Australia’s Emissions Safeguard Mechanism gets teeth

Following consultation completed on the various options to reform the Safeguard Mechanism in the second half of 2022, the Commonwealth Government has now released proposed changes to Australia’s emissions “Safeguard Mechanism” based on its preferred policy positions.

The Safeguard Mechanism is legislated through the National Greenhouse and Energy Reporting Act 2007 (NGER Act), has been in place since 1 July 2016 and applies to all facilities that emit more than 100,000 tonnes of direct carbon dioxide or carbon dioxide equivalent (CO₂-e) Scope 1 emissions (emissions produced on-site) each year.

The Government has now released for consultation the Safeguard Mechanism Reforms Position Paper as well as the exposure draft National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rule 2023 (Draft Rules) which set out the detailed design elements of the proposed reforms to the Safeguard Mechanism.

The main elements of the reformed Safeguard Mechanism are to be implemented through subordinate legislation (which is consistent with how the Safeguard Mechanism is currently legislated). One critical change which requires legislation is the proposal to establish a “below the baseline” credit trading scheme for covered facilities.

Following consultation in October 2022, the Government tabled its Safeguard Mechanism (Crediting) Amendment Bill 2022 in Parliament in November 2022. The amendments proposed in the Bill largely concern changes to the National Greenhouse and Energy Reporting Act 2007 for the creation of new tradeable Safeguard Mechanism credits (SMCs) as well as providing for the making of rules relating to interactions between the Safeguard Mechanism and the Emissions Reduction Fund.

Overview of the Safeguard Mechanism scheme

The current Safeguard Mechanism places a limit on the amount of greenhouse gases Australia’s largest industrial facilities can emit by assigning each facility covered by the Mechanism a ‘baseline’. Each year, every large facility within the Safeguard Mechanism needs to prove that their emissions for that year are below their baseline (reporting their emissions to the Clean Energy Regulator (CER)). Any facility that emits more greenhouse gases than allowed by their baseline has to take actions to offset their excess emissions (eg. through purchasing and surrendering Australian Carbon Credit Units (ACCUs)).

The Safeguard Mechanism currently covers approximately 215 facilities which represent approximately 28% of Australia’s national emissions. However, the scheme did not incentivise emissions reductions as baselines were set at a level that generally exceeded the actual facility emissions (often referred to as “emissions headroom”). Accordingly, the scheme made no real contribution to meeting Australia’s emission reduction targets.

The proposed reforms intend to change the Safeguard Mechanism so that it contributes proportionally to Australia’s new emission reduction targets. The Position Paper intends to achieve this in three primary ways:

• resetting current emissions baselines to reduce the “emissions headroom”;
• setting an annual decline rate so facility baselines reduce predictably and gradually over time aligned with the Government’s emission reduction targets of 43% by 2030 and net zero by 2050, as now legislated in the Climate Change Act 2022; and
• providing a financial incentive to reduce emissions by creating SMCs for below baseline performance.

Six main takeaways from the Safeguard Mechanism Draft Rules and Position Paper

Targets and baselines

Last year, the Federal Government legislated Australia’s commitment to cut greenhouse gas emissions by a minimum of 43% below 2005 levels by 2030 and to achieve net zero by 2050. As the Position Paper notes, changes in the Draft Safeguard Mechanism Rule are aimed at requiring Safeguard Mechanism covered facilities to deliver a proportional share of the national 2030 target. ^[1] In effect, this will lead to net emissions covered by the Safeguard Mechanism falling from a projected 143 million tonnes in 2022-23 before the reforms commence to no more than 100 million tonnes by 2030.

As for setting a facility’s individual baseline, the Government has decided to retain the existing production-adjusted (intensity) baseline framework, which allows baselines to grow and fall with production (reported, calculated and fixed baselines will no longer be available). This means that Safeguard facilities will need to improve the emissions intensity of their production in order to comply with their baselines.

An existing facility’s baseline will be calculated using a hybrid approach involving both site-specific and industry-average emissions intensity values. To reduce the “emissions headroom”, the site specific component will reduce over time while the industry average component will increase so that eventually all facilities will be subject to the industry average intensity values.

A new facility’s baseline will be determined based on international best practice emission intensity numbers which have been adapted for Australian circumstances. The same approach will apply to existing facilities that begin to produce new products.

Emissions Reduction Contribution

As set out in the table below, under the Draft Rules, a default baseline decline rate of 4.9% per year will apply to most covered facilities’ baselines until the financial year ending 30 June 2030.

From 2030 onwards, the baseline decline rate will be set in five-year blocks which the Government will seek consultation on in 2026/7. The Government will set indicative baseline decline rates from 2030 to 2050 as a guideline and to keep track of progress.

