1 July 2023 is approaching, along with the new Safeguard Mechanism Rules. What now?
With the reformed Safeguard Mechanism taking effect from 1 July 2023, the Federal Government registered the final legislative rules providing detailed design elements of the reforms on 5 May 2023. The reformed scheme will ensure that Australia's largest emitters are contributing towards Australia's emissions reduction task. Our alert released last week discusses the changes in detail.
Large emitters prompted to take action – time to consider your carbon credit strategy
The recent changes in the design of the Safeguard Mechanism have many large emitters contemplating their approach to meeting revised baseline requirements. Many of these entities operate facilities in the mining, oil and gas industries and do not have viable or readily available technologies to effectively avoid or abate their emissions meaning that they will need to consider carbon credits in order to meet their baselines. For these entities, procuring carbon credits will likely be a costly exercise required over a number of years given the International Energy Agency (IEA) modelling suggests large scale deployment of new technologies for these industries is not due for some years yet.
As simple as shopping for carbon credits?
Developing a strategy to acquire credits, whether they are ACCUs, the new safeguard mechanism credits, or credits from voluntary or international markets, may initially seem like a straightforward task. However, without a sound understanding of these markets and thorough due diligence, participation can quickly lead to ineffective and costly outcomes. At worst, it can result in greenwashing accusations and significant reputational damage which unfortunately is this case for those Australian corporates caught up in the Four Corners investigation into a Verra registered project located in Papua New Guinea earlier this year. This media attention should serve as a reminder that participating in carbon markets can have adverse financial and reputational consequences and requires careful upfront consideration.
There are a number of fundamental principles you should know upfront
McR ESG’s work in this area often involves helping clients to first understand the nature of carbon credits, including the range of credits available and best practice rules to be adopted regarding their use. Adding to the media noise and distraction regarding appropriate use of carbon credits, many reporting corporates are being approached directly by carbon farming participants to pursue projects on their land. At first glance, this may appear to be a sensible approach to commence participation however these proposals can shift the focus of decision making solely towards financial objectives without first ensuring that the proposed approach is sound.
Therefore, we advise a cautious and thorough evaluation of all options, ensuring that decisions are based on objective principles and a comprehensive understanding of the associated risks and benefits.
The following are some fundamental principles we believe are crucial to understand before embarking on project feasibility or procurement.
- Not all carbon credits are alike. Carbon offsets may be issued under compliance offset programs like ACCUs or voluntary offset programs, of which there are many available globally. Each program produces its own form of carbon offset and specific rules regarding matters such as approval and use. With such a large range of carbon credits available, different outcomes can result, depending on the rules of the program, and directly impact the integrity of the credits concerned. Higher quality offset credit programs like ACCUs have specific requirements as to technical matters including that the emissions reduced, avoided or abated by the program are real, additional, measurable, verifiable, and permanent. Robust due diligence should also consider the activities generating the credits and more generally the activities of the provider itself, as another common requirement is that the provider and program must not also cause significant social and environmental harm.
- Carbon credits should be used as a method of last resort. Arguably the most divisive matter when it comes to carbon credits is the question of their use. When it comes to decarbonisation, a best practice approach requires alignment with what is called the emissions mitigation hierarchy. Professor lan Chubb, Chair of the recent independent review of Australian carbon credits describes this best by explaining that offsetting should only be considered as the final step after efforts to first avoid and reduce emissions have been maximised . “Offsets can't be a device which big emitters use not to change their behaviour not to do something about reducing emissions.” Entities relying heavily on offsets without prioritising avoidance and reduction efforts can expect criticism and will have to justify why or how they cannot avoid or reduce the need for offsets.
- Voluntary and international carbon credit markets are different to the compliance market. As it stands, the Safeguard Mechanism only supports the use of ACCUs or Safeguard Mechanism credits. However, the Government intends to consult later in 2023 regarding the possibility of introducing international units to the legislative framework and may include the future use of international credits if they are of high integrity and contribute to Australia’s climate targets. There have been delays in recent years with the formation of an international market for credits due to concerns regarding double counting of credits by countries in the overall pursuit of Paris Agreement targets. However, these challenges are slowly being resolved and there will be further market evolution over the next couple of years and it is expected that international credits will eventually be added to the Safeguard Mechanism framework. While international credits may seem uncertain, there can often be sound financial and other strategic advantages for Australian safeguard entities to consider sourcing from international markets, including, for example, in order to partner with overseas customers or contractual partners to jointly pursue projects overseas that should not be dismissed and will require groundwork to execute.
- Carbon offset strategies require detailed due diligence. There are over 170 types of carbon offsets internationally, each falling into different categories with varying methodologies. When developing a robust strategy, it is essential to consider concepts like availability of co-benefits, measurement and reporting rules and outcomes, and third-party verification, as these areas are still evolving for many carbon credit categories. Buyers should conduct thorough due diligence to understand the risks and rewards associated with the credits, ensuring they align with their business goals while maximising co-benefit value. It is important to verify that the credits actually deliver the benefits as intended and are measurable. Additionally, as carbon projects span decades, it is necessary to understand the project activities through to project end, which can often be well beyond the timing of original participation.
- NGERs reporting may result in unintended offsetting liabilities. The reporting structure under the NGERs Act is designed in such a way that “facilities” can consist of activities and operations owned by multiple unrelated corporate entities. This means that the reported emissions may practically be carried out by several parties, but only the corporate entity with "operational control" is responsible for reporting them. Practically, this could mean that the entity with operational control assumes the responsibility for reporting emissions, managing all operations and activities within the facility, and fulfilling obligations related to surrendering offsets or holding Safeguard Mechanism credits for emissions that might have resulted from activities that were carried out or operated by others. Both reporting entities with “operational control” and other corporates responsible for activities captured within the “facility” will on both sides need to consider what contractual mechanisms exist for passing through the costs of procuring credits, or proportionate adjustment of the financial liabilities resulting from those other activities.
Given the current emphasis on greenwashing by regulators and market participants, it is crucial to conduct thorough due diligence before engaging in this emerging market. McR ESG recognises the high stakes involved and offers specialised advice to ensure our clients make informed decisions. We collaborate with our clients to ensure understanding and adherence to these key principles. Additionally, we assist in navigating market entry and incorporating other relevant strategic criteria for procurement or project development.
If you would like to have a more detailed conversation around your specific circumstances, please contact Louise Horrocks.