Labor climate policy: Implications for the Safeguard 2.0 market

Reputex

The ALP today released its “Climate Change Action Plan” policy, designed to establish a framework to meet Australia’s long-term emissions reduction obligations.

The cornerstone of the policy is the extension of the government’s Safeguard Mechanism scheme to tighten emissions limits for the industrial sectors, while enabling facilities to generate credits for emissions below their baselines.

The baseline and credit scheme will operate separately to the National Energy Guarantee, potentially facilitating a “two-speed” market in Australia via the different caps, targets, crediting and access to offsets.

In this article, we outline the key aspects of the ALP’s policy framework and provide initial commentary on the market implications for liable entities and offset proponents.

National and sectoral targets

The ALP’s policy framework is underpinned by a 45 per cent emissions reduction target (on 2005 levels) by 2030. This is the lower bound of the Climate Change Authority’s recommended 45 to 65 per cent target range.

Key national and sectoral commitments include:

• National target to reduce emissions by 45 per cent on 2005 levels by 2030;
• The national target is supported by the ALP’s 50 per cent renewable energy goal by 2030.
• Net zero emissions by 2050, consistent with the Paris Agreement to achieve a balance between emissions generated and those offsets, sequestered or removed in the second half of this century;
• Extending and tightening the Safeguard Mechanism

As noted in earlier updates, the ALP proposes to introduce a more robust ‘baseline and credit’ scheme under the government’s safeguard mechanism framework.

Key components of the ALP framework include:

• Extended threshold for inclusion: Currently set at 100,000 t/CO2e per annum, coverage of the scheme will be extended to facilities emitting over to 25,000 t/CO2e, aligning the Safeguard 2.0 market with the former Carbon Price Mechanism (CPM) and other regional markets (such as the China ETS).
• Facilities in the electricity sector will not be covered by the Safeguard Mechanism, but will be covered under ALP’s proposed NEG framework.
• Baselines decline: Emissions baselines will be set to reduce over time in line with the ALP’s economy-wide reduction target. Baselines will be set via consultation with industry and will be subject to review.
• Baseline start date: Baselines are expected to be set from actual reported emissions in 2019-20, commencing on July 1 2020.
• Crediting: Facilities may create credits below their emissions baseline, and trade with companies that exceed their baseline. Should a liable entity breach or exceeds its baseline it will be required to source an equivalent number of offsets for that year.
• Use of offsets: Offset rules are expected to be published governing the types of offsets eligible under a future scheme, including access to international offsets and Australian Carbon Credit Units (ACCUs). To support a domestic offset market, limits will be set on international offsets. Electricity offsets are also expected to be fungible with the Safeguard Mechanism.
• EITE activities: Energy intensive trade-exposed activities (EITEs) will qualify for exemption/free allocation, limiting new costs.
• Market observations and commentary – Implications for the Safeguard Mechanism 2.0 market
• Industrial emissions growth could create a short market

As we noted in our earlier Market Update, “Safeguard Mechanism 2.0 – Modelling the Australian carbon price to 2030”, assuming baselines are adjusted to decline at a linear rate, forecast growth in covered sector emissions is expected to see an aggregate market cap breached almost immediately, creating a short market setting.

That shortfall would be made up by the lowest cost combination of: credits for direct abatement by large emitters, domestic Australian offsets and allowable international units.

Local ACCUs are cheaper than international units

While international units were previously considered ‘least cost’ for Australian companies, the global market landscape has changed markedly since the repeal of the CPM, with Certified Emissions Reductions (CERs) no longer allowed in most markets.

In addition, European Union Allowance (EUA) prices have grown from under A$11 in 2015 to around A$34 in 2019 –  in line with 10-year highs – as oversupply in the EU ETS is rebalanced with underlying demand (under their Market Stability Reserve).

Given the high forward price trajectory for international allowances, we expect the future Australian carbon price to be underpinned by strong demand for cheaper Australian carbon credits and offsets.

With Australian Carbon Credit Units (ACCUs) the marginal source of emissions reductions under Safeguard 2.0, we continue to expect the Australian carbon price to converge with ACCU offset prices, reflecting the balance between underlying supply and demand, trending well below international prices.

Post-2020 rules under the Paris Agreement will be critical

Following the Bangkok climate talks at the end of 2018, negotiators have made headway on the practical details of how the Paris Agreement will be implemented, known as the Paris “rulebook”.

Key aspects are expected to be advanced in the lead up to COP25 in Santiago in December, specifically, how countries should format their climate pledges – such as the use of past carryover credits and how often Nationally Determined Contributions (NDCs) should be updated. Discussions will also aim to resolve how to repurpose the Clean Development Mechanism (CDM).

Many markets – including the EU ETS – have taken unilateral action, effectively eliminating the use of CERs in favour of domestic emissions reductions. For example, no CERs will be used in the EU after 2020, with the EU Commission adopting a ‘domestic emissions reduction target’ to support local emissions reduction activities.

Is there enough supply of ACCUs available to support the Safeguard Mechanism 2.0 market?

The Emissions Reduction Fund (ERF) currently forms the primary market for ACCUs, with the Regulator entering into contracts to purchase ACCUs. More recently, limited activity in a ‘secondary’ market has developed, underpinned by voluntary, state and territory government demand.

While the local market is illiquid, we continue to forecast growth in ACCU supply to support the local market, with new demand under Safeguard 2.0 likely to incentivise increased supply from domestic offset developers, particularly given the likelihood of a nominally short market. For more on this, please click here.

Longer term abatement availability in Australia?

Longer-term, the Australian carbon price will move broadly in line with the cost and volume of GHG emissions abatement required across the broader economy, set by the national emissions reduction target.

As shown in Figure 2, Australia has a significant volume of abatement below $25 per tonne, supporting ACCU generating activities in agriculture, (e.g. carbon sequestration in grazing lands), vegetation,  (e.g. avoided land and regrowth clearing of native forests and industrial categories (e.g. coal mine fugitive methane destruction).

Looking ahead

In broad terms, the ALP’s policy framework provides long-term architecture to guide high emitting industries towards Australia’s 2030 emissions reduction target, while ensuring liable entities have the flexibility to access external credits – such as emission reduction credits, domestic ACCU offsets or international units – to meet any compliance obligation at least cost.

Ultimately, Australian carbon price dynamics will be determined by how the market fills any shortfall, based on the lowest cost combination of 1) domestic Australian offsets; 2) international units; and 3) credits for direct emissions reductions at safeguard facilities, with the volume and type of demand having a large bearing on the Australian carbon price.

Please refer to our earlier Market Update, “Safeguard Mechanism 2.0 – Modelling the Australian carbon price to 2030” for more detailed market and pricing analysis, or contact our Melbourne office.

This article was originally published here by Reputex. Reproduced here with permission.