Carbon emissions: final legislative rules for the Safeguard Mechanism
On 1 July 2023, Australia’s Safeguard Mechanism reforms commence the setting of limits on net greenhouse gas emissions. The Federal Government recently released the detailed legislative rules implementing the reforms through three sets of rules, namely:
- National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023 (the Safeguard Amendment Rules);
- Carbon Credits (Carbon Farming Initiative) Amendment (No. 2) Rules 2023; and
- Australian National Registry of Emissions Units Rules 2023.
This article provides a high-level overview of the final Safeguard Mechanism reform package and discusses preparatory steps that corporations should consider taking to ensure compliance with the revised Safeguard Mechanism going forward.
Baselines & targets
The Safeguard Mechanism involves setting emissions baselines for designated large facilities emitting more than 100,000 tonnes of carbon dioxide equivalent each financial year (Covered Facilities).
Baseline decline rate
Under the Safeguard Mechanism, baselines are ratcheted down over time with the aim of achieving Australia’s target of 43% emissions reduction from 2005 levels by 2030. The baseline decline rate is 4.9% each year to 2030.1 Certain eligible emissions intensive trade exposed facilities will be able to apply for a reduced baseline decline rate, which we discuss below.
As noted in our previous article, a hard cap on overall net carbon emissions through to 2030 is now part of the package. If emissions from new or expanded Covered Facilities threaten the hard cap, then the Minster for Climate Change will report on whether changes to the Safeguard Mechanism are required, and it is possible that the baseline decline rate may change.
Existing covered facilities
The Safeguard Amendment Rules retain the existing concept of the ‘production-adjusted’ baseline for existing facilities, ie the baseline for a Covered Facility grows and falls with production output (thereby not penalising increased emissions resulting from economic growth).
The question remains whether the underlying baseline for a facility was to be based on ‘facility-specific’ benchmarks (accounting for facility-specific issues), or ‘industry-average’ benchmarks (holding all Covered Facilities making the same product to the same standard). The Safeguard Amendment Rules adopt a ‘hybrid’ approach. This means that Covered Facilities will be assessed on ‘facility-specific’ benchmarks from 1 July 2023, but over time the assessment weighting will transition increasingly to ‘industry-average’ benchmarks. The intention is to encourage Covered Facilities with high emissions compared to the industry average to align emissions with the industry average by 2030.
Emitters must apply to the Clean Energy Regulator (CER) by 30 April 2024 for an emissions intensity determination for each Covered Facility for FY2023/2024, which feeds into the establishment of the Covered Facility’s baseline.2
The Government will finalise and publish industry average emissions intensity values at a later date.
New covered facilities
New Covered Facilities are likely to be subject to more stringent baseline requirements.
Section 11 of the Safeguard Amendment Rules requires new facilities to adopt “best practice emissions intensity”.3 The Safeguard Amendment Rules do not define “best practice emissions intensity” for a new facility (except for new gas fields where the value is zero).
Where a best practice emissions intensity value for a production variable has not been set, the emitter will need to apply the default value for the Covered Facility.4 The Government will likely consider the approaches taken in other overseas jurisdictions and consult with the relevant industry to determine the “best practice emissions intensity number”.
Provisions relevant to the gas industry
As noted in our previous article, the Government has imposed a requirement that all new gas fields supplying existing LNG facilities must have ‘zero reservoir carbon’ during development.5
Relevant to the oil and gas industry, it is also notable that the reforms require methane and nitrous oxide emissions to be publicly reported. The Government is asking the Climate Change Authority to look at updating methane measurement, verification and reporting and implement any improvements by 1 July 2024 where practicable.
Flexible compliance arrangements
Banking & borrowing arrangements
Covered Facilities will automatically generate Safeguard Mechanism Credits (SMC) for emissions that are below the baseline, with the exception of landfills and facilities accessing borrowing arrangements or deemed surrender arrangements.7 Up to 2030, Covered Facilities will be entitled to unlimited banking of SMC, in addition to being able to trade those SMC with other Covered Facilities.
