Safeguard Mechanism: Why offsets are not an excuse for inaction

In a free market economy, price is the principal arbiter of consumption. Without price, consumption extends to the point that each individual’s interests are maximised, even where that consumption compromises the interests of the collective – a phenomena known as the tragedy of the commons.

Climate change is a classic example of the tragedy of the commons. Polluters profit by polluting, but everyone collectively shares the cost. This is why pricing emissions is so important.

The short history of pricing emissions

As a junior public servant at the Clean Energy Regulator during the implementation of the original Carbon pricing Mechanism (CPM) many years ago, I saw that the right to emit was awarded in a clumsy and sometimes arbitrary fashion.

The marginal cost to emit 1 tonne of CO2 equivalent after the first 24,999 tCO2e was $575,000 in 2013 dollars. Conversely, the incentive to reduce emissions once they fell below 25,000 tCO2e was zero.

There were many, many other such edge cases too; greatly exacerbated by the inclusion of facilities in the 25,000 – 99,000 tCO2e range, which were often more complex and less well equipped to respond.

Despite these challenges and the deep political discord it helped sow, the CPM worked. Pricing emissions and no longer treating the atmosphere like a commons, meant that polluters thought twice about polluting.

That is the beauty of price signals – they speak clearly in the universal language of money.

The CPM’s success occurred even though polluters (over the two-year life of the scheme) were only paying for the right to emit. $23, 2013 dollars, to emit 1 tCO2e.

In this scheme, there was no debate around what was being bought because there was no doubt – it was only the right to pollute that was purchased.

Skip forward to 2023, and much has changed.

Are Safeguard Mechanism credits and ‘user pays’ a gamechanger for cost-effective decarbonisation?

The Safeguard Mechanism (SGM) has done away with many of the edge cases. Only larger, better equipped companies are captured; and the marginal cost to emit 1 tCO2e after 99,999 tCO2e is the same as the marginal cost to emit the millionth tCO2e.

The scheme’s hybrid baselines, baseline decline curve and clear forward trajectory are all welcome changes over the CPM.

However, it’s the introduction of Safeguard Mechanism Credits (SMCs) and maturation of the Australian Carbon Credit (ACCU) scheme that represent the SGMs greatest potential.

This is partially because they provide options and mechanisms for companies to plan, reduce risk and manage costs, which are key to avoiding the reflexive push against regulation seen in the original CPM.

However, it’s what the step from permit scheme, to trading scheme, signals to decision makers that is the most important.

Where previously a company simply decided to buy permits to pollute or structurally decarbonise according to the economic merits in its own silo, that company now considers its place in the broader economy.

If it can decarbonise more cost effectively than others, it does so and sells those credits to other polluters.

Conversely, if it’s in a hard to abate sector, it pays others to reduce on its behalf – ensuring the most cost-effective decarbonisation is selected within the economy.

This system may sound like accounting magic, but it is the basis upon which the Australian and global free market economies work. And it works well.

There are understandable questions relating to the use of offsets in the SGM. Are they an excuse for inaction or a slight of hand? Valid questions.

Offsets are not an excuse for inaction

Importantly, the SGM is limited to ACCUs which, while not perfect, are very good; devoid of many issues facing so-called voluntary schemes and subject to active regulatory scrutiny and public interest.

ACCUs, at the very least, represent something better than simple permits to pollute which, inarguably, offered no actual direct environmental gain. Except the signal they send to polluters.

And this is the point about reliance on both SMCs and ACCUs. They are not an excuse for inaction or an easy way out. They are an unfunded liability that will grow both in terms of cost and risk with time, as demand balloons, until the pressure to invest capital and structurally decarbonise crosses a threshold that is unique for each company.

And when this occurs, and action is taken, the company making the decision will not only act in a way that is economically rational for itself, but also, economically rational for the economy more broadly.

This is how we decarbonise our industrial sector: Clear price signals incentivising profit maximising private industry to manage costs, reduce risk and deliver for their shareholders.

And it’s a system we know works because its the system that underlies Australia’s national wealth and prosperity.

Thomas Hodgson is director of Ndevr Environmental