What the new Safeguard Mechanism should do

The Safeguard Mechanism is a key policy in Australia’s fight against climate change, which caps emissions from big industrial facilities and other large polluters. Greenhouse gas emitters, from LNG platforms to mines to airlines, must keep their emissions below a baseline, or pay.

Now it faces reform, as the Albanese government has committed to amend the mechanism, to meet the 2030 target of cutting emissions to 43% below 2005 levels. But as ever, the devil is in the detail.

Host Kat Clay is joined by Alison Reeve, Deputy Program Director, and Esther Suckling, Associate, to discuss the Safeguard Mechanism design issues facing the government.

Read the Safeguard Mechanism reform paper

Transcript

Kat Clay: The safeguard mechanism is a key policy in Australia’s fight against climate change, which caps emissions from big industrial facilities and other large polluters. Greenhouse gas emitters from LNG platforms to mines to airlines must keep their emissions below a baseline or pay up. Now it faces reform as the Albanese government has committed to amend the mechanism to meet the 2030 target of cutting emissions to 43 percent below 2005 levels.

But as ever, the devil is in the detail. I’m Kat Clay and joining me today are Alison Reeve, deputy program director, and Esther Suckling, associate, to talk through some of the design issues the government must grapple with. So welcome, Alison. Welcome Esther. Hi Kat. So, Esther, I mean, the safeguard mechanism isn’t a new thing.

But there are several proposed changes here. What’s different about this and how will it work?

Esther Suckling: The big change here is that in the past, so since 2016, when the safeguard was rolled out, it was used to cap emissions. So, it was essentially in place to make sure that industrial facilities didn’t. Get over that cap.

But what we actually saw was that the cap sat well above where industrial facilities were actually emitting. So, there was a huge amount of headroom. And that’s meant that industrial emissions have only increased since the safeguard was put in place. So, the big change here is that now the safeguard will be used to try and drive down emissions in the industrial sector.

Every facility will still have a baseline, but that baseline will now decrease every single year. To the 2030 and 2050 points, the consequences for going over your baseline is having to pay. So, as you said, if you do exceed that number, you can either buy a safeguard mechanism credit or an accu, which you can get from the broader market.

And if you fall below your baseline and you do better than expected, you earn those credits. What we’ll see if the market for these credits is working correctly is that the price will respond to the demand. If in a certain year there’s a lot of demand, a lot of facilities have gone over their baseline.

We should see the price of those credits go up, and that should send a stronger signal to businesses to work harder to drive down their emissions. That would be the safeguard working well.

Kat Clay: Just before we move on, I mean, what did you say it was, an ACU?

Alison Reeve: An ACU is an, stands for an Australian Carbon Credit Unit, and what that is, is if you undertake a particular activity that the government has on its list of activities, that reduces emissions somewhere in the economy.

That might be planting trees. It might be how you manage a beef cattle herd. It might be how you manage, a wastewater facility. Then for the emissions that you, you save, you get credits for those that you can then sell to other people.

Kat Clay: Alison, why are these new revisions to the safeguard mechanism such a big deal?

Alison Reeve: As Esther said, industrial emissions have actually been growing, and they’re about to overtake electricity emissions as being Australia’s biggest source. Now, people who’ve been listening to the podcast for a while might remember we talked about this in-depth last year in August and again in July this year with related to two reports that we did on the industrial sector.

There’s nothing stopping those facilities from growing their emissions at the moment, and they’re simply. No way that we can cut emissions to 43 percent below 2005 levels without making a dent in industrial emissions. It’s not as big a deal as some people are making out. The industrial sector has had a carbon price before and they, they coped with it, but that was then repealed.

And many of these businesses Also have actually set themselves net zero targets and 2030 targets as well. Businesses are kind of going in this direction anyway, what the safeguard mechanism does is it probably brings, some rigor to that process and make sure that the laggards who haven’t made those decisions are keeping up with everyone else.

Kat Clay: Climate policy is always really complex. I mean, what are the challenges in designing this policy? And I might, might start with you, Esther.

Esther Suckling: As Alison was just saying, the main challenge here is to make sure this thing actually works. We need to see. Significant emissions reduction in this sector. And so that’s the kind of main game here.

One of the issues that we may run into has to do with what we call the emissions budget. So, 1 thing that the government floated in their submissions paper was, or the consultation paper about the safeguard. was the idea of reducing industrial emissions from 138 million tons in 2021 last year, down to 99 million tons in 2030.

And that represents a 28 percent reduction, which is in line with the fact that the industrial sector emits 28 percent of Australia’s total emissions. So, it’s kind of like the industrial sector pulling their weight. If you imagine a straight line between those two points and you’ve got time on the x axis, all of that area under your line gets laughing at couldn’t resist the chart.

