Explainer: recently announced reforms to the Safeguard Mechanism and implications for industry

On 10 January, the Australian Government announced further details of proposed reforms to the safeguard mechanism, intended to commence on 1 July 2023.  

Key features include a reset of existing baseline values to remove headroom, and introduction of a 4.9% decline rate each year to 2030 to ensure that safeguard facilities reduce emissions at the same pace as the economy as a whole, consistent with national and international obligations. This is anticipated to require emissions from safeguard facilities to reduce from 137 Mt CO2-e in 2020-21 to 99 Mt CO2-e in 2030, and constrain total emissions to 1,233 Mt CO2-e until 2030.

The proposed reforms are explained in the Government’s Safeguard Mechanism Reforms Position Paper (Position Paper) and are reflected in exposure drafts of the National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, Carbon Credits (Carbon Farming Initiative) Amendment (No 2) Rules 2023 and Australian National Registry of Emissions Units Rule 2023.  

The Department of Climate Change, Energy, the Environment and Water (DCCEEW) is seeking feedback on the reforms, with consultation closing on 24 February 2023.  

Recap

The existing Safeguard Mechanism

As explained in our earlier insight, the ‘Safeguard Mechanism’ is a mandatory decarbonisation framework that was introduced in 2016 by the former coalition government. It applies to Australian industrial facilities that release at least 100,000 tonnes of Scope 1 emissions (i.e. direct emissions) per annum. In practical terms, this equates to coverage of approximately 215 facilities, which are spread across all sectors of the economy and are estimated to be responsible for 28% of Australia’s total greenhouse gas emissions.

The Safeguard Mechanism sets limits (called baselines) on net Scope 1 CO2-e emissions from facilities.  Where the baseline is lower than business as usual operational emissions, it requires facilities to reduce their emissions and offset any residual emissions through the purchase and surrender of carbon credits.

The Safeguard Mechanism in its current form has been criticised for failing to incentivise reductions, owing to artificially high baselines that offer ‘headroom’. For example, in 2020-21, aggregate baselines were set at 180 Mt CO2-e, compared with actual covered emissions of 137 MT CO2-e.  

Reform agenda

Since forming government in May 2022, the Albanese federal government has pursued significant reform of climate policy and law, including:

• enactment of the Climate Change Act 2022 (Cth) which sets out Australia’s greenhouse gas reduction target of 43% below 2005 levels by 2030, and net zero by 2050; and
  
  
• release of the Safeguard Mechanism (Crediting) Amendment Bill 2022 (Draft Bill) (as discussed in our earlier insight).  

The latest reforms (announced last week) build on these earlier developments and prior consultation.  

Key elements of the reforms proposed are described further below.  

Key elements of the latest proposed reforms

Resetting baselines for existing facilities

As noted, the Government is proposing to reset baselines for existing Safeguard Mechanism facilities to remove headroom and compel immediate emissions reductions. The Position Paper states that all facilities will be on a production-adjusted (intensity) baseline, noting that most facilities already adopt this model, with only a small number still operating under fixed (absolute) baselines.  

The reset will adopt a ‘hybrid’ model, drawing on both industry averages and site specific emissions-intensity values.    

To give businesses sufficient time to prepare, the hybrid model would be initially weighted towards the use of site-specific emissions intensity values, but then transition to industry average emissions intensity values by 2030.   

Practically, facilities will be required to apply for their site-specific emissions intensity value by 30 April 2024, with the application accompanied by an audit and the value calculated by reference to actual facility data (over a multi-year period) as opposed to forecasts.  

Baselines for new facilities

For any new facilities that become safeguard facilities before 1 July 2023, their baseline will be set using industry average emissions-intensity values, set out in Schedule 2 of the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (Safeguard Rule).

Beyond 1 July 2023, baselines for new facilities not previously reporting under the National Greenhouse and Energy Report Scheme will generally be set in line with ‘international best practice, adapted for an Australian context’. This will also apply to existing facilities if they begin producing new products. The Government has yet to prepare a framework for determining international best practice, however this is expected to be prepared in consultation with industry shortly.

Declining baselines

Following discussions of an annual baseline reduction in the range of 3.5% to 6%, the Government has proposed that a 4.9% annual decline rate will apply to baselines for all existing and new facilities until 2030, with limited exceptions.

After 2030, decline rates are anticipated to be set in five-year blocks, and aligned with updates to Australia’s commitments under the Paris Agreement. For example, the decline rates for 2031 to 2035 will be considered during 2026-27 following Australia’s next updated commitment in 2025.

Compliance support and flexibility

The Position Paper outlines various mechanisms which offer compliance support and flexibility which feature in the proposed reforms. These include:

• Safeguard Mechanism Credits
  
  As set out in the Draft Bill (released in November 2022 and still before parliament), Government is proposing to introduce a new form of tradeable credit – known as ‘Safeguard Mechanism Credits’ (SMC) – to incentivise facilities to cut back their operational emissions as much as possible.  
  
  SMCs will be issued for facilities that reduce their operational emissions below their baseline.[1] SMCs can be sold to other safeguard facilities and surrendered for the purpose of meeting baseline targets. However, they will not be eligible for use more broadly beyond safeguard facilities.
  
