As the 1 July 2023 date for reforms to the Safeguard Mechanism looms closer, on Friday 5 May, the Federal Government registered a set of final legislative rules setting out the detailed design elements of the reforms. The rules follow publication of exposure drafts for consultation in January this year (read more about these in our article here), and enactment of the Safeguard Mechanism (Crediting) Crediting Amendment Act 2023 (Cth) (Crediting Amendment Act) last month (read more about this Act is in our article here).
The rules released on Friday are:
- the National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023 (Safeguard Amendment Rules), which set out the technical detail for the Safeguard Mechanism including approaches to baseline setting, baseline decline rates, and special treatment for trade-exposed facilities. Under amendments to the National Greenhouse and Energy Reporting Act (2007) introduced by the Crediting Amendment Act, the Minister was required to publish reasons why he is satisfied that these Safeguard Amendment Rules align with legislated ‘Safeguard Outcomes’ including (among other things), an objective that total net Safeguard emissions for all financial years between 2020 and 2030 do not exceed 1,233 million tonnes CO2e;
- the Carbon Credits (Carbon Farming Initiative) Amendment (No. 2) Rules 2023 (Carbon Credits Amendment Rules No 2) which amends Australia’s national carbon farming legislation to implement aspects of the reforms relating to carbon projects, and introduces a ‘cost containment measure’ to assist Safeguard Mechanism entities to meet their obligations; and
- the Australian National Registry of Emissions Units Rules 2023 which provides for ‘Safeguard Mechanism Credits’ (SMCs) to be treated in a similar way to Australian Carbon Credit Units (ACCUs).
In this article, we canvas the key features of the new rules, how they differ from the exposure drafts released in January, and what the rules mean for new and existing Safeguard Mechanism facilities as we look ahead to July.
Safeguard Amendment Rules
Baselines for existing facilities
Consistent with the Government’s proposed approach when it released draft legislation in January, the Safeguard Amendment Rules and explanatory statement confirm that emissions intensities for existing covered facilities are set using a ‘hybrid’ model which is initially weighted towards the use of site-specific emissions intensity values, and will transition to industry average emissions intensity values by 2030.
This transition is achieved by applying a ‘transition proportion’ when calculating the baseline emissions numbers for covered facilities, that increases each financial year to 2030. Facilities will need to apply to the Clean Energy Regulator (Regulator) by 30 April 2024 for an emissions intensity determination that will be relevant to the financial year beginning 1 July 2023. Of note, the calculation of facility-specific emissions intensity production variables can now be determined by reference to up to 5 years of historical data, rather than 4.
With respect to the production variables and industry average emissions intensity values that will be used to calculate baselines, the Government has not yet finalised these, but has indicated in a fact sheet released on Friday (Fact Sheet) that it will consult with Safeguard facilities to finalise these before reforms commence.
Baselines for new facilities and extensions of existing facilities
Early in the reform consultation process, the Government considered two approaches to setting baselines for new facilities under the proposed reforms, being best practice, or industry average. In January, the Government indicated a preference for the international best practice approach.
Consistent with that position, the Safeguard Amendment Rules confirm that ‘best practice emissions intensity’ values will apply for new facilities. However, with the exception of gas facilities (which we discuss below), the Safeguard Amendment Rules do not specify what these best practice values are.
According to the explanatory statement accompanying the rules, they will reflect international best practice adapted for an Australian context, which means, for example, adjusting for energy sources, the types of metal ores that are processed in Australia compared to overseas, or other resources that are used overseas but are not available in Australia. We expect that the Government will consult on best practice emissions intensity numbers for production variables over coming months. Where a best practice emissions intensity value for a production variable has not been set, the facility will need to apply the default value.
Special provisions for new gas fields and shale gas extraction activities
In the process of finalising the Crediting Amendment Act, the Government announced that new gas fields supplying existing LNG facilities will be treated as new facilities and will be subject to best practice baselines. For these fields’ reservoir CO2 emissions, best practice is zero given the existence of low-CO2 fields and opportunities for carbon capture and storage. The Safeguard Amendment Rules implement this change at new section 35A of the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (Safeguard Rules).
Further, new section 10 of the Safeguard Rules specifies that the baseline emission number for shale gas extraction facilities will also be zero. This implements one of the recommendations of the Independent Scientific Inquiry into Hydraulic Fracturing of Onshore Unconventional Reservoirs in the Northern Territory and aligns with the Government’s earlier announcement regarding new Beetaloo Basin entrants.
