Top 10 Considerations for Companies

With the dust having now settled on last year's historic COP21 negotiations in Paris, which resulted in a new global climate change agreement (Paris Agreement), the focus will be on domestic implementation of each Parties' Nationally Determined Contributions (NDCs).

Pursuant to the Paris Agreement, countries have agreed to keep global temperature increases to "well below 2°C". This overarching goal will guide countries' mitigation and adaptation efforts for the period between 2020 - 2030.

Australia's commitment to reduce its emissions by 26-28% by 2030, based on 2005 levels, will be implemented, in part, through the Government's Direct Action Plan. This consists of the $2.55 billion Emissions Reduction Fund (ERF) for the competitive purchase of carbon abatement (with the third auction to be held on 27 and 28 April 2016) and the ERF Safeguard Mechanism (Safeguard Mechanism) to "ensure that emissions reductions purchased through the ERF are not displaced by a significant rise in emissions above business-as-usual levels elsewhere in the economy."

On 1 July 2016, amendments to the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act) will come into force, implementing the Safeguard Mechanism.

From that date, facilities that exceed the 100,000 t CO2-e threshold will be issued with a baseline for their covered emissions and these facilities must then take steps to keep their emissions below the baseline - or face penalties. The Safeguard Mechanism is set to cover half of Australia's total emissions across various sectors including coal, aluminium, nickel, copper, electricity, oil and gas, transport and waste, with 80% of covered facilities expected to be located in Queensland, Western Australia and New South Wales.

RepuTex estimates that while 261 facilities will trigger the 100,000 t CO2-e threshold, only 85 facilities, run by 30 companies, will exceed their historical baselines.  It is unlikely any of Australia's current top 20 emitting facilities (which includes a number of electricity generators) will face penalties under the Safeguard Mechanism, even with forecasted increases to their CO2 emissions over the next decade.

The detailed rules for the Safeguard Mechanism are set out in the Safeguard Rule, which was made in October 2015 and provides guidance on how baselines will be set for covered facilities.

This alert sets out the top 10 considerations for companies under the Safeguard Mechanism. 

1.   Will my company be caught by the Safeguard Mechanism?

A facility that has direct (scope 1) emissions that exceed the 100,000 t CO2-e threshold (Designated Large Facility) will be covered by the Safeguard Mechanism.

Direct emissions include emissions from the release of Greenhouse Gases (GHGs) as part of industrial processes, mining and petroleum activities and also from the combustion of diesel and other fuels. This differs from the former Carbon Pricing Mechanism (CPM), under which emissions attributable to the combustion of certain fossil fuels, such as liquid petroleum fuel, liquid petroleum gas, liquefied natural gas or compressed natural gas were not included as covered emissions, unless liable entities specifically opted those fuels in.

The Safeguard Mechanism will also apply separate rules for the following sectors: 

Electricity - a sectoral-baseline applies for the electricity sector, which is the sum of total scope 1 emissions from grid-connected generators in 2009-2010 (198 million t CO2-e). If the sector exceeds this sectoral-baseline, individual baselines will then be applied. Historically, the Australian Financial Markets Association has used a Carbon Benchmark Addendum to help neutralise any risks associated with the impact of a carbon scheme on future electricity prices in the National Electricity Market. AFMA is currently reviewing the carbon reference price used in the Addendum. Whilst the Addendum is not intended to apply to the Safeguard Mechanism, this could change following the 2017 review of the Safeguard Mechanism;

Transport - companies in the transport sector have the option to define their facilities on a national or state basis; and

Waste - the Safeguard Mechanism is limited to emissions from waste that is deposited at a landfill after the Safeguard Mechanism comes into place on 1 July 2016.  In practice, due to the increased threshold for baseline setting, it is unlikely that many waste facilities will be subject to the Safeguard Mechanism in the short term.  

2.   Who is responsible for reporting under the Safeguard Mechanism?

Once a company determines that it is covered by the Safeguard Mechanism, the person who has operational control of the covered facility is known as the "responsible emitter", and will be liable for compliance with the Safeguard Mechanism. This allocation of responsibility  differs from that for companies reporting under the NGER Act, where the highest controlling corporation will primarily be responsible for reporting unless a reporting transfer agreement is in place.

Responsible emitters for facilities that are not already registered under the NGER Act will have to register by 31 August following the reporting year in which they first become a responsible emitter. Whilst some of the data required to be reported under the Safeguard Mechanism is already captured under existing NGER Act reporting obligations, further information about production inputs may need to be provided, depending upon how the facility's baseline is set (see below).

The Safeguard Mechanism does not change the Reporting Transfer Certificate (RTC) provisions in place under the NGER Act. RTCs continue to allow NGER reporting obligations to be transferred from a corporation with operational control over a facility (for example, contractors)  to the corporation with financial control over the facility.

