Since its election in May 2022, the new Federal Government has moved quickly on climate law and policy reform. Last week, the newly established Department of Climate Change, Energy, the Environment and Water released its Safeguard Mechanism Reforms: Consultation Paper (Consultation Paper), setting out its proposed reforms to the Safeguard Mechanism.

The Safeguard Mechanism is Australia’s primary instrument for controlling carbon emissions from large emitters, by setting emissions limits (or ‘baselines’), which covered facilities must either emit below or purchase carbon credits to offset any exceedance of that limit. The scheme currently covers 215 of Australia’s biggest emitters.

A key proposal flagged by Labor in its election campaign was to bring these entities under declining baselines, to align the mechanism with Australia reaching net zero greenhouse gas emissions by 2050.  In this article, we consider the government’s key proposed amendments to the Safeguard Mechanism.

It is important to note that Safeguard Mechanism reform is but one of a raft of proposed reform items Labor will introduce, or has introduced, as part of its legislative agenda. Already, Labor has introduced legislation to embed Australia’s emissions reduction target under the Paris Agreement, as well as commencing a review to strengthen the Emissions Reduction Fund and the value and integrity of Australian Carbon Credit Units. To read more on these recent pivotal developments in climate law and energy, see our article Movements in Australia’s climate and energy policy.

Submissions on the Consultation Paper are due by 20 September 2022, with transitional changes expected to take effect from 1 July 2023.

Key Takeaways from Safeguard Mechanism Reforms: Consultation Paper

• The current coverage threshold of 100,000 tonnes of Scope 1 (direct) CO2-e emissions each year will remain in place under the reformed scheme.
• Significantly, the government proposes changes to facility baselines to align the Safeguard Mechanism with Australia’s updated 2030 and 2050 targets and emissions budget in its Nationally Determined Contribution under the Paris Agreement (NDC). While final baseline decline rates will not be settled until other policy settings are finalised, indicative decline rates are expected to be between 3.5 and 6 percent each year to 2030. If a higher rate of decline is ultimately adopted, covered facilities will need to upscale their operational decarbonisation strategies and/or purchase more offsets in order to comply. 
• How baselines are set will be critical to determining the baseline decline trajectory, with important implications for Safeguard Mechanism facilities’ operations. The government is seeking feedback on whether to maintain a production-adjusted approach to baseline setting or revert to absolute limits, and how to minimise headroom. Setting absolute limits would entail particular challenges for covered facilities, by requiring reductions in absolute operational emissions.
• It is proposed that the Clean Energy Regulator (Regulator) will automatically issue new carbon credits called Safeguard Mechanism Credits (SMCs) to Safeguard facilities when their emissions fall below their baseline. SMCs have been proposed so that Safeguard participants can manage compliance costs as baselines decline.
• Emissions-intensive, trade-exposed entities (EITEs) will likely be able to access tailored treatment under the Safeguard Mechanism. The proposed amendments seek to balance genuine abatement incentives with the practical realities that many EITEs operate in hard to abate sectors where technological solutions are still nascent.

Setting baselines under the Safeguard Mechanism

Fixed versus production-adjusted baselines

The Consultation Paper seeks feedback on whether the Safeguard Mechanism should retain, and build on, the existing production-adjusted (intensity) baseline setting framework, or return to the fixed (absolute) approach, which applied when the Safeguard Mechanism initially commenced in 2016.

The current projection-adjusted approach allows a facility’s baseline to change annually as its production levels fluctuate: facilities comply with their baselines through reducing the emissions intensity of production. Conversely, fixed baselines place an absolute limit on covered emissions, and require facilities to reduce their production and / or improve emissions intensity in order to comply.

Combatting the headroom problem

The Consultation Paper notes the considerable ‘headroom’ – that is, the gap between how much carbon facilities are allowed to emit under their baselines, and their actual emissions – that currently exists for Safeguard Mechanism-covered facilities, and seeks input on how baselines can be set in a way that removes this headroom and enables crediting and trading to commence when baselines start to decline.

Baselines for new and existing facilities

Most facilities that are currently covered by the Safeguard Mechanism are afforded flexibility to set their baselines by reference to industry average emissions-intensity benchmarks (‘default’ values) set by government, or site-specific intensity values calculated by the businesses themselves. The Consultation Paper notes that this optionality has been identified as a contributor to the headroom problem, and seeks input on whether all baselines should be set by reference to just one of these reference points, or using different standards altogether.

The Consultation Paper also requests feedback on the best approaches to setting baselines for new facilities (that is, facilities that become covered by the Safeguard Mechanism after 1 July 2021).

