Legal development

Federal Government seeks feedback on proposed reforms to Safeguard Mechanism

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    What you need to know

    • The new Federal Labor Government has published its Safeguard Mechanism Reforms Consultation Paper, which sets out its proposals to reform the Safeguard Mechanism to drive emissions reductions from Australia's biggest emitters, in line with Australia's commitment under the Paris Agreement of reducing CO₂-e emissions to 43% below 2005 levels by 2030. 

    • The Consultation Paper is wide reaching and canvasses options to: reset the current baselines to remove existing headroom, consider the pace of baseline reductions over time, allow Safeguard Facilities that have emissions below their baseline to be issued with Safeguard Mechanism Credits that can be traded to other Safeguard Facilities that exceed their baselines and considers options to manage the impacts of the changes on 'emissions-intensive trade-exposed' facilities that have difficulty in passing on costs incurred because of the changes. 

    What you need to do

    • Companies with facilities covered by the Safeguard Mechanism should review the Consultation Paper and evaluate whether they have an emissions reduction strategy that is aligned with any of the proposals set out in the Consultation Paper.

    • Consider making a submission before the consultation period closes on Tuesday 20 September 2022.

    The Consultation Paper

    Part of the Government's wider climate agenda

    The Federal Government's Climate Change Bill 2022 has passed the House of Representatives and is expected to be passed by the Senate later this year.  Once enacted, it will enshrine Australia's commitments under the Paris Agreement to reduce Australia's national CO₂-e emissions to:

    • 43% below 2005 levels by 2030; and
    • net zero by 2050.

    The Powering Australia policy sets out the Government's plan to achieve net zero by 2050. 

    As part of the implementation of that plan, the Federal Government has released its Safeguard Mechanism Reforms Consultation Paper (Consultation Paper), which is open for submissions from industry and the public until 20 September 2022. 

    The Consultation Paper is wide reaching and uses technical language.  Terms that are italicised in this article are used in the same way as they are defined in this helpful Glossary published by the Clean Energy Regulator.

    The policy objective 

    The Consultation Paper considers reforms to the Safeguard Mechanism to achieve a reduction in emissions that is proportionate to contribution made by Safeguard Facilities.

    There are around 215 facilities covered by the Safeguard Mechanism (facilities that emit more than 100,000 CO2-e of scope 1 emissions each year). This group of facilities produces approximately 28% of Australia's CO₂-e emissions in 2020-21 (or 137 Mt out of 489 Mt of CO2-e from Australia's total scope 1 emissions in 2020/2021).

    The Consultation Paper estimates that the aggregate emissions from Safeguard Facilities will need to fall to about 99 Mt CO2-e in 2030, if they are to contribute their proportionate share of Australia's 2030 target. 

    Three key reforms to the Safeguard Mechanism

    The Federal Government is proposing three key changes to the Safeguard Mechanism:

    • reset the current baselines used in the Safeguard Mechanism to remove the headroom available to facilities, and then incrementally reduce them in line with our national targets; 
    • issue SMCs to facilities that emit less than their baseline; and
    • provide tailored treatment to 'emissions-intensive trade-exposed' (EITE) facilities so that they are not unreasonably disadvantaged compared to international competitors and emissions do not increase overseas.

    We discuss these in turn below.

    Reducing baselines gradually over time

    Resetting baselines

    One of the key problems identified by the Consultation Paper is that the aggregate total of all baselines under the Safeguard Mechanism (180 Mt CO₂-e in 2020-21) is significantly higher than the aggregate total of covered emissions (137 Mt CO₂-e) from Safeguard Facilities, and that this headroom is distributed unevenly across facilities covered by the Safeguard Mechanism.  

    The Consultation Paper indicates that baselines need to be reset to remove this aggregate headroom.  To do this, the Government proposes that all baselines will be set by one of the following three possible methods:

    • using default emissions intensity values - which would favour facilities that currently emit below their industry average;
    • using site-specific intensity values – which would increase the costs of setting baselines for facilities compared with  using the default values, but would mean factors that  cause a difference in emissions intensity between two facilities in the same sector would be taken into account; or
    • scaling baselines so that aggregate baselines equal aggregate emissions, which could be done in a uniform way and would benefit facilities that presently have headroom in their current baseline.

    The Government considers it critical that this aggregate baseline headroom is removed to ensure that Safeguard Facilities are incentivised to reduce their emissions below their baseline.  

