IN BRIEF 00000000 WWW.CORRS.COM.AU CORRS MAY 2016 1 INTRODUCTION The Carbon Pricing Mechanism, or the so called ‘carbon tax’, may have met its demise in 2014 but emissions trading schemes still prevail around the world, and in Australia under the Safeguard Mechanism. Originally introduced as a concession in order to secure the passage of the Coalition’s Direct Action Plan legislation through parliament, the Safeguard Mechanism has evolved from a roughly sketched concept into a much-spruiked key pillar of Direct Action. The finer details of the Safeguard Mechanism have emerged slowly. However, as we now approach the homestretch towards the commencement of the Safeguard Mechanism on 1 July 2016, we now have a near full picture of its operation and scope, and what it means for businesses. 2 OVERVIEW The Safeguard Mechanism is the final, critical component of the Emissions Reduction Fund (ERF). The first two elements of the ERF – a system for crediting of emissions reductions, and a fund to purchase emissions reductions through reverse auction – have now undergone three rounds of reverse auction and funding. However, on their own, the crediting and purchasing of carbon abatement could not prevent these reductions from being countered or even overtaken by significant rises in emissions elsewhere in the economy. The Safeguard Mechanism addresses this criticism by establishing baseline emissions levels for larger emitters. These large emitters must then ensure that their emissions do not exceed their baselines in any given year, and may purchase Australian Carbon Credit Units (ACCUs) to meet this obligation. THE SAFEGUARD MECHANISM COMMENCES ON 1 JULY 2016: WHAT DOES IT MEAN FOR BUSINESS? JILLIAN BUTTON (PARTNER) AND PATRICIA SAW (LAWYER) As further guidance emerges on its operation, it is apparent that the Safeguard Mechanism in all likelihood will not provide the hard emissions ceiling required if Australia is to meet its emissions reduction commitments. Together with the availability of ACCU offsets, the mechanism offers a range of “flexible compliance arrangements” which allow businesses to exceed their baselines without penalty in a variety of circumstances including business expansion and growth. However, the Federal Environment Minister Greg Hunt has been reported as stating that the Safeguard Mechanism can be tightened in the future,1 hinting that it could be used as a tool to stabilise and possibly even reduce emissions over coming years. 1. Footprint, Australian won’t be left behind on carbon, Hunt says (4 May 2016), available at https://www.footprintnews.com.au/nl06_news_selected.php?act=2&nav= 10&selkey=53523&utm_source=instant+email&utm_medium=email&utm_campaign=subscriber+email&utm_content=article+headline&utm_term=Australia%20 won%27t%20be%20left%20behind%20on%20carbon%2C%20Hunt%20says. PAGE 2 The Safeguard Mechanism is set out in a number of instruments made under the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act). The bulk of the operational mechanics is contained in the National Greenhouse and Energy Reporting (Safeguard Mechanism) Rule 2015, and is supported by amendments to the NGER Act and other NGER Act instruments. waste accepted by a facility before 1 July 2016. What is “operational control”? The test for operational control is identical to the NGER Scheme. An entity has operational control of a facility if it: • has the greatest authority to introduce and implement any or all of the operating, health and safety and environmental policies for that facility; or • has been nominated as having operational control over the facility, provided that the facility passes the eligible nomination test. The question of whether multiple activities or a series of activities are considered part of the same facility turns on whether those activities are under the overall control of the same entity. businesses, accounting for about half of Australia’s total emissions. Interactive workshops are being held throughout May involving the responsible emitters that will be covered by the mechanism, and a list of those entities will be published on the Clean Energy Regulator’s (Regulator) website. What kinds of entities are captured? The Safeguard Mechanism applies to a broad range of legal structures including corporations, partnerships, trusts and local councils. What are “covered emissions”? Covered emissions are direct emissions (or scope 1 emissions) which include, for example, emissions from manufacturing processes, fuel combustion, physical and chemical processes, and fugitive emissions. It does not, however, cover emissions for which there is no measurement method determined by the Minister, and it does not cover legacy emissions from the operation of a landfill facility attributable to 3 HOW DOES IT WORK? 3.1 Who is covered by the Safeguard Mechanism? The Safeguard Mechanism will apply to all ‘responsible emitters’ – entities that have operational control of one or more facilities that report under the National Greenhouse and Energy Reporting (NGER) Scheme and have “covered emissions” of more than more than 100,000 tonnes of carbon dioxide equivalence (t CO2-e) per year (Covered Facility). Safeguard Mechanism obligations will only apply to the emissions generated by the responsible emitter by Covered Facilities under its operational control. Different rules apply to gridconnected electricity generators, transport companies and landfill operators. The Government has estimated that the 100,000 t CO2-e threshold will cover around 140 large PAGE 3 What happens if operational control changes during a year? Consistent with the NGER Scheme, an entity will only be responsible for emissions that occur in the part of the year it had operational control. 