The Australian Federal Government’s Climate Change Bill, which incorporates Australia’s new emissions reduction targets of 43% below 2005 levels by 2030 and net zero emissions by 2050, is well on the way to becoming law. The Government is now reviewing existing federal climate regulations and policies to ensure they are geared towards achieving those targets, including the Safeguard Mechanism.
This article summarises the key issues to assist stakeholders to make submissions on the Safeguard Mechanism Reforms: Consultation Paper (Paper) within the tight timeframe that has been set.
Submissions are due by Tuesday 20 September 2022.
Why is reform proposed?
In its current form, the Safeguard Mechanism has not, and will not, result in reduction of emissions from the large emitting facilities that are subject to it. Safeguard Mechanism facilities comprise around 28% of Australia’s total emissions in 2020-21.
Two reasons are identified by the Australian Government in the Paper for why it is proposing reforms to the Safeguard Mechanism:
- To ensure covered facilities make a proportionate contribution to Australia’s new climate targets of achieving a reduction of national emissions to 43% below 2005 levels by 2030 and net zero emissions by 2050.
- To mitigate the risk of harming Australia’s competitiveness in international trade as a result of carbon leakage and decarbonisation regulation and policies of other jurisdictions (e.g. the European Union’s Carbon Border Adjustment Mechanism).
The Australian Government is looking to achieve those objectives in a manner that is effective, equitable, efficient and simple.
What reforms are proposed for the Safeguard Mechanism?
Overview
No change is proposed to the coverage of the Safeguard Mechanism, being facilities emitting 100,000 tonnes of “covered” CO2-e emissions per year. The reform is about how the Safeguard Mechanism can better deliver emissions reductions.
Four main areas are proposed for reform:
- Contribution of Safeguard Mechanism facilities to Australia’s climate change targets
- Development, implementation and administration of baselines for Safeguard Mechanism facilities
- Emissions trading and carbon credits
- Treatment of “hard to abate” facilities that have trade exposure
Contribution to Australia’s climate change targets
The Paper observes that to contribute a “proportionate share” of the national emissions target set for 2030, aggregate baselines must fall from 315 million tonnes of CO2-e in 2020-21 to 99 million tonnes of CO2-e by 2030. The key issue is what “proportionate share” means as between Safeguard Mechanism facilities and non-Safeguard Mechanism facilities, and whether all Safeguard Mechanism facilities are treated the same to achieve the reduction objectives. This is an opportunity for industry to contribute ideas for how it can be done in a manner that is effective, equitable, efficient and simple.
The Paper seeks comments on what “share” Safeguard Mechanism facilities should contribute towards Australia’s 2030 climate target. It notes that “proportionate share” is not the only option and seeks input from facility operators on alternatives.
Treating all Safeguard Mechanism facilities ‘as one’ and requiring equal contributions to reduction risks an ineffective and inequitable outcome. It may be more effective to take into account factors relevant to each facility, or sector, to achieve a better overall contribution to national emission reductions, for example, by calculating the contributions of facility operators to those reductions in a manner that is proportionate to the share of the 28% they contribute to the Safeguard Mechanism’s total emissions.
Different facilities have different opportunities and challenges to abatement. For some facilities, the abatement task may be delivered through improvements in energy efficiency and technology that are cost effective. However, for others, it will be important to have flexible options (e.g. through purchase of carbon credits).
Baselines
Fixed (absolute) vs production-adjusted (intensity) baselines
The Paper calls for comment on whether the existing production-adjusted baseline setting framework or previous fixed baseline approach is more effective.
In 2020, the King Review into additional sources of low cost abatement noted that the ‘essential design challenge [for baselines] is to strike a balance between measuring and crediting only genuine abatement while still encouraging commercial participation’ and that ‘setting baselines on an emissions intensity basis accommodates businesses increasing their production … encourages businesses to invest in their facilities, and new technology’. That finding was supported by the previous Government.
The Paper does not appear to marshal many arguments in favour of a return to fixed (absolute) baselines, citing only that they provide a simpler way of meeting climate outcomes. That being so, we anticipate that it is unlikely that the Australian Government will be minded to return to fixed (absolute) baselines in the absence of compelling reasons to do so. However, the current consultation on Safeguard Mechanism reform offers participants an opportunity to put forward arguments as to why a return to fixed (absolute) baselines may have merit for reasons that are additional to its simplicity in application.