Kat Clay: I know, I love that we’re describing charts on a podcast, but it is Grattan, so we have to get the chart love in somehow.

Esther Suckling: Yeah, so straight line down to 99 million tons. All of the area under that line is the cumulative emissions from the industrial sector, from all the safeguard facilities, which we’re allowing to these facilities to emit.

So that’s what we think of as the emissions budget. And if we are going to get down to 99 million tons, and it’s a straight line, that budget is just over 1200 million tons. So, one of the big challenges is how do you make sure that you don’t blow that budget? And a risk here is with new entrants, you’ve got your around 200 facilities in the safeguard at the moment, but what happens when a new cement manufacturer comes online in 3 years, if a lot of new facilities are coming online, and this will depend on the industries.

That we have in the safeguard, then you do run that really significant risk of having already apportioned the pie or the emissions budget to the existing players. And now having all these unaccounted-for emissions. And so, one thing we recommended in our submission was that the government should set baselines every five years.

So that gives them some flexibility to recalibrate it. If there have been a number of new entrants and to then adjust people’s baselines to account for that, there’s sort of a trade-off here between certainty and flexibility, because whilst you want that flexibility, you also don’t want to have this constantly changing signal for the players in the market as it stands.

So, we think that kind of five-year increment will give enough certainty for the near future. While still allowing to make sure we’re not going way over.

Kat Clay: I mean, Alison, did you have anything to add to that?

Alison Reeve: The other, issue that I think could potentially be a little bit contentious here is what are called emissions intensive trade exposed industries, sometimes nicknamed ETs.

One of the economic impacts that arises when you put a policy in place to cut emissions is that other countries might not move at the same speed. This means if you’re an exporter, you might face a cost. that your competitors don’t face. So, for example, Australia and Qatar both sell LNG to Japan. If we have the safeguard in Australia putting a cost on LNG plants by making them reduce their emissions and Qatar does not have a similar policy, Qatar might take some of Australia’s market share.

The other way that this happens too is if you’re producing something here, and it becomes more expensive because of the safeguard. Consumers might choose to use an imported product instead. So, we make paper cups in Australia, but we also import paper cups from China. Cafes might choose the cheaper cups, which might come from China.

If the safeguard is increasing the cost of Australian made paper cups and the local, local producer will lose some of their market share. In both of these cases, it’s not just the economic impact that matters, it’s also the emissions impact. Because if that activity effectively relocates away from Australia to countries that have less stringent rules, the amount of CO2 that ends up in the atmosphere is still going to be the same, or in some times it’s even more.

And so, on a global scale, we haven’t actually achieved what we wanted to do. Now, I did want to sort of point out that claims about trade exposure and companies claiming that, you know, they’ll be ruined and devastated. If anyone does anything about emissions can sometimes be a little bit overblown. More and more countries are putting in place carbon prices and emissions regulations.

So, for example, China’s got a broad carbon price coming in. That’s going to reduce emissions right across its economy. The European Union has a carbon price, some states in the US have carbon prices and so on. So, the case for assisting or exempting industries from having to cut their emissions through the safeguard or any other policy is actually a lot weaker than it used to be.

It’s not zero, but it’s sort of shrinking

Kat Clay: all the time. Yeah, just as you were speaking, my computer flashed up an alert that temperatures are rising, and I’m like, that’s a very apt warning from my computer. This does lead onto a really topical question. I mean, you’ve already said that it, it may cost, industries and businesses, you know, sales because.

People can procure the items elsewhere for cheaper, places that might not have the emission standards that we do. The money question is the big one. I mean, what else is it going to cost the economy?

Alison Reeve: This is a little bit uncertain, but again, we need to be careful not to sort of fall for overblown statements about job losses and costs to consumers and so on.

First of all, the design of the safeguard means that no one has to pay the price for all of their emissions for quite some time. So, on average, I think in the first year, it’s about a 4 percent cut in their emissions, which they can either choose to manage by changing how they operate their plant. You know, that might mean just finding a more efficient process, maybe plugging some leaks around the place and so on, or by choosing to go and buy the credits as Esther was explaining before.

So that means that the price is actually not going to be really strong and have a strong impact for quite a while. The second thing is we need to look not so much at what companies are telling the media, but what they’re telling their shareholders. There are about 99 companies. I think that, participate in the safeguard at the moment.

And at least 36 of those have disclosed that they use an internal carbon price. So, this means that their business decisions when they’re making them, they assume that they’re going to have to pay for those emissions one way or the other, and they set up what’s called a shadow price for that. For when we looked earlier in the year at all of the companies who are in the safeguard, of the ones who actually disclose what that price is in, you know, their annual report or on their website, More than half of them are assuming that they’re going to have to pay more than 100 per tonne of emissions, and that’s more than three times the current cost of offsetting.