3.2 How are initial baselines set? For every Covered Facility, the Regulator will make a baseline determination. Each entity’s baseline will be no less than 100,000 t CO2-e. A number of baseline determination methodologies will be available to the Regulator upon the commencement of the Safeguard Mechanism, which are discussed in detail in the attached Schedule. The most common way of determining baselines upon the commencement of the Safeguard Mechanism will be the reportedemissions baseline methodology. This type of baseline applies to existing Covered Facilities in respect of which emissions have been reported at least once under the NGER Scheme between 2009/10 to 2013/14. This baseline is set at the highest level of annual reported emissions from 2009/10 to 2013/14, although a number of adjustments may be made by the Regulator. For example, emissions might be excluded from the baseline if they relate to activities that are no longer carried out by the responsible emitter. A calculated emissions baseline will also be available at the commencement of the Safeguard Mechanism and will be suitable for new facilities or where an existing facility has undergone a significant expansion, such that a reportedemissions baseline is inappropriate. A calculated-emissions baseline is set by calculating the high point of estimated annual production multiplied by the estimated emissions-intensity of that production. As discussed in further detail in the attached Schedule, a calculatedemissions baseline will expire after three-to-five years (depending on the size of the facility) and will be replaced with a permanent baseline which is determined based on actual (rather than projected) production figures. 3.3 In what circumstances can baselines be adjusted? Should it become apparent that a facility will exceed its baseline for a year, a responsible emitter can apply to the Regulator for an adjustment of its baseline. Baselines can be: • increased if a facility undertakes a significant expansion (an increase in maximum productive capacity of more than 20%) via an application for a calculated-emissions baseline determination; • temporarily increased for one year where total emissions rose due to increased production, but was accompanied by an improvement in emissions intensity; • adjusted to accommodate emissions variability associated with the extraction of a natural resource or reserve, via an application for a calculatedemissions baseline determination. This includes facilities whose emissions rise because the resource properties have necessitated changes in extraction practices; or • adjusted if facilities expect to exceed their baseline in the first year of the operation of the Safeguard Mechanism because historical emissions are not representative of future business as usual emissions. In practice, it would be expected that few, if any, businesses would be subject to any penalties or requirements to offset additional emissions in the 2016/17 compliance year as they would be eligible to apply for a baseline adjustment. 3.4 What happens if a baseline is exceeded? Should a facility exceed its baseline, it will have a range of options available to it to manage excess emissions. A responsible emitter can apply for: • a multi-year period, allowing a facility to exceed its baseline in one year as long as its average emissions over a two or three year multi-year period are below its baseline. • an exemption declaration – the Regulator may grant an exemption declaration in exceptional circumstances. This is limited to situations where excess emissions are the direct result of a natural disaster or criminal activity. In addition, a responsible emitter may purchase and surrender ACCUs to offset its emissions above baseline levels. Guidance material has confirmed that facilities covered by the Safeguard Mechanism are eligible to participate in the ERF and can create ACCUs to offset excess emissions above baseline levels. Measures have been put in place to avoid the ‘double-counting’ of these emissions reductions. PAGE 4 a large number of smaller facilities that may in aggregate emit in excess of 100,000 t CO2-e. 5 NEXT STEPS IN THE IMPLEMENTATION OF THE SAFEGUARD MECHANISM In the lead-up to the commencement of the Safeguard Mechanism guidance material will continue to be progressively released by the Regulator. It is also expected that in this period the Regulator will commence work on baseline determinations, and will commence notifying businesses and seeking their comment on baseline emissions numbers prior to 1 July 2016. The first year of operation of the mechanism, during which responsible emitters will enjoy the right to apply for a baseline variation if a reported-emissions baseline is exceeded, seems unlikely to see many cases of non-compliance. Instead, as currently designed, the Safeguard Mechanism will operate more as a flexible emissions cap with many options for businesses to avoid the need to purchase offsets or pay penalties where emissions increase. The Government has previously indicated that the achievement of its 2030 emissions reduction targets are predicated on an assumption that the Safeguard Mechanism in itself will deliver a reduction of 200m t CO2-e between 2020 and 2030. The mechanism, in its current form, does not appear capable of stabilising emissions, let alone driving a downward emissions trend. 