Treatment for emissions-intensive, trade exposed facilities

Emissions-intensive, trade-exposed (EITE) facilities are trade exposed and have emissions-intensive production. These attributes mean a facility may face higher costs in reducing emissions and be less able to manage those costs because the price of its products are set in global markets. Unlike facilities covered by the Renewable Energy Target (RET) scheme, compliance costs vary between EITE facilities and depend on individual performance relative to their individual baselines.

All “trade-exposed” facilities, ie. facilities relating to a commodity with a trade share above 10% facility in a certain year, will be able to access $600 million in funds to reduce emissions through the Safeguard Transformation Stream of the Powering the Regions Fund. It is expected that approximately 80% of covered facilities will qualify as “trade exposed” and be able to access these funds. The Powering the Regions Fund is however subject to its own consultation process so the rules and eligibility criteria of that fund, and how it might be accessed by EITIEs, remains to be determined.

A subset of trade-exposed facilities which have a higher risk of carbon leakage, known as “trade-exposed, baseline-adjusted facilities”, will be to apply to the CER for a three-year period of reduced baseline decline rates. The reduced baseline decline rate will be lower than 4.9% but no less than 2%.

SMCs and other credits

Under the proposed Bill, facilities (apart from landfills) that produce less emissions than their baseline will be awarded SMCs. Each SMC is the equivalent of one tonne of carbon dioxide or CO₂-e emissions. These SMCs can be sold or traded with other facilities that are over their baseline to reduce their net emissions. Access to crediting and trading of SMCs will be available from 1 July 2023. This new market for SMCs may see the emergence of intermediaries and brokers to facilitate trade between facilities. Importantly, as current baselines will be reduced, no facility will automatically qualify for SMCs and must reduce their emissions to earn them.

Critically, SMCs are not offsets and therefore do not need to demonstrate the same level of environmental integrity or additionality like ACCUs. For example, SMCs could be issued for emission reduction activities, such as lighting upgrades, that would not be acceptable under a carbon offset scheme (eg. because they are deemed business-as-usual activity).

A facility that does not wish to sell their excess credits can also bank an unlimited number away for compliance in another year up until 2030. A facility failing to meet its obligations to decrease emissions can also, instead of buying SMCs, borrow credits for up to 10% of their baseline amount each year until 2030. However, the borrower will have to pay back the credits the following year with 10% interest.

Use of ACCUs to offset above baseline emissions will also continue to be allowed. However, facilities covered by the Safeguard Mechanism will no longer be able to register new ERF projects for ACCU generation. Existing registered ERF projects can continue to generate and sell ACCUs for their existing crediting periods or government purchase contract terms (for up to two years from scheme commencement). New emissions-reduction projects will instead help facilities fall below their baselines and therefore generate SMCs.

As a cost containment measure, an exposure draft of the Carbon Credits (Carbon Faming Initiative) Amendment (No. 2) Rules 2023 has also been released which allows for the CER to sell Commonwealth-held ACCUs into the market at a set price of $75 per tonne, indexed yearly from 1 July 2024 at the consumer price index plus 2%. It is hoped that this will help cap prices for covered facilities. This is effectively a “strategic reserve” to be operated by the CER but it is unclear at this time how it will be established and how facilities will be able to access them.

International offset units cannot currently be used to meet an emissions liability under the Safeguard Mechanism. However, the Federal Government has flagged the potential for further consultation in 2023 on the ability for the carbon offsets scheme in Australia to recognise high integrity international offsets to achieve compliance and more broadly contribute to Australia’s international climate targets.

Multi-year monitoring periods

To account for emerging technologies, the Draft Rules enables facilities to apply to the CER for multi-year monitoring periods (MYMP) of up to five years in length, provided that these will not continue after 30 June 2030. The object is to allow for the averaging of the compliance obligation over this period until such time as the relevant technological solution becomes available.

However, emitters who apply for a MYMP will be required to formulate a plan that sets out a credible basis for how the facility will utilise technology to reduce the facility’s cumulative emissions below the facility’s baseline within the declared MYMP. Importantly, that plan must be signed off by the responsible financial officer for the facility.

Enforcement

The scheme aims to ensure compliance through civil penalties and anti-avoidance measures. Importantly, to ensure integrity, the Federal Government is proposing to introduce anti-avoidance measures that would prevent a business from defining a facility with the intention of avoiding Safeguard Mechanism obligations. This means an existing facility could not split into a number of smaller facilities to bring each new facility below the 100,000 tonne coverage threshold. Further, according to the Position Paper, a facility will not be able to attach itself to a grid-connected power station to avoid Safeguard Mechanism obligations.