The Fiscal Impact of the California Global Warming Solutions Act of 2006 on California’s Fruit and Vegetable Processors July 2012 Andrew Chang & Company, LLC 1301 H Street Sacramento CA 95814 916-538-6091 0 About the Report Sponsors: The California Manufacturers & Technology Association works to improve and enhance a strong business climate for California's 30,000 manufacturing, processing and technology based companies. Since 1918, CMTA has worked with state government to develop balanced laws, effective regulations and sound public policies to stimulate economic growth and create new jobs while safeguarding the state's environmental resources. CMTA represents 600 businesses from the entire manufacturing community – an economic sector that generates more than $200 billion every year and employs more than 1.2 million Californians. About Andrew Chang & Company, LLC: The professionals at Andrew Chang & Company work with our clients to achieve tangible results by combining our best-in-class research and analyses with unique insights into public policy and business and government strategy and operations. Using advanced economic, statistical and business administration techniques, we provide strategy and operations consulting to Fortune 1000 firms and provide policy, economic, fiscal and operations consulting for public sector agencies and non-profit organizations to improve operations. 1 The Fiscal Impact of the California Global Warming Solutions Act of 2006 on California’s Fruit and Vegetable Processors (Table of Contents) Section Page Key Findings 3 1. Introduction 4 2. AB 32’s Impact on California’s Fruit and Vegetable Processors 5 3. Case Study: Pacific Coast Producers 12 4. Conclusion 20 Appendix A: Electricity Usage 21 Appendix B: Bibliography 22 2 The Fiscal Impact of the California Global Warming Solutions Act of 2006 on California’s Fruit and Vegetable Processors (Key Findings) California’s fruit and vegetable processing industry will incur increased costs amounting to $151.4 million cumulatively by 2020 and $34.5 million annually as a result of increased electricity costs associated with the California Air Resources Board’s AB 32 program. These burdens on California’s fruit and vegetable processing industry will result in an additional $1.0 billion in lost GSP by 2020 and destroy 2,000 jobs. In addition, working California families will lose approximately $76.6 million in earnings by 2020 as a result of ARB’s AB 32 program. Pacific Coast Producers, a grower-owner cooperative that processes apricots, peaches, pears, grapes, and tomatoes in the northern Central Valley, will incur $5.9 million in cumulative costs and $1.4 million in annual costs by 2020 as a result of ARB’s AB 32 program. These costs will affect Pacific Coast Producers’ ability to spend on capital projects to increase the efficiency of their production lines and increase the cost to their business at a time when China and other foreign producers emerge as global competitors in tomato production. The costs to this industry will ultimately be borne by consumers in increased food prices and decreased economic benefit to their communities. 3 1. Introduction “The Fiscal and Economic Impact of the California Global Warming Solutions Act of 2006 on California’s Fruit and Vegetable Processors,” by Andrew Chang & Company, LLC is a white paper in a series detailing the precise impacts from the earlier “The Fiscal and Economic Impact of the California Global Warming Solutions Act of 2006” study of the total fiscal and economic impacts of AB 32 as it has been specified by the California Air Resources Board. In an effort to highlight the impacts to private companies, this report details the fiscal impact and economic repercussions that will occur under the law for California’s fruit and vegetable processing industry from increased electricity costs as well as the cost of Cap and Trade. The report found that the cumulative GSP loss between 2012 and 2020 will be $85 to $245 billion between the Low and High Case. In the Optimistic Case, the total impacts to California consumers and the economy in the year 2020 are significant: Direct cost to California consumers is $35.3 billion Net effect on Gross State Product (GSP) is a 5.6 percent loss with 262,000 jobs lost $7.4 billion in lost state and local revenue $12.3 billion in lost statewide earnings Average family costs of over $2,500 a year, in addition to over $900 in lost annual family earnings This report details the impacts these policies will have on a specific private industry. This includes the impact of increased electricity costs and lost economic output, earnings, and employment from decreased economic activity. We also illustrate the impact to a specific company, Pacific Coast Producers (PCP), on its canning and processing operations for peaches, pears, apricots, grapes, and tomatoes in the northern Central Valley. 