4 HOW DOES THE SAFEGUARD MECHANISM COMPARE TO THE CARBON PRICING MECHANISM? The scope and operation of the Safeguard Mechanism evokes echoes of the former Carbon Pricing Mechanism (CPM). Its coverage is not dissimilar; as of November 2013 the CPM imposed obligations on 351 liable entities which accounted for about 60% of Australia’s emissions whereas the Safeguard Mechanism is expected to cover 140 entities and about 50% of Australia’s emissions. Of course, the intent of the Safeguard Mechanism differs, intending to only prevent significant rises in emissions across Covered Facilities whereas the CPM was intended to not only cap emissions but gradually lower that cap to achieve reductions across the economy. This fundamental difference bears out in the detail of the two schemes, with the Safeguard Mechanism providing a greater degree of flexibility and prioritising business growth and expansion over the containment of emissions in absolute terms. Under the Safeguard Mechanism, a responsible emitter that is likely to exceed its emissions baseline has a wide array of options at its disposal before it is necessary to purchase ACCUs. Furthermore, the CPM covered all emissions of an entity so long as it had operational control over a facility that emitted more than 25,000 t CO2-e. The Safeguard Mechanism on the other hand focuses only on the emissions of very large facilities that emit over 100,000 t CO2-e, and so overlooks entities with operational control over medium-sized facilities While the Safeguard Mechanism rule does not currently provide for international carbon credits to be purchased and surrendered in satisfaction of a responsible emitter’s liability, this will be subject to review in 2017. Finally, should a responsible emitter not avail themselves of the above options or otherwise still exceed their baseline, the Regulator will have ‘discretionary, graduated enforcement options’ available to it. The NGER Act a establishes a maximum penalty of up to 10,000 penalty units ($1,800,000). 3.5 Administration and reporting All responsible emitters must be registered with the Regulator and report their emissions in accordance with the NGER Act. Most existing responsible emitters are already registered and reporting emissions under the NGER Act, so a continuation of current practice should satisfy the Safeguard Mechanism reporting obligations. However, responsible emitters that were not previously covered by the NGER Act (such as operators of new facilities, or public authorities operating landfills) will be required to register and commence reporting their emissions. Responsible emitters must also keep records of their activities that relate to emissions reporting for five years after the emissions report was prepared. These records must also be readily accessible for inspection and audit. PAGE 5 • Revisit operational control: Participants in joint ventures and other arrangements where there is more than one entity involved in the operation of a Covered Facility should consider which entity has operational control, and will therefore be a responsible emitter under Safeguard Mechanism. This is likely to be the same entity that has reporting obligations under the NGER Scheme. Consideration should be given to whether any operational control nominations which have already been made are suitable in the context of a Safeguard Mechanism being introduced, and whether any terms should be renegotiated in light the new requirements introduced via the Safeguard Mechanism. • Arrangements between entities with ‘financial’ and ‘operational’ control: Unlike the CPM, the Safeguard Mechanism does not provide for the transfer of liability from an entity with operational control to an entity that has financial control of a Covered Facility. Responsible emitters should consider whether it is necessary to seek changes to arrangements with contracting parties with financial control over their facilities, who are likely to have control over capex and other decisions which will affect the responsible emitter’s exposure to offset costs. 6 KEY CONSIDERATIONS FOR BUSINESSES Despite the uncertainty surrounding the future of federal climate change regulation, there are steps that businesses should consider taking in preparation for the commencement of the Safeguard Mechanism. These include: • Baseline strategy: For those entities which expect to be covered by the Safeguard Mechanism, consideration should be given to the baseline determination methodologies, and a strategy put in place to manage the entity’s interactions with the Regulator in relation to their initial and future baselines. • Offset strategy: It is not yet clear what impact the Safeguard Mechanism will have on the market for ACCUs, although the flexibility of the scheme suggests that it is unlikely to stimulate large demand for ACCUs. Nevertheless, any entities expecting to exceed the baseline in the initial compliance years should establish an offset strategy, which may involve internally-generated offsets or third party offsets. The strategy should be flexible enough to account for the uncertainties around the future of the Safeguard Mechanism arising from the federal election and the Coalition Government’s scheduled review. It is against this backdrop that a review of the effectiveness of the Safeguard Mechanism will take place in 2017, just one year after the commencement of the mechanism. It will be interesting to observe at that time whether the Government will revise the architecture of the mechanism to bring Australia’s emissions into line with stated targets. It should also be noted that the Safeguard Mechanism will be in operation for just one day before the next federal election. Few areas of policy in Australia’s current political landscape are as fraught and changeable as climate change, and while the ERF and the Safeguard Mechanism enjoy the support of the current