Covered Facilities can borrow up to 10% of their baseline each year until 2030. A 10% ‘interest rate’ is applied to the borrowed SMC, except for in the first two years of the scheme, during which the ‘interest rate’ is only 2%.8
The Safeguard Amendment Rules also allow multi-year monitoring periods, for use where a Covered Facility exceeds its baseline due to a lack of available technology but has a firm and credible plan in place to reduce cumulative emissions. Multi-year monitoring periods can be up to five years long, ending no later than 2030. The CER will be able to reduce a multi-year monitoring period where the plan is not being properly implemented.
The Safeguard Amendment Rules clarify that a facility cannot rely on both borrowed SMCs and a multi-year monitoring period.9
Covered Facilities have continued access to domestic offsets (carbon credits) to meet Safeguard Mechanism obligations. Government-held carbon credits will be available for purchase at a fixed (not capped, as has been reported elsewhere) price of $75 per carbon credit (indexed from 1 July 2024 by reference to CPI plus 2%) – the intention being to assist to provide certainty to responsible emitters as to maximum compliance costs.
Importantly, as identified in our previous article, emitters will be required to justify their use of offsets if they use offsets for more than 30% of a Covered Facility baseline.10 They will need to provide the CER with a written explanation of why more carbon abatement was not undertaken at the facility during the period.11 Additional information includes whether there were limitations in available technologies that affected the level of carbon abatement undertaken, barriers, including regulatory barriers, to undertaking carbon abatement, and identifying future opportunities for carbon abatement.12 The written explanation will be published on the CER’s website.
At this stage, the Government is not allowing use of international offsets as part of the reforms. However, the Government has indicated it intends to consult in late 2023 on potentially establishing a legislative framework allowing use of high-quality international offsets and this may form part of a future reform package.
Tailored treatment for emission-intensive, trade-exposed (EITE) businesses
There are two types of categories of EITE facilities:
- Trade Exposed facilities, which will include all facilities whose main production variable is trade exposed; and
- Trade Exposed Baseline Adjusted (TEBA) facilities, which are a subset of trade-exposed facilities facing an elevated risk of carbon leakage.
Emitters for TEBA facilities can apply to the CER for a discounted decline rate based on a scheme impact metric which varies depending on whether the facility is a manufacturing or non-manufacturing facility. Manufacturing facilities will use scheme cost as a percentage of facility EBIT, reflecting the value-added nature of their margins:
- assistance will commence at 3% and the minimum baseline decline rate will be available at 10%; and
- the minimum baseline decline rate will be 1% each year.
Non-manufacturing facilities will use scheme cost as a percentage of facility revenue:
- assistance will commence at 3% and the minimum baseline decline rate will be available at 8%; and
- the minimum baseline decline rate will be 2% each year.
Both types of facilities will also be able access the Powering the Regions Fund (PRF), which will be used to support trade-exposed Covered Facilities invest in low emission technology. Note new or expanding coal and gas facilities are expressly excluded from accessing the PRF.
The Government has indicated that it will commission a review to examine the feasibility of an Australian carbon border adjustment mechanism (CBAM), to address risks of carbon leakage. The review will give particular consideration to a CBAM for the steel and cement sectors (including clinker and lime production).
As noted above, the Government also intends to consult in late 2023 on the possibility for international offsets to be used for Safeguard Mechanism compliance purposes.
More broadly, the Climate Change Authority will review the Safeguard Rules in 2026-2027 to ensure the rules are appropriately calibrated.
Organisations should ensure they are well prepared for, and ready to ensure compliance with, the Safeguard Mechanism reforms as from 1 July 2023.
The table below sets out some issues for consideration:
|Safeguard Mechanism to your facilities||Determine whether the Safeguard Mechanism covers any of your organisation’s facilities (100,000 tonnes of carbon dioxide equivalent (CO2-e) per year). Use the National Greenhouse and Energy Reporting Act 2007 (Cth) definitions of ‘facility’ and ‘operational control’. You should examine the legal structure of your organisation and seek to understand the boundary of your organisation’s facilities and which entity has operational control of each facility.
