Safeguard Mechanism Credits legislation

In August, the Department of Climate Change, Energy, the Environment and Water released a Consultation Paper outlining its proposed reforms to the Safeguard Mechanism, Australia’s primary instrument for controlling carbon emissions from large industrial emitters which make up approximately 28% of Australia’s direct emissions. A pillar of the proposed reforms was the introduction of tradeable ‘Safeguard Mechanism Credits’ (SMCs) to be issued to facilities covered by the Mechanism whose emissions fall below their designated ‘baseline’ emissions limit. The purpose of introducing SMCs is to allow covered facilities who can more easily reduce their emissions below their baseline to generate credits which they can sell to facilities whose emission reduction options are more costly or limited, thereby incentivising cost-efficient carbon abatement. Our summary of the Government’s Consultation Paper and SMCs can be found in this article 'Safeguard Mechanism reform: consultation paper released for feedback'.

The Government has received approximately 240 submissions from a range of stakeholders across government, community groups and industry and is considering those as it now prepares amendments to the Safeguard Mechanism Rule.  Meanwhile, the Department has released draft legislation which will enable the issuance by the Clean Energy Regulator, transfer and surrender of SMCs. The draft, titled the Safeguard Mechanism (Crediting) Amendment Bill 2022 (Cth) (Draft Bill), and accompanying legislative rule (the Carbon Credits (Carbon Farming Initiative) Amendment (Safeguard Facility Eligibility Requirements) Draft Rules 2022) (Draft Rule) are open for public consultation until 28 October 2022.

This update covers key features of the Draft Bill and Draft Rules, and what we expect to see over coming months as the Government counts down to the Safeguard Mechanism reforms taking effect in mid-2023.  

Key features of the Draft Bill

Safeguard Mechanism Credits to have similar characteristics to ACCUs

The Draft Bill amends the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act) to allow for creation of SMCs, and also to apply the same laws to SMCs about registration, transfers and use for compliance obligations that already apply to Australian Carbon Credit Units (ACCUs). The Bill also make changes to the Australian National Registry of Emissions Units Act 2011 (Cth) (ANREU Act) so that SMCs are treated in the same way as ACCUs in the Australian National Registry of Emissions Units (ANREU). Importantly, the Draft Bill enables legislative rules to prescribe SMCs for the purposes of the definition of ‘eligible international emissions units’ in the ANREU Act, which will have the effect that these units – like ACCUs – are classified as GST-free under relevant tax legislation and also as ‘financial products’ under the Corporations Act 2001.

Use of SMCs for Safeguard Mechanism compliance

The Draft Bill classifies both SMCs and ACCUs as ‘relinquishable units’ that can be used by covered facilities to reduce their emissions for the purposes of complying with their Safeguard Mechanism obligations, and also allows for legislative rules to enable other types of unit to be used for this purpose. Minister for Climate Change and Energy Chris Bowen has made clear, however, that at least for the moment, international units will not be able to be used for Safeguard Mechanism compliance, and that separate legislation would be required to allow for this. The question of whether to allow the use of international units drew strong views from across the spectrum of submitters on the Consultation Paper, with some businesses and industry groups advocating for international credits (for example, Paris Agreement compliant units) to be available for compliance use. Meanwhile, others supported a ban on the use of these units, or for their use only to be considered at a later point should market liquidity become an issue.

Bankability of Safeguard Mechanism Credits

The question of whether SMCs can be ‘banked’ (that is, whether an SMC created in one year can be stored and then surrendered for compliance in a future year), was a key discussion point in the Consultation Paper. One benefit of banking is that it makes it easier for facilities to maintain a supply of compliance SMCs in circumstances where there are fluctuations in their emissions from year to year. However, banking runs the risk of creating future oversupply of SMCs, leading to low prices which can erode market incentives to cut emissions. In the Consultation Paper, the Government had proposed that issuance of SMCs be phased, with Phase 1 operating for 2023-24 and 2024-25, and Phase 2 operating for 2025-26 to 2029-30, and that SMCs could be banked within – but not across – phases. A number of stakeholders who submitted feedback on the Consultation Paper supported banking, although many suggested that this should be in limited circumstances. The Government has not yet reached a decision on whether or how to limit banking. However, by requiring the Regulator to record the financial year vintage of each issued SMC, the Draft Bill reserves the ability for the Government to limit banking of SMCs, for example, by specifying that SMCs issued in certain financial years cannot be surrendered for compliance in future years.

