Australia's Net Zero ask of resources and industrial emitters

Australia's largest resources and industrial greenhouse gas emitters face stricter emissions caps 5 min read

With the new Australian Government's Net Zero emissions legislation progressing through Parliament, the Government has flagged tough new emissions caps for the resources and industrial sectors. These will have potentially far-reaching implications for both existing emitters and proposed new emissions-intensive projects.  

The 215 or so highest-emitting facilities in these sectors are already subject to a 'baseline' emissions regime, the so-called Safeguard Mechanism. Introduced in 2016, the scheme sets a ceiling on emissions, requiring each covered facility to ensure its net annual emissions remain below its specified baseline. However, the scheme has attracted criticism from some quarters for being too lenient on large emitters.

In its consultation paper released in August 2022, the Government concedes the Safeguard Mechanism has not been effective in reducing emissions and outlines its proposals to dramatically toughen the Safeguard Mechanism.

This Insight explores four main topics:

• tougher baselines
• expanding eligible credits and offsets
• concessional treatment for Emissions Intensive, Trade Exposed entities
• removing bespoke methodologies enjoyed by the mining and oil and gas sectors

Tougher baselines

The Government proposes to substantially reduce each facility's baseline (or target) via three important changes, starting on 1 July 2023, with a two-year transition period and an aim for all changes to be in place by 1 July 2025.

• Headroom reduction: a number of facilities currently operate well below their specified baseline, meaning the Safeguard Mechanism provides little incentive to reduce emissions. The Government's proposal to remove this 'headroom' by resetting the baseline for each facility will significantly heighten the Safeguard Mechanism compliance risk for many facilities.
• New facilities: new facilities will be subject to stringent baseline assessments, intended to reflect either an industry average (which would reflect the higher emissions of legacy facilities) or, potentially, 'best practice' baselines (which would be calculated as the top 10% of Australian industry performance). This policy would not apply to the expansion of production at existing Safeguard facilities (ie brownfield developments).
• Reducing baselines: having removed the headroom enjoyed by some emitters, the reforms would then implement an annual reduction in the baseline for all emitters (ie permitting fewer emissions each year) in line with Australia's climate goal – reducing national emissions to 43% below 2005 levels by 2030 and to achieve net zero emissions by 2050. The rate at which individual facilities will be required to reduce emissions each year is not yet settled, pending further policy design, but is expected to be somewhere between 3.5% and 6%.

The ratcheting down of baselines will cover facilities currently contributing 28% of national emissions and does not apply to the electricity sector, so it is by no means an economy-wide tool. The discussion paper does not canvas expanding the coverage of the Safeguard Mechanism to cover more emissions, an option which was at one point recommended by both the Climate Change Authority and the Grattan Institute.

Credits and offsets

In a major policy change, emitters that over-achieve against their target will automatically be issued Safeguard Mechanism Credits (SMCs), which will enable them to trade their surplus by selling SMCs to emitters that have exceeded their target. This switch to a 'baseline and credit' scheme will create a new market for tradeable SMCs, to be administered by the Clean Energy Regulator. It is intended that this regime could also commence on 1 July 2023, subject to legislative amendments being passed.

This reform, which is designed to allow the market to identify the lowest-cost source of emissions reductions, will provide both an important additional compliance mechanism for emitters and create new revenue opportunities for facilities that invest in emissions reduction technology and processes. That said, it remains to be seen how deep or liquid the market will be, particularly in the early years.

The Government will continue to allow Australian Carbon Credit Units (ACCUs), for example created by forestry offset projects, to be used for compliance purposes in the Safeguard Mechanism. Existing double-counting provisions would be retained to prevent Safeguard facilities with registered emissions reduction fund projects from generating both ACCUs and SMCs.

However, the Government has signalled a reluctance to admit international credits as a compliance mechanism for facilities that exceed their Safeguard Mechanism emissions target. Citing concerns about an evolving international landscape and robustness of some international offsets, the Government's language is notably cool on the prospect of linking the Safeguard Mechanism to international offset markets.  

Emissions Intensive, Trade Exposed entities

To mitigate the risk of simply forcing projects offshore, the Government has flagged a tailored approach to emissions intensive, trade exposed (EITE) facilities, which will continue to receive concessional treatment under the Safeguard Mechanism.

The Government cites the current methodology used in Australia's Renewable Energy Target as a possible model for assessing whether particular activities or industries should be regarded as trade exposed and emissions intensive.

Significantly, EITE facilities could enjoy concessions via one or more of:

• direct policy support from Government through grants and funding, eg via the Powering the Regions Fund;
• direct assistance in the form of free SMCs that could be used for compliance purposes (or potentially on-sold to others); and
• differentiated baseline decline rates, which would effectively shift the burden of emissions reduction to other (non-trade exposed) facilities.

Potential removal of inherent emissions variability for the mining and O&G industry

The Government also recognises that baseline setting arrangements may affect a number of facilities in the mining and oil and gas sectors. The Safeguard Mechanism allowed mining and oil and gas facilities to reset their site-specific emissions-intensity value once before 1 July 2025 using an 'inherent emissions variability' calculated baseline calculation, which could accommodate variables such as fugitive emissions.

However, the Government is now seeking views on removing this option. In order to promote the reduction of emissions over time, the Government has indicated the likely removal of this mechanism for the mining and oil and gas sectors.

Making a submission

Interested parties can make submissions on the Consultation Paper up to 20 September 2022.