'Safety net' or 'trampoline'? Emissions safeguard mechanism draft rules released

In brief

The Federal Government has released its draft rules for the emissions safeguard mechanism, which will impose financial penalties of up to $1.8 million on businesses that emit more than their allocated emissions baselines. Partner Grant Anderson and Associate Albert Yu report.

Background

As discussed in our Focus: Senate passes Emissions Reduction Fund legislation, the legislation that passed late last year to implement the Emissions Reduction Fund also included a legislative framework for the 'safeguard' mechanism under which large emitting facilities could be penalised for exceeding their emissions baselines. The safeguard mechanism is intended to make sure that the emissions reductions purchased by the Emissions Reduction Fund are not displaced by a significant rise in emissions above business-as-usual levels elsewhere in the economy.

This legislative framework includes the following key components.

• Establishment of the safeguard mechanism with effect from 1 July 2016.¹
• A requirement that an entity that has operational control over a designated large facility (a 'responsible emitter') must pay a civil penalty where the direct (scope 1) emissions from that facility exceed a baseline level of emissions, with the penalty amount, threshold for a large facility and baseline level of emissions to be determined by or in accordance with the regulations and safeguard rules.²
• A requirement that these covered entities must be registered with the Clean Energy Regulator and must report the relevant facility's emissions for a financial year to the Regulator by the following 31 October.³
• An expansion of the concept of operational control beyond corporations to other persons such as individuals, local councils and trusts.⁴
• In the event that a designated large facility exceeds the applicable baseline level of emissions, allowing the responsible emitter to offset such excess by surrendering Australian carbon credit units created under the Carbon Farming Initiative (as expanded to facilitate the Emissions Reduction Fund) or other carbon credit units specified in the safeguard rules. Such surrender must be made by the 1 March that follows the relevant assessment period.⁵

On 2 September 2015, the Government released drafts of the following legislative instruments which prescribe the significant features of the safeguard mechanism as foreshadowed by the legislative framework referred to above:

• National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015 (Cth) (the Rules);
• National Greenhouse and Energy Reporting Amendment (2015 Measures No. 2) Regulation 2015 (Cth) (the Amendment Regulations); and
• National Greenhouse and Energy Reporting (Audit) Amendment Determination 2015 (No. 1) (Cth) (the Amendment Determination).

The public consultation period for the draft Rules closes on Monday, 21 September 2015, while the public consultation period for the draft Amendment Regulations and Amendment Determination closes earlier on Wednesday, 16 September 2015. The Government intends to finalise these instruments by 1 October 2015.⁶

Key features of the safeguard mechanism

The key features of the safeguard mechanism proposed by the draft Rules, Amendment Regulations and Amendment Determination include the following.

Covered facilities

A facility with more than 100,000 tonnes of 'covered' (ie direct or scope 1) emissions per year will be a 'designated large facility' and so covered by the safeguard mechanism.⁷ As a consequence, the safeguard mechanism is expected to cover about 140 businesses, representing around half of Australia’s emissions.⁸

Existing facilities

Subject to the exceptions discussed below, the baseline level of emissions for a facility will be set by the Clean Energy Regulator at the highest reported annual covered emissions of the facility over the historical period 2009-10 to 2013-14.⁹ This is referred to in the draft Rules as the 'reported-emissions baseline determination' for the facility. This baseline level of emissions can, however, be adjusted by the Regulator to account for activities that have ceased to be conducted as part of the facility or to account for new activities that form part of the facility.¹⁰ In addition, the responsible emitter for the facility can apply to the Regulator to have that facility's historical emissions baseline temporarily adjusted upwards if the facility meets the 'initial calculated baseline criteria' – that is, if the facility's 2016-17 covered emissions have exceeded, or are reasonably expected to exceed, its historical emissions baseline.¹¹ This is intended to accommodate circumstances where historical emissions are not representative of future business-as-usual emissions performance of the facility (such as where the facility reported low production in the baseline period due to depressed economic conditions following the global financial crisis). An existing facility's (adjusted) reported-emissions baseline determination is a 'default' determination in the sense that it applies for all periods when another emissions baseline determination does not apply in respect of the facility.¹²

New facilities

For new facilities that exceed the 100,000tCO₂-e threshold, the baseline level of emissions will be set in the following manner.