New carbon abatement projects at covered facilities cannot generate ACCUs

A further proposed amendment included in the Draft Bill is to the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) (CFI Act) to allow legislative rules to prevent new carbon abatement projects that reduce covered emissions at Safeguard facilities from eligibility to generate ACCUs: instead, these would be able to generate SMCs. Accordingly, the accompanying Draft Rule prevents new eligible offsets projects from being registered if they reduce covered emissions at a Safeguard facility.

This amendment aligns with the Government’s proposal in the Consultation Paper, but contrasts with submissions from some industry stakeholders, who advocated that whether new Safeguard facility projects can earn ACCUs should be considered on a case-by-case basis. The approach to limiting eligible offsets projects that reduced covered (i.e. scope 1 emissions) at Safeguard facilities would clearly apply to projects that would have sought to use methods such as the facilities method but would not necessarily prevent the carrying out of other types of projects that sit outside the facility boundary.    

Facilities no longer covered can continue generating Safeguard Mechanism Credits

Interestingly, the Draft Bill also introduces legislative amendments that will allow facilities to continue to generate SMCs if they no longer meet the emissions threshold for coverage under the Safeguard Mechanism, so as to continually incentivise emission reductions even as facilities approach the Safeguard Mechanism’s coverage threshold.

Increased transparency

Whereas current legislation only requires the Regulator to publish quarterly information on the total number of ACCUs issued, the Draft Bill imposes additional obligations on the Regulator to publish information about the number of SMCs and ACCUs held in each individual ANREU account every quarter, as well as any additional information that is required by legislative rules. Legislative rules may also provide for accounts to be exempt from this requirement. This change implements a recommendation from the Climate Change Authority to improve the transparency of the carbon credit market.  

Areas for Feedback

The Explanatory Document notes a number of areas where the Government is seeking feedback in respect of the Draft Bill and Draft Rule. These include:

  1. the provisions in Schedule 1 of the Draft Bill relating to the NGER Act and Income Tax Assessment Act 1997 (Cth), which broadly allow for the issuance, transfer and surrender of SMCs, and for their tax treatment to align with that for ACCUs;
  2. the provisions in Schedule 2, which amend the ANREU Act to allow for SMCs to exist in the ANREU;
  3. the provisions in Schedule 3, which change the Clean Energy Regulator Act 2011 (Cth), Clean Energy (Consequential Amendments) Act 2011 (Cth) and NGER Act to address inconsistencies in the frameworks for protecting information under these Acts; and
  4. the provisions in Schedule 4 of the Draft Bill relating to the CFI Act, and the Draft Rule, which introduce changes that prevent carbon abatement projects that reduce covered emissions at Safeguard facilities from generating ACCUs.

Remaining issues for consultation and next steps for Safeguard Mechanism reform

Key aspects of the Government’s proposed Safeguard Mechanism reforms that are not addressed in the Draft Bill or Draft Rule include the mechanism for setting declining baselines and the treatment of emissions-intensive trade-exposed (EITE) businesses: these will be dealt with through amendments to the Safeguard Mechanism Rule, and the Minister has indicated that feedback will be sought on these arrangements later this year. In the meantime, debate among stakeholders on these issues, as well as how future legislative rules should deal with bankability of SMCs and use of international units, is likely to continue.

With respect to timing, in a speech to the Australian Financial Review Climate and Energy Summit on Monday, the Minister indicated that he intends for the Draft Bill to pass in the 2023 Autumn parliamentary sittings, and for the Draft Rule to be finalised by the end of March 2023, so that reforms can take effect from 1 July 2023.

Meanwhile, at the end of last month, the independent review of the integrity of ACCUs closed the submission period for participants’ experiences with the ACCU scheme and views on how the scheme might be improved. The review, led by Professor Ian Chubb, is expected to deliver its report to Government by the end of the year.