Critics of the Government's Australian Carbon Credit Unit Scheme (Scheme) may be perplexed by some of the findings presented in the much-anticipated Independent Review of Carbon Credit Units (the 'Chubb Review'), released on 9 January 2023. Contrary to certain claims that there is an inherent lack of integrity and transparency, the Chubb Review found that the Scheme is 'essentially sound' and has an important role to play in enabling Australia to reach its net zero goal by 2050. Nevertheless, it makes a range of findings culminating in 16 recommendations in the name of continuous improvement.

The Federal Government has concurrently released a suite of proposed reforms to the Safeguard Mechanism (which seeks to regulate the emissions of the country's largest polluters). View the consultation paper and draft legislative rules for the revised Safeguard Mechanism. Key among the proposed reforms is a carbon price cap of $75 a tonne to assist high emitting facilities to meet compliance obligations under the revised Safeguard Mechanism.

Below, we provide a summary of the recommendations and findings from the Chubb Review, an insight into the proposed architecture of the Safeguard Mechanism reforms, and some key takeaways for current and prospective market participants and regulated entities.

The Scheme

The Scheme regulates the creation and sale of Australian Carbon Credit Units (ACCUs). Each ACCU represents 1 tonne of carbon dioxide stored or avoided through an eligible offset project (being a project which avoids the emission of greenhouse gases or removes them from the atmosphere). ACCUs may be held, or sold to generate income either to the Australian Government or to private companies on a secondary market. The Scheme is regulated by the Clean Energy Regulator (CER) who is also responsible for issuing ACCUs.

Background to the Chubb Review

The Scheme has faced intensifying criticism from certain commentators for lacking integrity, transparency, and even venturing into fraudulent territory. Some have argued that the carbon abatement claimed to have been achieved through the Scheme has been overstated and that methods employed under the Scheme (being the established rules for estimating emission reductions) are ineffective and inherently flawed.

On 1 July 2022, the Federal Government announced the creation of an independent panel chaired by former Chief Scientist Professor Ian Chubb (AC) to undertake a review into the integrity of the Scheme and advise on how to strengthen its credibility and effectiveness. Following its appointment, the panel received and considered written submissions and conducted meetings with various stakeholders including project proponents, government agencies and industry. The panel's work culminated in its report released on 9 January 2023.

Recommendations of the Chubb Review

We set out a summary of the Chubb Review's 16 recommendations below.

1. Scheme governance

The panel recommended that the roles of Scheme assurer, Scheme regulator and those with respect to policy development should be clear and undertaken by 'visibly separate bodies' to enhance confidence in the integrity and transparency of the Scheme.

2. A new assurance body

Currently, the Emissions Reduction Assurance Committee (ERAC) is the body responsible for assessing the compliance of offset methods against the Offset Integrity Standards (OIS) under the Scheme's governing legislation and sits within the CER. The panel proposed the reconstitution of the ERAC as the Carbon Abatement Integrity Committee (CAIC). Key to the reconstitution are the recommendations that the CAIC should have an independent source of funding from the CER, an independent secretariat and unfettered access to all relevant information to support its assurance role.

3. Role and remit of the CER

A frequent feature in critiques of the Scheme is that the CER plays too many roles and is (either actually or perceived to be) conflicted. To avoid actual or perceived conflicts of interest, the panel recommended a clarification over the role and remit of the CER. For example, it should continue to be responsible for project monitoring, compliance and enforcement, and providing transparent project and scheme information. It should also undertake new initiatives such as reducing complexity of the Scheme, improving accessibility of information and creating a public register of previous rulings and precedents. Notably, the CER should cede responsibility for administering the Federal Government's purchase of ACCUs to another entity.

4. Increased data sharing

The panel recommended an amendment to the Scheme's governing legislation to maximise transparency through increased data sharing and disclosure, and a loosening of restrictions around data access whilst balancing the protection of commercial-in-confidence information. The panel encouraged the Federal Government to explore the concept of a national platform for accessing information about the Scheme.

5. Reforms to method development

The panel found that the current prioritisation of developing methods based on widescale potential uptake and volume should be replaced with a more modular approach that emphasises proponent-led method development. This will provide project proponents with beneficial flexibility to propose and develop methods suitable to their particular purpose and more tailored to local contexts. The panel also recommended that methods should be more dynamic and capable of supplementation by modifications (method modules) that can be developed by proponents for existing eligible offset activities.

6. The OIS

The panel found that the OIS are broadly fit-for-purpose, but made a number of recommendations to assist in improving their interpretation. The panel also recommended that the OIS should be supplemented with a set of clearly defined ACCU Principles to support method development, project implementation, regulation and assurance.

7. Scheme-level risk management

The panel recommended exploration by the Climate Change Authority on the implementation of a mandatory cancellation of a percentage of ACCUs. The purpose of this would be to ensure carbon abatement is appropriately conservative across the Scheme and reduce the potential for over-crediting of abatement. The panel also recommended further consideration be given to this because, for example, it may risk upward pressure on the ACCU price, with implications for the cost-effectiveness of abatement.