However, unlike the former CPM, the Safeguard Mechanism does not include provisions to allow the transfer of liability for facilities, such as under a Liability Transfer Certificate. This means that if contractors have operational control over a facility but do not have financial control of the facility, they cannot transfer liability under the Safeguard Mechanism back to the company with financial control over that facility. Companies in this situation with facilities that are likely to exceed their baselines under the Safeguard Mechanism should consider this issue in their contractual arrangements.

Given the potential disconnect between those who may have historically reported under the NGER Act and the CPM and those who have liability under the Safeguard Mechanism, corporations should also be aware that reporting data provided by other companies may be used as part of determining a corporation's liability under the Safeguard Mechanism. 

Based on our experience working with responsible emitters, some examples of key issues for companies to consider in relation to responsibility under the Safeguard Mechanism are:

  • whether responsible emitters for facilities are already registered under NGERS;
  • any changes to a company's corporate structure that may affect operational control; 
  • any new acquisitions and divestments (in particular joint ventures); and
  • the role of contractors at facilities and whether any changes to the activities undertaken by

      contractors would result in a change in operational control.  

3.   How are baselines set for existing facilities?

A facility's baseline emission number will be a number ascertained in accordance with the Safeguard Rule. If a baseline determination has not been made for a facility, the default baseline will be

100,000 t CO2-e. In some cases, a facility may apply for a baseline to reflect its particular circumstances. Audit reports may also be required depending upon the method used to allocate a facility's baseline. Baseline determination methods (pre-2020) are summarised below, with more details in sections 5 and 6 below. 

A summary table of available baseline determination methods (pre-2020) is provided below.

Click here to view table.

4.   When can a Reported-Emissions Baseline Determination be used?

For existing covered facilities, the baselines will, in most instances, be set at the highest level of reported emissions during the financial year years 2009/10 - 2013/14 (Reported-Emissions Baseline Determination). If a facility has existing NGER Act data for all 5 years or it exceeded the coverage threshold for 3 to 5 years, then the Clean Energy Regulator (Regulator) will commence the determination process automatically. However, if a facility only has data for 1 of the 5 years, the responsible emitter must notify the Regulator in writing before 1 August 2016, if it is seeking a reported-emissions baseline for the facility.  

5.   What activities may impact baseline reporting for facilities?

If there have been material changes to activities at a facility that will impact on how a Reported-Emissions Baseline Determination is likely to be set, the impacts of these changes on future emissions profile (and impacts for baseline) at the facility should be reviewed. We note that in some industrial sectors, the benchmark period for determining a historical baseline coincided with the global financial crisis and reduced production levels.  This may mean that production levels are on an increasing trend.

Some key issues to consider are:

  • whether there have been changes to one or more activities at a facility which would result in emissions attributable to the activity changing by more than 5%;
  • if emissions have decreased, due to the cessation of a particular activity, is the activity likely to be re-instated in the next 3 years?; and
  • what evidence is available to support the future intended use of the facility?

If there have been changes to the facility boundary since the peak of emissions during the financial year 2009/10 - 2013/14 that would materially alter its emission profile (for example,through the cessation or commencement of new activities), this may also affect how a baseline is set.  

6.   What happens if there is insufficient emissions data?

Where there is insufficient historical emissions data for facilities to make a Reported Emissions Baseline Determination, or where historical emissions may be a poor indicator of future emissions (either due to significant expansion or inherent emissions variability associated with the extraction of natural resources), the Regulator may adopt a calculated-emissions baseline approach to set the baseline for a facility (Calculated-Emissions Baseline Determination). This may only be used twice before 2024, meaning that the timing of using these approaches is critical.

Under the Safeguard Rule, a Calculated-Emissions Baseline Determination for a facility may be made if any of the following criteria apply: 

  • it is a new facility; 
  • there is a significant expansion of an existing facility;
  • the facility meets the inherent variability criteria; or
  • in 2016, the facility is expected to exceed its reported emissions baseline.

An applicant for a Calculated-Emissions Baseline Determination must provide an explanation and supporting evidence that it fulfils the criteria for a Calculated-Emissions Baseline Determination. The applicant must apply to the Regulator in the approved form, with an accompanying audit report, no earlier than one year before the requested start date of the baseline and no later than the first 31 October after the end of the first financial year to which the baseline will apply. 

A key issue for companies that may require a Calculated-Emissions Baseline Determination, particularly those existing facilities with inherent emissions variability, is when to apply for the first Determination. As the method can only be used twice, and in most cases will only apply for 3 years, companies may wish to explore managing potential baseline exceedances through other measures such as multi-year monitoring periods, before applying for a new baseline.  

7.   How are new baselines set?

Both Calculated-Emissions Baselines and Production Adjusted Baselines will be set by the Regulator having regard to a facility's: 

  • production variables; and
  • emissions intensities,

which will, before 2020, be based on information supplied by a company and audited.