• Up to 2019-2020: If a facility's scope 1 emissions were not reported under the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGERA) for all of the five years from 2009-2010 to 2013-14 (eg a new facility might only have reportable emissions for 2013-14), the facility's baseline level of emissions can be set by a 'calculated-emissions baseline determination'.¹³ Under a calculated-emissions baseline determination, the facility's baseline level of emissions will reflect an audited emissions forecast provided by the responsible emitter for a three-year period or, in the case of facilities with emissions in excess of 2mtCO₂-epa, a five-year period. The baseline level of emissions will be the highest forecast level of annual emissions during this period.¹⁴ On the expiry of the determination (at the end of the forecast period), the facility's emissions baseline will be 100,000tCO₂-e¹⁵ or any applicable reported-emissions baseline (see below) unless the responsible emitter obtains a subsequent production-adjusted baseline determination.¹⁶ This latter baseline will 'reset' the facility's emissions baseline to its highest actual annual level of covered emissions during the forecast period,¹⁷ which is likely to be more favourable to the responsible emitter than either of these default options because otherwise the responsible emitter would presumably not have applied for a calculated-emissions baseline determination in the first place.
  
  As an alternative to a calculated-emissions baseline determination, the responsible emitter may instead be able to have the facility's baseline level of emissions set under a reported-emissions baseline determination, in which case the baseline will be the highest annual reported covered emissions for the facility as determined from the limited data of reported emissions that is available for the facility for the period between 2009-10 to 2013-14. This alternative will be available if:¹⁸
  • the facility's emissions were reported under the NGERA for at least three years of the five-year period from 2009/10 to 2013-14 and those reported emissions exceeded 100,000 tCO₂-epa – in such a case, the responsible emitter does not need to make an application to the Clean Energy Regulator, as this baseline will apply in the absence of the responsible emitter applying for a different baseline; or
  • the facility's emissions were reported under the NGERA for at least one year in that five-year period, those reported emissions exceeded 100,000 tCO₂-epa and the responsible emitter has applied to the Clean Energy Regulator for such a determination before 1 August 2016.
  These methods of establishing an emissions baseline recognise that the final investment decision for a facility that comes into existence before 1 July 2020 is likely to have been made by 1 July 2016, so that the emissions profile of the facility cannot be easily altered to respond to the introduction of the safeguard mechanism.
  

• From 2020-2021: As from 1 July 2020, the baseline level of emissions for a new facility¹⁹ can be set by way of a 'benchmark-emissions baseline determination'. In such a case, the baseline level of emissions will be set at the highest forecast level of annual covered emissions, calculated by applying a benchmark measure of emissions intensity to expected production over five years (where the facility's emissions exceed 2mtCO₂-epa or three years (in any other case).²⁰ This method of calculating an emissions baseline is intended to encourage emissions best practice for new facilities for which a final investment decision has not been taken as at 1 July 2016. On the expiry of the benchmark-emissions baseline determination (at the end of the three- or five-year period, as applicable), the responsible emitter will presumably wish to avoid the facility's baseline defaulting to 100,000tCO₂-e²¹ and so will be incentivised to apply for a production-adjusted baseline determination. In such a case, the production-adjusted determination baseline will set the facility's emissions baseline at the highest level of annual covered emissions during the period of the benchmark-emissions baseline determination, as calculated byy applying the benchmark emissions intensity to the highest annual level of production.²²

While calculated-emissions and benchmark-emissions baseline determinations are made by the Clean Energy Regulator on application by the responsible emitter, the responsible emitter will have an incentive to lodge an application for such a determination because otherwise the facility's emissions baseline will be the lowest possible baseline of 100,000tCO₂-e.

Significant expansions

The responsible emitter for a facility may apply to the Clean Energy Regulator for a permanent increase in the facility's baseline level of emissions if there is a significant expansion in the facility's production capacity. A facility will undergo a significant expansion in capacity if its maximum productive capacity increases by more than 20 per cent, or if it produces a new product (or products) that account for more than 20 per cent of the facility's revenue, in either case as a result of the installation of new plant or equipment over a three-year period. The emissions baseline determination can take the form of a calculated-emissions baseline determination (that lasts for three to five years, depending on the size of the facility) or a benchmark-emissions baseline determination (that lasts for three years), as applicable (see above).²³ On the expiry of the determination, the facility will either default to its reported-emissions baseline determination (if any) or a baseline of 100,000tCO₂-e, unless (as is likely to be the case) the responsible emitter applies a production-adjusted baseline determination.²⁴

Production fluctuations

The responsible emitter for a facility may apply to the Clean Energy Regulator for a temporary increase in the facility's baseline level of emissions in any year where the exceedance of the baseline is accompanied by an improvement in the facility's emissions intensity. This is a temporary adjustment and will only be effective for the relevant year.²⁵

In addition, the responsible emitter for a facility may apply to the Clean Energy Regulator for the facility's emissions to be assessed against the facility's emissions baseline over a period of two or three years (rather than one year).²⁶ The use of such a multi-year period will accommodate facilities with cyclical emissions, as well as those in respect of which emissions abatement measures are to be implemented in the shorter term.

