Safeguard Mechanism Update
The Australian Government’s Safeguard Mechanism (SGM) is undergoing changes following recent reviews into its effectiveness and political drivers, to better ensure the mechanism reduces Australia’s emissions following the IPCC’s most recent report (AR6). In this article, we explain the changes announced on the 27th of March, 2023.
The SGM applies to facilities emitting over 100,000 tonnes CO2e (scope 1 emissions) in a financial year. It covers a range of industry sectors such as electricity generation, oil & gas, mining, manufacturing, parts of transport, and waste. The overall objective of the SGM scheme is to:
Achieve Australia’s net zero target by 2050;
Keep Australian businesses competitive in the era of decarboniastion; and
Support largest emitters to reduce emissions by introducing credits for facilities that emit less than their baseline.
What is involved in the new SGM reforms?
After negotiations through Parliament, additional reforms have been agreed to come into effect 1 July 2023. These changes are intended to strengthen the ability of the Mechanism to reduce emissions, and will align to achieving Australia’s Paris Agreement Nationally Determined Contribution to reducing emissions. The key changes include:
A hard cap on total emissions – this will constitute an absolute ceiling on actual emissions – it will be set at 140 million tonnes of CO2e, which is the current level of emissions and will decrease over time to 100 million tonnes by 2030
New gas projects will be accountable for onsite emissions from day one – new gas projects for the LNG export market will be required to have net zero CO2 emissions from the first day of operation
New projects that could lead to the SGM emissions ceiling being breached will be subject to a rigorous assessment – the Government will conduct assessments, and may impose project-specific requirements for how emissions are to be dealt with to ensure the carbon budget is not breached
Facilities must genuinely cut emissions, and not rely on offsets – if a facility is using more than 30% offsets to remain under their baselines, the reasoning will need to be explained to the Clean Energy Regulator. While no penalty is proposed at this time, the cost of buying offsets is expected to increase, providing an indirect financial cost to this approach
Public funding through the Powering the Regions Fund will not be directed to coal and gas projects – this $1.9 billion fund to help the transition to net zero, will not be used to decarbonise coal and gas projects
These reforms are predicted to reduce Australia’s emissions by 205 million tCO2e by 2030, which will be key to reducing emissions by 43% by 2030. They build on previously announced reforms to the SGM from earlier in 2023, (previously covered in our article here), which included annually reducing baselines, removing headroom, transitioning to production-adjusted baselines and changes to baseline setting practices, and the introduction of credit trading between facilities.
Productivity Inquiry recommendations and alignment
The Productivity Commission’s Advancing Prosperity report (published prior to the most recent SGM reform announcements), outlined recommendations relating to the SGM in managing the climate transition in economically efficient manner. While the recommendations have been addressed in the recent announcements, there are still some gaps – including:
Defining SGM baselines in absolute emissions terms, rather than emissions intensity terms. Production-adjusted baselines allow for SGM-covered sectors to increase their overall emissions, which would unfairly impose greater absolute abatement on non-covered sectors to meet the absolute national emissions target. Production-adjusted baselines also complicate investment planning, as facility owners need to make long-run output estimates while understanding aggregate emissions reduction pathways. A total emissions ceiling partly addresses this recommendation, but doesn’t address the role of production-adjusted baselines under a hard-cap model. Future guidance may provide more light on this.
The SGM coverage should be expanded to include individual electricity generators and the transport sector, and reducing the facility emissions threshold of 25,000 tCO2e. The argument is that the current ‘sectoral’ treatment of the electricity sector reduces the extent that low emissions sources can compete, and increases the abatement pathway cost. Expanding transport sector coverage would provide transport technology neutrality (e.g. reducing a carbon disadvantage for EVs if the electricity sector moved to a facility basis). Reducing the facility thresholds to 25,000 tCO2e would only marginally increase the proportion of emissions covered, but would place a wider range of facilities on a level playing field and reduce domestic production moving to smaller, less efficient facilities. It would also reduce the occasions of facilities leaving the SGM control as they decarbonise below 100,000 tCO2e.
