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Counting the cost of carbon

Reforms to the nation’s Safeguard Mechanism are the latest tool in the Federal Government’s bid to achieve its 2030 and 2050 greenhouse gas emissions targets.

Proposed reforms to carbon markets are entering a critical phase as the Federal Government seeks to shore up Australia’s climate target goals.

 

Following the passage of legislation, changes to the nation’s Safeguard Mechanism will take effect from 1 July and seek to reduce the emissions limits, or baselines, of about 215 industrial facilities in Australia, across the metals, mining, oil and gas, and manufacturing sectors.

 

The reforms are the centrepiece of the government’s plans to achieve a 43 per cent emissions-reduction target below 2005 levels by 2030, and net-zero by 2050. They will compel those companies that breach their caps to either trade emissions with others, or buy Australian carbon credit units (ACCUs). On average, polluters will be required to cut emissions by 4.9 per cent a year to 2030, or face penalties. 

 

The government has also promised to create new Safeguard Mechanism credits (SMCs) that allow polluters that make extra emissions cuts to earn a credit for every tonne of CO2 below their baseline. “Think of them as carrots for the good students that do well,” says Christophe Denoux, Head of Sustainable Trading at Westpac.

 

‘Favourable’ response from markets

Hugh Grossman, managing director of carbon markets research firm RepuTex, says the government proposals address structural weaknesses in the existing Safeguard Mechanism and should generate momentum for emissions reductions. The key now is to establish the right architecture to ensure the 2030 and 2050 goals are met.

 

Grossman favours two main levers to pull – first, ongoing emissions reductions in the electricity sector, a large emitter that is already on a “decarbonisation journey”; and second, implementation of the latest Safeguard Mechanism changes. 

 

“Until now, industrial emissions have been the elephant in the room. Now that we have new policy, we’ve begun to see the market respond fairly favourably,” Grossman says.

 

While he welcomes an overhaul that will “drastically cut the headroom for heavy emitters”, Denoux acknowledges concerns among some Safeguard Mechanism opponents who believe it will allow large polluters to simply keep buying an unlimited number of carbon credits while continuing to emit.

 

“Companies can still get away with not reducing their emissions,” he says. “They can pay to pollute. All they have to do is buy ACCUs. So, I can see that from a philosophical point of view that this doesn’t go down well with everyone.” To address those concerns, amendments have been made to the legislation, forcing entities using more than 30% to meet compliance obligation to publicly justify their use.

 

National security issue

The stakes are high for the Safeguard Mechanism initiatives, with Prime Minister Anthony Albanese having described them as “a national security issue” because, if they fail, Australia is unlikely to meet its emissions reduction targets.

 

Despite criticism around the unrestricted use of ACCUs in the revised safeguard mechanism, an independent review of the integrity of the ACCU scheme, led by Australia’s former Chief Scientist Ian Chubb, has endorsed the credibility of the scheme, although he has recommended changes to how it is managed.

 

This includes stripping the government agency, the Clean Energy Regulator, of some of its power in overseeing the system to “enhance confidence and transparency” and closing down the contentious “avoided deforestation” methodology, which has seen carbon credits awarded to some landholders for not clearing land in farming areas where they had no intention of cutting down trees.

 

Elisa de Wit is a partner at Norton Rose Fulbright Australia and leads the law firm’s global carbon markets practice. She believes the reforms bring much-needed certainty to carbon markets for large Australian emitters as the nation transitions from a predominantly voluntary emissions trading market to more of a government-led compliance trading framework.

 

“There’s a pretty firm marker now in place in terms of the 2030 target and the net-zero target by 2050,” she says. “The question is ‘how we are going to get there?’."

 

Supply and demand issues will determine the answer, according to de Wit. On the supply side, she notes that the Chubb Review has recommended giving carbon market operators greater ability to drive forward new types of offset projects through the use of private sector methodologies. 

 

On the demand side, de Wit expects voluntary purchases of ACCUs to continue to grow, while the success of the compliance component of the reforms will hinge on how easy it is for companies to reduce emissions to create SMCs.

 

“Unless it’s going to be cost-effective to reduce emissions to generate those SMCs on a par with where ACCUs are trading, you would have thought as a compliance approach that the entities would just purchase ACCUs. That’s just going to be more cost-effective,” de Wit says.

 

Carbon pricing a crucial tool

The World Bank notes that carbon pricing is crucial as it “captures the external costs of greenhouse gas emissions” for outcomes such as crop damage, droughts and property losses from floods. 

