Steel framed housing will feel the carbon bite

By James Morgan-Payler and Lucy Watts.

27 July 2011 – The residential and commercial building sectors produce 23 per cent of Australia’s greenhouse emissions.

Although the carbon tax covers a broad range of industry sectors, it is important to note that only facilities directly responsible for emitting carbon pollution will have obligations under the mechanism to reduce their emissions or purchase carbon permits

As the construction industry principally contributes to emissions indirectly, through its acquisition of materials, resources and services (for example cement, steel, electricity, transport and waste disposal) the industry itself is unlikely to have any direct obligations under the mechanism.

The major source of direct emissions in the construction industry is the use of transport and other liquid fuels either on site or in transportation.

The use of such fuels may be captured by the complementary regulatory arrangements designed to impose an equivalent carbon price on the use of transport and other liquid fuels.

The equivalent carbon price is imposed through reductions in fuel tax credits available for businesses, and where that option is not available, by increasing fuel excises.

Light commercial vehicles (4.5 tonnes or less) and household vehicles will be exempt from the imposition of an equivalent carbon price.

Other business use of transport fuels will be subject to the equivalent carbon price on all transport fuels (and some other liquid fuels in certain situations) from 1 July 2012.

Indirect costs for the industry

The mechanism is likely to result in increased costs passed down from direct emitters who are suppliers to the construction industry.

The majority of increased costs to the industry are likely to be as a result of higher electricity prices, manufacture of carbon intensive materials such as cement, and the transportation of goods.

Although increased electricity rates will be experienced by industries and households alike the construction industry will be particularly exposed to higher supply costs.

Production costs of carbon intensive materials used in construction, such as aluminium, concrete, bricks, glass and steel are expected to increase.

The additional costs of production in these industries are likely to be passed on to customers.

Most of these industries however will be supported as “emissions-intensive trade exposed” industries or through bespoke assistance arrangements, being provided with either free carbon permits commensurate with their exposure, or with cash payments.

This is likely to lessen the extent of the carbon liabilities for those industries, and, as such, the costs actually passed through to construction consumers.

The assistance schemes referred to above that are of particular relevance to the construction industry are the Jobs and Competitiveness Program, the Steel Transformation Plan and the Clean Technology Program.

Jobs and Competitiveness Program

Under the JPC about $9.2 billion of assistance will be provided to help business and support jobs in the first three years of the mechanism.

The assistance aims to prevent “carbon leakage” that is moving activities offshore to countries without a carbon pricing mechanism to allow for cheaper production.

Emissions-intensive trade exposed industries, including many manufacturers of construction materials, may be eligible.

We note that although steel, aluminium and glass manufacturers are all considered to be eligible for assistance under the JCP the brick manufacturing industry is excluded as it is not considered to be exposed to competition from cheaper overseas markets.

Steel  transformation plan

The steel industry will be one of the most heavily affected sectors under the mechanism.  In order to ease the transition the Government will provide $300 million to encourage investment, innovation and productivity in the Australian steel manufacturing industry.

Clean technology program

The introduction of the mechanism will see higher standards of energy efficiency in design and materials as demand for buildings with lower operating costs increases.

Although the construction industry has already been implementing processes for more energy efficient buildings and facilities through programs such as the Green Building Program the increased use of such design and materials will be further assisted by a number of clean technology programs aimed at supporting investments in energy efficient capital equipment and low-pollution technologies, processes and products:

  • Clean Technology Investment Program: $800 million in grants will be provided to manufacturers.
  • Clean Technology Food and Foundries Program: over six years up to $50 million in assistance will be provided to the metal forging and foundry industries.
  • Clean Technology Innovation Program: $200 million over five years for development in renewable energy, low-emissions technologies and energy efficiency.

Notwithstanding the assistance schemes being implemented by the government some increased costs are likely to still be incurred by the industry.

The consideration of which party is liable for these rising costs under the construction contract will now be an issue for parties to existing contracts and those entering into construction contracts in the future.

Energy efficiency trading scheme

The policy announcement made on 10 July 2011 included the development of a national energy savings initiative, a market-based tool for driving economy-wide improvements in energy efficiency.

The federal government will “immediately establish a working group” to seek agreement on the replacement of existing state mandatory energy savings schemes (such as exist in NSW, Victoria and South Australia) and to report in the first quarter of 2012.

The development of such a scheme is consistent with the findings of the Prime Minister’s Task Group on Energy Efficiency, which reported to the government in late 2010.

