Safeguard Mechanism reforms and what you need to know about their impact on new and growing industrial facilities
By Leigh Staines (Partner, Energy Transition) and David To (Senior Manager, Energy Transition)
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The Safeguard Mechanism is a critical element of Australia’s climate policy
As the world becomes increasingly focused on mitigating climate change, governments around the globe are exploring ways to reduce greenhouse gas emissions. In Australia, the Safeguard Mechanism is a critical element of the country's climate policy to meet its recently legislated commitment of reducing national emissions to 43% below 2005 levels by 2030, and achieve its long term goal of net zero emissions by 2050. The Safeguard Mechanism was designed to hold industrial facilities with significant production emissions accountable for their impact on the environment and the economy. In this article, we will explore the origins of the Safeguard Mechanism, the challenges it has faced, proposed reforms, and how these reforms will impact new and growing facilities.
The challenge of balancing economic growth with reducing emissions remains a contentious issue for governments
Climate policy needs to manage a delicate balance between economic growth and emissions reduction. There has been criticism by some experts and advocates that Australia needs to do more to transition to a lower carbon economy. The Safeguard Mechanism was introduced in 2016 following the repeal of the Carbon Pricing Mechanism. Its purpose is to limit Scope 1 greenhouse gas emissions1 from large industrial facilities, primarily those in the mining, manufacturing, and electricity sectors.
The Safeguard Mechanism applies to facilities that emit more than 100,000 tonnes of carbon dioxide equivalent (CO2-e) per year. This currently includes 215 facilities totalling 136 million tonnes per annum of CO2-e, which is 28% of Australia’s total emissions of 487 million tonnes per annum CO2-e in 2020-21.2
The Safeguard Mechanism does not differentiate between projects that contribute to the future Australian economy and those that are likely to be phased out
The purpose of the mechanism is to ensure that emissions from these facilities are capped at a level consistent with Australia's international climate commitments to remain under the 1.5 degree Celsius target stipulated in the Paris Agreement. The Safeguard Mechanism is an essential part of Australia's overall climate policy, and is administered by the Clean Energy Regulator under the National Greenhouse and Energy Reporting Act 2007 (NGER Act). However, the Safeguard Mechanism does not explicitly incentivise projects that contribute to the future Australian economy, such as local production and manufacturing, over those that are likely to be phased out through the energy transition, such as thermal coal power generation. Additional policies may be required to incentivise projects that promote economic growth in Australia.
A focus on reducing Scope 1 can indirectly impact Scope 2 - for better or worse
The mechanism accounts for Scope 1 emissions only, but may indirectly incentivise reductions in Scope 2 emissions as well. For example, a facility that reduces its electricity consumption from the grid as part of its decarbonisation strategy would lower its Scope 2 emissions. However, there are scenarios where Scope 2 emissions may increase as the facilities reduce their Scope 1 emissions. For example, if a facility replaces its on-site fossil fuel combustion with electricity from the grid, this could result in an increase in Scope 2 emissions in the short term if the electricity comes from a fuel source such as coal, before transitioning to renewable sources. Facilities impacted by the Safeguard Mechanism need to also closely monitor the direction of their Scope 2 emissions.
There’s been evolution of the Safeguard Mechanism since its introduction in 2016
Since its introduction in July 2016, the Safeguard Mechanism was amended in March 2019 following an extensive consultation process. Changes were implemented to ensure that large emitting facilities do not exceed their scope 1 emissions baseline. There are currently four approaches to setting emissions baselines3 ranging from historical high points of emissions through to actual production and benchmarked intensity factors. Looking ahead to 2030 and beyond, all facilities will have baselines set by defined industry specific emission intensity factors, in the interim there is likely to still be hybrid approaches to the baseline calculation.
Under the current system, the baselines have not declined year on year in a trajectory towards meeting Australia’s emissions targets. While the intention of the SGM was to decrease emissions from the affected sectors, data has shown that emissions covered by the mechanism have in fact increased by 7% since its inception.4
A consultation period for Safeguard Mechanism policy reform has recently been completed with further changes to the mechanism expected to come into effect in 2023. One of the key proposed changes is that all facilities impacted by the mechanism will now be required to follow a declining emissions trajectory. As to how this, and the other proposed reforms, are specifically implemented is yet to be defined. However, with the proposed legislative amendments to facilitate new Safeguard Mechanism reforms expected to be finalised by July 2023, anyone involved in new or growing facilities should be preparing for change.
Proposed changes to the Safeguard Mechanism mean that all facilities will now be required to follow a declining emissions trajectory. Anyone involved in new or growing facilities should be preparing for change.
The proposed changes have significant impact for new or growing facilities
The Safeguard Mechanism was established as part of the Emissions Reduction Fund to signal to businesses to avoid emissions increases beyond business-as-usual levels. The gap in the design of the mechanism causing a challenge for establishing new facilities, or step change levels of growth in existing manufacturing and heavy industry businesses, is that they are not included within today’s business-as-usual on an absolute basis.
