By Thomas Hodgson and Matthew Herington, from Ndevr Environmental, gold sponsors of the CMI summit.
The Australian Government’s Safeguard Mechanism (SGM) places emissions limits – or baselines – on Australia’s largest emitters. Facilities with more than 100,000 tonnes of scope 1 (direct) carbon emissions per annum must keep their emissions below a baseline or purchase Australian Carbon Credit Units (ACCUs) to make up the difference. The SGM currently includes flexible provisions designed to accommodate business growth and continued normal operations, which has allowed most emitters to escape penalty for non-compliance. Despite this, the SGM could drive significant spikes in demand for ACCUs by February 2022. This unforeseen demand (in an increasingly supply-constrained market) could have significant implications for Australia’s still nascent carbon markets.
The Safeguard Mechanism Multi-Year Monitoring Period
28 Responsible Emitters currently report under a SGM Multi-Year Monitoring Period (MYMP). The intent behind allowing emitters to report under a MYMP is to provide a time buffer for businesses to reduce emissions back below the SGM capture threshold, or transition to an appropriate production or calculated baseline.
The MYMP lasts for either two or three years. MYMPs that expired on 30 June 2019 only resulted in a cumulative demand of 1,742 ACCUs due to some large emitters dramatically reducing their emissions in 2019. Any exceedance from MYMPs concluding on 30 June 2020 was delayed by one year due to the COVID-19 pandemic, allowing those entities an additional year to manage, or further increase, those emissions.
Had this delay not occurred, two businesses would likely have collectively exceeded their MYMP allowance by 880,586 ACCUs as at end of June 2020 (See Figure 1). Assuming an ACCU price of $22 on the secondary market, this equates to a cost impost for these two businesses alone of close to $19 million.
There are several important outcomes from this situation worth noting.
1. It means that in FY20, two companies’ combined, and principally one company alone, may have incurred a greater SGM liability than all previously captured SGM entities who weren’t over the threshold due to ACCU production. The design of the SGM is such that this reflects the relative luck of these two companies more than their operating practices.
2. By extending the expiry of the MYMP to ostensibly reduce the burden on businesses already impacted by COVID-19, there may be a perverse outcome whereby due to increasing ACCU prices on the secondary market, the price of compliance has increased materially. There is also the possibility that the extension has increased the overall SGM exceedance of the MYMP liable emitters by delaying the necessary move to a Transitional or Production-Adjusted Baseline. Something anecdotal evidence suggests is likely.
3. Finally, by providing the extension, the size of the demand spike for ACCUs resulting from the SGM could have significantly increased. Now, both facilities in an excess emissions position that were on a MYMP set to expire on 30 June 2020, and those set to expire by 30 June 2021, could require ACCUs at around the same time, further exacerbating the recently observed price spike in ACCUs.
Demand for ACCUs is likely to continue climbing as a direct result of the Safeguard Mechanism
To put this last point in perspective, since Q1 2019, an average of 197,000 ACCUs have been taken from the secondary market and surrendered through the SGM or voluntarily per quarter. As shown in Figure 2 below, the number of ACCUs required to meet the now delayed 2020 MYMP exceedance could alone be more than four times the average quarterly surrender rate otherwise observed. This excludes any ACCUs that will need to be surrendered for MYMPs that expire by 30 June 2021, or SGM emitters without a MYMP, or potential additional excess emissions for 2020 MYMP emitters; suggesting that demand for ACCUs in an illiquid market is likely to continue climbing as a direct result of the SGM. It is noted however that measures could have been taken to significantly reduce emissions against their SGM baseline.
Organisations expecting to exceed their SGM baseline, either through the MYMP or other mechanisms, should consider this dynamic carefully to avoid being caught by the coming ACCU demand peak. So too should ACCU developers, or those seeking carbon neutrality through Climate Active where participants are increasingly seeking the confidence that comes from Australian offsets.