Electricity generation sector

Grid-connected electricity generators must comply with a different set of rules. These generators are initially subject to a sectoral emissions baseline of 198 million tonnes rather than an individual baseline for each generator.²⁷ That is, grid-connected electricity generators will effectively be exempt from the safeguard mechanism unless and until their collective covered emissions exceed 198 million tonnes. If the collective covered emissions from these generators exceed 198 million tonnes then, beginning from the financial year which is two years after the financial year in which such excess occurs, this sectoral baseline arrangement will end and the generators will be treated in the same way as other facilities subject to the safeguard mechanism (ie they will have to comply with individual emissions baselines).²⁸

Landfill sector

As noted above, the recent amendments to the NGERA expanded the concept of operational control beyond corporations to local councils. 31 This has significant implications for the coverage of landfill facilities by the safeguard mechanism, given that many landfill facilities are operated by local councils.²⁹

Landfill facilities that emit more than 100,000CO₂-epa of scope 1 emissions, excluding legacy emissions, fall within the safeguard mechanism (legacy emissions are also excluded from the existing measurement of all landfill facility emissions, including in relation to esceedence calculations).³⁰ For these purposes, legacy emissions are emissions from waste accepted into the landfill facility before 1 July 2016. Accordingly, a landfill facility may be the subject of a reported-emissions baseline determination and may have the benefit of a calculated-emissions baseline determination and subsequent production-adjusted baseline determination (for new facilities and significant expansions).³¹ However, instead of a benchmark-emissions baseline determination, the responsible emitter for a landfill facility that emits more than 100,000tCO₂-epa of covered emissions may apply for a 'landfill-benchmark baseline determination' that takes effect on or after 1 July 2020.³² Unlike other baseline determination methods, a landfill-benchmark baseline determination is a formula rather than a baseline emissions number. The formula calculates the baseline emissions number applicable to a landfill facility for each financial year by reference to non-legacy emissions adjusted for an oxidisation factor and excluding such proportion of those emissions as would be captured at a benchmark capture efficiency rate.³³ Unlike other benchmark-emissions baseline determinations, a landfill-benchmark baseline determination has no fixed expiry date.³⁴

Transport sector

Interstate transport operators will have the option of defining their facilities on a national or state basis.³⁵ Depending on the circumstances, this can enable transport businesses to effectively adjust their emissions baseline for the purposes of the safeguard mechanism.³⁶

Mining and oil and gas sectors

Responsible emitters in the mining and oil and gas sectors may be able to have their emissions baselines increased by applying to the Clean Energy Regulator for a calculated-emissions baseline determination applicable to facilities that satisfy the 'inherent emissions variability criteria'. This will be the case for natural resource extraction facilities, and natural gas processing or liquefaction facilities associated with the extraction of natural gas, where the grade, depth or other properties of the resource or natural gas reserve have a direct effect on the covered emissions or covered emissions intensity of the facility. In such a case, the responsible emitter will generally be able to have the facility's baseline level of emissions increased, up to two times until the 2024-25 year, to correspond to the highest annual emissions forecast for the next three years.³⁷

Exemption for natural disasters

Where covered emissions for a facility exceed the facility's emissions baseline as a direct result of a natural disaster (or criminal activity), the Clean Energy Regulator may exempt the resultant emissions from the exceedance calculation. In deciding whether to grant such an exemption, the Regulator must take into account the steps taken both before and after the natural disaster (or criminal activity) to mitigate the risk of the facility's emissions exceeding the applicable baseline as a result of the natural disaster (or criminal activity).³⁸

Agriculture and land sector

The safeguard mechanism does not apply to emissions in respect of which the Minister has not made an applicable measurement determination under the NGERA.³⁹ The National Greenhouse and Energy Reporting (Measurement) Determination 2008 (Cth) (made under the NGERA) does not encompass land based emissions covered by the Intergovernmental Panel on Climate Change categories ‘Agriculture’ and ‘Land Use, Land Use Change and Forestry’.⁴⁰ Therefore, with certain limited exceptions such as emissions from fuel combusted in the course of agriculture or land-based activities, emissions from the agriculture and land sector (eg emissions from livestock) are largely excluded from the safeguard mechanism.