There are a number of ways to set baselines for existing and new facilities. For existing facilities, the baseline will be set as a hybrid of industry average and site-specific emissions intensity values. For new facilities, the baseline will be set according to international best practice emissions intensity numbers, which are yet to be developed. Until there is clarification, this makes investment decisions on which technologies to employ difficult. Lack of investment adds to sovereign risk for Australia if the investment is diverted to other countries with greater clarity on climate policy. Building a facility with the latest and lowest emissions technology may mean tougher compliance targets if the baseline is set at a lower intensity than older higher emissions technologies. Under the Safeguard Mechanism, businesses that exceed their emissions baselines are required to purchase carbon offsets in the form of ACCUs or reduce emissions elsewhere in their operations. Failure to comply with the Safeguard Mechanism can result in financial penalties of $250 per tonne of CO2-e.
To enable facilities to grow production without being penalised requires a production-adjusted framework. A “reserve” has been established in the Safeguard emissions budget to accommodate higher-than-expected production growth at existing and new facilities, as well as the impact of differential decline rates for those that meet the Trade Exposed Baseline Adjusted (TEBA) threshold. For hard-to-abate industries and those classified as Emissions Intensive Trade Exposed (EITE), in addition to a lower decline rate, there will be funding support for new technologies. The critical risk for both global emissions and Australian economic prosperity is carbon leakage, where Australian facilities shut down and move offshore to areas where there is a lower carbon price. These countries often have higher emissions intensity which result in higher global emissions, an unintended consequence of the Safeguard Mechanism. The government has committed to reviewing the EU Carbon Border Adjustment Mechanism and its potential application to Australia.
Impacts on new and growing facilities
New Facilities
The proposed approach is for the baseline to be based on international best practice emissions-intensity benchmarks, adapted for Australian circumstances.
For new facilities, there may be limited decarbonisation options to maintain emissions below the baseline. Flexible compliance options may need to be used for facilities to meet their compliance obligations.
In contrast, for existing facilities, the proposed approach is a hybrid of site-specific intensity and industry average emissions intensity. It is weighted towards site specific baselines in the short term, transitioning to industry-average benchmarks by the 2030.
Growing Facilities
The proposed approach is to retain the production-adjusted framework where the baselines rise and fall annually with production. This allows the focus to be on emissions intensity, where facilities can grow production and remain competitive.
For facilities that meet the emissions intensive trade-exposed test based on a cost impact metric, a differential decline rate is applied to the baseline with the minimum being 2%. This is to support those facilities that face significant scheme impacts and have limited technologies to reduce their emissions, such as the hard to abate sector.
Organisations must have strategies in place to manage their compliance obligations and net zero commitments
A well designed Safeguard Mechanism is absolutely critical to enable Australia to meet its emissions reduction commitments. As Australia and the world moves towards the development of green industries, the key is managing the transition of the existing high-emitting industries towards that objective.
The latest changes to the Safeguard Mechanism will come into effect from July 2023, with revised baselines applying from the 2024-25 financial year. A review will be undertaken in 2026-27 once two years of post-reform data are available.
In conjunction with a well-defined decarbonisation strategy, organisations must begin preparing applications for site-specific emissions intensity values, Emissions-Intensive, Trade-Exposed (EITE) status, and Multi-Year Monitoring Period (MYMP). Technologies that can reduce emissions in the short term and long term will need to be identified or allocated R&D funds. Scenarios of where emissions will exceed the baseline will need to be modelled and the financial impact forecasted. A worst case scenario can be applied as the government-held ACCUs will have a cost containment measure of $75 per tonne CO-e in 2023-24, increasing with CPI plus 2 percent each year.
The latest changes to the Safeguard Mechanism will come into effect from July 2023, with revised baselines applying from the 2024-25 financial year. A review will be undertaken in 2026-27 once two years of post-reform data are available.
A step in the right direction
The latest Safeguard Mechanism reforms take a further step towards future-proofing Australia’s commitment to a net zero target. Collaboration between government, industry and investors will be key in navigating an optimum pathway to balance both emissions and economics.
References
1. Scope 1 greenhouse gas emissions are the emissions released to the atmosphere as a direct result of an activity, or series of activities at a facility level.
2. Safeguard Mechanism Reforms - Position Paper January 2023 - DCCEEW.gov.au
3. https://www.cleanenergyregulator.gov.au/NGER/The-safeguard-mechanism/Baselines
4. RepuTex Energy (2021) The Economic Impact of the ALP’s Powering Australia Plan, https://www.reputex.com/wp-content/uploads/2021/12/REPUTEX_The-economic-impact-of-the-ALPs-Powering-Australia-Plan_Summary-Report-1221-2.pdf
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