On 23 August 2021, the Australian Department of Industry, Science, Energy & Resources published a discussion paper (Discussion Paper) outlining options to incentivise emissions reductions below existing baseline limits by establishing a Safeguard Crediting Mechanism (SC Mechanism).

The SC Mechanism is designed to incentivise, and provide another option for, Australia’s largest greenhouse gas (GHG) emitting businesses to adopt new technologies that will reduce emissions below existing agreed limits set under the Safeguard Mechanism.  This 'below baseline' crediting scheme was a key recommendation of an expert panel report examining additional sources of low-cost abatement (King Review).

It is important for all companies that have net-zero ambitions or ambitions that go beyond a business as usual baseline limit compliance position, to consider the Discussion Paper closely to understand the potential risks and opportunities flowing from the proposed SC Mechanism.

The last date for submissions on the Safeguard Crediting Mechanism is 5 October 2021.

This article will provide an overview of the SC Mechanism, how it differs from the current Safeguard Mechanism and Emissions Reduction Fund (ERF), and what large emitters should consider now before its implementation.

What is the current Safeguard Mechanism?

Australia’s existing climate change policy framework includes the National Greenhouse and Energy Reporting (NGER) Scheme, the Safeguard Mechanism and the ERF.  The Safeguard Mechanism requires companies (referred to as “facilities”) that emit more than 100,000 tonnes of GHG emissions a year (Safeguard facilities) to offset any GHG emissions that are above their set baseline by surrendering Australian Carbon Credit Units (ACCUs).  Safeguard facilities can purchase ACCUs on the secondary market or generate their own ACCUs through eligible carbon abatement and sequestration projects. However, the Discussion Paper stated that only a few of the Safeguard facilities have generated their own ACCUs.

A key issue with the Safeguard Mechanism is that it does not, in itself, operate to ‘reduce’ GHG emissions of large emitting industry sectors – rather it sets broad baseline limits within which companies can operate. While the intention of the Safeguard Mechanism was not to facilitate a net- zero economy, it has become clear that the Safeguard Mechanism alone will not enable any such ambition to be achieved.

What is the Safeguard Crediting Mechanism?

The Safeguard Crediting Mechanism will use the existing Safeguard Mechanism architecture to provide credits to facilities who reduce their emissions intensity by undertaking ‘transformative’ abatement projects.

To date, Safeguard facilities have mostly met their GHG offset obligations by purchasing ACCUs on the secondary market, rather than generating their own ACCUs through carbon abatement or sequestration projects under the ERF.   

The SC Mechanism will create new incentives, and another option, for Safeguard facilities to participate in carbon abatement activities by rewarding Safeguard facilities with tradeable Safeguard Mechanism Credits (SMCs) if they deploy low-emissions technology that results in their GHG emissions intensity falling below agreed baseline levels. Emissions intensity is measured by the volume of emissions per unit of some economic output, such as production, rather than measuring absolute reduction in GHG emissions. Safeguard facilities could therefore earn SMCs by investing in technology which improves energy efficiency or bringing forward upgrades to newer, more efficient technologies.

The ability to earn SMCs is likely to be more attractive to Safeguard facilities than earning ACCUs under the ERF, because the cost of deploying low-emissions technology is expected to be lower than the costs to Safeguard facilities of developing eligible projects under the ERF.

The proposed SC Mechanism will build on Australia’s existing climate change policy framework and consist of two key elements:

• Crediting: Safeguard facilities will receive SMCs for reducing the emissions intensity of their operations below their baselines through ‘transformative’ projects; and
• Purchasing: the Government has committed A$279.9 million over ten years to support the purchases of SMCs under the SC Mechanism. SMCs will also be able to be sold in the voluntary market or to meet compliance obligations under the Safeguard Mechanism.

The below diagram provides a summary of how the SC Mechanism is proposed to operate.

Will SMCs be treated the same as ACCUs?

ACCUs can only be earned by eligible projects for emissions avoidance or carbon storage in vegetation and soil.  In contrast, SMCs can only be earned by Safeguard facilities by deploying low-emissions technology that results in their emissions intensity falling below agreed baseline levels. As a result of these differences, ACCUs and SMCs are likely to be differentiated by the market, in terms of both price and liquidity.

How will the Safeguard Crediting Mechanism be established?

