02 Sep 2021

Your feedback sought on unique crediting arrangement for Australia’s largest greenhouse gas emitters

By Kathryn Pacey, Brendan Bateman and Olivia Back

Facilities with direct greenhouse gas (GHG) emissions (Scope 1 emissions) of more than 100,000 tonnes a year covered by the Safeguard Mechanism (such as those in the industrial, manufacturing, transport, mining, oil and gas sectors) contribute significantly to Australia's total GHG emissions, so more options to reduce emissions in those sectors are a major priority in the transition to a net-zero economy.

We're now moving a step closer to this; a new discussion paper from the Department of Industry, Science, Energy and Resources is seeking stakeholder input on the design of the King Review-recommended Safeguard Crediting Mechanism, which could give them the opportunity to generate a different type of carbon credit to the Australian carbon credit unit (ACCU).

The King Review's recommendation to promote "transformative abatement projects"

In 2020, an expert panel appointed in 2019 by the Minister for Energy and Emissions Reductions, chaired by Grant King, recommended that the Federal Government establish a "below-baseline crediting arrangement" specific to large facilities with Scope 1 emissions of more than 100,000 tonnes a year.

The King Review recommended an arrangement that incentivises these facilities finding new, innovative ways of reducing their Scope 1 emissions. Facilities which reduced their emissions intensity by undertaking "transformative abatement projects" would receive credits. Instead of functioning as an offset scheme, this arrangement would be a "low-emissions technology deployment incentive scheme" which would encourage the realisation of abatement opportunities in industrial facilities that are not currently being accessed under the Emissions Reduction Fund (ERF).

The Federal Government accepted the King Review's recommendation, and committed to undertake further consultation on the mechanism's design and implementation arrangements. It then allocated $279.9 million from the 2021-22 Budget to establishing the crediting mechanism and supporting investment in transformative abatement and emissions reduction projects.

The current Safeguard Mechanism and the proposed Safeguard Crediting Mechanism

The Safeguard Mechanism, as it currently operates, provides a framework for these large facilities to measure, report and manage their GHG emissions. It is intended to ensure that these facilities keep their emissions at or below emissions baselines which are set by the Clean Energy Regulator. The reality however is that the Safeguard Mechanism generally permits generous baselines such that emissions from covered industrial (ie. non-grid connected electricity) facilities have in fact increased. The mechanism has also been criticised for making no contribution to achieving Australia's current 26-28% emission reduction target.

It is envisioned that the Safeguard Crediting Mechanism would build upon the Safeguard Mechanism architecture, including (amongst other pieces of legislation) the National Greenhouse and Energy Reporting Act 2007 and the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015. Amendments would be required to the legislation to implement the new Safeguard Crediting Mechanism.

As a policy instrument, the Safeguard Mechanism is neither a stick nor a carrot – it just exists. However, the proposal to establish a crediting element may provide an incentive for covered facilities to take advantage of abatement opportunities.

According to the discussion paper, the Safeguard Crediting Mechanism would be comprised of a crediting element and a purchasing element. Facilities would receive Safeguard Mechanism Credits (SMCs) for successfully reducing the emissions intensity of their operations and these SMCs could be purchased by the Government or private entities.

The design of the Safeguard Crediting Mechanism

The discussion paper seeks input on the design of several elements of the Safeguard Crediting Mechanism and provides a high-level overview of the options that have been considered by the Government and the Government's preferences.

A pilot phase

A pilot phase would gauge enthusiasm for SMCs. According to the discussion paper, the Government's preference is to start the pilot phase on 1 July 2022, which could run for 2 or 3 years.

Design options for crediting

The largest amount of stakeholder input is sought in relation to the design options for crediting.

Under the Safeguard Crediting Mechanism, the credits a facility would receive would be determined by crediting reductions in emissions intensity. This means that credits would be issued for "cleaner production, not for simply reducing output".

Facilities would be credited for their abatement efforts, relative to a new reference level based on historical emissions intensity performance and not the facility's existing baseline. 

The Government's preference is for abatement to be calculated with reference to historical data (ie. the data before the emissions reduction activity takes place) and using a past fixed year or years to set a reference emissions intensity level (as opposed to, for example, using the most recent year).

In relation to new facilities, which inevitably lack historical date, to avoid crediting "business as usual" outcomes, the discussion paper suggests that a reference emissions intensity for a new facility could be more stringent than the emissions intensity used to set the facility’s safeguard baseline. The discussion paper also invites views on whether new facilities should have access to this new mechanism.