8. Human-induced regeneration (HIR) method

Broadly, HIR projects under the Scheme involve the undertaking of an 'HIR activity' with a view to causing an area of land to be regenerated and attain forest cover (and sequester carbon via the regenerated forestation). The panel found that the HIR method is sound, clarified the interpretation of what the method requires, and recommended that the CER publish data and results from HIR projects.

9. Avoided deforestation method

This method under the scheme involves the protection of native forest in areas that would otherwise be cleared. Given the uncertainty surrounding the volume of eligible land clearing permits (which a proponent must have in order to register an avoided deforestation project under the Scheme), the panel recommended that no new project registrations be permitted under this method.

10. Landfill gas methods and carbon capture storage (CCS)

Broadly, landfill gas methods under the Scheme involve the combustion of landfill gas with a view to capturing it, or for the generation of electricity. The panel recommended that any adjustments to the crediting period (i.e. the period during which ACCUs can be claimed) of a landfill gas project should also result in a review and adjustment to the project's baseline (i.e. the proportion of landfill gas destruction required under existing legislation). With respect to the CCS method (which provides for the capture of greenhouse gases that would have been released into the atmosphere), the panel provided limited commentary but considered it to have an important role to play in combating climate change.

11. Free, Prior and Informed Consent (FPIC)

With respect to the broader implications of the Scheme on the community, the panel assessed the architecture of the Scheme vis-à-vis First Nations Australians. The panel recommended removing the current ability for proponents to conditionally register projects on land subject to Native Title before obtaining consent from the relevant First Nations Australians. This will allow the Scheme to better achieve the principles of FPIC and reduce the potential for an imbalance in bargaining power.

12. Carbon service providers

The panel recommended that service providers in the carbon market should be accredited and regulated under a set of mandatory performance standards.

13. Co-benefits

The panel found that the quality and attributes of ACCUs generated under the Scheme are not well understood. Co-benefits are an important type of ACCU attribute and represent the additional benefit or value of an ACCU from, for example, an economic, social or environmental perspective. The panel recommended that the CER develop processes through which proponents should evidence and subsequently claim co-benefits.

14. Scheme participation

The panel made a number of recommendations targeted at improving capacity and capability building in rural and remote communities to participate in and benefit from the Scheme. With respect to the participation of First Nations Australians specifically, improved carbon literacy will be beneficial when it comes to Native Title consent and also support individuals to share relevant knowledge of cultural land management practices.

15. Coherency of reforms regarding First Nations Australians' rights

The recognition and enhancement of First Nations Australians' rights under the Scheme should be harmonised with recommendations proposed in concurrent reforms e.g. the Samuel Independent Review of the Environment Protection and Biodiversity Conservation Act 1999 (Cth).

16. Climate Active

The panel recommended that this initiative (a voluntary Federal Government certification program for businesses) abandon an impending requirement for accredited organisations to use a minimum of 20% ACCUs in order to offset their emissions. This recommendation was made to preserve flexibility and prevent businesses from leaving the Climate Active program.

The Federal Government has provided in-principle acceptance of the recommendations in the Chubb Review, will progress legislative reform and consider funding to support their implementation through the 2023-2024 Budget. The Government has also promised alignment between these reforms and the proposed Nature Repair Market. View the Government's official response to the Chubb Review.

Reforms to the Safeguard Mechanism and a carbon price

Off the back of the Chubb Review's release, the Federal Government released proposed reforms to the Safeguard Mechanism on 10 January 2023.

The Safeguard Mechanism has been in place since 2016 and provides a legislated framework that limits the emissions of around 215 large industrial facilities (covering around 28 per cent of national emissions) by requiring them to keep their emissions below an emissions limit (a baseline). Currently, facilities that are likely to exceed their baseline have several options to manage the excess emissions, such as purchasing and surrendering ACCUs.

The Federal Government has proposed a broad suite of reforms to the Safeguard Mechanism. Some of the most notable reforms include:

Decline rates

A largely uniform 4.9% decline rate to baselines annually until 2029-30, which will apply to all new and existing Safeguard facilities and mean those facilities are required to deliver a proportional share of the national 2030 target (equating to an estimated 205 million tonnes of abatement by the end of the decade). Post-2030 decline rates would be set in five-year blocks, after updates are made to Australia’s Nationally Determined Contribution under the Paris Agreement.

Decline rates for 2030-31 to 2034-35 are proposed to be set by 1 July 2027. In addition, in order to ensure the 2030 target will be met and to account for higher-than-expected production growth from existing and new facilities and trade exposed baseline adjustments, a reserve will be established and built into baseline decline rate calculations, which will be applied equally to all facilities.

Baseline setting

A hybrid approach to setting baselines for existing facilities, which would be heavily weighted towards site-specific levels at scheme commencement, with a transition to industry average benchmarks by 2030. For new facilities (or existing Safeguard Mechanism facilities if they begin producing new products), baselines would be set at international best practice levels, adapted for an Australian context which would be subject to annual decline rates.

