Zero emissions or zero progress: is the Safeguard Mechanism really going to achieve net zero?

11:06pm 17 October 2023

Written by Tia Fitzpatrick

While net zero 2050 may be decades away, achieving a sustainable emissions level is gearing up to be one of the biggest issues that our future politicians, economists, and scientists alike will struggle to grapple. With the introduction of the new 'Safeguard Mechanism' at play, Tia Fitzpatrick investigates whether the policy will actually make change, or simply continue to allow big corporations to stuff their real emissions levels under the rug, or worse, profit from them.

To reach Australia’s 2050 net zero emissions target, the Labor Party and Greens struck a climate deal on 1 July 2023 called the Safeguard Mechanism (SM). The shiny new policy aims to limit greenhouse gas emissions from industrial facilities emitting more than 100,000 tonnes of carbon dioxide (CO2) per year (Taylor, 2021).

The policy itself is actually nothing super new from the 2016 version, except that it sets production-adjusted, legislated limits – known as baselines – on emissions, rather than the previous method of fixed baselines based on historical emissions (ADCCEEW, 2023). The rule is simple: firms exceeding their baseline are required to either reduce emissions or purchase Australian Carbon Credit Units (ACCUs) to compensate (CER, 2023).

Economic Background

So what do we economics consider a cost-effective mechanisms? We say, one that satisfies the equimarginal principle: whereby marginal cost of emissions abatement is equalised across all producers for lowest possible aggregate cost (MC1=MC2 in figure 1.1, you'll have to scroll a bit to see it).

Australia’s Clean Energy Regulator (CER) runs REVERSE auctions where firms submit confidential bids for abatement subsidies and CER selects bids that maximise abatement for the lowest price (CER, 2020). Subsequently, firms require a subsidy above their MC to be cost-effective in reducing emissions.

As some firms must reduce more pollution to meet their baseline, they are incentivised to trade ACCUs in a secondary market – increasing the price of ACCUs and establishing a price floor (PACCU) which minimises abatement costs. This process of purchasing and selling ACCUs continues until the equimarginal principle is satisfied (MC1=MC2) and the policy is cost-effective (Figure 1.1). It's a bit like trading halloween candy with your siblings. As you and your younger brother trade, the "value" of the candy (i.e ACCUs) rises when one of you has fewer of the desired candies left, making it more valuable.

Additionally, for mechanisms to be efficient, aggregate marginal social benefit must equal aggregate marginal abatement. Figure 1.2 illustrates the social losses (DWL) that occur if MSB≠MC (ie when PACCU is under equilibrium due to under-abatement) as target emissions reduction is at an inefficient quantity (PACCU≠P*), resulting in a cost-effective but inefficient policy. Put simply, in order to deliver the most optimal outcome, the benefit of lower emissions (let's say, less people with asthma, fresher air in our forests) would be equivalent to the emissions actually abated by firms.

SM Issues

Unfortunately, the SM is inefficient.

As the mechanism ties baseline amounts to outputs of Australia’s largest polluting companies, it could inadvertently incentivise higher output and higher overall emissions as facilities can simply emit more provided output increases (CER, 2022). This exacerbates pollution concerns and lowers abatement incentive for large firms (Gluyas, 2023). Further, even if firms exceed baselines, ACCUs can be exploited with significant evidence showing “at least 75% of Australian carbon credits don’t result in real emissions reductions,” such as credits being sold for not clearing land that was never going to be cleared anyway (Armistead, 2023). Not ideal!

Alternative Policy

A more efficient alternative to SM would be implementation of a standard cap-and-trade system, aligned with Coase Theorem. Under this, government would set an absolute cap on total allowable emissions - to be reduced over time to align with climate goals – and issue a set number of ACCUs, to be priced according to market forces (Canada's Ecofiscal Commission, 2019; IEA, 2023). This enables price to be set at MSB=MC, reaching an equilibrium – leading to cost-effectiveness whilst encouraging dynamic efficiency by enabling market forces to minimise abatement costs.