    Declining baselines

    The Government proposes that baselines will decline over time but notes that the "baseline decline rates" will be finalised once other policy settings have been finalised.  The Government will consider whether the baseline decline rate should:

    • be linear until 2030 or softer pre-2025 and steeper between 2025 and 2030;
    • be consistent across all Safeguard Facilities or softer for some facilities (eg EITE facilities) and steeper for others; and
    • be proportionate for Safeguard Facilities compared with other sectors of the economy.

    How Safeguard Facilities can reduce emissions

    The Government is seeking comments on its proposals to change the way that Safeguard Facilities can reduce their Scope 1 emissions by:

    • Safeguard Mechanism emissions trading - automatically issue Safeguard Mechanism Credits (SMCs) to facilities that emit less than their baseline and which can then be sold to other Safeguard Facilities that exceed their baselines. It is proposed that SMCs can only be surrendered to meet Safeguard Mechanism obligations.  This would effectively create a Safeguard Mechanism emissions trading system. 
    • whether SMC's can be "banked" and "borrowed" – allowing facilities to create and bank SMCs in one year, for use in later years or exceed their baselines in one year, and to satisfy this liability in future years.
    • banning Safeguard Facilities from generating ACCUs – banning facilities from generating ACCUs from new offsets projects because in this case emission reduction projects will be required to meet a  declining baseline (and therefore would not meet additionality requirements under the CFI Act). Facilities could still continue to use ACCUs to manage compliance with the Safeguard Mechanism and generate ACCUs for existing offsets projects.  
    • no use of international credits to reduce emissions – retaining the prohibition on the use of international offsets to reduce emission (although this might be reconsidered in the future).  

    Proposed measures for EITE facilities

    The Consultation Paper seeks feedback on the tailored treatment of EITE industries, being industries that may have higher costs in reducing emissions and are less able to pass on such costs because its product price is set in global markets, such as steel and aluminium producers.  

    The Government proposes assessing EITE eligibility based on:

    • facility-specific emissions intensity; or
    • emissions intensity for each type of activity, based on average emissions at the industry level.

    Initial responses from industry have also been in favour of the facility-specific option, with industry participants warning that if the industry-average approach is adopted, facilities sitting below their industry average would automatically be provided with SMCs for no reduction in emissions, meaning that in practice, SMCs will not necessarily equate to a tonne of actual abatement. 

    In addition, the Government has proposed the following tailored treatments of EITE facilities for consideration:

    • funding to assist facilities in adapting low emissions technology (rather than providing concessions within the Safeguard Mechanism scheme, such as less stringent baseline decline rates);
    • a mechanism whereby the Government reserves a percentage of all SMCs credited under the scheme and provides them to EITE facilities, with the intention of either bringing a facility’s costs down to the concessional treatment threshold or by providing for a percentage of the costs that exceed the concessional treatment threshold; and
    • applying differentiated baseline decline rates for EITE facilities (although the Government acknowledges concerns about the environmental effectiveness and fairness of this approach).

    A key challenge for Government in determining the treatment of EITE facilities is the tension between protecting the international competitiveness or Australian export industries while ensuring that all industries contribute to achieving Australia's emission reduction targets.  

    Next steps

    The Government has ambitiously proposed:

    • the release of an exposure draft of the new Safeguard Mechanism Rule by early December 2022;
    • completing all changes (including legislating any necessary amendments to the National Greenhouse and Energy Reporting Act 2007) by 31 March 2023; and
    • that reforms will take effect from 1 July 2023, starting with a 2-year transition period, and with all changes taking effect from 1 July 2025.

    Before then, though, industry stakeholders are encouraged to make a submission in response to the Consultation Paper.  Submissions close on Tuesday 20 September 2022. 

    We recommend that companies with facilities covered by the Safeguard Mechanism:

    • assess what their proportionate share of meeting Australia's international global emissions reduction target will involve in the period to 2030 and beyond, and evaluate whether they have an emissions reduction strategy that is aligned with achieving this target;
    • consider how the design options provided in the Consultation Paper affect their business, particularly with respect to how the new baselines should be determined and how the proposed SMC mechanism may work in practice;
    • if they are an EITE facility, consider what contribution the facility can reasonably be expected to contribute to emissions reductions and the means by which they may be insulated, at least to some degree, from the impacts of the proposed changes.

    Climate change policy has become a much more active space since the federal election, and industry should expect plenty of commentary about the Consultation Paper in the weeks to come.  We will look at what key commentators are saying about the Government's proposed reforms in a further article next month.

    AuthorsJeff Lynn, Partner; Sophie Westland, Senior Associate; Fergus Calwell, Lawyer; and Alice Jiang, Lawyer.

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.

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