Compliance flexibility

Providing further flexibility on how facilities can achieve compliance, including:

• introducing 'Safeguard crediting and trading' from 1 July 2023. Under this arrangement, Safeguard facilities will earn tradable credits when their emissions are below their baseline (that is, for over-performing on their individual emissions limit), which can be traded to businesses whose abatement is more expensive;
• continued access to domestic offsets to meet compliance obligations (allowing cost-effective abatement outside of the scheme), with the use of high quality international offsets to be considered further by the Government in 2023 and implemented as part of a separate reform package if appropriate;
• access to banking and borrowing arrangements. Under this arrangement, facilities could bank years where they beat their baseline, or borrow up to 10 per cent of their baseline each year (with a 10 per cent interest rate proposed for such borrowing to encourage its use only when it is genuinely needed); and
• allowing multi-year monitoring periods, where a facility has exceeded its baseline due to a lack of available technology, but has a firm and credible plan in place to reduce cumulative emissions before the end of the five year period. This will allow a facility’s baseline trajectory to match available and emerging technologies within a multi-year compliance period.

Integrity reforms

These include no longer allowing Safeguard facilities to generate ACCUs in the future, subject to certain transitional arrangements.

Tailored treatment for emissions-intensive, trade-exposed (EITE) facilities

EITEs that have an elevated risk of carbon leakage due to estimated cost impacts at the facility level can apply for a lower baseline decline rate, reflecting the specific impacts faced by the facility and will be locked in for 3 years. All EITEs (which covers around 80% of Safeguard participants) will be able to access dedicated funding of an initial $600 million to support decarbonisation activities. The Government has also committed to further considering a carbon border adjustment mechanism or CBAM (which would work by imposing an import tariff and potentially an export rebate on trade with countries without equivalent climate policies) as a potential mechanism for addressing carbon leakage and helping ensure trade competitiveness does not compete with decarbonisation objectives. However, any potential future CBAM would need to complement the Safeguard Mechanism reforms and take into account the interests of key trading partners.

Price cap

A carbon price cap of $75 per tonne of carbon dioxide (increasing with CPI plus 2 per cent each year) for Government-held ACCUs available for purchase by facilities. This is proposed as a price cap or cost containment measure and aims to give commercial certainty about maximum compliance costs.

The proposed reforms to the Safeguard Mechanism will be a key pillar in the Government's plan to realise its legislated targets of reducing emissions to 43 per cent below 2005 levels by 2030, and net zero emissions by 2050.

These reforms are open for comment until 24 February 2023 and submissions can be made on the Department of Climate Change, Energy, the Environment and Water website. The revised Safeguard Mechanism is expected to commence on 1 July 2023. A review is also slated for 2026-2027 which will consider matters such as the appropriate treatment of international units, the suitability of arrangements for emissions-intensive, trade-exposed activities, the price cap, and treatment of flexibility mechanisms beyond 2030 (such as banking and borrowing and multi-year monitoring periods).

Key takeaways for market participants or new entrants

The Chubb Review and proposed Safeguard Mechanism reforms collectively represent a major step forward in the maturation of Australia's response to climate change.

Following the implementation of the Chubb Review recommendations, market participants and the broader community should benefit from greater transparency and access to information under the Scheme. Increased transparency and simplification of the Scheme's architecture will likely result in greater confidence in the integrity of ACCUs and lead to broader participation in the market, for example for regional communities and First Nations people. We expect current market participants and new entrants to have a particular interest in the recommendation for a proponent-driven method development framework, which is aimed at facilitating flexibility, accessibility and innovation when it comes to emission reduction methods. Fundamentally, the Chubb review confirms that, with some targeted enhancements, carbon offsetting will continue to have a key role to play in the short and long term in Australia's decarbonisation story, both as a mechanism for assisting regulated entities to achieve compliance and as the voluntary market continues to provide organisations with a means to meet their decarbonisation commitments.

For entities regulated under the Safeguard Mechanism, policy certainty on decline rates, scheme architecture and timing, increased flexibility on achieving compliance, access to dedicated funding and cost certainty through the price cap are all welcomed by industry and will contribute to a more orderly transition to a decarbonised economy and will go some way in reducing investment risk for regulated facilities.

The proposed Safeguard Mechanism architecture means that the winners will be those who take a strategic approach to compliance, working in factors such as facility-specific decarbonisation rates, Government funding availability, banking and borrowing Safeguard Mechanism Credits between years, multi-year compliance monitoring, current and future carbon price expectations, interaction with the proposed Nature Repair Market, and the price cap, and potential future reforms such as the inclusion of high quality international offset units and the CBAM. In addition, facilities that actively consider and realise the opportunities presented by the scheme (such as 'beating the baseline' to earn and trade Safeguard Mechanism Credits) will be able to realise the potential commercial upside provided by the scheme.

Our team is ready to assist current and new participants in the domestic carbon market and regulated Safeguard Mechanism facilities to navigate these changes and seize the array of opportunities they present.

Please contact Joshua Dellios or Sarah Barker to discuss how we can support you.