 

It also “provides an economic signal to emitters and allows them to decide to either transform their activities and lower their emissions, or continue emitting and paying for their emissions”. If the price is too low, however, it can lead to accusations of greenwashing.

 

A cap of AUD 75 a tonne has been set by the Albanese Government at the start of the revised scheme, increasing by CPI+2% yearly. Grossman from RepuTex expects that cap to rise to about AUD 100 a tonne by 2030, in line with Consumer Price Index assumptions. In any case the cap is unlikely to be breached in the next few years, he notes.

 

RepuTex believes demand and pricing for ACCUs will be strongly influenced by the scale and timing of on-site emissions reduction actions by companies. It says major low-emissions technology and projects could lead to increased SMC issuance, and weaker demand growth for offset projects, with potential for up to three-quarters of all emissions reductions to be derived from on-site actions by 2030.

 

“As policy is implemented, we expect a supportive environment for industry investment decision-making, growing over the decade as price incentives strengthen,” Grossman says. 

 

“Over time, our modelling suggests that this will shift investment from the purchase of offsets toward permanent, on-site emissions reductions – at large scale. Ultimately, internal actions are the best hedge against the ongoing and increasing cost of sourcing carbon offsets each year, so they will be favoured.” 

 

Two possible scenarios are likely for carbon pricing, he believes. In an extreme case, industry will elect to make large, early investments in onsite emissions reduction technologies. “If that occurs, we could see a slightly lower price path for ACCU offsets, as internal actions are favoured by industry.”

 

Or emitters may be slow to make large investments and make more use of ACCU offsets.

 

“The truth is likely to be somewhere in the middle, where we see a really good blend of internal abatement and offsets, creating a supportive environment for carbon offset prices going forward,” says Grossman, who notes that the government plans to review the price cap in 2026-27.

 

“If the government doesn’t review the price cap, we see the potential for policy to act as an artificial ceiling on the cost of internal action by industry, potentially constraining higher-cost technologies that will be required to decarbonise industry. Technologies like carbon capture and storage will need a high price to unlock and incentivise those technologies to be more widely utilised.”

 

A concern for Denoux is that a relatively low carbon price – he says some large emitters are factoring in an internal price of carbon closer to AUD100 a tonne – could reduce incentives to cut emissions. On the other hand it is also true that, given the rapid evolution of the technology, some companies might also prefer to delay their investment in decarbonisation, waiting for some early technological solution to mature.  

 

A work in progress

However, Denoux welcomes the move in Australia towards a European-style compliance market courtesy of the reformed Safeguard Mechanism.

 

There is still work to be done on the ground by emitters, he notes, with high-polluting Australian exporters in some sectors potentially facing a carbon dioxide emissions tariff in Europe in the form of the Carbon Border Adjustment Mechanism (CBAM) from 2026.

 

He also thinks that the European scheme for carbon credits trading has advantages over the Australian model. In Europe, emitters pay into a government pool of money, with a large portion of the proceeds invested into the best carbon-reduction projects. Whereas, in Australia emitters can buy into specific projects based on their own perception of the impact.

 

The other advantage, Denoux explains, is that with the European system, if the price of carbon was to double, the amount of money flowing into decarbonisation would also most likely increase significantly, increasing the size of the abatements. With the Australian system, if the price of ACCUs was to double, it would simply mean that the projects would receive double the amount of money for generating the same amount of carbon abatements. 

 

A significant increase on the price of ACCUs should, in theory, increase the incentive to register new projects – but it is a second order effect.

 

“What I like about the European system is that you get a large pool of money and then you allocate to the solution with the highest impact,” Denoux says.

 

De Wit says that while industry leaders are “broadly supportive” of the Safeguard Mechanism changes, “the devil is in the detail and there’s still quite a lot for government to work out”. 

 

She also notes that the framework covers emitters who are currently responsible for just 28 per cent of Australian carbon emissions. “There’s still this other large proportion of our total emissions that need to be addressed.”

 

Options include expanding the Safeguard Mechanism scheme to get greater market coverage, including expanding coverage of the transport and agriculture sectors, and fine-tuning regulatory and policy approaches “to address the remainder of the emissions footprint”.

 

While there are ongoing discussions about carbon credit systems and their integrity, de Wit has no doubt they are an important component of sustainability and emissions-reduction efforts. “It’s my very strong view that they have a role to play,” she says. “We have to throw everything we can at this problem and carbon markets are central to those goals.”

Download the infographic: On the way to net-zero: Safeguard Mechanism reforms (PDF 1MB)

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