  The Position Paper further explains that:
  
  
  • Facilities that cease to be subject to the Safeguard Mechanism framework (i.e. where emissions fall below the 100,000 tonnes CO2-e coverage threshold) will remain eligible to generate SMCs for five years thereafter.  This is to incentivise facilities to continue reducing emissions when they are operating close to the coverage threshold; and
    
    
  • ‘Banking’ and ‘borrowing’ reforms will be introduced, allowing facilities to hold, surrender or trade issued SMCs up to 2030 and to borrow up to 10% of their baseline each year, to be repaid the following year subject to interest at 10%. SMCs will not be available for a facility during the borrowing year.
    
    
• Australian Carbon Credit Units
  
  To preserve integrity and avoid double-counting with SMCs, the Draft Bill provides that new projects that reduce covered emissions at a safeguard facility will no longer be able to create Australian Carbon Credit Units (ACCUs).  
  
  However, existing safeguard facilities will continue to be able to buy and surrender ACCUs as an alternative to reducing on-site emissions, or purchasing and surrendering SMCs.  
  
  To assist in managing compliance costs, Government-held ACCUs are proposed to be made available for sale at a capped price of $75 per tonne of CO2-e in 2023-24, increasing with CPI plus 2% each year.
  
  
• Multi-year emission reduction projects 
  
  The Position Paper proposes extended multi-year monitoring period function (MYMP) periods which will be introduced via amendments to the Safeguard Rules to allow facilities to develop and implement credible long term emissions reductions projects.
  
  This acknowledges that many safeguard facilities may not have access to immediate abatement technologies, but that abatement opportunities are expected to become available in coming years. The MYMP function will enable facilities to ‘average out’ a baseline exceedance in an initial year (or years) with below-baseline emissions in subsequent years after the reduction project is implemented.
  
  An application for MYMP status would need to be made by 15 November in the relevant compliance year. It is proposed that MYMPs could have a maximum period of five years, and must not extend beyond 2030, however this is expected to be reviewed in 2026-27.
  
  Facilities with MYMP status will not be entitled to generate SMCs, or have access to borrowing.
  
  
• Support for particular facilities
  
  The reforms provide various assistance measures, recognising that ‘hard to abate’ facilities may struggle to reduce emissions in line with the default 4.9% reduction in annual baselines.
  
  For example, support will be available to ‘Trade-Exposed Facilities’, which can access funding from a dedicated $600M Safeguard Transformation Stream (STS) within the Power the Regions Fund.  The STS will operate to provide a range of funding opportunities to support on-site decarbonisation. It is anticipated that approximately 80% of existing safeguard facilities will qualify as Trade-Exposed Facilities.
  
  Additional support may be available for ‘Trade-Exposed Baseline Adjusted’ facilities (TEBAF) (a subset of Trade-Exposed Facilities) who may apply for a discount to the 4.9% baseline decline rate, depending on how impacted the facility is (capped at a minimum baseline decline rate of 2% per annum).

Implications

The Position Paper and draft rules released last week provide key details that will be closely considered by all who are interested in the journey towards net zero.

For example, facilities subject to the Safeguard Mechanism will be evaluating how the proposed reform will impact their existing strategy for emissions reduction, cost implications, whether there is sufficient certainty in the reforms (particularly for ‘Trade-Exposed Baseline Adjusted’ facilities), what support may be available, and what issues need to be raised in consultation before the detail is finalised. To the extent there are material cost implications, listed corporations will also need to consider if disclosure obligations are triggered. Other stakeholders will be evaluating whether the proposed reform does enough, with some already expressing concerns that more is needed.  

One issue that continues to attract significant attention is how these reforms will impact on the price of carbon, whether such costs are incurred through emissions reduction initiatives or carbon offsets. For example, market analyst RepuTex expects prices to rise following the latest reform announcements, but has also suggested that the existing surplus of ACCUs will constrain near-term prices, which will be fortuitous for ‘compliance buyers’ (being facilities that need to purchase offsets in order to meet their baseline).    

Closely related to the price of carbon is the integrity of carbon credits that can be used to offset emissions. Maintaining, or rather restoring, confidence in the ACCU scheme following recommendations made in December 2022 by the Independent Review of Australian Carbon Credit Units chaired by Ian Chubb AC will be more important than ever. That is, to ensure integrity in the supply of offsets invariably required to support the proposed reduction of Safeguard Mechanism baselines.  

As presently proposed, the reforms will allow only ACCUs or SMCs to be used by facilities subject to the Safeguard Mechanism to meet their baseline obligations. However, the Government has indicated that it will consult on creating a legislative framework for international units in 2023, indicating that international credits may become available in the years ahead.

Next steps

The changes to the Safeguard Mechanism have been foreshadowed for some time and are an important step for the Federal Government to implement its commitment to reducing Australia’s Co2-e emissions.  

However, the final detail is not yet locked in and may still change. The reforms are subject to consultation, rely on legislation which is currently before Parliament as well as new rules which can be the subject of Parliamentary disallowance.  

Resolution of the final detail will need to occur promptly given the intended commencement date of 1 July 2023.

Further, the Draft Bill has been referred to the Senate Environment and Communications Legislation Committee, which is accepting submissions until 25 January 2023. The Senate Committee is due to report its findings by 2 March 2023.

We recommend that existing and future safeguard facilities monitor the progress of the reforms and consider participation in consultation opportunities wherever available.