Following the introduction to Parliament of the Safeguard Mechanism (Crediting) Amendment Bill 2022 (Bill) in November last year, on Tuesday, the Federal Government took the next important step toward implementing reforms to the Safeguard Mechanism, publishing the Safeguard Mechanism Reforms Position Paper (Paper) and exposure draft legislative rules that set out detailed design elements of the proposed changes. The package of reforms are expected to take effect in July this year.

The exposure draft National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rule 2023 (Draft Safeguard Amendment Rule) proposes amendments to the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (Safeguard Rule) that will reform fundamental elements of the Safeguard Mechanism, including approaches to setting baselines for covered facilities.

Alongside the Draft Safeguard Amendment Rule, the Government has also released an exposure draft of the Carbon Credits (Carbon Farming Initiative) Amendment (No. 2) Rules 2023 (Draft Carbon Farming Amendment Rule), which will limit the eligibility of emissions reduction projects at Safeguard Mechanism facilities to generate Australian Carbon Credit Units (ACCUs), and exposure draft Australian National Registry of Emissions Units Rules 2023, which will enable trading of Safeguard Mechanism Credits (SMCs) in the Australian National Registry of Emissions Units.    

Together, these draft instruments propose significant changes to the operation of the Safeguard Mechanism, including:

• Imposing a 4.9% per year baseline decline rate for most covered facilities;
• Providing for tailored treatment for Emissions-Intensive, Trade-Exposed (EITE) facilities;
• Allowing the Clean Energy Regulator (Regulator) to issue SMCs to covered facilities that emit below their designated baselines, with SMCs able to be transferred and surrendered for compliance purposes;
• Providing for an array of flexibility arrangements aimed at facilitating compliance with declining baselines, including unlimited ‘banking’ of SMCs until 2030, access to baseline borrowing arrangements, multi-year monitoring periods and the ability for the Commonwealth to sell ACCUs to covered facilities at a fixed price.

Key elements of proposed Safeguard Mechanism reforms in the exposure drafts

In this article, we highlight key elements of the Government’s proposals and what they will mean for covered emitters.

Targets and baselines

The emissions reduction task

Last year, the Federal Government legislated Australia’s commitment to cut emissions by a minimum of 43% below 2005 levels by 2030 and to achieve net zero by 2050. As the Safeguard Mechanism Reform Position Paper notes, the changes in the Draft Safeguard Amendment Rule are aimed at requiring Safeguard Mechanism covered facilities to reduce emissions in a way that results in these facilities contributing their proportional share of the national 2030 target, which has been estimated at approximately 28%.

In effect, this means that in 2030 the target for the Safeguard Mechanism would be, at a maximum, 100 Mt CO2-e. Between 2021 and 2030, the cumulative target would be at a maximum 1,233 Mt CO2-e. If these targets are reached, the Government expects that the Safeguard Mechanism would deliver approximately 205 million tonnes of abatement by 2030 (relative to current trends).

Baseline setting

The framework

Following consultation last year on the appropriate framework for setting facility baselines, which found widespread support among stakeholders for the current production-adjusted framework, proposed amendments to the Safeguard Rule will retain the production-adjusted approach, with the consequence that covered facilities need to improve the emissions intensity of their production in order to comply with their baselines.

Setting baselines for existing facilities

Last year, the Federal Government consulted on whether to set baselines for existing Safeguard Mechanism facilities using benchmark (industry average) emissions-intensity values, using site-specific emissions-intensity values, or a ‘hybrid’ approach combining both elements.

Following consultations, the Draft Safeguard Amendment Rule allows for baselines for existing Safeguard Mechanism facilities to be set using a hybrid approach. According to the Paper, this approach would be initially weighted towards the approach of using site-specific emissions-intensity values and would transition to the use of benchmark (industry average) emissions-intensity values. The Government has highlighted that this hybrid approach aims to give businesses time to prepare for an industry average benchmark approach and allow the short-term impacts of such an approach to be introduced in increments that are manageable.

According to the Paper, all facilities will require both site-specific and industry-average emissions intensity values for all relevant production values, and ‘inherent emissions variability’ criteria will be removed. This signals a significant shift from the current approach to baseline setting, which allows facilities a degree of optionality as to which approach is used.

Facilities will be required to apply for site-specific emissions intensity values by 30 April 2024.