Government, the Labor party has pledged to revive emissions trading in Australia with the establishment of two different emissions trading schemes, one for the electricity sector and the other applicable to other industries. To implement this policy vision of this scale and scope would require an extensive suite of new legislative instruments as opposed to a simple strengthening of the existing ERF and Safeguard Mechanism framework. Ultimately, the future of the Safeguard Mechanism is highly dependant on the outcome of the federal election and the bargaining power of the minor parties and independents who were crucial to the establishment of the Safeguard Mechanism in the first place. PAGE 6 CONTACT DETAILS Melbourne Jilian Button, Partner +613 9672 3493 0413 805 109 firstname.lastname@example.org Brisbane Michael MacGinley, Partner +617 3228 9391 0417 621 910 email@example.com Sydney Christine Covington, Partner +612 9210 6428 0419 607 812 firstname.lastname@example.org • Cost pass-through clauses: The commencement of the CPM in 2012 triggered the negotiation of carbon cost pass-through clauses in a range of contracts, from power purchase agreements through to commercial leases. Some of these clauses were broadly drafted so as to be capable of covering cost pass-through under the Safeguard Mechanism. Organisations inside and outside the coverage of the Safeguard Mechanism should review existing carbon cost pass through clauses and explore what their potential consequences are with the introduction of the Safeguard Mechanism. Consideration should also be given to negotiating cost pass-through clauses for new contracts. • Remain alert: Emissions intensive industries that are outside the coverage of the Safeguard Mechanism should remain alert to possible changes in the scale and design of the Safeguard Mechanism or, if there is a change of government, the introduction of an altogether new emissions trading scheme which may be broader in scope. PAGE 7 SCHEDULE: HOW WILL BASELINES BE DETERMINED? 1 BASELINES METHODOLOGIES The Regulator will determine the baseline for each Covered Facility by applying one of the following types of baselines: • reported-emissions baseline; • calculated-emissions baseline (available prior to 2020); • benchmark-emissions baseline (commencing after 2020); • production-adjusted baseline; or • default 100,000 t CO2-e baseline. The type of baseline will establish how the Regulator will calculate the facility’s baseline emissions number which cannot be any less than 100,000 t CO2-e. Diagram 1 provides a general overview of how the Regulator will determine which baseline determination methodology to use upon the commencement of the Safeguard Mechanism. Diagram 1: Baseline determinations generally available upon commencement of Safeguard Mechanism *calculated-emissions baseline determinations will be replaced with benchmark-emissions baselines post-2020. PAGE 8 2 REPORTED-EMISSIONS BASELINES For existing facilities, this will be the most common type of baseline determination upon commencement of the Safeguard Mechanism. Who does this baseline apply to? This type of baseline applies to existing Covered Facilities in respect of which emissions have been reported at least once under the NGER Scheme between 2009/10 to 2013/14. The Safeguard Mechanism Rule provides that the Regulator must make a reported-emissions baseline determination in the following three circumstances: NO. OF YEARS BETWEEN 2009/10 TO 2013/14 THE ENTITY HAS REPORTED ITS EMISSIONS UNDER THE NGER ACT: NO. OF TIMES ‘COVERED EMISSIONS’ FOR COVERED FACILITY EXCEEDED 100,000 T CO2-E ‘OPT IN’ REQUIRED? 1 Every year At least once No 2 3-4 years All three times No 3 1-2 years At least once Yes – before 1 Aug 2016 – see below How is this baseline calculated? This baseline is set at the highest level of annual reported emissions from 2009/10 to 2013/14, although a number of adjustments may be made by the Regulator. For example, emissions might be excluded from the baseline if they relate to activities that are no longer carried out by the responsible emitter. Is an application to ‘opt in’ required? A reported-emissions determination will generally be made by the Regulator without any need for the responsible emitter to make an application. However, in the case of a Covered Facility that: • has reported its emissions for less than three years under the NGER Scheme between 2009/10 to 2013/14; and • where its ‘covered emissions’ exceeded 100,000 t CO2-e in at least one of those years; the entity responsible for that Covered Facility is entitled to opt-in to a reported-emissions baseline. Optin applications must be submitted to the Regulator by 1 August 2016. Does this baseline expire? No – this baseline does not expire and will therefore continue to apply unless and until it is replaced by another baseline (which might occur, for example, if the facility were to be expanded in the future). 