A baseline-and-credit greenhouse gas emissions system for Australia: Reforms to the Safeguard Mechanism

On 30 March 2023, the Australian Federal Parliament passed the Safeguard Mechanism (Crediting) Amendment Act 2023 (Cth) (Safeguard Act). The Safeguard Act, together with the Federal government's proposed reforms to the design of Australia's safeguard mechanism (Safeguard Mechanism) published in its Position Paper in January 2022, will require large greenhouse gas emitters to reduce their net greenhouse gas emissions under a baseline-and-credit trading system.

The government claims the reformed Safeguard Mechanism will reduce Australia's total greenhouse gas emissions by 205 million tonnes of CO2-e by 2030, but it will have important implications for Australian industrial and resource businesses as they reduce net greenhouse gas emissions. The broader consequences of the reforms on future investment in new resource and hydrocarbon (in particular LNG) projects has already been questioned by key customers of Australian LNG, and will undoubtedly be the topic of much debate to come.

What is the Safeguard Mechanism?

The Safeguard Mechanism was established under the National Greenhouse and Energy Reporting Act 2007 (Cth) (National Reporting Act) and came into force on 1 July 2016.

Under the Safeguard Mechanism, designated large facilities (covered facilities) are those, which emit more than 100,000 tonnes of CO2-e each financial year, and includes mining, gas production and processing, manufacturing, and transport facilities. There are presently 215 covered facilities, accounting for approximately 30 percent of Australia's greenhouse gas emissions. The covered facilities are required to keep their net scope 1 (i.e., direct) emissions of greenhouse gases at or below their emissions baseline, or limit.

The Safeguard Mechanism became a political flashpoint during the 2022 federal election because under the previous federal government, covered facility baselines did not have an emissions reduction trajectory and were often higher than reported emissions. As a result, the Safeguard Mechanism provided limited incentive for covered facilities to reduce their greenhouse gas emissions.

The current federal government's climate change policy has two key components. The first was to legislate more ambitious greenhouse gas emission reduction targets, which was achieved with the Climate Change Act 2022 (Cth) (Climate Change Act). The second was to reform the Safeguard Mechanism by requiring covered facilities to reduce their net greenhouse gas emissions. The Safeguard Act delivers on this second reform, and will be followed by regulations that set out details on the mechanics and operation of the reformed Safeguard Mechanism.

Background to the reforms

In response to its criticisms of the Safeguard Mechanism under the previous government, the current federal government released its "Safeguard Mechanism Reforms Consultation Paper" in September 2022, which called for submissions from industry and the public. Following this consultation process, the government published its Position Paper in January 2023, and tabled the Safeguard Mechanism (Crediting) Amendment Bill in Parliament.

The Bill had a fraught passage through the Federal Parliament as the Opposition parties refused to support it. This meant that in order for the Safeguard Act to pass the Senate, the government required the support of the crossbench and Greens senators. This support was ultimately forthcoming after the government agreed to changes aspects of the proposed reforms.

The key reforms to the Safeguard Mechanism are considered below.

Key reforms to the Safeguard Mechanism

Declining baselines

In its Position Paper, the government announced that most covered facilities will be required to reduce their net greenhouse gas emissions (i.e., their baselines) by 4.9 percent each year until 2030, although value-added manufacturing in hard-to-abate industries may qualify for a discounted decline rate.

The Safeguard Act has 'hardwired' a net greenhouse gas emissions outcome of 100 million tonnes of CO2-e from covered facilities for the financial year commencing 1 July 2029, and a total cap of 1,233 million tonnes of CO2-e for all financial years between 2020 and 2030. If emissions from new or expanded covered facilities threaten the achievement of these outcomes, then under reforms discussed below the Minister for Climate Change will need to report on whether changes to the Safeguard Mechanism would be required.

The overall emission of greenhouse gases from covered facilities after 2030 will continue to decline based on five-year rolling averages toward zero net CO2-e emissions by the 2049 – 2050 financial year.

Baseline calculation methods for existing facilities

The government has committed to retaining the production-adjusted baseline calculation method, by which the baseline of each covered facility grows and falls with production output. However, this left the question of whether baselines should be calculated by industry-average emissions intensity benchmarks to hold all covered facilities making the same product to the same standard, or to set baselines using site-specific emissions-intensity values.

The proposed Safeguard Mechanism reforms adopt a hybrid approach to how baselines are calculated, using a formula that weights site-specific and industry-average emissions intensity values. This weighting will shift over time from site-specific intensity values to industry average emissions intensity values by 2030. This is intended to ensure covered facilities with particularly high emissions compared to their industry standard better align with the industry average.

Baseline calculation methods for new facilities

While not an explicit requirement of the Safeguard Act, the government's Position Paper proposed that all new covered facilities would have their baseline calculation determined using 'international best practice, adapted to the Australian context.' However, in its announcement of the passage of the Safeguard Act the Minister for Climate Change made two very important statements about how international best practice would be applied to new gas projects:

• New gas fields supplying existing liquefied natural gas facilities will be treated as new facilities so that they are given international best practice baselines for the CO2 in their new fields. For these fields' reservoir CO2 emissions, best practice is zero net emissions given the existence of low-CO2 fields and opportunities for carbon capture and storage. This will effectively mean that all CO2 emissions from new gas fields will either need to be avoided or offset through the surrender of Australian Carbon Credit Units (ACCUs) and Safeguard Mechanism Credits (SMCs);
• In relation to the Beetaloo basin in the Northern Territory, all new gas entrants in the basin will be required to have net zero scope 1 emissions from entry.

Safeguard Mechanism Credits (SMCs)

Under the Safeguard Act, SMCs can be issued where a covered facility's total greenhouse gas emissions are below its baseline level. Each tonne of emissions is envisaged to represent one SMC, which may be traded to allow other covered facilities to reduce their net emissions in order to meet their baseline.

This reform is intended to incentivise covered facilities to reduce their emissions by allowing them to generate and trade SMCs, thereby profiting from their emissions reduction actions. This framework is designed to operate consistently with the continued use and treatment of ACCUs in terms of their registration, transfer and reporting.

What happens if a covered facility's emissions exceed the baseline

If a covered facility's greenhouse emissions exceed the baseline, the emitter must procure and surrender ACCUs or SMCs for each excess tonne of CO2-e (noting that an ACCU or SMC represents one tonne of CO2-e). To limit the potential compliance costs, including through possible supply constraints in the ACCU market, the government has committed to an AUD$75 price cap for government-held ACCUs, indexed at two percent each year. The price cap will be reviewed in 2026-27.

The proposed reforms do not permit the use of international carbon credit units, although the government has indicated that, it will consult on amending legislation that enables high integrity international units to be included in the Australian National Registry of Emissions Units and provide a mechanism for such units to be used for compliance at a future time, if warranted.

Under the current statutory regime, if a covered facility's net emissions exceeds the baseline emissions limit during a financial year, the facility is liable for a maximum of 10,000 penalty units. As a penalty unit is AUD$275, the maximum penalty for failing to meet an emissions baseline is AUD$2.75million. The Safeguard Act will removes this cap and instead specifies that the number of penalty units will be equal to the difference between the covered facility's total net emissions and their baseline during the period, better reflecting the magnitude of the non-compliance.

Absolute cap on gross greenhouse gas emissions

The Safeguard Mechanism operates on the principle that covered facilities must ensure their net greenhouse gas emissions achieve their baseline. These net emissions encompass the total or gross emissions from the covered facilities, less any offset of all or part of those emissions through the procurement and surrender of ACCUs or SMCs.

The Greens had two primary concerns about this aspect of the government's Safeguard Mechanism reforms. The first was that covered facilities were not sufficiently incentivised to reduce their gross emissions, as they could avoid significant penalties for exceeding their baselines by surrendering ACCUs or SMCs. The second concern was that new covered facilities, or the expansion of existing covered facilities, could result in an increase to the overall greenhouse gas emissions from all covered facilities.

To address these concerns, the Safeguard Act includes an objective that total gross greenhouse gas emissions from covered facilities must continue to decline each year based on calculating the five year rolling average emissions. This reform is accompanied by reforms to the Climate Change Act in which:

• If the Minister for Environment approves a new or expanded covered facility under Commonwealth environmental law and is provided with an estimate of the scope 1 emissions from the approved facility, the Minister must provide the estimate to the Minister for Climate Change, the Climate Change Secretary and the Climate Change Authority. While there is presently no obligation on project proponents to provide such estimates under the Environment Protection and Biodiversity Conservation Act 1999 (Cth) (EPBC Act), the government has indicated that it will require estimates of scope 1 and 2 emissions to be provided under new legislation that is proposed to be tabled in Parliament later this year to replace the EPBC Act;¹
• In its advice to the Minister for Climate Change in preparing the annual climate change statement, the Climate Change Authority must address whether gross and net greenhouse gas emissions from covered facilities are declining consistently and are achieving the numerical targets referred to earlier in this newsletter, having regard to any new or expanded covered facilities and any scope 1 emission estimates provided by the Minister for Environment.
• If gross or net emissions are not declining or if the numerical targets in the Safeguard Act are not being achieved, the Minister for Climate Change’s annual climate change statement must address whether amendments to the Safeguard Mechanism are required to achieve those outcomes.

Strengthening of reporting obligations

The reforms include a requirement to publish the baselines for all covered facilities, their use of ACCUs and SMCs, and methodologies used in generating ACCUs. Where facilities use ACCUs and SMCs to offset for more than 30 per cent of their emissions, the covered facility will be required to provide a report detailing the reasons why more onsite abatement is not being achieved.

Other key initiatives

The government has committed to provide funding to the manufacturing sector and trade-exposed industries of at least AUD$1 billion, through the Powering the Region Fund. This includes AUD$600 million for the Safeguard Transformation Stream to support decarbonisation of trade-exposed facilities and AUD$400 million to support industries, which provide critical inputs to clean energy industries, such as steel, cement and aluminium.

In addition to the Safeguard Mechanism amendments, the Government has stated it will undertake a carbon leakage review to consider the merits of introducing a carbon border adjustment mechanism to protect the competitiveness of trade-exposed industries, which the EU has recently agreed to introduce.

_{1 Nature Positive Plan: Better for the environment, better for business (December 2022), p.14}

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