Transition from existing arrangements

By the commencement of the Safeguard Mechanism reforms in mid-2023, most Safeguard Mechanism facilities will already be using production-adjusted baselines, however a small number of facilities will still be in their final year of using a calculated baseline. These entities will need to bring forward their transition to using production-adjusted baselines by one year since fixed and calculated baselines will not be available from the commencement of the Safeguard Mechanism reforms.

When the Safeguard Mechanism reforms commence, it is proposed that all Safeguard Mechanism facilities be required to use production variables determined by the Federal Government, as published in Schedule 2 of the Safeguard Rule. That schedule is not finalised and the Federal Government will consult with business to finalise the remaining production variables as well the associated emissions-intensity values.

Setting baselines for new facilities

Under the Draft Safeguard Amendment Rule, new facility baselines will be based on best practice emissions-intensity benchmarks. Exactly what constitutes best practice emissions-intensity has not yet been determined, but the Paper notes that this will be based on international best practice benchmarks that are adapted for Australian circumstances and that the Government will consult with stakeholders on a framework for determining best practice over coming months. 

The Paper notes that baselines for new Safeguard Mechanism facilities would also be subject to an annual decline rate, in the same way as existing Safeguard Mechanism facilities.

The requirement for new Safeguard Mechanism facilities to use baselines based on best practice emissions-intensity benchmarks would not apply to existing Safeguard Mechanism covered facilities. However, the Paper notes that they will apply to existing Safeguard Mechanism facilities if they start producing new products. In effect, this means that any existing or new facility that for example, invests in new equipment that results in the production of a new product that requires the use of a new production variable, would be subject to a more stringent baseline.

Special rules will apply to determining baselines for new landfill facilities.

Baseline decline rates

Under the Draft Safeguard Amendment Rule, a default decline rate of 4.9% per year will apply to most covered facilities’ baselines every year until 2030. This will be implemented through applying an ‘Emissions Reduction Contribution’ (ERC) to each facility’s baseline each year, with this ERC declining each year at a consistent rate set out in the Draft Safeguard Amendment Rule.

The Paper notes that the proposed default decline rate takes account of the need to build in an emissions budget ‘reserve’ to account for uncertainties such as baselines volumes for new Safeguard Mechanism facilities, production growth, which may, at existing Safeguard Mechanism facilities, be higher than expected, and differentiation of decline rates among EITE facilities which we discuss below.

Post-2030 decline rates will be set in five-year blocks, with the rates for 2031-35 to be subject to consultation in 2026-27 following submission of Australia’s updated Nationally Determined Contribution under the Paris Agreement.

Tailored treatment for EITE businesses

The Draft Safeguard Amendment Rule provides for tailored treatment of two types of EITE facilities:

• Trade exposed facilities, which would include all facilities undertaking a trade exposed activity (with production variables for these activities set out in a schedule to the Draft Safeguard Amendment Rule); and
• ‘Trade Exposed Baseline Adjusted facilities’, which are trade-exposed facilities that face an increased risk of carbon leakage. Responsible emitters will be able to apply to the Regulator for a determination that their facility classifies as a ‘Trade Exposed Baseline Adjusted facilities’.

With respect to Trade Exposed Baseline Adjusted facilities, and facilities that have been EITE baseline-adjusted facilities in previous financial years, the Draft Safeguard Amendment Rule provides for these facilities to be subject to tailored decline rates, according to formula that will be set out in the Safeguard Rule. 

The Draft Safeguard Amendment Rule allows responsible emitters to apply to the Regulator for their facility to be classified as a ‘Trade Exposed Baseline Adjusted facility’ for a particular financial year and the following two financial years. The Amendment Rule prescribes the types of information that these applications must include, including a requirement that they be accompanied by a safeguard audit report.

Facilities which successfully apply to be classified as Trade Exposed Baseline Adjusted facilities will be subject to a discounted baseline decline rate, which will be a minimum of 2% every year. Decline rates for these facilities will take account of cost impacts for the facility, according to formula that will be contained in the Safeguard Rule. Cost impacts will include considerations of the cost of carbon credits.

Importantly, the Paper proposes that all EITEs would be able to access a $600 million Safeguard Transformation Stream of the Powering the Regions Fund (PRF). The PRF would be a program linked to the Safeguard Mechanism that would provide funding opportunities for on-site decarbonisation activities of EITEs. Some EITEs would also have access to other PRF streams.