The need to remove ‘headroom’ from baselines
Legacy issues mean the aggregate of Safeguard Mechanism facility baselines sits well above emissions. In 2020-21, aggregate baselines were 180 Mt CO2-e compared with covered emissions of 137 Mt CO2-e, resulting in a “headroom” gap of 43 Mt CO2-e. The Paper notes that the distribution of headroom across Safeguard Mechanism facilities is uneven, with two consequences if “headroom” is maintained: (1) all Safeguard Mechanism facilities have an artificially high baseline decline rate, which may be inequitable for facilities without “headroom”; and (2) it will delay the commencement of crediting and trading until around 2026-27 (by which time, aggregate baselines would be below aggregate emissions, causing market scarcity).
The Paper notes the consequences of “headroom” may be managed by calibrated or uniform scaling of baselines to remove headroom in the first year. However, that is not the only option put forward. Industry participants have the opportunity to put forward their views on the most equitable and effective approach to managing “headroom”.
Setting baselines for new entrants
The Paper identifies two options for new entrant baselines: (1) best practice (calculated as the average emissions intensity of the top 10% of Australian industry performance); or (2) industry average (consistent with the current framework for existing facilities from 1 July 2021).
The best practice approach recognises that new facilities have the opportunity to utilise the latest advances in technology and incorporate best practice into design. It is more suited to using site-specific emissions-intensity values for existing facilities. By contrast, the industry average approach is simpler. It assists in avoiding market imbalance between greenfield vs brownfield facilities if benchmark (industry average) emissions-intensity values are adopted for existing facilities.
The Paper does not suggest site-specific emissions intensity values for new participants (as distinct from best practice average emissions intensity values), observing that there would be “a number of challenges”, for example, it “could create incentives to design facilities with higher emissions-intensities and then reduce those emissions and benefit under the mechanism”.
Whether site-specific emissions intensity values would create such “incentives” or not may be tied, to some extent, to the effectiveness of State / Territory regulations in avoiding the authorisation of facilities designed with higher emissions-intensities than the emissions-intensities for that facility can reasonably and feasibly be. In some case, it may be possible for the environmental approvals process for a new facility under State / Territory law to be applied in a manner that requires the facility’s emissions-intensities to reduce / mitigate emissions to the greatest extent reasonable and feasible. In such a circumstance, the possibility of using site-specific emissions intensity values to create “incentives” of the type described in the Paper may be more theoretical than real. Having said that, one potential benefit of not using site-specific emissions intensity values for new participants may be a greater consistency and simplicity in setting baselines for new facilities.
In any event, site-specific emissions intensity values should not necessarily be discounted for new entrants without further detailed consideration and evaluation of use of such values against other options for setting baselines for new facilities. Operators of new facilities may wish to further consider the potential benefits of that approach in informing a submission on the Safeguard Mechanism reforms.
New technologies
The Paper suggests that advances in and the availability of new technologies may be potentially addressed through extending multi-year monitoring periods. This could benefit facilities with limited near-term abatement opportunities to manage their own abatement path. Any risk, in terms of ensuring emission reductions are delivered, could be managed through appropriate safeguards (e.g. use of carbon credits or offsets).
Indicative baseline decline rates
The Paper acknowledges that understanding baseline decline rates will assist businesses to assess “the costs and impacts of Safeguard Mechanism reforms” and that “indicative decline rates are expected to be between 3.5 to 6% each year”. This range in indicative decline rates reflects design options and other factors, including whether there is any change to the existing production-adjusted baseline setting framework and the treatment of emissions-intensive, trade-exposed (EITE) activities. The Paper also foreshadows the option of aligning decline rates with the process for update of Australia’s Nationally Determined Contribution (NDC) under the Paris Agreement, which may simplify the process for reporting on Safeguard Mechanism facilities contributions to emissions reductions as part of Australia’s NDC reporting.
Emissions trading and carbon credits
Safeguard Mechanism Credits
The King Review looked at ways to ‘unlock’ emissions abatement opportunities from Safeguard Mechanism facilities that are not being realised under the Safeguard Mechanism or the ERF, including a new baseline crediting arrangement in addition to surrendering ACCUs as an alternative to reducing on-site emissions. The Paper identifies Safeguard Mechanism Credits (SMCs) as an option to allow facilities with low-cost abatement to sell credits to facilities whose abatement options are more costly or limited.
