Carbon Markets Outlook

OUTLOOK: Safeguard reform – Australian carbon offset price, supply and demand outlook

On 10 January the Australian Government released its detailed design proposal for the reformed Safeguard Mechanism framework, releasing a position paper and draft amendments to the Safeguard Rule and related subordinate legislation.

The government’s design proposal for the Safeguard Mechanism takes key steps to addresses potential structural weaknesses raised in our earlier analysis, with the adoption of “hybrid” site-specific baselines now likely to reduce reliance on outdated / high industry average (default) values in the early years of the scheme.

This will mitigate initial oversupply risks, while declining baselines will create demand for emissions reductions. We therefore consider downside risks attributed to inefficient policy design to be significantly lower, creating a positive environment for Australian carbon credit unit (ACCU) and Safeguard Mechanism Credit (SMC) prices.

While the new Safeguard Mechanism will trigger a structural change in Australia’s carbon market, demand and pricing for ACCU offsets will be strongly influenced by the scale and timing of on-site emissions reduction actions by industry. The ‘availability’ and ‘cost’ of low-emissions technology will therefore become the key parameter to inform both ACCU and SMC pricing over the next decade.

In particular, we see potential for state and federal low-cost financing programs such as the Safeguard Transformation Stream of the Powering the Regions Fund (PRF) to accelerate industrial abatement projects that would otherwise have low rates of return, high costs of capital, and long payback times. The earlier, larger scale of on-site actions by industry could lead to increased SMC issuance, and weaker demand growth for offsets, with potential for up to three-quarters (74%) of all emissions reductions to be derived from on-site actions by 2030. This is despite industry having unfettered access to carbon offsets, with on-site actions favoured as a permanent hedge against ongoing offset costs, and higher forecast offset prices.

While we see potential for the material contribution of on-site emissions reductions by industry, large capex decisions remain subject to long lead times and require strong price incentives. This should see industry follow a more progressive transition pathway, with a sustained period of support for ACCUs as industry initially relies on external offsets, in parallel to larger direct investments.

As this occurs, we expect ACCU and SMC prices to show significant convergence, while the spread between Generic and nature-based ACCUs will continue to narrow as compliance buyers become the largest source of demand in the market.

In this quarterly Carbon Market Outlook, we present our updated expectations for ACCU prices and supply-demand fundamentals over a 10-year rolling horizon. Specifically, we consider scenarios for market development under the new Safeguard Mechanism framework, modelling the interaction between industrial GHG emissions reductions, demand for external abatement, and long-term ACCU-SMC price development.

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