Flexible compliance arrangements

In addition to tailored treatment for EITE facilities, the Draft Safeguard Amendment Rule envisages an array of flexibility mechanisms aimed at assisting covered entities to comply with the declining baselines. Key arrangements include:

• Multi-year monitoring periods to account for emerging technologies – Importantly, the Draft Safeguard Amendment Rule enables facilities to apply to the Regulator for multi-year monitoring periods of up to five years in length, provided that these will not continue after 30 June 2030. The Draft Safeguard Amendment Rule introduces a requirement for emitters who apply for a multi-year period to formulate a plan that sets out a credible basis for how the facility will utilise technology to reduce the facility’s covered emissions below the facility’s baseline emissions number for the declared multi-year period.
• Borrowing – the Amendment Rule introduces a mechanism that allows responsible emitters to apply for a ‘borrowing adjustment determination’ for a particular financial year. Successful applicants may ‘borrow’ up to 10% of a facility’s baseline each year until 2030, with a 10% interest rate applied during the year following the borrowing event.
• Safeguard Mechanism Credits to be issued for below-baseline emissions – the Draft Safeguard Amendment Rule sets out details on how responsible emitters can apply for issuance of SMCs when their facilities emit below their designated baselines, and how the number of SMCs to be issued to a facility is calculated. These changes compliment the changes proposed in the Bill, which provide for the issuance, transfer and surrender of SMCs, and was introduced into Parliament last year. The Draft Safeguard Amendment Rule effectively provides for automatic issuance of SMCs to most covered facilities who emit below their baselines. There will, however, be some facilities which are ineligible for SMC issuance, including landfills, Safeguard Mechanism facilities accessing borrowing arrangements (when these arrangements cause an increase to the facility’s baseline), facilities subject to deemed surrender provisions, and facilities with multi-year monitoring periods. Facilities which cease to be covered under the Safeguard Mechanism will also be able to generate SMCs for a period of five years after they fall below the 100,000 tonne CO2e coverage threshold.
• Surrender and banking of SMCs – As foreshadowed in earlier consultations, the Draft Safeguard Amendment Rule will allow SMCs to be surrendered by covered facilities to meet compliance obligations (like ACCUs), or alternatively sold to other covered facilities or banked for future use. Significantly, the Paper proposes that unlimited banking of SMCs will be permitted until 2030.
• International Units - While the Draft Safeguard Amendment Rule does not allow for use of international offsets for compliance, the Paper notes that the Government may consider allowing access to high integrity international offsets at some future time and will consult in 2023 on the possibility of establishing the legislative framework for international units.
• Cost containment measure for sale of Commonwealth ACCU holdings – A notable feature of the Bill is the introduction of provisions allowing legislative rules to enable the Commonwealth to transfer ACCUs from its ANREU Account, to provide the Government with flexibility as to how it manages its holdings of ACCUs. Accordingly, the Draft Carbon Farming Amendment Rules specifically allow for the Regulator to sell ACCUs from the Commonwealth’s ANREU Delivery Account to covered facilities for compliance purposes, at a set price of $75 per ACCU, indexed yearly from 1 July 2024 at the consumer price index plus 2%. The Paper envisages that this mechanism will provide a cost containment measure that will prevent excessive costs of compliance.

Emissions Reduction Fund Projects

Consistent with the Government’s position in earlier consultations, the Draft Carbon Farming Amendment Rules will amend the Carbon Credits (Carbon Farming Initiative) Rule 2015 so that projects that reduce emissions covered by the Safeguard Mechanism will no longer be eligible for registration with the Emissions Reduction Fund. Projects that are already registered would be able to generate and sell ACCUs during their existing crediting period, but will not be able to enter new carbon abatement contracts with the Federal Government. The Paper clarifies that Safeguard facilities will still be able to register projects which do not relate to covered emissions, for example, land sector projects and projects that reduce electricity use.

 Additional policy options to address carbon leakage

Outside of the changes proposed in the exposure drafts, the Government has committed to undertaking a review of policy options to address carbon leakage in 2023, including the potential to introduce an Australian carbon border adjustment mechanism, following strong interest in this type of mechanism from stakeholders in earlier phases of the Safeguard Mechanism consultation process.

Next steps in the Safeguard Mechanism reform process

Submissions on the Paper and draft subordinate legislation are due by 24 February 2023, with the Government looking to finalise legislative instruments to implement Safeguard Mechanism reforms by April 2023, so the reforms can commence on 1 July 2023.

Given the strong interest of stakeholders in the Safeguard Mechanism reform process to date, we expect to see a number of submissions on the drafts. In the interim, the Government is also consulting separately on the design of the PRF, with consultation open until 3 February 2023.