Penalty for exceeding the baseline level of emissions

The civil penalty where the direct (scope 1) emissions from a covered facility exceed its baseline level of emissions is $18,000 for each day the excess occurs, with an aggregate penalty of up to $1.8 million.⁴¹ The amount of the penalty is not connected to the extent of the baseline exceedance, although the court has a discretion as to the actual amount of financial penalty payable for such baseline exceedance and the exercise of that discretion entails having regard to the nature and extent of the contravention.⁴²

The Explanatory Statement to the Rules states that this penalty is not intended to raise revenue, and would only be a 'last resort'.⁴³ Indeed, the Environment Minister Greg Hunt has stated that 'it is our clear expectation that no businesses will pay penalties'.⁴⁴

The penalty can be avoided if the responsible emitter for the exceeding facility nets off the excess emissions by surrendering Australian carbon credit units or other carbon units specified in the Rules. The draft Rules do not currently specify any other carbon units for this purpose.

In addition to imposing a civil penalty, the court could also issue an injunction requiring the responsible emitter to rectify a baseline exceedance, eg by requiring the responsible emitter to acquire and surrender the number of carbon units that is necessary to cover the exceedance.⁴⁵

International credits

In particular the draft Rules do not prescribe any international carbon credit units that can be used to offset above-baseline emissions from covered facilities. However, the Explanatory Statement to the Rules states that the role of high quality international units in the safeguard mechanism will be reviewed between 2017 and 2018 (as part of the broader review of the Emissions Reduction Fund and safeguard mechanism at this time), subject to appropriate accounting rules being agreed as part of the United Nations Framework Convention on Climate Change meeting in Paris in December 2015.

Effectiveness of the safeguard mechanism

The safeguard mechanism as set out in the draft Rules has been criticised as ineffectual by both the Opposition⁴⁶ and independent senator Nick Xenophon,⁴⁷ whose support was critical for the passage through the Senate of the legislation to implement the Emissions Reduction Fund. It is, however, unclear whether this dissatisfaction is likely to lead to the Senate disallowing the Rules if they are made in their current form.

The Climate Institute has also criticised the scheme, stating that the proposed safeguard mechanism was 'more a pollution trampoline than a safety net'.48 In this respect, consultants RepuTex project that, with the safeguard mechanism as proposed by the Government, emissions covered by the safeguard scheme will grow by around 20 per cent through to 2030.⁴⁹ Indeed, such growth is not necessarily inconsistent with the Government's position: as the Explanatory Statement to the Rules states, the Emissions Reduction Fund is designed to accommodate economic growth and allow businesses to continue to operate at business-as-usual levels (including as regards emissions).⁵⁰

Finally, the administration of the safeguard mechanism, entailing the assessment of a range of different baselines and applications for changes to those baselines, is likely to be resource-intensive from the perspective of the Clean Energy Regulator. If the Regulator is not adequately resourced, then there may be a backlog of decision-making or, equally concerning, hastily made decisions that do not adequately consider all relevant factors.

Next steps

The draft Rules are open for consultation until 21 September 2015 and so affected businesses have a short time period within which to make submissions on them.

However, in preparation for the introduction of the safeguard mechanism, the operators of facilities that will be subject to the mechanism should consider including in their supply contracts provisions that enable them to pass through to their customers the costs they incur in relation to the mechanism. These costs may include the cost of investing in emissions abatement, or of purchasing Australian carbon credit units, to keep the relevant facility's emissions below its allocated baseline. They may also include the costs of any penalty payments the operator incurs for exceeding the emissions baseline. While the safeguard mechanism as currently proposed would seem to be relatively benign, it is not out of the question that, over time, it may be modified to ratchet down baselines and impose penalties for baseline exceedances that are proportionate to the exceedance, thereby transforming the mechanism into a more traditional baseline and credit trading scheme. This needs to be borne in mind when negotiating carbon cost pass through provisions for longer-term supply contracts.

If you would like any further information, or assistance in drafting your submission, please contact any of the people below.