3 CALCULATED-EMISSIONS BASELINES This baseline will be available upon application prior to 2020 and will be most relevant for new facilities or where an existing facility has undergone a significant expansion, such that a reported-emissions baseline is inappropriate. Who does this baseline apply to? Calculated-emissions baselines apply to facilities that lack sufficient historical emissions data because: • the facility is new or has submitted a limited number of NGER reports (where it is expected the facility will exceed 100,000 t CO2-e in its first year); or • the facility has significantly expanded or is subject to inherent emissions variability related to natural resources extraction. How is this baseline calculated? A calculated-emissions baseline is set by calculating the high point of estimated annual production multiplied by the estimated emissions-intensity of that production. PAGE 9 The intent is for benchmarks to be set at the average weighted emissions intensity of the bestperforming (least emissions intensive) 10% of the Australian operations carrying out the same productive activity. These benchmarks will be set out in the Benchmark Emissions-Intensity Index provided in Schedule 1 to the Safeguard Rule. Is an application required? Yes – a responsible emitter will be required to apply to the Regulator for this type of baseline. Does this baseline expire? Yes – this baseline will only apply for five years for facilities with emissions greater than two million t CO2-e per year (although this cannot apply to an existing facility), or otherwise for three years for all other facilities. What do I do after a benchmarkemissions baseline expires? As per calculated-emissions baselines, once a benchmark-emissions baseline expires, the responsible emitter may apply for a production-adjusted baseline which will be based on actual production figures rather than estimated production figures. If no application is made, then a default baseline applies. 5 DEFAULT BASELINES A default baseline of 100,000 t CO2-e applies when there is no baseline determination in force – for example, where a facility is not eligible for a reported-emissions baseline or a calculated-emissions baseline, or a calculated-emissions baseline expired and the responsible emitter did not apply for a productionadjusted baseline. 4 BENCHMARK-EMISSIONS BASELINES Benchmark-emissions baselines commence after 1 July 2020 and are intended to apply to new facilities and significant expansions after calculated-emissions baselines are no longer available. Who does this baseline apply to? This baseline will apply to new facilities and significant expansions of existing facilities, but will not apply to landfill facilities or electricity generators. How is this baseline calculated? The rules around calculating a benchmark-emissions baseline are complicated but essentially involve calculating individual baselines for each production variable for a facility (with each individual baseline calculated based on estimated production levels multiplied by an emissions intensity benchmark), and aggregating each of those baselines. What is a production variable? Generally speaking, a production variable is an output from a facility, or multiple outputs grouped together if they are similar in emissions intensity. It can also be an input where, for example, a facility creates multiple products from a single input and a change in the quantity of that input directly impacts on the facility’s emissions. What is an emissions intensity benchmark? Emissions intensity benchmarks will be developed by the Department of the Environment following the input of stakeholders, technical working groups and public consultation. Is an application required? Yes – a responsible emitter will be required to apply to the Regulator for this type of baseline. Applications can be made between: • up to one year before the reporting year within which the baseline will start; and • up to the 31 October after the end of the first year covered by the determination. Does this baseline expire? Yes – this baseline will only apply for five years for facilities with emissions greater than two million t CO2-e per year, or otherwise for three years for all other facilities. What do I do after a calculatedemissions baseline expires? The responsible emitter may apply for a production-adjusted baseline. A production-adjusted baseline is calculated in the same way as a calculated-emissions baseline, but substitutes estimated annual production with actual production figures. If the responsible emitter does not apply for a productionadjusted baseline, a default baseline will be applied by the Regulator (see below). A production-adjusted baseline determination does not expire and so will continue to apply unless and until it is replaced by another baseline determination. PAGE 10 Those that are covered by the mechanism may be the subject of a reported-emissions, or calculatedemissions (and subsequently a production-adjusted baseline), but may also apply for a landfillbenchmark baseline determination that will take effect on or after 1 July 2020. A landfill-benchmark baseline determination is a formula based on a number of factors including reported non-legacy emissions, the benchmark capture efficiency and oxidation factors. 6 ELECTRICITY AND LANDFILL BASELINE DETERMINATIONS Separate rules apply to gridconnected electricity generators, transport facility operators and landfill facilities. Grid-connected electricity generators will be covered by a single sectoral baseline to reflect the fact that the electricity sector behaves more like a single entity. The electricity sectoral baseline has been set at 198 million t CO2-e. If this baseline is ever exceeded it will cease to apply, and the Regulator will impose individual facility baselines on each electricity generator for Covered Facilities. Transport facility operators that operate nationally may: • report emissions from their operations as if operations in each state was an individual facility; or • opt to report their emissions as a single national transport facility. Landfill facilities will only be Covered Facilities if they emit more 100,000 t CO2-e, excluding legacy emissions (emissions arising from waste deposited at the landfill facility before 1 July 2016). In practice, this will mean that very few landfill facilities will be expected to fall under the Safeguard Mechanism.