. Our experience working with global mining organisations has shown that using Marginal Abatement Cost Curves (MACCs) is valuable and can provide the rigour needed for the CFO to make informed decisions and deliver tangible cost savings.

Q:  What are the features of the Plan for the mining sector versus the original CPRS?
Under the original CPRS proposal, activities that were defined as emissions-intensive and trade-exposed (EITE) were in line for transitional assistance in the form of free carbon units. This continues to be the case under the recent legislation, however most mining activities do not meet the criteria of an EITE activity which leaves miners open to considerable additional liabilities, despite most of their production being exported. The CPRS lacked detail on dealing with fugitive emissions from gassy coal mines the new Plan provides more detail and an assistance package of $1.264bn over six years for the 25 gassy coal mines that meet the eligibility threshold.

Q:  Will this affect Australias competitive advantage internationally?

The carbon price will add cost to existing and potential future operations. This cost will be factored in to decision making when considering the economics of, for example, expanding an Australian mine again or expanding a mine elsewhere in the world. While the mines themselves are unable to be moved, capital is mobile and mining companies will invest their money on the projects that generate the best return. The carbon price, including its impact on input prices, will make Australian projects more expensive than they otherwise would be and will decrease the return generated. Of course, if these projects remain the best options available to a company, they are likely to continue to go ahead, so long as they still meet internal return hurdles.

Q:  How will the carbon price interact with the MRRT?

The deductibility of units under the proposed Minerals Resource Rent Tax and existing Petroleum Resource Rent Tax will depend on whether the Units are used to abate emissions resulting from activities that occur within the taxing point/ring fence under the applicable resource tax. For vertically integrated operations, there will need to be apportionment where both the upstream and downstream operations produce emissions.

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Q:  Will investment in future Greenfield projects suffer as a result?

As mentioned, the carbon price will add to the cost of constructing and operating a mine in Australia, therefore reducing operating margins and increasing capital costs. As a result, those Greenfield projects which are more marginal may struggle to generate sufficient return to support the capital investment. Combined with the MRRT, the changing tax environment for a miner in Australia may also lead companies to look elsewhere in their exploration efforts. We know the mining industry is global and miners are already investing more of their exploration funds in emerging countries. This may encourage Australian miners to continue focus offshore.

Q: Will the owners of mines be directly liable?

The liable entity will generally be the person with operational control over the mine facility (that is, authority to introduce and implement any or all of the operating, health and safety, and environmental policies for that mine). Therefore liability may not reside with the entity that has financial control over the mine but rather with: Joint venture operators for mines held by unincorporated joint ventures Mining contractors Natural gas retailers, who are initially responsible for the emissions from the use of natural gas by their customers

Q:  What impact does the carbon price have on unincorporated joint venture interest/s?
The operator of a facility held by an unincorporated joint venture (UJV) has the ability to transfer liability for surrender of carbon units to the UJV participants in proportion to their respective interests. Since a carbon price liability arises on facilities that produce 25,000 tonnes or more of CO2-e for covered emissions, the legal entity holding the UJV interest may be responsible for surrendering carbon units to cover their emissions. Besides creating an obligation to comply with the carbon pricing mechanism this creates a number of other issues.

Those issues include how the UJV participant ensures that the operators calculation of liability is accurate, how the UJV participant can influence the operator with respect to business decisions to reduce emissions (such as changing the fuel mix or using lower emissions technology) and whether the UJV participant can pass on the further cost (or renegotiate its contracts). It is important to highlight that where liability is transferred, the fact the UJV participant may have a small interest (say 5%) does not negate the need to comply as it is the facilitys emissions that determine whether it is covered by the carbon price. Therefore, it will be appropriate to agree with the operator in advance whether (or not) the liability is going to be transferred.

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Q:  With the introduction of a carbon price into the market, what are the potential flow through effects in terms of key mining suppliers? Will this result in an additional cost for miners to absorb?
Additional costs expected to be incurred by mining suppliers and passed down the supply chain include: increased energy costs increased transportation costs, in particular for rail transportation increased contractor costs, in particular where the carbon unit liability resides with the mining contractor increased capital expenditure costs (steel, cement, fuels) The ability to pass on these costs by mining companies will be constrained by both the terms of existing long term contracts and the characteristics of the market in which the mine production is sold.

Q:  How will this affect M&A activity?

Wherever there is strong strategic imperative M&A activity will continue unabated. We have already seen this after the governments carbon pricing announcement with the Peabody/ Arcelor bid for Macarthur in the coal sector and in the Upstream gas sector with Origin and ConocoPhillips announcing FID for the APLNG project. Carbon pricing presents all mining companies with an opportunity to make changes to their asset portfolio and operations to manage their carbon exposure and to pursue M&A opportunities to enhance their competitive position. A key impact on M&A will be seen in the pricing of companies or assets that are liable (or likely to be liable) in a carbon priced world. For many smaller producers or explorers this is not likely to be an issue. For those mines that are caught, sellers will need to understand the impact carbon has on their own valuation through: cost and tax imposts; the ability, or inability, to pass those costs on to end users;

working capital and cash flow implications; and changes in their cost of capital. Buyers of those assets will need to understand the same for the targets they seek to pursue. For buyers this understanding will prove to be more elusive as they will need to rely on due diligence to accumulate their knowledge. Uncertainty in the minds of buyers over the quantum of the carbon impacts will most likely mean that in the near term they will seek even lower acquisition values as a cushion or safety net against the risk of lower returns post acquisition. This initial uncertainty over appropriate valuations in a carbon priced world may well see some sale or bid processes delayed or not able to reach completion, at least over the next 18-24 months. Acquisition or project debt is unlikely to be too heavily impacted as banks have been focusing on the expected introduction of carbon pricing for a number of years. Once the new landscape is understood, banks are likely to work with miners to establish sustainable capital structures.