SMCS would not be carbon “offsets” because they are generated within a regulated emissions limit and could not be used outside the Safeguard Mechanism. The purpose of SMCs is to introduce further flexibility for Safeguard Mechanism facilities to meet their compliance obligations through trading.
One interesting aspect of the SMCs proposal relates to inter-temporal flexibility in allowing facilities to (within reason) manage the timing for their abatement activities without jeopardising environmental outcomes, particularly if implementation of energy efficiency and abatement technology is “lumpy”. The Paper puts forward two main options for managing inter-temporal flexibility: (1) banking of SMCs (where SMCs created in the current year can be used for compliance in future years); and (2) borrowing of SMCs (where a facility’s liability is reduced in a particular year, but then increased by a corresponding amount in a future year). One benefit may be the creation of further flexibility in the manner compliance is achieved. However, to make such an approach work, certain details will need to be managed, such as default by a facility operator (e.g. by requiring the purchase of credits or offsets in an event of baseline exceedance) and safeguards to ensure such arrangements do not jeopardise achievement of the facility’s proportionate contribution to Australia’s 2030 emissions reduction target.
ACCUs and Eligible Offsets Projects under the ERF
The Paper acknowledges that there are strong reasons to retain flexibility in allowing Safeguard Mechanism facilities to use ACCUs to meet compliance obligations. However, it identifies that there would be double-counting where Safeguard Mechanism facilities were able to continue registering ERF projects and generating ACCUs from those projects that reduce their direct emissions (in the sense that the declining baseline framework means that the reductions might no longer be considered additional, in that they are required by the new regulatory constraints / restrictions). The Paper proposes to address this by adding the volume of ACCUs generated by a facility in a given year onto the facility’s net emissions number. It also proposes that no new ERF projects would be registered at existing facilities moving forward.
One important aspect of the ACCUs reform for Safeguard Mechanism facilities is the treatment of “deemed surrender” provisions in ERF contracts for Safeguard facilities. Deemed surrender provisions mean that, if a Safeguard Mechanism facility creates ACCUs from an ERF project and sells them back to the Government under contract, the volume of ACCUs sold will be subtracted from the facility’s net emissions number. The Paper calls for comment on whether these should be retained. Two options are put forward: (1) removing the deemed surrender provisions for existing ERF contracts held by safeguard facilities / facilities that become covered by the Safeguard Mechanism; or (2) continuing existing deemed surrender arrangements for facilities with an ERF contract for the duration of their existing contract via grandfathering provisions.
The immediate removal of deemed surrender provisions in ERF contracts, without appropriate grandfathering provisions, may operate in an inequitable way for existing Safeguard Mechanism facilities. This may particularly be the case where the relevant carbon abatement contracts have significant volumes of ACCUs yet to be delivered and the facility operator has taken the deemed surrender provisions into account in managing its compliance under the Safeguard Mechanism in immediate future reporting years. It would be prudent for such operators to carefully consider the provisions of their contracts with the Australian Government to assess the potential impacts of the reforms on them, especially where no grandfathering provisions are introduced.
International offsets
The Australian Government has signalled that “international offsets are not proposed to be part of the initial enhanced Safeguard Mechanism”. Some consideration needs to be given to this to ensure the policy setting is right as markets develop.
Treatment of “hard to abate” facilities that have trade exposure
The Paper acknowledges the need for concessional treatment of EITEs and reflects on the many international emissions reduction schemes that include support or concessions for facilities producing EITE products such as steel. Tailored treatment of EITEs is important for ensuring that Australian businesses are not competitively disadvantaged relative to international competitors and that there is limited ‘carbon leakage’. The Paper considers that EITE facilities could be determined by emissions intensity at the industry level or at the facility level.
A facility-specific approach to setting baselines would have the benefit of enabling issues relating to EITEs industries to be considered and tested objectively. However, that makes the compliance and reporting regime created by the Safeguard Mechanism more complicated to administer. Without doubt, the treatment of EITEs as part of the reformed Safeguard Mechanism is a particularly complex issue. EITE facilities should consider making submissions on the practical challenges they face.
Conclusion
This is the most significant opportunity since the Safeguard Mechanism commenced for stakeholders to raise ideas on how it should operate to effectively encourage emission reductions that contribute to Australia’s targets.
The deadline for submissions is Tuesday 20 September 2022.