The Clean Energy Regulator will be responsible for administering the SC Mechanism.  Legislative changes to the existing regulatory scheme (including the National Greenhouse and Energy Reporting Act 2007, the Australian National Registry of Emissions Units Act 2011 and the Carbon Farming Initiative Act) will be necessary to allow for the following:

• the establishment of an SC Mechanism framework;
• the creation of SMCs;
• the surrender of SMCs by Safeguard facilities to meet their compliance obligations under the Safeguard Mechanism;
• the purchase of SMCs by the Clean Energy Regulator; and
• the vesting of ownership in SMCs and procedures for transferring SMCs.

Who will be entitled to participate in the Safeguard Crediting Mechanism?

The SC Mechanism is intended to be a voluntary scheme available to Safeguard facilities.

How will agreed baselines be determined?

In line with the King Review, the view in the Discussion Paper is that Safeguard facilities should not be credited with SMCs based purely on emissions reductions below a Safeguard facility’s existing baseline under the Safeguard Mechanism, but instead be credited for abatement relative to a new baseline based on historical emissions intensity performance, which would be lower than their Safeguard Mechanism baseline. The Discussion Paper provides two options for the setting of a baseline emissions intensity level, using historical information:

• most recent period: the reference emissions intensity level could be based on the most recent year (or years) before the emissions reductions commence; and
• a past, fixed period: the reference emissions intensity level could be based on a fixed year (or years) prior to programme commencement (2019-20 or earlier). This fixed period would be common to all Safeguard facilities regardless of when the emissions reductions take place.

The Discussion Paper is seeking views on which method would be the most appropriate.

How is the amount of credits determined?

As proposed in the King Review, the method for determining how many SMCs a Safeguard facility will receive will be based on the reductions in the Safeguard facility’s emissions intensity, as opposed to absolute emissions reductions. The King Review noted that crediting reductions in emissions intensity would encourage emissions reductions from improvements in production processes and efficiency. In contrast, if absolute emissions are used as the basis for crediting, there is a risk that Safeguard facilities could be credited for reductions in production, and possibly even plant closures.  

Will SMCs be sold to the Government via an auction process similar to the ERF?

Safeguard facilities that earn SMCs for achieving abatement relative to the new lower reference level can choose to enter into an arrangement to sell their SMCs to the Government. It is currently proposed that this would occur in a similar fashion to the existing auction process for Government purchases of ACCUs under the ERF.  Safeguard facilities will also be able to sell their SMCs to private entities or surrender SMCs to help meet their compliance obligations under the Safeguard Mechanism.  

How will the Safeguard Crediting Mechanism be implemented?

A two to three-year pilot phase could potentially begin in July 2022 to test the market appetite for SMCs. This is intended to provide Safeguard facilities with enough time to deploy low-emissions technology to position them to achieve qualifying emissions intensity reductions. It is proposed that an evaluation could take place towards the end of the pilot phase to examine the effectiveness of the SC Mechanism and consult on how post-pilot phase crediting arrangements could be improved. The Discussion Paper is inviting views on the length and start date of a pilot phase and the issues to consider when the pilot phase is being evaluated.

What will be the impact on the ERF?

It is not clear how the SMC and ACCU markets will interplay going forward – including whether there is a risk that the SMC market may compromise the abatement levels currently achieved under the existing ACCU market.  For example, if the SC Mechanism incentivises Safeguard facilities to reduce their emissions intensity, this may result in Safeguard facilities being less dependent on ACCUs generated under the ERF to meet their Safeguard Mechanism obligations, which may in turn reduce secondary market demand for ACCUs from the Safeguard facility sector.  However, any negative impact on demand from this sector is likely to be replaced by demand from other market participants, including the increasing number of Australian companies seeking to fulfill their net zero emission ambitions. Overall, it will be important for the Government to ensure that the SMC and ACCU markets work together to ensure that genuine abatement can be achieved.

How can Safeguard facilities position themselves to participate in the Safeguard Crediting Mechanism?

Safeguard facilities who are interested in participating in the SC Mechanism may wish to commence planning to deploy low-emissions technology to lower their emissions intensity to a level that will position themselves to earn SMCs once the SC Mechanism is up and running.

Next Steps

The last date for submissions on the Safeguard Crediting Mechanism is 5 October 2021.