Due the relatively flat MSB curve for emissions (as small decreases to emissions has minimal impact on climate change benefits), a carbon tax (CT) would also be beneficial by reducing DWL estimation error of the MC curve (Fell, 2012). As shown in figure 2, even with an uncertain MC, the CT price mechanism minimises DWL in comparison to a cap-and-trade policy (blue vs. yellow area) as tax can be set at a price level closer to equilibrium (Ptax).

A further advantage of CTs is that they can be applied flat across an entire economy, incentivising all polluters to abate – unlike the SM which only included 212 of Australia’s high-polluting firms (Ragabi, 2023). The effectiveness of CT was proved in the British power sector in 2023, leading to substantial declines in electricity-related CO2 emissions by 26% within 3 years (Gugler, 2023).

Whilst SM is cost-effective, output-based baselines and unlimited supply of weakly enforced ACCUs leads the policy to be inefficient. Rather, policies including a cap-and-trade market for carbon permits or CT offer both cost-effective and efficient results for climate improvement, ultimately assisting achievement of Australia’s climate goals. It's essential that our policymakers consider more future-proof, sustainable measures in order to ensure positive environmental policy for future generations.

The question remains: what is it going to take to lower emissions once and for all?

Reference List

ADCCEEW. (2023). Safeguard Mechanism Reforms. Canberra: Commonwealth of Australia. Retrieved from https://www.dcceew.gov.au/sites/default/files/documents/safeguard-mechanism-reforms-factsheet-2023.pdf

Armistead, A. (2023). The Safeguard Mechanism and the junk carbon credits undermining emission reductions. Retrieved from https://australiainstitute.org.au/post/the-safeguard-mechanism-explained/

Bureau of Meteorology. (2022). State of the Climate 2022. Retrieved from http://www.bom.gov.au/state-of-the-climate/

Canada's Ecofiscal Commission. (2019). Carbon Pricing: How does a cap and trade system work? Retrieved from https://www.youtube.com/watch?v=bxs6ZrxLvHg

CER. (2020). Auction Format. Retrieved from https://www.cleanenergyregulator.gov.au/ERF/Want-to-participate-in-the-Emissions-Reduction-Fund/Step-2-Contracts-and-auctions/auction-format

CER. (2022). Safeguard facility reported emissions 2020-21. Retrieved from https://www.cleanenergyregulator.gov.au/NGER/The-Safeguard-Mechanism/safeguard-data/safeguard-facility-reported-emissions/safeguard-facility-reported-emissions-2020-21

CER. (2023). Australia Carbon Credit Units. Retrieved from https://www.cleanenergyregulator.gov.au/OSR/ANREU/types-of-emissions-units/australian-carbon-credit-units

CER. (2023). The Safeguard Mechanism. Retrieved from https://www.cleanenergyregulator.gov.au/NGER/The-Safeguard-Mechanism

Fell, H. (2012). Prices versus quantities versus bankable quantities. Retrieved from https://www.sciencedirect.com/science/article/abs/pii/S0928765512000371?via%3Dihub

Gluyas, R. (2023). Safeguard mechanism explainer – Labor and the Greens strike a deal to cut emissions. Retrieved from https://news.nab.com.au/news/safeguard-mechanism-explainer/

Gugler, K. (2023). Carbon pricing and emissions: Causal effects of Britain's carbon tax. Retrieved from https://www.sciencedirect.com/science/article/pii/S0140988323001536?via%3Dihub

IEA. (2023). Australia has raised its climate targets and now needs to accelerate its clean energy transition, says new IEA review. Retrieved from https://www.iea.org/news/australia-has-raised-its-climate-targets-and-now-needs-to-accelerate-its-clean-energy-transition-says-new-iea-review#

Ragabi, M. (2023). A carbon tax can have economic, not just environmental benefits for Australia. Retrieved from https://www.nationaltribune.com.au/a-carbon-tax-can-have-economic-not-just-environmental-benefits-for-australia/

Saunders, M., & Denniss, R. (2021). Overpromise and underdeliver – A brief history of Australian climate plans. The Australia Institute.

Taylor, A. (2021). Australia's plan to reach our net zero target by 2050. Retrieved from https://www.minister.industry.gov.au/ministers/taylor/media-releases/australias-plan-reach-our-net-zero-target-2050

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