Production Variables

Baselines may be determined on the basis of production variables, which refers to the quantity of an output, the quantity of the input or the quantity of an intermediate product.

Emissions Intensities

Emissions intensity is determined over the relevant reporting period, which is usually one year (unless a multi-year monitoring period declaration is in place). This means that if the emission intensity of a production variables changes on a temporal basis, it will be averaged out over the reporting period in circumstances where the responsible emitter is applying for a baseline declaration other than a Benchmark-Emission Baseline (or a Production-Adjusted Baseline Determination - see section 8 below). 

Based on our experience working with responsible emitters, some of the key issues that are arising when preparing applications for new baselines are: 

  • how to define the applicable production variables.  Little guidance is given as to the level of granularity appropriate for products, such as "coal" or a particular grade/type of coal; and 
  • is there are clear correlation between the input / output and the level of emissions? It may not always be the case that less product means less emissions and vice versa.  

8.   What happens when a company gets sufficient emissions data?

Another method of determining baselines is a production-adjusted baseline determination (Production-Adjusted Baseline Determination), which is based on actual, historical data. This can be used following the expiry of a Calculated-Emissions Baseline -  provided that the facility's covered emissions exceeded 100,000 t CO2-e in one of the financial years covered in the determination, and that there is no subsequent Calculated-Emissions Baseline Determination covering the facility.

Additionally, reductions in emissions intensity may be relied on to vary a facility's baseline. This would be appropriate for facilities whose emissions exceed their baseline because of increased production, but whose emissions intensity have passed an emissions intensity test. For example, where the facility demonstrates that its emission intensity has improved compared to historical performance.  

After 2020, instead of using data provided by the applicant to set a new baseline, benchmark emissions factors will be used. These are to be provided in a Schedule to the Safeguard Rule. A baseline set using this method will be a Benchmark Emissions Baseline. Once set, that baseline will apply until changed.

A key consideration for companies which are likely to change their baselines after 2020 will be how the benchmark levels are set - for example, whether emissions intensities are linked to industry best practice.  

9.   Can carbon credits be used offset a facility's excess emissions?

Under the Safeguard Rule, Designated Large Facilities must keep net emissions below baseline levels to avoid an "excess emissions situation".  Where a facility exceeds its baseline, there are a number of flexible tools to manage the exceedance, for example, applying a multi-year baseline which averages emissions out.  However, if this does not assist, responsible emitters can surrender "prescribed carbon units" or eligible carbon offsets, at any time to remain below their baseline.

Credits issued under the ERF, which are known as Australian Carbon Credit Units (ACCUs), are eligible offsets under the Safeguard Mechanism. Current amendments to the NGER Act indicate that it is "immaterial whether a unit specified in the Safeguard Rule was issued in or outside Australia", which leaves open the possibility of international units being used to offset a facility's excess emissions in the future.

The Government's current policy position is that ACCUs are the only prescribed carbon units that can be used; however it has also indicated that the purchase of international units may be allowed from 2017. A number of Australian companies have already begun buying international offsets, and others who have purchased carbon units under the former CPM which have not yet been converted into the ERF may be able to use those for compliance with the Safeguard Mechanism in the future.

The Government has also indicated its support for activities designed to reduce emissions from deforestation, forest degradation, forest conservation and the sustainable management of forests and enhanced forest stocks (REDD+), which may be used to meet obligations in the future. However, this has yet to be confirmed and it is unclear what role REDD+ will play in the Safeguard Mechanism going forward.    

10.  What are the penalties for failure to comply with the Safeguard Mechanism?

The Regulator has enforcement powers aimed at ensuring companies comply with their obligations under the Safeguard Mechanism. These include the power to issue infringement notices, to accept enforceable undertakings, and to seek injunctions to deal with instances of emissions exceedance.

As a last resort, the Regulator may seek to impose civil penalties on companies who contravene their obligations. The maximum penalty is  the lesser of 100 penalty points per day (currently $18,000 per day), with a maximum of 10,000 penalty points in total ($1.8 million). 

2017 Review of the Safeguard Mechanism

There will be a broader review of the Government's Direct Action Plan commencing by 30 June 2017, with a final report to be issued by 15 November 2017. As part of this, the Government will review, among other things, the effectiveness of the operation and effectiveness of the Safeguard Mechanism, as well as the role of international units may play in companies meeting their obligations under the Safeguard Mechanism.

Given Australia's intention to reduce emissions by 26-28% below 2005 levels by 2030, there is the possibility that the Safeguard Mechanism could be tightened - imposing more stringent and decreasing baselines on designated large facilities. This could ultimately result in the scheme operating as an effective  baseline-credit trading scheme in the future.