Setting a rate for baseline decline

Importantly, the Consultation Paper seeks input on how best to reduce Safeguard Mechanism baselines in a way that is consistent with Australia’s emissions budget under its NDC, which commits Australia to reducing national emissions by 43 percent below 2005 levels by 2030, and reaching net zero emissions by 2050.

According to the Consultation Paper, for facilities currently covered by the Safeguard Mechanism to contribute to their proportional share of the national emissions target, aggregate baselines must fall from 137 million tonnes to 99 million tonnes CO2-e by 2030: this equates to a need for Safeguard Mechanism facilities to cumulatively abate 170 million tonnes of CO2-e over the next 8 years. Feedback is sought as to what extent the Safeguard Mechanism should contribute to Australia meeting its emissions reduction targets.

The government expects indicative decline rates of between 3.5 and 6 percent each year, although final decline rates cannot be settled until other policy settings have been finalised. Variables that will feed into calculating the decline rate include, among other things, whether baselines are set using the ‘fixed’ or ‘production-adjusted’ approach: decline rates are likely to be higher if a production-adjusted approach is taken. Another key consideration is whether a ‘reserve’ is built into the decline rate, so that the rate is steeper (to accommodate for the potential introduction of new covered facilities, and higher than expected emissions growth in upcoming years).

With respect to post-2030 decline rates, the Consultation Paper suggests that these be set in 5-year blocks, with the process for setting them aligned with updates to Australia’s NDC. For example, decline rates for 2030 to 2035 could be the subject of consultation in 2026 following Australia’s NDC update in 2025.

Introducing safeguard mechanism credits and the use of offsets

It is proposed that the Regulator will automatically issue SMCs to facilities when their emissions fall below their baseline. SMCs will only be traded within the Safeguard Mechanism. It is proposed that Safeguard facilities will continue to receive SMCs when their annual emissions fall below 100,000 tonnes as an incentive to continue reducing emissions. SMCs have been proposed so that Safeguard participants can manage compliance costs as baselines decline. Safeguard participants with relatively low-cost abatement will be able to sell SMCs to Safeguard facilities with more costly or limited abatement options.

SMCs will not be carbon “offsets” like ACCUs, because they will be generated within a regulated emissions limit, which will limit the overall emissions of Safeguard participants. Therefore, SMCs will not need to be 'additional' as defined under the Carbon Credits (Carbon Farming Initiative) Act. It is anticipated that the crediting and trading of SMCs will commence on 1 July 2023.

The Government is now seeking consultation on a range of issues relating to the use of SMCs and their interaction with ACCUs, including (among other things):

• whether banking and borrowing arrangements should be implemented for SMCs;
• whether Safeguard facilities should still be able to generate ACCUs for reducing direct (scope 1) emissions if they have an existing registered ERF project and whether to retain double counting provisions to prevent a facility from generating both ACCUs and SMCs;
• whether Safeguard facilities should still be allowed to participate in ERF projects that reduce emissions from electricity use (scope 2) emissions; and
• whether international units should be available for compliance under the Safeguard Mechanism at a point in the future when rules for international trading have been settled.

Assessing and protecting emissions-intensive trade-exposed sectors

The Consultation Paper also considers avenues for tailored treatment of EITEs. EITEs are businesses that are affected by carbon pricing and cannot pass through costs of that pricing due to issues of international competition or their market share: these are big emitters often operating in hard to decarbonise sectors who are unlikely to stay below their baselines and are therefore more exposed to the Safeguard Mechanism regime.

In the Consultation Paper, the government proposes how to define EITEs for the purposes of assessing eligibility for ‘tailored’ (concessional) treatment under the Safeguard Mechanism.  The paper then sets out three possible forms of tailored treatment.

In order to assess whether an entity is an EITE and therefore eligible for tailored treatment, the Government proposes a “comparative” approach that assesses whether Australian businesses are disadvantaged compared to international competitors, and aims to ensure no emissions “leakage” overseas.  EITEs could be defined as:

• Trade-exposed: “assessed as a trade share greater than 10 per cent or a demonstrated lack of capacity to pass through costs due to potential for international competition”; and
• Emissions-intensity: based on the “cost intensity” at the facility level, being the “cost per unit or revenue of value added at the facility level”, rather than the emissions intensity. 