4 2. AB 32’s Impact on California’s Fruit and Vegetable Processors AB 32 will increase the cost of electricity for all consumers including private enterprise, and some of those private industries will face costs associated with Cap and Trade credits and offsets. Moreover, the economic slowdown caused by AB 32 will adversely affect the state economy and cause a decrease in economic output and state employment. For this study, we examined the impact to the fruit and vegetable processing industry in the state. Agriculture is an integral part of the California economy and its history – indeed, California is the largest agricultural state in the union, growing over 400 crops. California is the world's fifth largest supplier of food and agriculture commodities. One of the key components of that industry is the fruit and vegetable processing sector, providing grapes, lettuce, strawberries, tomatoes, pears, oranges, broccoli, garlic, carrots, apricots, lemons, avocados, olives, peaches, and a host of other fruit and vegetable products to the rest of the United States and foreign countries. In particular, California processes one-third of the world’s supply of tomato products, nearly all of the country's canned peaches and frozen peaches. All told, the food processing industry generally accounts for more than 3 percent of the entire Gross State Product, and the fruit and vegetable processing sector specifically ships out $13.1 billion in product annually. A significant percentage of that money comes directly to California from outside the state and funnels economic benefit and tax revenue into the communities that produce these products. However, the food processing industry as a whole has been doing more with less. Gross product has been increasing for last decade while total employment in the industry has been declining. Since the 1970s, processed fruit and vegetable consumption among American families has decreased by almost 3 percent despite overall fruit and vegetable consumption increases over the same period. The industry tends to fare well during times of economic slowdown as people rely on their goods compared to additional costs of fresh fruit and restaurant dining, but the cost impact of AB 32 will make domestic processors more costly 5 compared to their overseas competition. Due to these factors, in addition to increased competition in the foreign market, several analytical reports expect a gradual but persistent decline in revenue and profit. The direct AB 32 costs will come primarily from increased electricity costs and the cost of credits and offsets under Cap and Trade. The cumulative fiscal impact to fruit and vegetable processing from 2012 to 2020 will be $151.4 million. The increased electricity costs and costs from Cap and Trade will significantly increase costs for processors, as shown in Figure 2.1. Figure 2.1 Cumulative Costs for Fruit and Vegetable Processors SOURCE: U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011; U.S. Department of Energy, "Table 5.1. End Uses of Fuel Consumption," 2006 Manufacturing Energy Consumption Survey, February 2010; California Air Resources Board, "Mandatory GHG Reporting Data Emissions Reported for Calendar Year 2010," March 12, 2012; Main Report, Appendix D, I It is important to note that AB 32 programs choose industries that are winners and losers, and the money that is being extracted from these companies has no guarantee of being recycled into the industries that have been most harmed. The costs of the law could have much greater impacts than even analyzed here. Costs such as implementation of the law, hiring 6 outside contractors to process Cap and Trade credit and offset sales, and other administrative burdens are not shown here, but could easily double the annual costs to industry. In Figure 2.2, we describe the annual additional electricity costs for processors they will have to bear under AB 32. In 2020, the additional cost increases to $18.2 million across the industry. The impact of the increased cumulative electricity cost of $84.4 million will amount to approximately 56 percent of the increased costs over the implementation period. The annual cost in 2020 is also the equivalent of more than 420 average employees across the industry, a 1.4 percent reduction in the industry’s total statewide workforce. Figure 2.2 Annual Additional Electricity Costs for Fruit and Vegetable Processors SOURCE: U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011; U.S. Department of Energy, "Table 5.1. End Uses of Fuel Consumption," 2006 Manufacturing Energy Consumption Survey, February 2010; Main Report, Appendix D As an industry that faces capped carbon emissions, certain fruit and vegetable processing facilities will need to purchase credits and offsets to meet state Cap and Trade standards. The impact of these costs, as described in Figure 2.3, amount to $16.3 million annually in 2020 and $67.1 million cumulatively over the implementation period. The cumulative impact represents the other 44 percent of increased costs, and the annual impact in 2020 is the equivalent of a 7 reduction in the industry’s workforce of 385 average employees, or nearly 1 percent of the state workforce. When considering the cumulative costs of both impacts, the potential decrease in employment would reach 3,500 jobs impacted, or more than 11 percent of the industry’s workforce. Figure 2.3 Annual Cap and Trade Costs for Fruit and Vegetable Processors SOURCE: California Air Resources Board, "Mandatory GHG Reporting Data Emissions Reported for Calendar Year 2010," March 12, 2012; Main Report, Appendix I Economic impacts will follow as well. The total lost Gross State Product from impacts to the fruit and vegetable processing industry will reach $1.0 billion by 2020, a greater amount than the annual gross product of California’s textile industry. That $1.0 billion impact to gross product is also greater than the annual gross product of all food-related manufacturing in the San Diego, Santa Barbara, and Redding metropolitan areas. This economic loss is important because it will hit cities that are already high in unemployment and low revenues. Cities in California’s Central Valley will face a significant burden and bear a disproportionate impact of these economic losses. 