So if you take both of those things into account, right, first of all, that in the first year, they’re only probably going to have to look at 4 percent of their emissions, and that most of them assume, are assuming that that’s going to cost three times what the actual market price of offsets is, you can see that the impact on the economy is likely to be quite muted for quite a long time.

There’s one other thing I think it’s worth talking about here too. Esther was talking about an emissions budget for the safeguard before. We also have an emissions budget for the country now, as part of the legislation that the government passed back in July. And that means if the industrial sector doesn’t pull its weight, then someone else has to make up that effort somewhere else.

So, households or farmers or small businesses have to do more emissions reduction, and that could actually have a harder impact on the economy. If those forms of emissions reductions are not as cheap as the ones that you could do in the industrial sector.

Kat Clay: Is there a situation where it would be more cost effective for a business to purchase those credits and, and purchase mechanism credits versus actually doing the work to reduce emissions?

Alison Reeve: There would be. I mean, there, there are some facilities in the safeguard who a lot of their emissions come from chemical processes or high temperature heat processes. Both of those sorts of processes are still subject to a lot of R& D and innovation to find an alternative that doesn’t have emissions associated with it.

So, there will be some facilities who will find that they’re having to offset for quite a while until someone invents a new process or a new technology that they can implement that will mean that their emissions drop quite a lot. What we’ll probably see, I think is that a lot of businesses will find That things that they have neglected to do before because they didn’t think it was economic will now turn out to be economic.

And so, they’ll do those things. The other thing is that the high energy prices that a lot of businesses are facing at the moment actually creates quite a strong incentive for them to go and look at how they’re using energy. Energy, particularly gas in their businesses and find ways to reduce that use because they will not only reduce the, their safeguard burden.

They will also save themselves some money.

Esther Suckling: And I just add there to that, as we were saying with that headroom before the start of the episode. A lot of companies haven’t had a very strong incentive to actually have to reduce their emissions and now it’s kind of coming to bear that there’s a bit of a crunch here.

So, as Allison was saying, there might be a whole number of smaller things that facilities might be able to do to avoid having to pay that price for going over their baseline.

Kat Clay: The mental image I’m getting here is one of those Indiana Jones trap ceilings that just starts coming down while you’re stuck in the room.

So, you better do make some moves to get out of this quickly.

Alison Reeve: Well, that’s the thing is Indiana Jones does end up escaping, right? And so, you know, I think the same will happen for businesses that I think a lot of them will surprise themselves in how well they cope.

Kat Clay: So, I mean, Esther, how do we actually know when the safeguard mechanism is doing its job?

Esther Suckling: There are a few ways that we will be able to. Tell that the safeguard is doing what we want it to and it’s successful. the first is pretty tangible. So, we’d like to see that the safeguard effectively reduces emissions. The first year that it’s operating. That’s kind of an important first win to set the precedent for the rest of the policy.

and along with that, we would like. To ensure we’d like to see that within the first five years, there’s no blow out of the budget. So, any. Amount that’s admitted cumulatively over the budget is within 10 percent over because it’s important to generate that confidence in the market amongst the industrial facilities that are part of this and also in the public who can start to see this policy working.

The second thing goes to some of Allison’s points around businesses investing in this clean and technology. That is a huge shift that Ideally, the safeguard will be able to really push forward seeing those investments into yeah, lower carbon alternatives at different plants, different industrial sites will kind of indicate that this is working.

And the third thing, it’s a little bit more political, but it’s that if you imagine us at the next federal election, we don’t want the safeguard to be something that’s up for scrubs. For the opposition to suggest that they’ll remove. We frankly don’t have the time to go back to square one with the industrial sector emissions.

And so, we’d want to see this as a policy that has broad support on both sides of politics amongst the public amongst industry. And so that it can be carried forward and continue to be effective as a long run signal within this sector.

Kat Clay: And I think understanding it goes a long way to understanding why it’s important as well.

So, I really appreciate you both coming on this podcast. I feel like I learned something about the safeguard mechanism. If you’d like to read more about our research into climate change, please do go to our website grattan.edu.au and you can access all of our research there for free. We’re a not-for-profit organization.

So, if you’ve enjoyed the podcast this year, we’re getting towards the end of the year. We would love it. If you could donate at grattan.edu.au forward slash donate. And if you’d like to talk to any of our podcast guests or Grattan itself more about this particular topic, you can find us all on Twitter at Grattaninst and on all other social media channels at Grattaninstitute.

As always, please do take care and thanks so much for listening.