Final Safeguard Mechanism reforms set to commence: outlining the impact on covered facilities - Clean Air / Pollution

A key element of the Federal Government's strategy to achieve net zero carbon emissions by 2050 has been enacted, primarily via the passing of the Safeguard Mechanism (Crediting) Amendment Act 2023 (Cth) (Amending Act) on 30 March 2023, and by amendments to the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (Cth) (Safeguard Rules) which were made on 5 May 2023. The amendments to the Safeguard Mechanism will commence on 1 July 2023.

The Safeguard Mechanism amendments principally reflect the Government's Position Paper and exposure draft amendments released on 10 January 2023. However, the final version contains a number of key changes.

In this article we discuss the principal differences between the final Safeguard Mechanism amendments and what was proposed in the earlier Position Paper and exposure draft reforms (discussed in our previous article).

Key changes from Position Paper

Minister must amend Safeguard Rules where emissions not declining

The final amendments introduce a new object of the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act) to achieve particular 'safeguard outcomes', which include among other objectives that:

total net emissions from all facilities subject to the Safeguard Mechanism (covered facilities) do not exceed 1,233 million tonnes of CO₂-e between FY2020/21 and FY2029/30;
total net emissions from all covered facilities for a financial year are not to exceed 100 million tonnes of CO₂-e by FY2029/30, and are to reach net zero by FY2049/50; and
the five-year rolling average of all covered facilities' gross emissions (i.e. the average covered emissions from the previous five years, not counting offsets) is less than:

from 1 July 2025, the five-year rolling average from three years earlier; and
from 1 July 2027, the five-year rolling average from two years earlier.

The above outcomes are significant in light of other amendments that oblige the Minister for Climate Change to undertake public consultation and amend the Safeguard Rules where the Minister or the Secretary of the Department of Climate Change receive advice that emissions from covered facilities are not reducing consistently with any of the above outcomes being met, and that the Safeguard Rules need to be amended to achieve them.

Several mechanisms for advice are provided for in the amendments. For example, under the new section 15A of the Climate Change Act 2022 (Cth) (CC Act), the Minister responsible for the Environment Protection and Biodiversity Conservation Act 1999 (Cth) (EPBC Act) must report to the Minister for Climate Change, the Secretary of the Department of Climate Change and the Climate Change Authority (CCA) whenever a new or expanded project has been approved under the EPBC Act that may cause a new entrant into, or increase an existing covered facility's emissions under, the Safeguard Mechanism. Under the new section 14(1A) of the CC Act, the CCA must also include information indicating whether or not emissions are declining in line with the above safeguard outcomes in its annual climate change statement to the Minister.

Increased support for manufacturing sector

The final reform package includes increased funding commitments under the Powering the Regions Fund (PRF), including $600 million in targeted support for decarbonisation efforts at emissions-intensive trade-exposed (EITE) facilities, and $400 million to support domestic manufacturing including steel, cement and aluminium.

Consistent with the original Position Paper, EITE facilities are able to apply to be 'Trade Exposed Baseline Adjusted' (TEBA) facilities and have their baseline decline rate lowered from the default 4.9% per annum. A lower decline rate will be available from when the facilities' annual cost of compliance with the Safeguard Mechanism exceeds 3% of their annual revenue, and top out at a minimum decline rate of 2% where their cost of compliance is 8% or greater.

However, under the final amendments, manufacturing facilities that are EITE facilities are subject to slightly different arrangements. They may have their baseline decline rate reduced if their annual cost of compliance exceeds 3% of Earnings Before Interest and Taxes (EBIT) for the facility, calculated in accordance with Australian accounting standards and any EBIT Guidelines published by the Secretary of the Department of Climate Change from time to time. In addition, a manufacturing facility can use an 'accelerated depreciation factor' for the purposes of calculating its EBIT, thus increasing the likelihood that it will qualify for a lower baseline decline rate. Manufacturing facilities will also have a lower minimum decline rate such that a reduction will begin at 3% cost of compliance and top out at a minimum decline rate of 1% where their cost of compliance is 10% or greater.

The cost of compliance is calculated by multiplying the difference between a facility's baseline and its higher gross emissions (in tonnes of CO₂-e) by the Safeguard Mechanism default prescribed unit price for the relevant financial year, which is the estimate of the average price of a 'prescribed carbon unit' (i.e. an Australian Carbon Credit Unit (ACCU) or a Safeguard Mechanism Credit (SMC)) for the financial year, as published by the Secretary of the Department of Climate Change before the end of the financial year.

Manufacturing facilities are receiving more favourable treatment than other EITE facilities as they can be more capital-intensive and generally have lower margins, and incentivising investment in this sector may assist in decarbonisation of production by replacing ageing assets with newer, more efficient technology.

The new Schedule 2 of the Safeguard Rules specifies which production variables are used to determine whether a facility is an EITE facility and/or a manufacturing facility for these purposes.

Best practice emissions intensity variables to apply to facilities that do not apply for a new baseline in time

The final reform package confirms the approach in the Position Paper that baselines for existing facilities will be set on a 'production adjusted' basis, i.e. by reference to the 'emissions intensity' of each applicable production variable (set out in Schedule 1 of the Safeguard Rules). The variable used to represent emissions intensity will be applied using a 'hybrid model' that will initially be weighted towards a facility's site-specific emissions intensity (i.e. the actual emissions per unit of output of the relevant product for the facility) and transition to a set industry average emissions intensity by 2030.

Conversely, baselines for new entrants (and any new production from existing covered facilities) would be subject to a set 'emissions intensity number' (EIN) that represents international best practice within the industry on the basis that new investments ought to have the opportunity to utilise the most emissions-efficient technology available.