Note also that bespoke coverage does apply based on the industry your organisation is involved in (eg upstream oil & gas and manufacturing).Even if none of your facilities are covered, you should proactively consider emissions reduction strategies for your operations. You should also actively monitor whether emissions at relevant facilities are likely to increase in future, which could trigger compliance with the Safeguard Mechanism. DLA Piper can assist you in determining whether the Safeguard Mechanism applies to your facilities.
|Obtain an emissions intensity determination for your Covered Facilities||
If your organisation does have Covered Facilities, you must apply to the CER by 30 April 2024 for an emissions intensity determination for those facilities.You should ensure your application is submitted by the deadline, and should develop a timeline in relation to preparing this application as well as assess different scenarios for the emissions intensity determination awarded, including the potential impacts on the facility, budgets etc. DLA Piper can assist you in obtaining an emissions intensity determination.
|Engage with Government and industry bodies on default and best practice emissions intensity matters||
If your organisation does have Covered Facilities, you should also proactively engage with the Department of Climate Change, Energy, the Environment and Water and industry bodies on establishing the default and best practice emission intensities for production variables that are applicable to your facilities and industry.
Consider engaging with the Government on potential future reforms such as establishing a carbon border adjustment mechanism and allowing for the use of international carbon credits under the Safeguard Mechanism. DLA Piper can assist you in your engagement with the Government.
|Plan for onsite abatement||
Emitters will be required to justify their use of offsets if they use offsets for more than 30% of a Covered Facility baseline.
Emitters should be undertaking both long and short-term planning for on-site carbon abatement activities.Planning and budgeting for future projects should also factor in on-site carbon abatement strategies as required. DLA Piper can help formulate your carbon abatement strategies.
|Plan for procurement of carbon credits and/or SMCs||
Consider if you need a procurement strategy for Australian carbon credit units and/or SMCs as a matter of priority.
Are there opportunities at one of your Covered Facilities to generate SMCs for below baseline performance? Is there the possibility for investment into carbon credit projects? Alternatively, consider budgeting for the purchase of carbon credits or SMCs. You might have your commercial, finance and strategy teams model the various implications of these different possibilities.Planning and budgeting for future projects should also factor in carbon credit and SMC procurement strategies as required. DLA Piper can help formulate your carbon credit and SMC procurement strategies.
|Develop compliance strategies
There are significant liabilities associated with a Covered Facility’s net emissions exceeding its baseline during a financial year. A penalty unit is currently $275 and the maximum number of penalty units payable for the offence is equal to the difference between the Covered Facility’s total net emissions and its baseline.
Compliance and legal teams should develop compliance strategies and be actively involved in decisions across the organisation to ensure the Safeguard Mechanism is complied with, and to advise on the potential implications flowing from decisions made.Compliance and legal teams should also run internal training sessions for the management team and certain business units to ensure awareness of the Safeguard Mechanism and its impact on the organisation. DLA Piper can support you with developing relevant compliance strategies.
|Review key contracts||
Check whether the Safeguard Mechanism affects contractual obligations or trigger certain contract provisions, in particular in procurement and supply contracts.
For example, the commencement of the Safeguard Mechanism reforms could give rise to a right to pass through certain costs, raise a price review, change the scope or timing for completion of an obligation (such as a reporting obligation), or even trigger a right to terminate.
Consider pass through of costs both where your company is the 'upstream' party (ie making a supply and potentially seeking to pass on costs) or the 'downstream' party (ie receiving a supply and potentially at risk of having such costs passed through to it).Your legal team should consider the implications of this by reviewing key contracts. If your organisation has a large number of contracts, a sample might be reviewed. DLA Piper can assist you to review your key contracts.
|Incorporate into M&A and due diligence
||Consider the impact of the Safeguard Mechanism on any target business and its operations, and incorporate questions about being directly affected, compliance, information and the flexibility of contracts in any review. DLA Piper can help you understand the impact of the Safeguard Mechanism on a target business and its operations.|
|Evaluate potential opportunities
||Aside from the obvious risks, the Safeguard Mechanism reforms also present opportunities for businesses.
Organisations should be motivated to ‘beat their baselines’ to be able to earn and trade SMCs.The Government is also in the process of finalising the funding rules for the PRF and National Reconstruction Fund. Your business may be eligible to access funding under these arrangements. DLA Piper can keep you updated regarding the proposed reforms.
1 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 32.
2 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, ss 14, 19.
3 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 11(1).
4 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 29.
5 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 35A.
6 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 10(2).
7 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 56.
8 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, ss 47 – 51.
9 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, ss 51.
10 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 72C.
11 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 72C(4)(c).
12 National Greenhouse and Energy Reporting (Safeguard Mechanism) Amendment (Reforms) Rules 2023, s 72C(b)-(c).