Carbon

Opinion: the big part of the safeguard mechanism attracting little attention

Raphael Wood, 28/03/2023

Aurecon director and Carbon Market Institute board member Raphael Wood

In this contributed article, Raphael Wood argues that debate over the Federal Government’s recently passed Safeguard Mechanism bill has lacked an important detail. He explains the new Safeguard credits and why they are central to the new legislation. Mr Wood is a director of Aurecon’s carbon advisory arm and on the board of the Carbon Market Institute.

 

 

The Federal Government has today passed its Safeguard Mechanism amendment bill following a deal with the Greens. The announcements in yesterday’s deal were sensible and effective, not putting limitations on the market and ensuring integrity issues are addressed – in-line with the Chubb-review.

But a strange aspect of arguments over the government’s Safeguard legislation is that they aren’t focused on the issue that takes up the bulk of the Bill – making it possible for industry to earn and sell new Safeguard credits.

In the Senate committee report on the Bill, neither the government nor the Greens refer to Safeguard credits in their recommendations, while Senator Pocock’s 17 recommendations only explicitly refer to them once.

For industry, the broad consensus that Safeguard credits will have an important and legitimate role to play should be a huge relief as this will be their primary market.

The reason is that the ability to create and sell Safeguard credits will be a crucial consideration in investment decision-making, as businesses develop new tactical plans to decarbonise.

Facilities that are doing better than minimum requirements will profit from being able to sell their Safeguard credits to other Safeguard-covered businesses, and won’t have to buy Australian carbon credit units (ACCUs). This gives them a strong commercial incentive to decarbonise fast.

In contrast, hard to abate or laggard facilities will incur the expense of having to buy Safeguard credits, or ACCUs.

One issue that cropped up in the Senate inquiry, was the merits of imposing a cap on the number of ACCUs that Safeguard-covered sites can use, in addition to their use of Safeguard credits.

Senator Pocock favours the idea, while independent MP Zali Steggall in the House of Representatives has also proposed a gradually tightening quantitative cap.

Their goal is to make sure that companies don’t over-rely on ACCUs.

However, the disadvantages of a quantitative cap on the use of ACCUs would far outweigh any benefits. That’s because it’s almost impossible for government to get the cap right, and quantitative caps disrupt carbon markets in unpredictable ways, potentially leading to undesirable volatility or damage to investor confidence.

The risk to adding restriction and limits is one of over-complexity, which is an enemy of a well-functioning, predictable market, and also makes it much harder for third parties to scrutinise market performance.

Another proposal put forward by Senator Pocock could serve as something of a constraint on the use of ACCUs by Safeguard facilities – albeit a softer one than a volumetric cap.

The Senator has suggested preventing Safeguard-covered sites from using old ACCUs, by imposing “vintage” restrictions.

This would ensure that the demand from Safeguard-covered facilities for ACCUs prompts new abatement projects.

A rolling window in which facilities can each year use ACCUs that are up to five years old would be the sweet spot – slightly longer than the three years that Senator Pocock has proposed.

Five years, instead of three years, would give offset project developers greater confidence to establish new projects, because the slightly longer window allows them more flexibility to choose when to sell each vintage of credits to Safeguard facilities.

The Senate committee inquiry process confirmed that all parties are committed to ensuring Australia’s manufacturing industries survive and thrive as the economy decarbonises.

And several organisations giving evidence to the inquiry – including the Australian Industry Group and the Australian Workers Union – view an EU-style Carbon Border Adjustment Mechanism (CBAM) as a key tool to protect these industries against imports from countries without a carbon price.

The government has so far only said it will investigate a Carbon Border Adjustment Mechanism, but if it is going to implement one, it should commit to it as soon as possible, so work on its design can proceed immediately and investors and emitters can make investment decision sooner with more confidence.

If Australia had a Carbon Border Adjustment Mechanism, then it wouldn’t be possible for other countries that produce steel and cement to undercut Australian manufacturers simply because they lack any form of carbon price.

It’s true that a Carbon Border Adjustment Mechanism takes time to put in place, with FY27 likely to be the earliest possible date that it could start.

But that’s not as much of a problem as it might at first seem.

The strengthened Safeguard would start on July 1 this year. But businesses have nine months after the end of each financial year before they will have to give the government any ACCUs or Safeguard Mechanism Credits.

That means Safeguard facilities – including steelworks and cement works – don’t have to hand over any ACCUs or Safeguard credits until March 2025.

And while they might contract to buy them much earlier than that, they can do so through a forward contact, which means they don’t have to pay for them until that date.

So, the gap between strengthened Safeguard liability starting to bite, and a potential Carbon Border Adjustment Mechanism entering into force – at least for steel and cement – is not as great as it might first appear.

Once in place, a Carbon Border Adjustment Mechanism would give heavy industries more confidence to embark on ambitious, expensive projects to cut their in-house emissions in line with limiting temperature rise to 1.5 degrees – which the Aurecon supported Australian Industry Energy Transitions Initiative has shown is possible.

As Safeguard negotiations have gone down to the wire, politicians appear to be – to a very large extent – in broad agreement on Safeguard credits.

 

 

 

 

 

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