The final amendments provide that facilities are not obligated to apply for a new emissions intensity determination (which specifies the applicable facility-specific EIN), but if they do not, they will be subject to the best practice EIN for the relevant production variable or, if none has been established, the default (i.e. industry average) EIN for the relevant production variable set out in Schedule 1 of the Safeguard Rules.

Applications for emissions intensity determinations for FY2023/24 are due by 30 April 2024.

Changes to calculations based on historical emissions data

An application for an emissions intensity determination must include historical information on production variables and covered emissions of greenhouse gasses for the facility. This information will be used to determine the site-specific emissions intensity of production at the particular facility.

The Position Paper suggested that historical emissions data would include the four most recent financial years' worth of data (i.e. FY2018/19 to FY2021/22), excluding the highest and lowest figures as outliers. The final reforms provide for the submission of data from FY2017/18, and specify how outliers will be omitted based on how many years' worth of historical data are submitted.

Lower interest rate for 'borrowing adjustment' for the first two years

The reforms provide for covered facilities to be able to borrow up to 10% of their baseline each year (i.e. to increase their baseline by up to 10% in one year and decrease by a corresponding amount the following year, plus interest) to assist with managing timing of abatement efforts.

The Position Paper initially provided for a 10% interest rate to apply to such arrangements, however the final amendments provide that a 2% interest rate will apply for the first two years until 1 July 2026 to make the transition easier on covered facilities and incentivise early investment in onsite abatement efforts. Beyond this, the 10% interest rate will apply.

Regulator empowered to vary multi-year monitoring periods

Covered facilities can apply for an up to five-year multi-year monitoring period (MYMP) on the basis that activities will be undertaken that are reasonably likely to reduce its cumulative covered emissions over the relevant period (e.g. where particular abatement technology cannot be implemented within a normal twelve-month monitoring period). An application for a MYMP must be accompanied by a firm and credible plan that is likely to be effective to achieve the cumulative emissions reduction over the specified period.

The final reforms have introduced the ability for the Regulator to end a MYMP early where emissions are not being adequately reduced because the plan is not being (or cannot any longer be) implemented.

Net zero emissions from new gas fields and shale gas extraction facilities

New gas fields, even where supplying an existing covered facility, will be treated as a new entrant into the Safeguard Mechanism and subject to a baseline of zero in respect of reservoir carbon dioxide emissions, on the basis that international best practice is already net zero in light of available decarbonisation technology such as carbon capture and storage.

Facilities that engage in shale gas extraction will also be subject to a baseline of zero from entry into the Safeguard Mechanism. This was previously articulated in relation to proposed projects in the Northern Territory's Beetaloo Basin, but will equally apply to any project that meets the test for a 'shale gas extraction facility' - i.e. a facility that undertakes activities that involve the extraction of gas from a geological formation through processes that include hydraulic fracturing, where the extracted gas is constituted by more than 90% shale gas and emissions from the extraction and use of such gas would likely exceed 100 million tonnes of CO₂-e if the formation were fully exploited.

Covered facilities can generate SMCs for up to ten years after exiting the Safeguard Mechanism

The new section 58B of the Safeguard Rules allows covered facilities that are no longer subject to a baseline under the Safeguard Mechanism - i.e. those that reduce their annual emissions to below the coverage threshold of 100,000 tonnes CO₂-e - can potentially continue to issue SMCs under the Safeguard Mechanism, where their emissions are less than their applicable baseline, for up to ten years after exiting, as opposed to the five years proposed in the Position Paper.

Covered facilities to account for efforts where 30% of baseline is offset

The new section 72C of the Safeguard Rules provides that a covered facility can surrender offsets (ACCUs and SMCs) to meet its baseline emissions number provided that, where ACCUs account for 30% or more of its baseline emissions number in a monitoring period, it will be required to provide a written justification - which is to be made public - to the Regulator, addressing (among other things) why more abatement activities have not been undertaken at the facility. While there is no limit on the amount of offsets that a facility can use to meet its baseline, this justification process is intended to generate greater accountability for implementation of abatement efforts and incentivise onsite decarbonisation in favour of reliance on offsets.

Next Steps

Many of the new reforms are significant for existing covered facilities, as well as projects that may meet the coverage threshold of 100,000 tonnes CO₂-e per annum in the future.

In particular, the broad ministerial powers to amend the Safeguard Rules where emissions are not declining may be a risk for projects that could be subject to compliance rules that are different from those on which the project was originally predicated. This is particularly relevant given the reforms introduce far harsher penalties for failing to surrender sufficient offsets by the annual due date.¹

In light of the fast-approaching implementation date of 1 July 2023, facilities should be reviewing their compliance approach and considering abatement opportunities to meet lower baselines over the coming years, particularly given the need to justify more than 30% offsetting. Facilities should also prepare to apply for an emissions intensity determination by the due date of 30 April 2024 to avoid being subject to a best practice or default EIN for their baseline determination.

Facilities (and those looking to invest in facilities, especially those in the manufacturing sector) should also be looking at their eligibility for concessions and flexible arrangements under the reforms, including PRF funding, TEBA status and borrowing arrangements.

With a review of the reforms scheduled for FY2026/27, facilities should also monitor how the amendments impact their operations over the next few years, with a view to providing detailed feedback to the Federal Government once consultation commences.

Footnote

¹Consistent with the Position Paper, the final amendments introduce a new mechanism for calculating the penalty under section 22XF of the NGER Act where a covered facility has not sufficiently reduced or offset its emissions to meet its baseline emissions number for a monitoring period (typically a financial year) by the following 1 April. Where previously the civil penalty was the lesser of 100 penalty units per day of exceedance and 10,000 penalty units,^[1] the number of penalty units is now equal to the difference between the net emissions number and the baseline number for the facility (in tonnes of CO2-e), which is potentially much more significant. A penalty unit is currently equal to $275.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.