8 Figure 2.4 Lost California GSP from Industry Impacts SOURCE: U.S. Department of Commerce, "Gross Output by Industry," Bureau of Economic Analysis, December 13, 2011; U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011; Main Report, Appendix C Employment across the state will also decrease as a result of increased costs to the industry. Employment across the state will decrease by 2,000 jobs in 2020, or would be the equivalent of doubling the decline in fruit and vegetable processing employment from 2009 to 2011 in the state. These are not just job losses related to production and processing, but of support industries such as skilled labor for maintenance and food and other service industries in the area of each facility. 9 Figure 2.5 Lost California Employment from Industry Impacts SOURCE: U.S. Department of Commerce, "Gross Output by Industry," Bureau of Economic Analysis, December 13, 2011; U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011; Main Report, Appendix C The lost earnings impact will reach $76.6 million for all Californians in the year 2020. This impact will fall across an estimated 14.1 million households in 2020 and is the equivalent salaries of 1,800 average employees in the fruit and vegetable sector – or 5.7 percent of the total sector’s employment. 10 Figure 2.6 Lost California Earnings from Industry Impacts SOURCE: U.S. Department of Commerce, "Gross Output by Industry," Bureau of Economic Analysis, December 13, 2011; U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011; Main Report, Appendix C 11 CASE STUDY: The Impact of AB 32 on Pacific Coast Producers The impacts to the fruit and vegetable processing industry are going to be significant, as the previous figures highlight. However, the impacts are going to be pronounced on individual companies in the industry and will dramatically affect the way they are able to operate. The Pacific Coast Producers (PCP) cooperative, which was formed in 1971 and been in constant operation for more than 40 years, provides canned peaches, pears, apricots, grapes, and tomatoes to customers across North America. The company employs 3,500 individuals during growing seasons for their products, with 700 year-round employees working full-time in the off-season, and with unionized employees having been with the company for an average of 12.5 years. Operates six locations in the northern Central Valley (Lodi (3), Oroville, Woodland and Palermo). The company is actively involved in the communities they operate in, sponsoring local charities, sitting on the boards of hospital associations and Salvation Army, and being active in local events and sports leagues. The company is one of the largest private employers in Butte County and hires locally, especially helpful considering their facilities are often located in areas of high unemployment. Like most of its companions in the industry, the people of Pacific Coast Producers strive to be good neighbors and good citizens. The nature of their production is seasonal. In the case of tomatoes, the time from field to can is typically less than 6 hours. Unlike traditional heavy and light industry manufacturing, products cannot be stockpiled or otherwise stored for production at a future period where electricity pricing may be more affordable or production conditions may be more favorable. During the harvest season, out of necessity facilities operate 24 hours a day, 7 days a week with three full shifts. And unlike other manufacturing, if the raw product is not used because of decreased production, it typically rots in a field and is wasted or not grown at all. 12 The additional costs for Pacific Coast Producers will come primarily from Cap and Trade costs associated with their Woodland tomato facility, although all facilities will experience increases in fuel and electricity costs. The facility, which provides canned peeled tomatoes pureed and concentrated products of all types and tomato paste, operates above the threshold CO2e limit set by the California Air Resources Board. As seen in Figure 2.7, our Optimistic Case determines that the total impact from the cost of credits and offsets will reach $1.2 million annually in 2020. Along with $0.1 million in annual increases in the cost of electricity and some costs associated with an increase in transportation fuel prices, Pacific Coast Producers will pay $1.4 million in additional costs in 2020 without any additional benefit or production to show for the cost. Figure 2.7 2020 Additional Costs for Pacific Coast Producers SOURCE: Pacific Coast Producers, Electricity and Transportation Fuel information, accessed July 2012; California Air Resources Board, "Mandatory GHG Reporting Data Emissions Reported for Calendar Year 2010," March 12, 2012; Main Report, Appendix I When examining the cumulative impacts to the company between 2012 and 2020, the numbers become even more staggering. By 2020, the company will have spent $5.9 million on Cap and Trade, electricity, and transportation fuel costs combined. That figure represents real 13 money that could be spent on improving their business. In addition, the uncertainty and complexity surrounding the Cap and Trade process can prove incredibly costly for companies that are not large corporations or financial institutions. Pacific Coast Producers is unsure about participating in the November 2012 credit auction because of uncertainty surrounding