8 | Carbon pricing | Implications for the Mining sector

How do you account for the carbon price?

Accounting for the carbon price will vary depending on the nature of the underlying business, the emissions intensity of the operations, and the level of government assistance received. What do I need to consider to maximise value to my organisation?
There is currently no prescribed accounting guidance for companies to apply in recognising the impact of the scheme in their financial statements. Consequently, there is expected to be a diverse range of accounting approaches applied in the marketplace (as has been the European experience) which can result in significantly different outcomes in the income statement and balance sheet. This may impact a number of key metrics, for example, bank covenants, employee incentive schemes and regulatory licence compliance measures (e.g. AFSLs). Companies will also have to disclose their accounting policies in respect of the scheme so users can understand the impact within the financial statements.

Where choice exists, companies should invest time understanding which accounting policy most appropriately aligns with the underlying economics of the transaction and also meets their strategic business objectives. Companies should consider: Impact of the scheme on asset impairment calculations Accounting for free permits received Accounting for cash received as part of the government assistance package Accounting for payments / contractual arrangements for early closure of generation facilities Impact of government assistance on asset impairment assessments Where permits should be recognised on the balance sheet How permits should be accounted for on an on-going basis Accounting for forward contracts to purchase or sell permits Accounting for carbon clauses within sales/purchases/derivative contracts Accounting for liability to surrender permits over generation period. Visit www.pwc.com.au/carbonprice

Want to know more?

9 | Carbon pricing | Implications for the Power and Utilities sector

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Next steps
Actions

Assess whether you are directly liable

Determine the facilities over which you have operational control Determine the quantity of covered emissions for each facility Assess whether each facility is liable Set up a carbon price project office to manage carbon work streams

Manage the cost implications for your business

Identify emissions abatement opportunities and assess the financial viability of each using marginal abatement cost curves Investigate your ability to access Government funding for abatement and energy opportunities Review existing supply contracts and assess the potential carbon price pass through impacts Develop a carbon procurement/trading strategy internationally linked units via the local auction process Carbon Farming Initiative projects Consider liability transfer options to enable you to manage your own carbon price risk from gas retailers within joint ventures within corporate groups from contractors Assess your ability to pass on additional costs to customers review existing and future customer contracts for pass through clauses assess your market characteristics (local vs international prices/competitors) consider product pricing changes consider potential product substitution impacts Develop accounting policies for the treatment of carbon units Assess your overall future cash flow impacts and develop cash flow management strategies to maintain working capital Update relevant asset NPVs and assess potential asset impairments Consider the impacts on your current and future investment decisions

Consider the potential revenue impact

Manage your balance sheets impacts

10 | Carbon pricing | Implications for the Mining sector

Further reading
You can read more about the carbon price and how it may affect your business at www.pwc.com.au/carbonprice

whatwouldyouliketogrow.com.au

The Australian Governments Climate Change Plan

What should business consider?

19th July 2011

Australias Carbon Price What Does it Mean for your Business?

August 2011

pwc.com.au

Carbon pricing Implications for the Power and Utilities sector

Carbon pricing Implications for the Power & Utilities Sector

Contacts: Mike Shewan
Power & Utilities Industry Leader Tel: +61 3 8603 6446

Contacts: Liza Maimone

Sustainability & Climate Change Leader Tel: +61 3 8603 4150

John Tomac
Partner Tel: +61 2 8266 1330

Liza Maimone
Sustainability & Climate Change Leader Tel: +61 3 8603 4150

Carbon Price Mechanism

Tax implications for businesses impacted by the carbon price and its complementary measures
1 August 2011

Tax implications for businesses impacted by the carbon price and its complementary measures
Contacts: Michael Davidson
Partner Tel: +61 2 8266 8803

pwc.com.au

What does the Climate Change Plan mean for the Australian M&A environment?
Deals point of view August 2011

What does the Climate Change Plan mean for the Australian M&A environment?
Contacts: Jock OCallaghan
Partner Tel: +61 3 8603 6137

Impact on M&A activity Accessing funding Complexity for due diligence Conclusion

2 5 6 7

Liza Maimone
Sustainability & Climate Change Leader Tel: +61 3 8603 4150

Peter Munns
Partner Tel: +61 3 8603 4464

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Contacts
New South Wales
Marc Upcroft Partner marc.upcroft@au.pwc.com +61 (2) 8266 1333 John Tomac Partner john.tomac@au.pwc.com +61 (2) 8266 1330

South Australia
Andrew Forman Partner andrew.forman@au.pwc.com +61 (8) 8218 7401

Victoria
Michael Happell Partner Energy, Utilities and Mining Leader michael.happell@au.pwc.com +61 (3) 8603 6016 Liza Maimone Partner Sustainability and Climate Change Leader liza.maimone@au.pwc.com +61 (3) 8603 4150

Queensland
Brian Gillespie Partner Energy, Utilities & Mining Consulting Leader brian.gillespie@au.pwc.com +61 (7) 3257 5656 Wim Blom Partner wim.blom@au.pwc.com +61 (7) 3257 5236

Western Australia
Darren Smith Partner darren.a.smith@au.pwc.com +61 (8) 9238 3240

pwc.com.au
 2011 PricewaterhouseCoopers. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers a partnership formed in Australia, which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity.