23 May 2023

A plain English guide to the Safeguard Mechanism and what it could mean for industry in Australia

On March 30, 2023, the Australian parliament passed the Safeguard Mechanism Amendment Act 2023,. This Act, together with the Federal government’s proposed reforms to the design of Australia’s Safeguard Mechanism, will require 219 of the largest greenhouse gas emitting facilities in Australia to reduce their net greenhouse gas emissions by approximately 5% a year to help us meet our 2030 emissions reductions target (43 per cent below 2005 historic emissions levels).

The government is confident that the reformed Safeguard Mechanism will reduce Australia’s total greenhouse gas emissions by a substantial 205 million tonnes by 2030. However, these changes will also have important implications for Australian industrial and resource businesses as they now have a concrete and ongoing incentive to avoid and reduce future emissions (you can read an earlier background article on the Safeguard Mechanism here).

What is the Safeguard Mechanism and who does it apply to?

To better understand the Safeguard Mechanism, it’s worth noting that it was established under the National Greenhouse and Energy Reporting Act 2007, which came into effect in July 2016. The mechanism targets high emitting facilities, known as “covered facilities,” that emit over 100,000 tonnes of CO2-e each financial year. These facilities include mining, gas production and processing, manufacturing, transport facilities, and other types of facilities, which account for approximately 30 percent of Australia’s greenhouse gas emissions. Covered facilities are required to keep their net ‘scope 1’ (direct) emissions of greenhouse gases at or below their emissions baseline or limit. If a facility’s direct emissions exceed their set baseline, the facility operator is required to offset the excess emissions by purchasing and surrendering Australian Carbon Credit Units (ACCUs, ‘Australian carbon offsets’ ) or Safeguard Mechanism Credits (SMCs).

The Safeguard Mechanism became a contentious topic during the 2022 federal election, as under the previous government, covered facility baselines were not ratcheted down over time to incentivise yearly emissions reductions. This resulted in facilities’ baselines often being excessively lenient, sometimes even higher than reported emissions, resulting in a net increase in emissions from covered facilities. As a result, the mechanism did little to put Australia on a path towards meeting our national emissions reduction targets.

The government initiated a consultation into the reforms in September 2022. Industry and the public provided submissions – TEM contributed our perspectives to this process. Following on from the feedback, the government published its Position Paper in January 2023, and the Safeguard Mechanism Amendment Bill was then tabled in Parliament on March 30th, 2023. The details of the Bill were rigorously debated, and it ultimately passed with support from the crossbench and Greens senators after the government agreed to changes to aspects of the proposed reforms.

The Key Reforms to the Safeguard Mechanism

The reforms to the Safeguard Mechanism will be brought into effect on 1 July 2023. A key reform is the introduction of declining baselines, where most covered facilities will be required to reduce their net greenhouse gas emissions by 4.9 percent each year until 2030. Which is the equivalent of taking 2/3rds of the nation’s cars of the road for the same period.

The mechanism’s baseline calculation methods have been reformed for both existing and new facilities, with a hybrid approach that uses a formula weighting site-specific and industry-average emissions intensity values. The weighting will shift over time from site-specific intensity values to industry-average emissions intensity.

If you are wondering what this actually means, a site-specific emissions intensity value is calculated based on how much a facility has emitted in the past. This means that the emissions baseline is tailored to the specific emissions profile of the facility, taking into account factors such as the type of equipment used and the efficiency of operations.

In contrast, an industry-average emissions intensity value is based on the average emissions intensity of all facilities within the same industry sector in Australia. This means that all facilities within the same industry sector will have the same baseline, regardless of their individual emissions profiles.

The advantage of using a site-specific emissions intensity value is that it provides a more accurate reflection of a facility’s actual emissions profile, and can incentivise individual facilities to improve their emissions intensity. However, it can also be more complex and time-consuming to calculate.

On the other hand, using an industry-average emissions intensity value can simplify the process of setting baselines, but it may not reflect the emissions profile of individual facilities as accurately, potentially leading to either over- or under-regulation. This is why the government has gone for a formula combining the two methods of emissions calculations.

Safeguard Mechanism Credits (SMCs)

A second key reform that will be introduced to the scheme is the ability for covered facilities to generate Safeguard Mechanism Credits (SMCs). These credits will be awarded to facilities that reduce their direct emissions on site, below their baseline levels. They are similar to a carbon credit in that they equate to one tonne of CO2 equivalent that has not made it into the atmosphere. The key differences are that SMCs represent emissions that have been avoided at the facilities themselves, and they can only be traded between companies within the Safeguard Mechanism. SMCs won’t be able to be sold or traded on the open market, unlike ACCUs.

To assess if a facility is eligible to receive SMCs, the Clean Energy Regulator will essentially do two things:

  1. First, they will compare the facility’s actual greenhouse gas emissions for a financial year with the facility’s baseline emissions limit (which is set by the government as explained in the previous section).
  2. Second, they will look at the number of Australian Carbon Credit Units (ACCUs) that the facility has surrendered to the government that year to offset their emissions.
  3. If the facility’s actual emissions are below their baseline limit and they did not surrender any ACCUs, then they are eligible to receive SMCs for the difference between their actual emissions and their baseline limit. Put simply, if they emit less than their baseline, and don’t need to use offsets, they can earn SMCs

What happens if a facility generates more emissions than its prescribed baseline

If a facility generates more emissions that its baseline, then the company that owns the facility has a couple of options.

  1. If the company fails to take action, they will face a fine. According to the current legal requirements, if a covered facility exceeds the baseline emissions limit in a financial year, they can be fined a maximum of 10,000 penalty units. Each penalty unit is valued at AUD$275, which means that the maximum penalty for exceeding the emissions baseline in any given year is currently AUD$2.75 million. This could go up significantly in the future.
  2. A much safer option is to buy and surrender Australian Carbon Credit Units (ACCUs) or Safeguard Mechanism Credits (SMCs) for each excess tonne of CO2-e it emits, with each ACCU or SMC representing one tonne of CO2-e. By virtue of the fact that both ACCUs and SMCs are limited in number, the price of each of these units will be subject to market supply and demand dynamics. To seek to provide some level of comfort to covered facilities, the government has created a pool of ACCUs that it will put aside for covered facilities to be able to purchase. The price of those units is set at AUD$75 per unit, increasing at 2% plus CPI each year. This pool of ACCUs is known as the cost containment measure, and its settings will be reviewed in 2026-27. Companies can also source ACCUs from the secondary market, and it must be noted that this $75 price does not impose a price celling on the whole ACCU market – it only applies to ACCUs owned by the government that have been put aside to sell to safeguard covered companies. There is a possibility that government-held ACCUs become sold out, and that the market price for high quality ACCUs climbs much higher than $75.

At this stage, the proposed reforms don’t allow for the use of international carbon credit units. Nonetheless, the government plans to consult on amending the legislation to include high-integrity international units in the Safeguard scheme, enabling their use for compliance in the future if deemed necessary. They would likely need to meet very strict quality and integrity standards equivalent to those applied to the Australian ACCU market.

Input from the Greens

The Greens had two primary concerns regarding the Labor Government’s Safeguard Mechanism reforms. Firstly, covered facilities were not sufficiently incentivised to reduce their gross emissions. Secondly, new facilities entering into the scheme, or the expansion of existing covered facilities, could result in an increase in 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. A five year rolling average is a simple  calculation that smooths out fluctuations in data over a period of five years by taking the average of the data from the current year and the previous four years. This helps to provide a better understanding of trends and patterns in the data over time.

The changes driven by the Greens include updates to the Climate Change Act that make it harder to initiate new oil, gas and coal projects. Under the new rules, if the Minister for the Environment approves a new hydrocarbon project or a project the they know will produce a large amount of emissions, they will need to provide an estimate of these emissions to  the Minister for Climate Change, the Climate Change Secretary, and the Climate Change Authority – all of whom will be part of the decision making process of approving or rejecting new high emissions projects.

As part of the reforms, the Climate Change Authority must advise the Minister for Climate Change on whether greenhouse gas emissions from covered facilities are consistently declining and meeting the set targets. If the emissions are not declining as they are supposed to and not meeting agreed targets, then the Safeguard Act itself will be revised to create a stricter and more effective set of rules that are more likely to achieve large scale emissions reductions.

The changes also require all covered facilities to publish their baselines, methodologies, and use of ACCUs and SMCs. If a facility uses more than 30% of ACCUs to offset their emissions, they must explain why they’re not reducing their emissions onsite. It’s unclear if there will be any penalties for this but it sends a signal that the government – and the public – will be watching more closely than in the past.

What does all this mean for industry in Australia?

The strengthening of Australia’s Safeguard Mechanism will have a significant impact on the mining and energy generation sectors in Australia. It also sends a strong signal to the Australian economy more broadly. The message is, you can no longer emit for free and whilst the first to pay will be Australia’s largest emitters, it is possible that this legislation opens the door for wider-spread emissions legislation gradually covering the rest of Australia’s economy.

The hard-to-abate industries such as cement, steel and aluminum will feel the pressure of the new legislation in the most immediate way. Technological solutions to abate these sectors are dramatically expensive at present. Whilst the cost of technologies for synthetic fuels, biofuels and hydrogen are likely to go down as innovation and scale ramp up, they still require companies to make large investment of capital and human resources over a long-time horizon. For example, cement manufacturers have invested in energy efficiency and alternative fuels, but longer-term options which offer a scalable solution, such as replacing natural gas with green hydrogen and implementing carbon capture and storage (CCS) are unlikely to become viable before 2030.

The mining industry has several options available to reduce its carbon footprint. One option is to transition to electric or hybrid vehicles at mine sites. Demand for these solutions will be high. It will likely drive rapid innovation in a sector that is intrinsically linked to our ability to achieve a decarbonised economy at scale and within a short enough timeframe to avert a climate disaster.

Additionally, mining companies can implement clean energy and land sequestration projects, which can help offset their carbon emissions. These can be implemented on site where they have sufficient underutilised land. They can also be implemented as part of joint-ventures with carbon project developers such as TEM. This is a particularly attractive option in the immediate term, as reducing emissions at existing open-cut mines can be more challenging, and further research and feasibility studies are needed to identify and develop effective solutions.

Similarly, the natural gas and LNG production industries have several options for reducing their emissions, such as investing in best-practice technologies, reducing gas leaks, and electrifying equipment. Some gas companies have confirmed that they have carbon capture and storage (CCS) technology ready to help reduce emissions. CCS technology can be prohibitively expensive, and is yet to be proven economically and environmentally feasible at scale. Here at TEM we have a strong preference for nature-based solutions to climate change. Nature-based solutions such as reforestation, avoiding land clearing, protecting coastal ecosystems, and Indigenous led savannah burning projects have an inherent twin-benefit in that they simultaneously address climate change and the catastrophic global decline in biodiversity. This twin global peril has historically often been overlooked in our push towards Net Zero emissions. Over recent years, the shift towards addressing both challenges simultaneously has gained significant traction.

Some mining and resource companies are already taking significant steps towards Net Zero. First movers are reaping the rewards, either through taking advantage of new business opportunities, or mitigating their emerging risks – or both. Fortunately, most are now recognising the importance of a decarbonising economy as a business opportunity. In anticipation of increased demand for carbon credits, some companies are investing in large portfolios of high-quality credits while they are still affordable.

The role of offsets

For almost all companies, carbon offsets are a crucial component of a sophisticated net zero strategy. They will inevitably become a core component of the industrial, mining and energy sector’s ability to meet the compliance requirements under the changes to the Safeguard Mechanism. Managing your organisation’s exposure to the dynamic nature of the carbon market is recommended as part of your decarbonisation strategy. This requires having a plan in place to mitigate price increases and market liquidity constraints. As TEM’s Partnerships Manager for Mining, Resources and Energy, I can connect your company with some of the best carbon offsets available on the Australian and international markets as well as to custom project development and Joint Venture opportunities. To understand how TEM can assist with this important transition towards a sustainable future, get in contact with me directly: info@tem.com.au.

Important information

This information has been prepared by Tasman Environmental Markets Australia Pty Ltd (TEM), a corporate authorised representative (ABN 97 659 245 011, CAR 001297708) of TEM Financial Services Pty Limited (ABN 58 142 268 479, AFSL 430036). This material is for general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation, or needs. While we believe that the material is correct, no warranty of accuracy, reliability, or completeness is given, except for liability under statute which can’t be excluded. Before making an investment decision, you should first consider if the information is appropriate for your circumstances and seek professional financial advice. Please note past performance is not a guarantee of future performance.