the program, and unsure if they should use a consultant for purchasing and accounting for credits and offsets. Mona Shulman, vice president General Counsel with the company, has concerns about competing with large financial institutions or other large entities on the credit market. Figure 2.8 Cumulative Costs for Pacific Coast Producers SOURCE: Pacific Coast Producers, Electricity and Transportation Fuel information, accessed July 2012; California Air Resources Board, "Mandatory GHG Reporting Data Emissions Reported for Calendar Year 2010," March 12, 2012; Main Report, Appendix I 14 Part of the reason the additional costs could be so frustrating is that the company has taken it upon itself to operate in a highly efficient manner. And these costs do not take into account the spending the company would have to undertake to increase mandatory efficiency levels. Using research and consultants, the company regularly works in the offseason to improve the efficiency of its natural gas-fired boilers and recover as much energy as possible. For companies like these, efficiency is not just good for the environment, it is also good business. Money saved on energy keeps costs and prices low, helping PCP compete in a global market. As seen in Figure 2.9, the company uses computer automation as much as possible to monitor boiler operations and interface with modern systems that allow even greater efficiency in their operations than was even possible a decade ago – systems that can adjust water recovery temperatures on the fly and increase or decrease boiler output so that no energy is wasted. They have decreased the amount of steel used for their cans because it keeps costs down, and they have reduced their water use by 50 percent in the last decade. As succinctly put by Dan Sroufe, vice president of operations, “if you’re not progressive at lowering costs, you’re not going to stay in business.” Show me where else in the world an industry can make such a huge, vital contribution to the health of the world with less environmental impact. Essentially, what affects food processors, affects agriculture. The cost impact of the Cap and Trade on food processors threatens that relation, that productivity. Pacific Coast Producers is right to be worried.” John Larrea, director of government affairs California League of Food Processors, 15 Figure 2.9 Modern Boiler Control Panels SOURCE: Andrew Chang & Company, courtesy of Pacific Coast Producers Since the company sells roughly 90 percent of their products outside the state, Pacific Coast Producers bring money directly into the California economy. They use energy to evaporate water from tomatoes to make tomato paste, thus reducing shipping costs and the emissions associated with it by decreasing the total amount of loads required to move the product by up to 80 percent. Pacific Coast Producers understands that, ultimately, the consumer will choose the best alternative tomato product supplier by price or choose a cheaper fruit or snack product. The $5.9 million in cumulative costs will have to be passed along somewhere, and they worry that the consumer will be unwilling or unable to absorb those additional costs. Since growers and processors are so closely linked, the impact on the processing industry will naturally also impact the growers. According to John Larrea, the director of government affairs with the California League of Food Processors, the huge success of California agriculture is due to the cooperation between growers and processors. He states: “The relationship between California’s agriculture and food processing industries is symbiotic. Together our industries are one of the most efficient and productive enterprises in the world. California agriculture and food processing produce enough nutritious fruit, vegetables, olives, nuts, poultry, meat, dairy, cheese and other products 16 to feed not only California, but the nation, as well as a significant portion of the world – both safely and at a reasonable cost. When one measures the size of our combined production and the efficiency of our operations here in California, the total of our production produces only about 1.7 million tons of CO2 annually. That’s less than ½ of one percent of the total emissions produced by all industry in California. Show me where else in the world an industry can make such a huge, vital contribution to the health of the world with less environmental impact. Essentially, what affects food processors, affects agriculture. The cost impact of the Cap and Trade on food processors threatens that relation, that productivity. Pacific Coast Producers is right to be worried.” The rise of the Chinese agriculture and food production also worries Pacific Coast Producers. China has begun making significant inroads into tomato canning and processing, an area that has been led by California for decades. Leakage of business and equipment overseas is a very real concern. Speaking about the need to upgrade or purchase new equipment, Shulman said, “Our overseas competitors would be more than happy to take our discarded equipment.” The company has done a great deal to increase their efficiency. PCP has also undertaken upgrades to equipment that are not required out of a desire to be a better steward to their communities and the environment. For years, a small boiler, pictured in Figure 2.10, operated without the need for environmental review because of its size. Despite the fact that undertaking a capital project to upgrade it would bring it under environmental