No additional Emissions Intensive Trade Exposed Industries (EITEIs) protections provided through the SGM. Protections for EITEIs would transfer the cost of emissions abatement to other sectors or to taxpayers. The Commission argues that the SGM already provides the majority of emissions rights for free, which is more generous than the provisions of both the EU emissions trading scheme and the former Australian Carbon Pricing Mechanism.
Effects on Australian industries
Some industries will be impacted more than others. A significant number of coal and gas projects in the development pipeline will effectively be unviable, due to either breaching the emissions cap, or not being financially able to decarbonise, capture pollution, or procure enough offsets to operate. These changes may have impacts to cost of living and energy security impacts over the short-medium term. Gas prices (and associated electricity prices) have significantly risen over the last twelve months, accompanied by rising cost of living due to a range of factors. The drivers for these cost increases will worsen as the transition continues, as a consequence both of changes in the supply mix as well as on the demand side. On the supply side, the removal of coal and replacement with renewables and firming capacity is likely to drive continued rises in power prices, while on the supply side the investments in low voltage capacity in the distribution system from EV penetration and the phasing out of gas will be profound. There is no doubt that a just transition will be an expensive transition as it relates to power prices in the next decade.
For other industries concerned about leakage to other countries with less stringent or costly carbon requirements, the reforms contain adjustments to the ‘Trade Exposed Baseline Adjusted settings’ to minimise the impact on the competitiveness of trade-exposed industries. The Government has also outlined a clearer commitment to review the potential for an CBAM (similar to what will take effect in the EU in 2026), to support industries like steel and cement – despite the Productivity Commission arguing that it would be unnecessary to protect against carbon leakage and would risk acting as a form of trade protectionism.
In addition, $400 million of the $1 billion funding for the manufacturing sector and trade-exposed industries through the Powering the Regions fund will be directed towards industries providing critical inputs into clean energy industries.
Progress towards climate goals
These announcements are the strongest step towards climate action taken by the Australian Government in a long time, and are a key part of aligning future carbon reductions to Australia’s targets. However, more policy for, funding of, and implementation of climate change mitigation and adaptation actions is needed both within Australia and globally to limit temperatures to 1.5°C – 2.0°C.
Climate change policies, funding and levers should be complementary and avoid duplication to ensure and efficient transition. If the Safeguard Mechanism is to be continued and strengthened, the most efficient option could be to designate an expanded Safeguard Mechanism as the key policy piece, and align other mechanisms around it, per the Productivity Commission’s recommendations.
Regardless of the future of the Safeguard Mechanism, collective action to decarbonise and adapt to climate change is in the hands of all organisations and individuals. How Australian businesses and government tackle key issues like scope 3 emissions, transition support for affected communities, and the decarbonisation of all sectors, will be a challenge to be met by all.
How Can Rennie Help?
Strategic planning following these reforms: Rennie’s strategy team has worked with a range of clients (including in the fossil fuels value chain) in understanding how climate change risk and associated economic shifts will impact their business, and support them to design strategies that will support them to shift operations into new areas that will provide sustainable dividends in a low carbon economy. Rennie can support leadership in navigating what these new legislations will mean in your context.
Establish SGM Baseline: Rennie is well positioned to help existing facilities and new entrants in establishing safeguard baselines. It is imperative to understand the implications of SGM for potential entrants who are just under the limit of covered emissions (100,000 tons of CO2e). Rennie team can design a clear pathway for reducing emissions against baseline, benefitting new entrants from generating SMCs since beginning.
Establish decarbonisation pathways: Rennie has the in-house capability to develop GHG inventory (baseline), identify GHG emission reduction measures and design a decarbonisation strategy. Rennie teams can develop a Marginal Abatement Cost Curve (MACC) for the identified opportunities to aid decision making.
Offset strategy: Rennie can work with client teams to develop carbon offset strategies, that meet the business’s needs and preferences regarding offset procurement, nature-based solutions, and social and environmental co-benefits. Rennie can assist with the screening of land parcels for their ability to generate ACCUs by implementing ERF projects that are best fit for the identified land type.
Review Safeguard Mechanism Credits (SMCs): Rennie can undertake a review of the credibility and longevity of available SMCs. It will enable participants to make sound investment decisions.
Contact us to find out more.