The Consultation Paper notes the importance of ensuring that emissions reductions, not increases, are incentivised, and proposes that historical emissions could be used to set a ceiling as to the relevant level of emissions going forward. This would ensure that ceilings are linked to proven emissions data, so that facilities are subject to specific, tailored limits. The paper further proposes that the cost of compliance could be based on ACCU pricing, though this cost could be lowered if a facility had its own, cheaper abatement avenues. EITE classifications would also be reviewed periodically. These approaches ensure there is flexibility in the mechanism to adapt to changes in a facility’s production and revenue, as well as reflecting the impact of declining baselines.

The Government has also indicated that it may, in future, compare EITEs to global competitors’ exposure to carbon pricing, which may detract from the rationale to treat EITEs differently to entities reporting normally under the Safeguard Mechanism. This would likely mean that classification as an EITE becomes harder, given the existence of carbon prices and cap-and-trade regimes in a number of Australia’s global trading partners.

The Consultation Paper proposes three possible forms of special treatment for EITEs:

• Financial assistance to help facilities meet their emissions reduction obligations, which could include grants through the new Powering the Regions Fund or the National Reconstruction Fund, as well as established entities such as the Australian Renewable Energy Agency and Clean Energy Finance Corporation.  Such assistance would be subject to the relevant fund’s grant requirements. This would mean that entities would still need to compete with other applicants for funding.
• Direct assistance to help facilities meet emissions reduction obligations, for instance providing SMCs to facilities.  In order to ensure that abatement is still achieved, the Government would withhold a certain percentage of all SMCs credited under the Safeguard Mechanism.
• Application of differentiated baseline decline rates, which the Consultation Paper notes might initially be most relevant for EITEs just exceeding their baseline that are impacted by costs largely due to the baseline decline rates themselves.  However, this could reduce environmental effectiveness (as emissions are not reduced quickly enough) as well as impacting fairness, as other entities would need to reduce emissions faster.

The Government is now seeking consultation on how best to treat EITEs under the Safeguard Mechanism, including (among other things):

• the appropriateness of a comparative approach built on existing EITE definitions;
• the effectiveness of additional funding opportunities and the kinds of financial or other arrangements that would assist decarbonisation in this space.  In that regard, the Government expressly requests feedback on appropriate design features for the Powering the Regions Fund; and
• whether providing SMCs directly or applying differential baselines is appropriate support for EITEs.

Transitioning to emerging technologies

The Government has recognised that for certain industries, the availability of cost-effective abatement technologies may be delayed and that some form of inter-temporal flexibility may be needed to manage the transition to declining baselines.

The existing concept of multi-year monitoring periods (MYMPs), which currently operate over two or three year periods to manage compliance risks, have been highlighted by the Government as potentially being an appropriate feature of the Safeguard Mechanism to continue, particularly given that some technologies required to decarbonise industries are yet to become commercially viable. MYMPs could be determined on a facility basis and with regard to current and emerging technologies.

However, the Government proposes that MYMPs are only available in certain circumstances, for instance where a facility “reasonably anticipates” that it will be able to reduce its emissions over the MYMP period and, further, that MYMPs would not extend beyond 2030 to ensure that actual emissions reductions are achieved. Given the imperative to reach net zero by 2050, and indeed the growing calls to reach net zero even earlier than that and with less reliance on carbon credits, ensuring that decarbonisation does not occur right at the very end of this time frame is imperative in limiting global warming. Striking the balance between flexibility in the face of technology challenges while also encouraging genuine abatement will be key.

Broader policy issues in the Consultation Paper

Other policy issues considered in the Consultation Paper include:

• what transitional or other arrangements should be in place for site-specific production variables;
• whether oil refinery production variables should remain fixed and not generate SMCs, or become production adjusted and be eligible to generate SMCs;
• whether existing government-defined production variables are suitable for the Safeguard Mechanism;
• whether the inherent emissions variability calculated baseline approach should be removed; and
• in relation to landfills, whether landfill baselines should decline at the same rate as other facilities and should be able to generate SMCs in the transitional implementation phase; and also whether long-term arrangements for landfills should be considered prior to full commencement of Safeguard Mechanism reforms in 2025.

Next steps

Public submissions on the Consultation Paper are due by 20 September 2022. Further feedback will be sought on a more detailed design proposal and proposed changes to subordinate legislation later in the year. The reforms will be implemented through subordinate legislation, including the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (Cth), with some amendments required to be made to the National Greenhouse and Energy Reporting Act 2007 (Cth).

Once finalised, the Safeguard Mechanism reforms are set to take effect from 1 July 2023, with two implementation phases: the first transition phase will commence on 1 July 2023, with changes to take full effect from 1 July 2025. The design of these phases will be informed by the current consultation process.