review by the local air board and cost a fair amount of money, PCP implemented the project because “it was the right thing to do.” 17 Figure 2.10 Voluntarily Upgraded Small Boiler SOURCE: Andrew Chang & Company, courtesy of Pacific Coast Producers Capital and time willing, there are a host of other efficiency projects that the company plans on undertaking. The customers of Pacific Coast Producers, too, are requesting that the company increase its “green” footprint. Unfortunately, the off-season is typically the only time that significant improvements can be made to equipment. The capital costs associated with those improvements can be significant, and the limits on capital only allow for a few projects a year. Some efficiency systems can run upwards of $900,000, which it should be noted is less than the total fiscal impact from AB 32 to the company in 2020 alone. The company does make those investments regularly, and the results are evident. As seen in Figure 2.11, they upgraded one of their Woodland facility’s large gas boilers to reduce carbon emissions, heat loss, and reduce nitric oxide and nitrogen dioxide emissions. The upgrade also included an electronic panel that links in with their central computer system, allowing easier regulation of temperature, water flow, and pressure. When purchasing upgraded equipment and 18 boiler parts, they try to purchase from within California as much as possible. The company has also implemented the latest technology in lighting, electrical distribution, equipment, process equipment automation, water and fuel conservation, and waste mitigation. There are, however, no new technologies available to significantly reduce carbon emissions further. Figure 2.11 High-Efficiency Large Boiler SOURCE: Andrew Chang & Company, courtesy of Pacific Coast Producers Pacific Coast Producers is the model of a company that is doing everything that should be expected of them: producing safe food products that provide economic and employment benefit to their communities and California, while undertaking efforts to better the environment, improve efficiency, and provide the most affordable cost to the consumer. But even with their improvements and efficiencies, the company still stands to lose millions of dollars that would be better served going towards projects that would make them a stronger company. 19 3. Conclusion The increased cost of electricity coupled with the costs from Cap and Trade upon fully implementing AB 32 will create a $151.4 million cumulative impact to the fruit and vegetable processing industry over the length of the implementation period, with a $34.5 million impact in the year 2020. The state will also bear additional economic impacts from these costs. California will face $1.0 billion in lost GSP by 2020, as well as approximately 2,000 jobs through the same period. In addition, California earnings will decrease by approximately $76.6 million by 2020. Pacific Coast Producers, a company that processes apricots, peaches, pears, grapes, and tomatoes, is an example of how these impacts would drive down efficiency growth and affect the lives of working men and women. The conservative $5.9 million cumulative cost will affect their ability to spend on capital projects to increase the efficiency of their production lines and increase the cost to their business at a time when China and other nations are beginning to emerge as global competitors for one of the cornerstones of their business: tomato processing. These costs will ultimately be borne by consumers or the company and its growers if production is slowed, and the uncertainty with implementation of the Cap and Trade program could even further increase the cost of doing business. AB 32 chooses industries that are winners and losers, and the money that is being extracted from these companies has no guarantee of being recycled into the industries that have been most affected. The costs of the law could have much greater impacts than even analyzed here. 20 Appendix A: Electricity Usage 2012 2013 2014 2015 2016 2017 2018 2019 2020 Additional Electricity Cost per GWh1 (Real $) $1,121.2 $2,509.0 $2,300.2 $4,093.2 $4,847.7 $6,117.7 $7,819.1 $9,006.8 $11,313.8 Food and Vegetable Processing Usage2 (in GWh) 1970.9 1921.6 1873.5 1826.7 1781.0 1736.5 1693.1 1650.8 1609.5 1 See Main Report, Appendix D U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011; U.S. Department of Energy, "Table 5.1. End Uses of Fuel Consumption," 2006 Manufacturing Energy Consumption Survey, February 2010 2 21 Appendix B: Bibliography California Air Resources Board, "Mandatory GHG Reporting Data Emissions Reported for Calendar Year 2010," March 12, 2012 Cook, Roberta, "Tracking Demographics and U.S. Fruit and Vegetable Consumption Patterns," Department of Agricultural and Resource Economics, University of California, Davis, October 2011 IBISWorld Market Research, "Canned Fruit and Vegetable Processing in the US Industry Market Research," March 27, 2012 U.S. Census Bureau, "2010 Annual Survey of Manufactures," November 15, 2011 U.S. Department of Commerce, "Gross Domestic Product by State," Bureau of Economic Analysis, June 5, 2012 U.S. Department of Commerce, "Gross Output by Industry," Bureau of Economic Analysis, December 13, 2011 U.S. Department of Energy, "Table 5.1. End Uses of Fuel Consumption," 2006 Manufacturing Energy Consumption Survey, February 2010 U.S. Department of Labor, "Quarterly Census of Employment and Wages: California," Bureau of Labor Statistics, accessed July 2012 22