A comprehensive Safeguard Mechanism strategy for energy & resources companies

A comprehensive Safeguard Mechanism strategy for energy & resources companies

By Dr David T Kearns (Sustainable Services) and Raphael Wood (Market Advisory Group)

This article is a practical strategy guide on the forecasting, regulatory, technical and carbon market aspects of facilities affected by the ERF Safeguard Mechanism.

The Safeguard Mechanism presents risks to industrial businesses in Australia. ACCUs are not readily available in this market and demand will increase over time, so it is incumbent on carbon & environment professionals to manage your emissions profiles and make longer term plans to ensure you meet your obligations.

I’ve written this article with Environment and Carbon managers in mind. If that’s you, you may wish to skip straight to the strategy overview section.

Background

The Emissions Reduction Fund (ERF) Safeguard Mechanism commenced on 1 July 2016. It requires facilities that emit over 100,000 tonnes CO₂e of direct (scope 1) emissions to ensure that their emissions over a financial year do not exceed that facility’s “baseline” emissions (the highest annual emissions in the period from 2009-2013).

If a facility exceeds its baseline, it needs to acquire Australian Carbon Credit Units (ACCUs) to cover the amount of its emissions above its baseline. These need to be surrendered to the government by the end of February following the end of the financial year. Failure to do so can lead to significant additional financial penalties.

The purpose of the safeguard mechanism is to “safeguard” (hence the name) the emissions reductions the government has been paying for under the ERF. The government wanted to prevent emissions rising in areas of the economy not affected by the ERF.

It’s fair to say the government was quite generous with the safeguard mechanism, allowing high baselines to be set and the opportunity to calculate alternative baselines based on forecasts if companies wished. The rules are complex and we won’t try to cover them all here.

We recently had our first look at the impacts of the Safeguard Mechanism for its first full year in operation (1 July 2016 to 30 June 2017). Of the 131.3 million tonnes of CO₂e emitted by the covered facilities, 448,000 ACCUs (0.34% of total emissions) were surrendered.

This doesn’t sound like much, but acquiring ACCUs is not a straightforward exercise. The market for ACCUs in Australia is relatively thin (see Raphael’s commentary in section 5) and the first surrender date in February stretched the capacity of the existing ACCU market to meet demand.

The limited availability of ACCUs in the spot market has highlighted the need for all safeguard mechanism facility operators to take an active and strategic role in managing their emissions and potential obligations. This is because if your CO₂e emissions are predicted to rise above their baseline, you might not be able to acquire ACCUs as required by the legislation. And this could lead to financial penalties.

As explained below, without management, the Safeguard Mechanism will grow to be an increasing risk to business growth. As a result, your business strategy needs to incorporate carbon strategy and management as a regular and ongoing priority.

Safeguard Mechanism Strategy Overview

Let’s take a strategic overview of the options available to the ~200 facilities covered by the safeguard mechanism:

  1. Wait and watch. This is appropriate if your facility is operating well below its baseline (at least 10% below).
  2. Adjust your Safeguard Mechanism baseline, under the available provisions
  3. Reduce Scope 1 emissions at covered facilities
  4. Generate ACCUs for your covered facility yourself, by undertaking ERF projects at your other facilities
  5. Procure ACCUs from third parties, either through longer-term arrangements or through the spot market, to cover your emissions in excess of your baseline.

If you would prefer advice on how to execute this strategy, please email david@sustainableservices.com.au

1. Wait and watch

Let’s say your facility has a baseline of 250,000 tonnes CO₂e. In 2016/17, your facility’s scope 1 emissions were 224,500 tonnes, and in 2017/18 (the year just ended) they were 231,100 tonnes. Your facility is trending comfortably under its baseline. If this is you, there is no need to take immediate action.

Recommendation: Undertake continuous emissions forecasting for your facility. Incorporate any planned plant expansions, production increases, new product lines, or efficiency upgrades in your projections.

Forecasting will help ensure you aren’t caught short in an excess emissions situation in a future year. This will give you the time you need to adopt one or more of the remaining strategies below.

2. Adjust your safeguard mechanism baseline

The majority of facilities used their “reported baseline” - a figure calculated by the Clean Energy Regulator based on the facility’s historic emissions. However, in the first full year of the Safeguard Mechanism (2016/17), many took advantage of the generous provisions to increase their baselines. Of the 204 covered facilities:

  • 122 (36%) were granted a “calculated baseline”

  • 6 (3%) were allowed “multi-year monitoring” (see below)

  • 2 (1%) had a “default baseline” applied.

Calculated baselines are intended for facilities that are new (and so don’t have historical emissions to determine a baseline) or for which historic emissions aren’t a good guide to future emissions.

Calculated baselines can be obtained under one of several criteria (categories);

  • Initial;
  • New facility;
  • Significant expansion; and
  • Inherent emissions variability.