Another topic discussed in the paper is the length of the crediting period. The crediting periods used in the ERF generally have a 7 year crediting period. The discussion paper suggests that shorter crediting periods may be suitable for this mechanism because "industrial sector projects could be expected to have commercial benefits and shorter pay back periods than, for example, land sector projects which deliver strong environmental outcomes, but may have little or no commercial value". Adopting a shorter crediting period however could reduce the incentive to participate if significant upfront capital investment is needed.

The Government's preference is to introduce a 5 year crediting period for the pilot phase, to be reviewed and adjusted if necessary. 

Lastly, the discussion paper notes that abatement projects would not be able to be registered as both an ERF project and below-baseline crediting project. 

Promoting programme integrity and ensuring only genuine abatement is credited

An issue flagged in the discussion paper is achieving the balance of ensuring that the framework will promote integrity and allow for genuine abatement to be credited whilst encouraging participation.

Several design elements are put forward to promote integrity:

  • Discounting or use of a buffer: the discussion paper suggests crediting only a portion of calculated emissions reductions could help to address uncertainty regarding whether emissions reductions would have taken place anyway. Adopting a percentage buffer such as 95-95% would, it is suggested, make the final reference level more conservative. An alternative approach is to directly apply a discount to the abatement generated rather than to the reference level.
  • Transformation statements: these statements could require businesses to explain what actions they have taken to reduce emissions and how they were transformative. These statements would allow for transparency and provide information to the market. The King Review suggested that participants could be subject to a duty of utmost good faith when making the statements.

Time limits: there could be time limits on the use of SMCs, for example for Safeguard compliance purposes.

Design option for purchasing

The Government would purchase SMCs and will do so through a new arrangement under the Climate Solutions Fund. It is unclear if such a purchasing regime would operate similar to the ERF through the reverse auction process.

The discussion paper also notes that SMCs could be specified as prescribed carbon units, like ACCUs under the NGER Act. This would mean that facilities covered by the Safeguard Mechanism could surrender SMCs to help meet their compliance obligations.

Lastly, SCMs could be purchased by private entities. The discussion paper notes: "[I]t is likely that there will be demand for SMCs from the voluntary market. The level of demand from the voluntary market is likely to be influenced by the crediting mechanism's design settings"

Design issues

The Grattan Institute coincidentally released on the same day as the Government's discussion paper its own recommendations for how the Safeguard Mechanism could be adjusted to produce more effective emissions reductions ('Towards net zero: Practical policies to reduce industrial emissions').

The report noted that the industrial sector is responsible for 30% of Australia's emissions, of which 80% comes from just 194 facilities. Reducing emissions from these facilities will be critical to achieving significant emission reductions consistent with the goals of the Paris Agreement.

In addition to a number of initiatives to encourage emissions reduction in the industrial sectors, the Grattan Institute recommended that the existing Safeguard Mechanism be modified and extended, to provide the right signals to inform investment decisions. Existing facilities would be provided incentives to reduce emissions by adopting currently available technologies, and new facilities would be required to meet more stringent benchmarks. One incentive proposed is a below-baseline crediting scheme similar to that proposed in the discussion paper. However, in order for such a crediting scheme to work, other changes would be required, including:

  • amending baselines under the Safeguard Mechanism to reflect actual emissions of facilities;
  • reducing baselines over time to a trajectory that contributes to achieving emission reduction targets, without exemptions;
  • new facilities being required to adopt emissions intensity benchmarks substantially lower than industry average benchmarks;
  • enforce consequences for breaching baselines - this would likely generate demand for below baseline credits.

The proposal to enable covered facilities to generate SMCs has also been criticised as creating a second rate credit compared to ACCUs, where the threshold to demonstrate genuine abatement is likely to be less strict. There is significant concern that if not properly designed, the crediting mechanism could undermine the integrity of the existing Australian carbon market. The fact that there has been very low interest by industry to use existing industrial and energy efficiency facility methods under the ERF, which could generate ACCUs, would suggest that the bar will have to be set lower if industry is to be encouraged to implement emission reduction projects.

Next steps

Submissions on the proposed Safeguard Crediting Mechanism close on 5 October 2021.

The Department plans to then develop an exposure draft of the subordinate legislation needed to implement the crediting mechanism, which it would also seek stakeholder input on.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.