Baseline decline rates
Under new section 32 of the Safeguard Rules, the baseline decline rate that will apply for most covered facilities will be set at 4.9% per year to 2030, which aligns with the Government’s position in the exposure draft legislation. Certain eligible emissions intensive trade exposed facilities will be able to apply for a reduced baseline decline rate, which we discuss further below.
Key flexibility mechanisms for covered facilities
The Safeguard Amendment Rule, along with the Crediting Amendment Act and other rules released on Friday, provide a suite of flexibility measures designed to help facilities manage challenges associated with complying with declining baselines. These measures include:
(a) Emissions intensive trade exposed (EITE) facilities
Significantly, the Safeguard Amendment Rules introduce specific measures to support EITE businesses. There are two types of categories of EITE facilities:
- Trade Exposed facilities, which will include all facilities whose main production variable is trade exposed; and
- Trade Exposed Baseline Adjusted (TEBA) facilities, which are a subset of trade-exposed facilities facing an elevated risk of carbon leakage. These facilities are eligible to apply for discounted baselines based on a ‘scheme impact metric’ that will differ depending on whether the facility is a manufacturing or non-manufacturing facility.
The Government has confirmed that both types of EITE facility will be eligible to access support from the Powering the Regions Fund.
As the Government announced in the process of finalising the Crediting Amendment Act, manufacturing TEBA facilities will use scheme cost as a percentage of facility Earnings Before Interest and Taxes (EBIT). Assistance will commence at 3%, and the minimum baseline decline rate available will be 1% each year. Conversely, non-manufacturing TEBA facilities will use scheme cost as a percentage of facility revenue: assistance will also commence at 3% and the minimum baseline decline rate will be 2% each year.
New Schedule 2 of the Safeguard Rules provides the basis for defining the ‘trade exposure’ of facilities, by listing the trade-exposed production variables and specifying whether these are also manufacturing production variables. Trade exposed manufacturing production variables include (among others), tonnes of aluminium, silicon, zinc, lime and also iron ore sinter for use in integrated iron and steel manufacturing. Non-manufacturing trade exposed production variables include, among others, tonnes of run-of-mine coal, iron ore, and gigajoules of extracted oil and gas.
(b) Surrender of ACCUs and SMCs for compliance
Safeguard facilities will automatically generate tradeable SMCs when their emissions are below their baseline, with the exception of landfills and facilities accessing borrowing arrangements or deemed surrender arrangements. Under new section 58B of the Safeguard Rules, covered facilities that then fall below the coverage threshold can continue to generate SMCs for up to 10 years. While not set out in legislative rules, the Government has confirmed that unlimited banking of SMCs will be allowed until 2030.
Importantly, as announced by the Government in the process of finalising the Crediting Amendment Act, while there is no limit on how many ACCUs a facility can surrender for compliance, new section 72C requires that where a facility surrenders ACCUs equal to more than 30% of its baseline, it must submit a statement to the Regulator setting out a number of matters. These include whether limitations in available technologies affected the level of carbon abatement undertaken at the facility during the period; whether there are barriers to undertaking carbon abatement; and information about future opportunities for undertaking carbon abatement at the facility. The Regulator will publish this information.
Outside of ACCUs and SMCs, international offsets will not be able to be used for compliance initially. However, the Government has indicated that it intends to consult in late 2023 on the possibility of establishing the legislative framework for international units, and the explanatory statement that accompanies the Safeguard Amendment Rules confirms that use of international units will be considered as part of the review of Safeguard Mechanism policy settings in financial year 2026-27.
(c) Borrowing adjustment
Consistent with the Government’s position in January, new sections 47 to 51 of the Safeguard Rules enable facilities to apply for a ‘borrowing adjustment’ of up to 10% of a facility’s baseline each year to 2030, with a 10% interest rate applied in the year after borrowing occurs. Interestingly, new section 47 reduces this interest rate to 2% until July 2026, to provide covered businesses time to adjust to the new arrangements and support early investment in onsite abatement. This was not a feature of the exposure draft legislation.
(d) Multi-year monitoring periods (MYMPs)
Largely consistent with the draft legislation, the Crediting Amendment Act enables facilities to apply for MYMPs of up to 5 years ending no later than 2030 on application (under amendments to sections 65 and 67 of the Safeguard Rules). Applications need to include a plan setting out how the responsible emitter will undertake activities that are reasonably likely to enable the responsible emitter to reduce the net emissions number for the relevant facility for the MYMP.
