How to live with the new carbon budget

The Albanese government felt so strongly about its emissions budget, it went to the trouble of making it law. Legislating a national target and a fixed emissions budget impose a discipline on policy-makers, ministers and businesses alike. The more concessions given away to one sector of the economy, the burden falls on others to keep within the emissions budget. Anyone calling for or granting special treatment should explain who else will pick up the slack.

Proposed reforms to the safeguard mechanism, released on Tuesday, will ask Australia’s largest industrials to do their share. These facilities already operate under emissions caps, but from July 1, these caps (called “baselines”) will start to come down by 4.9 per cent each year. Companies will need to adjust operations to stay under their baselines, or purchase credits or offsets for excess emissions.

Safeguard facilities will do 28 per cent of the work to achieve the 2030 target, directly proportional to their share of national emissions in 2021. This equates to a safeguard emissions budget for the decade of 1.2 billion tonnes.

But just as personal budgets become uncomfortable when we are faced with real decisions, so too must the government navigate sticky compromises to stay within this emissions budget.

A key decision in reforming the safeguard is divvying up the emissions budget between incumbent facilities and new ones. The government has set aside a “reserve” within the safeguard emissions budget that will be allocated to new facilities. This is created by requiring older facilities to take on stronger baselines. As well, new facilities must be built to meet international best practice, and will have declining baselines.

But what exactly is “best practice”? Anyone who’s tried to benchmark their company, business unit, or product against best practice knows that it’s a difficult exercise. “Best practice” for industrial facilities is as much a result of geography, history, and social norms as it is of engineering excellence. Defining “best practice” in law for Australia’s myriad industrial outputs will be fraught and contested.

Meanwhile, reforms to setting baselines don’t provide much reward to those companies who’ve already moved to reduce emissions. The government’s proposed approach softens the immediate impact of declining baselines on emissions-intense facilities, and provides less credit to the early movers who are already performing well. Some companies may argue they should get more.

Concessions to emissions-intensive trade-exposed companies (EITEs) are another trade-off. Generous concessions to exporters and those facing import competition – like those in the Gillard-era carbon price – would have consumed much of the budget, leaving domestic-focussed industries doing all the work. But no protection for EITEs means emissions go offshore (as do jobs and investment).

The reformed framework for EITEs is more rigorous than the approach currently used for the renewable energy target. It also maintains incentives to reduce emissions by keeping most of the assistance outside the safeguard mechanism, with emissions concessions going only to those who can show a significant reduction in revenue. The government’s assumption seems to be that the number claiming a concession will be small.

The obvious question is: what will this cost and who will ultimately pay? Unlike previous carbon price proposals, the reformed safeguard places no cap on the electricity sector, and hence electricity prices will be unaffected. There may be some effect on gas prices, but this will be dwarfed many times over by recent domestic price rises caused by the war in Ukraine.

The reforms include a “cost containment measure” which limits the price of compliance to $75 per tonne. This is well above the current price of offsets, which is hovering around $34 per tonne. But it’s well below the average internal carbon price that most companies are imposing on themselves as part of investment decisions. Grattan Institute’s research shows that, on average, safeguard companies factor in a carbon cost of $96 per tonne. Higher carbon prices provide the investment signal for new technology to commercialise, whether this is green steel using hydrogen, low-emissions cement, or minerals processing powered by renewable energy.

Setting a budget is one thing, staying within it is more difficult. The “reserve” looks pretty small, and allocating it between new facilities and emissions-intensive trade-exposed companies will require constant trade-offs going forward. Exactly how this will be done is not clear. How do new facilities know how much budget is available? If there’s not enough budget to cover everything in the pipeline, who decides which companies get what? What happens if EITEs concessions are larger than forecast? The government has left some scope to adjust in 2029 and 2030 if needed, but if forecasts are badly wrong, this may be too late and the budget will be blown.

Nevertheless, there should now be enough certainty for business to get on with the job of reducing emissions. Political debate can focus on increasing ambition and improving operations, not undermining or weakening the policy. And, next New Year’s Eve, let’s all hope emissions are within the budget.