The development of a national energy savings initiative is unlikely to have a significant impact on building processes, however more broadly it is likely to impact on the environmental and efficiency standards that construction customers demand.

Contracts

Following the announcement of the mechanism it is essential to conduct a review of existing contracts to determine what liabilities may be incurred and whether any contractual rights or obligations, concerning the pass through of costs, have arisen.

A similar review should also be undertaken with respect to any contracts that are currently being finalised or tendered for. Key issues to be aware of in the contractual pass-through of carbon cost include:

  • The scope of the triggering event, whether defined as a “change of law”, “change of tax” or as a specific “carbon cost pass-through” clause.
  • The scope of the costs that may be passed through: whether indirect costs may be passed through as well as direct costs;.
  • The mechanisms for transparency in disclosure of how carbon costs are to be calculated; and
  • The procedures for the cheap and efficient resolution of disputes.

For construction contracts that will be in operation after 1 July 2012, it is necessary to consider whether the principal or contractor will be liable for cost increases passed through from suppliers, as well as for direct carbon cost increases (which will rest with the party that has “operational control” over the relevant facility).

Contract structure

There is a range of contractual structures generally used in the construction industry, and the type of contract entered into will impact upon any cost liabilities arising from the mechanism.

In particular, whether the contract is cost plus, lump sum, schedule of rates or a mixture, will go some way to determining whether the contract sum may be increased as a result of the mechanism.

For example, under a cost plus contract the contractor will be entitled to be paid for costs incurred, as well as an additional amount (usually a percentage or commission).

The risk therefore of any increase in the cost of construction materials is borne by the principal (subject to any guaranteed maximum price mechanism).

By way of contrast where the contract price is a fixed sum contractors are less likely to be able to pass on increases in the costs of construction materials, unless that fixed sum is subject to a valid carbon cost pass through arrangement.

Similarly, where a schedule of rates or bill of quantities is used the costs incurred by a contractor are also usually in effect ‘fixed’ and the contractor will most likely remain responsible for any increase in the cost of construction materials.

It is important to note that under contracts for domestic building works, cost escalation is only permitted in limited circumstances and in most instances contractors will be unable to pass on increased costs as a result of the mechanism.

Specific contractual entitlements

Where a specific clause allocates liability for increases in the cost of materials flowing from a carbon tax, liability will be allocated according to the terms of the specific clause.

However, with the exception of recent major projects, most contracts already on foot in the construction industry are unlikely to specifically allocate the risks associated with the mechanism.

Although most contracts will specifically address the rights and obligations of the parties where there is a change in law, whether the provision adequately deals with the introduction of the mechanism will depend on the drafting.

It is not unusual for these clauses, even where they do provide an entitlement to claim costs, to require that extra works actually has to have been carried out (so cost increases alone may not be claimable).

Parties need to careful check their existing contracts (and in-house standard forms) to see whether or not an entitlement arises and importantly whether any time limits are required to be complied with in order to access such entitlements.

Importantly change in law clauses will ordinarily require that for a claim to exist the change must be unforeseeable.  Clearly, since the federal government’s announcement, this will be difficult to argue.

Accordingly, going forward contractors will need to ensure that any increased costs are either expressly dealt with or a contingency included within the agreed price.

Of course a general “rise and fall” clause may also provide an entitlement subject to its terms.  However, increasingly such clauses are not being included on standard construction projects unless in response to some specific and foreseen price risk.

Next steps

The costs impact of the mechanism will be widespread across the economy and will need to be accounted for by the construction industry. In particular, participants in the construction industry should consider:

  • Risk allocation under both supplier and purchaser side contract arrangements for contracts currently under consideration, including consideration of the scope and triggers for the pass-through of costs.
  • With respect to current contracts, whether any contractual obligations have arisen, what liabilities may be incurred and whether there are any entitlements that can be exercised.
  • Their existing contracting policies to ensure that in going forward, this risk is either priced or otherwise expressly provided for.
  • Assessment of the direct carbon liabilities that may be incurred, in particular through the use of transport and other liquid fuels.
  • The impacts of the mechanism and its complementary measures on the broader strategic focus of the construction industry.

This includes its affect on the prices of certain materials, the types of technologies being used in the construction process and the demands of customers operating in a regulatory environment that places an impost on the emission of carbon and other greenhouse gases.

James Morgan-Payler and Lucy Watts are partner and associate respectively with the international  legal practice, Norton Rose.