Importantly, in a change from the exposure draft legislation, the Government has introduced a new section 69B into the Safeguard Rules enabling the Regulator to vary (i.e. reduce) the length of a MYMP where this plan is not implemented.
(e) Cost containment reserve for sale of Commonwealth ACCU holdings
Safeguard facilities will also be able to benefit from the ability to purchase ACCUs at a fixed price of $75 in 2023-24, increasing with CPI plus 2 per cent each year. According to the Fact Sheet, funds received from this measure will be allocated to the Powering the Regions Fund, to support additional abatement to meet Australia’s emissions reduction targets. This change is set out in the Carbon Credits Amendment Rules No 2 (discussed below).
Carbon Credits Amendment Rules No 2
In January, the Government introduced amendments to the Carbon Credits (Carbon Farming Initiative) Rule 2015 (Principal Carbon Rule) which removed the ability of projects that solely reduce emissions covered by the Safeguard Mechanism at Safeguard facilities to be registered as carbon projects under national carbon farming legislation, and set up the infrastructure for the cost containment measure.
Following those amendments, the Carbon Credits Amendment Rules No 2 have been registered in largely the same form as the exposure draft legislation that was released in January. They amend the Principal Carbon Rule to:
(a) prevent the Regulator from entering into carbon abatement contracts for ACCUs from carbon projects that occur at covered facilities (under new section 10A of the Principal Carbon Rule). This change will affect future carbon abatement contracts, as well as contracts entered into at the most recent auction in March 2023 (which were subject to a revised Code of Common Terms enabling the Regulator to suspend deliveries and terminate the contracts if this Rule were made); and
(b) implement the ‘cost containment reserve’ by enabling the Regulator to sell ACCUs from the Commonwealth Emissions Reduction Fund Delivery Account for the purposes of Safeguard Compliance (new section 11AB of the Principal Carbon Rule).
One feature of the Carbon Credits Amendment Rules No 2 that was not contained in the exposure draft is an amendment to project eligibility criteria that has the effect of preventing eligible offsets projects from being issued ACCUs for undertaking a new ‘activity’ that results in carbon abatement of covered emissions from the operation of a Safeguard facility.
Australian National Registry of Emissions Units Rules 2023
The Crediting Amendment Act amended the Australian National Registry of Emissions Units Act 2011 (Cth) (ANREU Act) to enable SMCs to be traded in the Australian National Registry of Emissions Units, and enabled legislative rules to prescribe certain characteristics of SMCs. Accordingly, the new Australian National Registry of Emissions Units Rules 2023 specify (at section 5) that SMCs are an ‘eligible international emissions unit’. This will help to ensure that SMCs are treated in the same way as ACCUs under federal anti-money laundering and tax legislation. Importantly, SMCs will also be classified as financial products under the Australian Securities and Investments Commission Act 2001 (Cth) and Corporations Act 2001 (Cth).
The rules also set out processes for SMCs to be transferred, and require the Regulator to cancel SMCs in a registry account where this account is closed.
The need for transparency around SMC and ACCU holdings has been a point of discussion throughout the reform process, and the Government has indicated that it will consult further on options to make further legislative rules to increase transparency in unit holdings and market transparency.
What should Safeguard facilities do now?
With much of the detail of the reforms now final, and 1 July 2023 not far away, Safeguard facilities need to prepare in earnest for the more stringent compliance requirements that will commence from the beginning of the coming financial year. Steps that your business can take to prepare include:
- engaging with the Department of Climate Change, Energy, the Environment and Water on the setting of default and best practice emissions intensities for production variables that apply to your facilities;
- considering whether your facilities will be eligible to apply for classification as a manufacturing or non-manufacturing TEBA facility, noting that manufacturing facilities can be eligible for a more reduced baseline decline rate of a minimum 1%;
- considering the utility of a procurement strategy for ACCUs and SMCs, including whether there are opportunities at your covered facilities to generate SMCs for below baseline performance;
- monitoring for opportunities to engage with Government over coming months as the Government considers the role of international credits for compliance use under the Safeguard Mechanism in the future; and
- watching for developments as the Government finalises funding rules for the Powering the Regions Fund and National Reconstruction Fund, and consider whether your facility may be eligible for assistance.
Companies looking to develop emissions intensive new facilities (or expand existing covered facilities) should keep track of the Government’s developments of best practice emissions intensities and develop robust strategies to minimising scope 1 emissions where possible. Those in the LNG industry should take note of the net zero baselines that will apply for reservoir CO2 in new fields supplying existing LNG facilities and for shale gas projects and consider how carbon capture and storage may be integrated into project design.