The Initial calculated baseline ship has sailed - if you didn’t apply back in 2017 you have missed out. This was essentially a big free kick for any facility likely to exceed its reported (historic) baseline, which is why it was so popular.

The New facility criterion obviously only applies if your facility is “new” (commenced operation after financial year 2014/15), and therefore can’t have its baseline set from historic emissions levels. If you have a new facility and its emissions are likely to exceed 100,000 tonnes then we strongly urge you to apply. If you don’t your new facility will be lumped with a default baseline of 100,000 tonnes. This could be financially disastrous if your new facility emits any significant level above that amount.

Inherent emissions variability criterion is available for mining or oil & gas extraction facilities, so long as you can demonstrate that your emissions will vary as a result of the properties of the extraction you are undertaking.

Significant expansion criterion can be used if you have increased your facility’s production by at least 20% or have begun production of a “significant” new product.

Production baseline variation is calculated based on actual production, unlike the calculated baselines (which are based on forecast production). These cannot commence until 1 July 2019, and will replace calculated baselines after they expire.

Multi-year monitoring is not a baseline variation, but it can be useful for facilities that expect temporary spikes in their emissions but anticipate their average emissions over several years being below their baseline.

Recommendation: Undertake a thorough review of the baseline options available for your specific facility. The provisions are quite generous and will allow many facilities to avoid being impacted by the safeguard mechanism at all.

You need to do this review ahead of time, because some of the baseline provisions are time-limited (the options expire after certain dates), there are critical due dates for applications, and because you need to supply an application to the Clean Energy Regulator that has been audited by Registered Greenhouse and Energy Auditor.

If after exploring options 1 and 2 you are unable to stay below your baseline, you will need to look at options 3, 4 and 5 (in that order of priority).

3. Reduce scope 1 emissions at your covered facility

Clearly one way to stay below your baseline is to implement projects that reduce or curb your emissions growth. The safeguard mechanism only looks at your scope 1 (direct) emissions, so these need to be the focus. Projects that reduce grid electricity use (scope 2) will not help you stay below your Safeguard Mechanism baseline.

Here is a non-exhaustive list of options available to reduce your scope 1 emissions:

  • Energy efficiency projects: This is a broad topic, but fortunately most Safeguard-covered facilities have looked at this already. The Energy Efficiency Opportunities (EEO) program was repealed by the Australian Government in 2014, but while it was active most large energy-using facilities were required to identify, screen and price energy efficiency projects. Even if these projects were not viable in 2014, with rising electricity and gas prices there is a good chance some of these projects will now be financially attractive. With the cost of avoided ACCUs included in your analysis, many could be worthy of rapid implementation.
  • Fuel switching: Search for replacement fuels that provide the same energy with lower GHG emissions. Examples include using solid biomass or refined liquid biofuels (for which biogenic CO₂ emissions are taken to be zero) in place of fossil fuels, or replacing coal with natural gas.
  • Fugitives flaring: For oil, gas and underground coal mining facilities, flaring of fugitive methane emissions is now standard industry practice. If your facility is one of the few remaining examples that is venting its fugitive emissions, flaring could be a quick and easy way to reduce your scope 1 emissions.
  • Operations optimisation: recent developments in industrial plant controls, system modelling, machine learning and artificial intelligence (AI) have begun to open up a new generation of plant optimisation which can help you reduce your emissions. David Kearns’ company Sustainable Data specialises in the use of Machine Learning and AI to help companies optimise their plants to reduce emissions and increase productivity, all without requiring capital projects. We will be happy to help you with your emissions challenge.
  • Move your scope 1 emissions offsite: By replacing on-site power generation (scope 1) with grid electricity (scope 2), you effectively move the emissions offsite, reducing your covered emissions under the Safeguard Mechanism. Similarly, by pre-processing your feedstock or post-processing products at other facilities and producing emissions elsewhere, you can also move your emissions offsite.

Recommendation: start by looking at your EEO priority projects list. A quick review of the financials with updated energy prices may yield some excellent projects with a quick payback and avoided Safeguard Mechanism obligations. If these don’t yield enough emissions savings to keep you below your baseline, consider the other options listed above.

4. Generate your own ACCUs (through ERF Projects at other facilities)

The Emissions Reduction Fund (ERF) is a way for new ACCUs to be created on the back of emissions reduction projects in areas like agriculture, forestry and industrial abatement projects. You can then use these ACCUs to offset your Safeguard Mechanism facility emissions, bank an excess for future years, and/or sell excess ACCUs to the broader carbon market (see 5 below).

Note: you should not aim to generate ACCUs from your Safeguard-covered facility that is in an excess emissions situation with these methods. The Safeguard Mechanism rules essentially cancel out any emissions reductions from ERF projects at that facility (to avoid double-counting).

