Inevitable Policy Response: Safeguard Mechanism explained

March 30, 2023
ESG Insights

Protection against the inevitable policy response

Ethical Partners Funds Management welcomes the announcement from the Federal Government and the Greens yesterday that a deal has been struck to secure passage of the Safeguard Mechanism Amendment Bill through the House of Representatives and most likely the Senate. In this note we explain what the Safeguard Mechanism will do and why we believe the Ethical Partners Australian hare Fund is well placed given the transition risks faced for certain types of companies impacted by the mechanism.

The intent is for the updated scheme to be in operation as of July 2023. Minister for Climate Change and Energy, Chris Bowen, said the finalisation of the Safeguard Mechanism Bill was a key milestone in achieving Australia’s 43% emissions reduction target by 2030. Ethical Partners has been advocating in support of this issue over the past eight months.  

These well overdue reforms will introduce a hard cap on emissions to ensure the Mechanism reduces 205 million tonnes of greenhouse gas emissions to 2030, as well as provide an incentive for the more rapid deployment of decarbonisation programmes. It also allows Australian companies to incorporate a more certain price on carbon into their investment decisions and forward growth strategies.  

The Ethical Partners Australian Share Fund does not invest in fossil fuel producers which account for a large proportion of the 215 sites covered under the Safeguard Mechanism. The balance of the sites including steelworks, cement producers, smelters, waste facilities and other manufacturing facilities will now have an increased incentive to transition to alternate energy solutions over time. Many are examining this very issue now. The new legislation is likely to accelerate that effort.

The Fund cannot own fossil fuel companies due to many reasons. We cannot continue to burn coal and gas indefinitely if we are to limit global warming to 1.5 degrees above pre-industrial levels. The Fund contributes to the notion that capital should be allocated away from fossil fuel production and towards renewable sources of energy. This will also contribute to lower levels of air and water pollution, the former a contributor to increased mortality globally and the latter often having a devastating impact on biodiversity.

Inevitable policy response and stranded asset risk

But the Fund also does not own fossil fuel companies (perhaps pragmatically) because Governments across global markets are increasingly enacting regulatory and legislative policies in order to tackle the risks surrounding climate change and pollution. The Safeguard Mechanism is one such inevitable policy response. Other policy changes over time will include higher taxes, mandated carbon pricing and tariffs or carbon border adjustment mechanisms as Governments increasingly realise that someone has to pay for the transition to cleaner energy - and who is better placed to do so than the very companies earning revenue from the production of commodities responsible for much of the damage. Further, many of these companies face stranded asset risk. That is, the value of key assets decline as they approach the end of their useful life. Further still, costs of remediation can be high and difficult to estimate with research showing that these costs are usually materially underestimated and under-provisioned for by companies.  This is an issue that Ethical Partners has been considering in our investment process for many years

Further incentives to investigate clean energy options

The Safeguard Mechanism (whilst not perfect as we outlined in our collaborative statement with ASFI, IGCC and 11 other investors) discourages new investment in fossil fuel projects and similarly implicitly encourages investment in renewable energy over time. According to the Clean Energy Regulator, in 2022 developers committed to building 4.3 gigawatts (GW) of new large-scale renewable energy capacity. This is a near 50% increase from 2021. 60% of total investment was announced in the second half of the year – perhaps demonstrating growing confidence in Australia’s renewable energy policy and market settings after years of minimal policy direction from the previous Coalition Federal Government. This large step up in investment is an important step to transition the electricity system to 80%+ renewable energy by 2030 to meet Australia’s legislated 2030 emissions reduction target.

As members of Investor Group on Climate Change (IGCC), we reiterate the words of the CEO, Rebecca Mikula-Wright: “The willingness of a diverse range of lawmakers to work together provides investors with the greater clarity they require to deploy the billions of dollars Australia needs to reach net zero by 2050. Reform of the Safeguard Mechanism sends a positive signal to investors around the world that Australia is joining the global investment boom in cleaning up economies, addressing energy security and modernising industry.”

Some of the key elements of the Bill include:

• An agreement by Labor that it will expressly legislate “policy intent” to cut annual emissions from the country’s 215 biggest resources, manufacturing, and industrial polluters, plus any new entrants, from 140 million tonnes to 100 million tonnes by 2030.

• Increasing transition support to decarbonise high emitting industries including steel, cement, and aluminium from $600 million to $1 billion.

• $1 billion in funding for the manufacturing sector and trade-exposed industries to decarbonise.

• A review to examine the feasibility of an Australian carbon border adjustment mechanism (CBAM).

• Facilities that rely on carbon offsets for more than 30% of their abatement task will have to explain to the Clean Energy Regulator why they are “not doing more” to reduce direct emissions. This is a development (carbon reduction vs carbon offsets) that Ethical Partners sees as a very positive change and is a key factor in how we assess the credibility of a company’s transition plan.

• Gas fields will need to adopt international best practice baselines for carbon dioxide in their new fields. All new gas entrants in the Beetaloo Basin will also be required to have net zero scope 1 emissions from entry. This lays the groundwork for more obstacles to new investment in gas supply.

• Recent changes to the Bill (with the Greens taking credit for the change) could halt approximately half of the 116 fossil fuel projects that may no longer go ahead because they will not be able to fit under the hard pollution cap. According to UBS, of the proposed 116 new coal and oil and gas projects, 45% are owned by ASX listed companies (some with joint ownership).

The Amendment Bill, if legislated, will be far more powerful and harder to overturn than in its previous form. We believe that high carbon emitting companies need to decarbonise rapidly to remain competitive in the global economy and this legislation is a step in the right direction. We reiterate our belief that that real emissions reduction must come first and foremost for all companies and that the reliance on carbon offsets can only be minimal and a last alternative.  

We believe it is our responsibility to ensure that our investment activities work towards limiting global warming to 1.5 degrees. More detail on our approach, strategy, risk management and targets in regards to climate change risk and opportunity can be found in our inaugural TCFD.

We continue to assess the impact of the proposed Safeguard Mechanism on all relevant ASX listed companies through our proprietary Ethical Partners Opportunity and Risk Assessment (EPORA) and the Ethical Partners Carbon Alignment Process (EPCAP). We will also look to engage on this policy change, its implications for carbon pricing and carbon value at risk across the market and the need for accelerated decarbonisation and the critical need for credible, consistent, and comparable transition plans, with a minimal use of offsets, in our active company engagements.

Ethical Partners is a signatory to the Safeguard Mechanism Reforms: Joint Finance Industry Statement and has supported the IGCC submissions and government advocacy on the mechanism through our active involvement in the IGCC policy advocacy working group.

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