A range of ERF “methods” are available for resources and industrial businesses who wish to claim ACCUs for emissions reduction projects. These include:

  • Industrial Electricity and Fuel Efficiency
  • Refrigeration and Ventilation Fans
  • “Facilities” method (a non-prescriptive method for NGER-reporting facilities only)
  • Coal mine waste gas
  • Oil and gas fugitives
  • Aviation
  • Land and Sea Transport
  • Alternative waste treatment
  • Landfill gas
  • Source separated organic waste
  • Wastewater treatment

For example, let’s say you have two facilities: a minerals processing plant (Safeguard-covered) and a separate manufacturing facility (not Safeguard-covered). You are going to replace some old pumping systems at the manufacturing plant with modern efficient versions. You estimate you can save approximately 5000 tonnes CO₂e each year from this upgrade in saved electricity use.

You implement an Industrial Electricity and Fuel Efficiency ERF project for this plant upgrade. Each year, you claim ACCUs (varying amounts, depending on your real-world plant activity) from this project. You then use these at your minerals plant to reduce its Safeguard Mechanism obligations.

Interestingly this example enables you to save scope 2 emissions (grid electricity) to offset Safeguard Mechanism obligations. This isn’t possible if you save grid electricity use at the Safeguard-covered facility itself, because the Safeguard Mechanism only considers direct (scope 1 emissions).

You may have considered some of these ERF project options before. When the ERF was first implemented, ERF projects were promoted with the idea that you could contract with the Australian Government to be paid cash in return for ACCUs you created. The business risk of contracting with the government for future emissions reductions, along with the complexity of the methods, seems to have frightened off a lot of potential project proponents.

However, if you are already planning efficiency projects or installing new equipment at your non-Safeguard site, there may be a case for applying for an ERF project. There is little business risk if you are simply generating ACCUs for your own use (rather than for sale to the government).

Recommendation: review your other facilities’ planned activities to see if you can claim ACCUs under one of the ERF methods for use at your Safeguard-covered facility.

5. Procure ACCUs from third parties

The above emissions avoidance and reduction options should be considered in light of the price of ACCUs.

It may be a surprise to some, but the secondary market for ACCUs is alive and well providing a clear price signal to corporates planning their emissions reduction strategy. At the time of writing, the spot price of ACCUs is trading in the mid-$14 range.

However, you may not be able to just turn up and purchase your compliance offsets when you need them, as the market for ACCUs is currently relatively thin. The demand required in February for 2016/17 Safeguard Mechanism compliance saw the spot market move from the mid $12 range to a reported high of around $17. In markets this thin, even a reasonably small compliance demand can influence the spot price quite dramatically.

The reason that the spot market is thin is due to the underlying structural fundamentals of the carbon market at the moment. Most of the carbon farming projects currently producing ACCUs have contracts with the Federal Government through the ERF. As such, almost all ACCUs currently being created are required to be delivered to the Government to fulfil those contracts. Supply to the secondary market comes from two sources: a small number of projects which are not contracted, and any surplus ACCUs from projects over and above their contracted volume.

The supply side of the carbon market is similar in many ways to the Renewable Energy Target (RET) market, where projects require long term offtake certainty, delivered by long term Carbon Purchase Agreements (CPAs). You can think of CPAs as similar to Power Purchase Agreements (PPAs).

The current supply and demand dynamic means that the spot price should trade at a premium to the long term CPA price, as project proponents prefer the certainty of a long term offtake to a slightly higher spot price.

Another carbon market fundamental, playing out around the world, is that the price of carbon should trend higher over time, in line with the Marginal Abatement Cost Curve (MACC). The MACC is the indicative carbon price that certain activities require to be commercially viable. This rise over time, as the cheapest activities are undertaken and exhausted and more expensive activities become the new supplier.

Recommendation: Locking in long-term ACCU offtakes as soon as possible should allow you to realise the benefit of both a discount to the spot market, and locks in prices at current levels before they march up the MACC.

For a current or potential Safeguard-liable entity, this long term contracting option requires that you need to forecast your likely future needs and get procurement underway well in advance.

There are then a range of internal procurement and governance structures you will need to put in place to get approval to make long term purchases. The counter-party and project risk assessments in themselves can take 6 months or longer in most large corporates.

In short; develop a strategy, plan ahead and if required procure ACCUs at the lowest cost. For an introductory risk assessment of your business under the Safeguard Mechanism, email me at david@sustainableservices.com.au.


Dr David T Kearns is founder and Principal Consultant of Sustainable Services, and co-founder of industrial machine learning / AI startup, Sustainable Data. He brings two decades of engineering, carbon and sustainability experience to his consulting work with clients across heavy industry, resources and energy sectors.

Raphael Wood is the founder and Managing Director of Market Advisory Group, an independent environmental market consulting firm. Raphael has worked in the mining sector, financial markets, government and carbon project development providing a unique insight into all aspect of the Australian carbon markets.

About David T Kearns

I'm an independent professional working in energy, carbon, sustainability and machine learning

Comments