Canadian emissions trading scheme

The Canadian government has been engaged in a long process to develop its own greenhouse gas (GHG) emissions trading scheme. Major steps in this process have been:

  • 21 October 2006—notice of intent to develop regulations to control GHG emissions
  • 26 April 2007—Canadian government releases framework plan for GHG emissions control (initial Turning the Corner document)
  • December 2007—Government formally requires industry to provide information on its GHG emissions
  • March 2008—revised framework document released, Turning the Corner, and
  • since March 2008 the Canadian Federal Government has been progressively releasing further details of the proposed scheme.

In 2006, Canada s GHG emissions amounted to 721 megatonnes of carbon dioxide equivalent (Mt CO2-e), which is 22 per cent over 1990 emission levels and 29 per cent above its Kyoto target. Although this represents a significant increase over the past 16 years, Canada has recently been experiencing a declining trend since 2003; 2006 emissions are 2.8 per cent below 2003 levels. Canada s economic GHG intensity the amount of GHGs emitted per unit of economic activity was 11 per cent lower in 2006 than in 2003.

Several Canadian provinces are participating in conventional emissions trading schemes set up by various regional groupings in North America. Further, Alberta has implemented its own emissions intensity-based trading scheme. If and how these various regionally based emissions trading schemes link with the proposed Canadian scheme (let alone any Federal United States (US) emissions trading scheme) is not yet clear.

ISSUES AND ARGUMENTS

The Scheme
Other policies
Assessment—Emissions Intensity Approach
Assessment—Other Matters

The Scheme
The proposed Canadian emissions trading scheme is a baseline-and-credit system. The government proposes intensity-based targets that will come into force in 2010, which may lead to absolute reductions in emissions of greenhouse gases from industry by 2020, based on 2007 growth forecasts (see below on emissions intensity). Brief details of the proposed scheme follow.

The Canadian government is seeking to reduce the countries total GHG emissions by 20 per cent relative to 2006 levels by 2020. Canada has a further target of reducing such emissions by between 50 to 60 per cent, relative to 2006 levels, by 2050. It is important to note that these are targets, not absolute limits on GHG emissions.

Coverage
The following industries would be formally included in the proposed scheme:

  • power generation
  • oil and gas (including oil sands, upstream oil and gas, natural gas pipelines and petroleum refining)
  • pulp and paper
  • iron and steel
  • smelting and refining of metals (including aluminium)
  • cement
  • lime
  • potash, and
  • chemicals and fertilisers.

Not all emitting facilities in these sectors would be subject to the proposed scheme. The following table illustrates thresholds for five particular sectors that a facility in that sector has to exceed before it is subject to the proposed scheme:

SECTOR THRESHOLD PER YEAR
Chemicals 50 kt CO2e
Fertilizers (nitrogen-based) 50 kt CO2e
Natural gas pipelines 50 kt CO2e
Upstream oil and gas 3 kt/facility and 10,000 barrels of oil equivalent/day/company
Electricity 10 MW

Source: Canadian government, Environment Canada, Turning the corner—regulatory framework for industrial greenhouse gas emissions, March 2008, p. 8.

Specific industry targets
The proposed scheme imposes a specific target for individual facilities participating in the proposed scheme:

  • An 18 per cent reduction in emissions intensity (see below) over 2006 levels by 2010 and a further 2 per cent a year reduction in following years.
    • By 2015 a 26 per cent reduction in emissions intensity, and 33 per cent reduction by 2020 would be required.

    • New facilities, commencing operation after 2004, would have a three year commissioning period applied to them before being required to improve their emissions intensity. After the third year new facilities would be required to improve their emissions intensity by 2 per cent per annum
    • a specific clean fuel standard applies to these new facilities. That is, a new facility will have their targets calculate as if they were using the 'cleanest' available fuel.

For existing and new facilities, fixed process emissions, which are emissions tied to the production and for which there are no alternative reduction technology, would receive a 0 per cent target. This approach would apply to facilities where there was no way of reducing emissions save shutting down production.

The same 18 per cent initial target applies both to corporate entities and a sector as a whole.

The specific firm targets form the basis for the specific obligations under the proposed scheme. If a firm's emissions intensity breached its target it would be obligated to either purchase additional emissions credits/offsets from various sources or make contributions at the specified rate to the proposed Canadian Technology Fund (see below on compliance for further details).

It is also important to note that there are no absolute upper limits for GHG emissions. Rather, the scheme depends on increasing the cost of such emissions over a reducing baseline over time.

Emissions trading
Where a facility improved its emissions intensity by more than the required annual amount it would be issued with emissions credits, equal to the difference between their target and the actual emissions intensity for that year achieved. Such facilities could trade these credits with other participants in the scheme or save them for future use.

Emissions intensity
The use of an emissions intensity approach is relatively uncommon. In the Netherlands, long-term agreements on energy efficiency, which have been made with industry and other sectors since 1992, are expressed in energy consumption per physical unit of product. In the UK, France and Germany, voluntary agreements on CO2 include more relative than absolute targets. Argentina also has a voluntary emissions control regime based in emissions intensity measures.

In the US, in February 2003, the Bush administration announced a series of voluntary global warming agreements with the industry, most of which are expressed in greenhouse gas intensity (electric utilities, wood/paper industry, chemical industry, and cement industry) or energy intensity (oil and gas industry, iron and steel industry, railroad). It does not seem likely that the US will now follow up on this proposal.

Canada's approach
The key concept in the proposed scheme is that of emissions intensity. This refers to a facilities output of the six GHG gases mentioned in Annex 1 to the Kyoto Protocol, measured in terms of CO2-e per unit of economic output or activity. At this point the exact unit of economic output has not been precisely defined.

The emissions intensity approach can be seen as an interim measure. During the period 2020 2025 the Canadian Government intends to move to a fixed cap and trade approach. The stated reason is to take account of the emissions trading scheme developing elsewhere in North America.

Compliance
Apart from the purchase of surplus emissions credits scheme participants can satisfy the obligations under the proposed scheme in a number of ways, as follows:

  • Purchase of emissions credits generated by the Kyoto Protocol s Clean Development Mechanism. However scheme participants can only satisfy 10 per cent of their annual obligations in this way.
  • Purchase of emissions credits generated by Canada's domestic GHG emissions offset scheme (see below).
  • Participants that took acceptable 'early action' measures may use the resulting credits to satisfy their obligations. Emissions credits from this source may also be saved for later use, or sold to other scheme participants.
  • Make contributions to a Technology Fund at the proposed rate of C$15 per tonne/CO2-e. This compliance mechanism will be available only for a limited number of years. A scheme participant may initially satisfy up to 70 per cent of their annual obligations in this way. However, this percentage falls sharply during the initial years of the scheme to 0 per cent by 2018.
  • Emissions credits may be generated by direct investment in large scale emissions reductions projects such as carbon capture and storage projects.

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Other policies
The proposed Canadian emissions trading scheme will not operate in a vacuum. The Federal government has proposed additional measures be adopted that will complement the operation of the scheme. Amongst these measures are:

  • The mandatory use of carbon capture and storage technology for new facilities in oil sands and power generation sectors and the encouragement of retrofitting this technology where appropriate.
  • The establishment of a Technology Fund to invest in qualifying GHG emissions reduction projects.
  • Development of cleaner power sources, mainly through additional hydroelectric and nuclear power stations and the advanced retirement of coal fired power stations.
  • The Federal GHG Emissions Offsets scheme, where sectors not formally covered by the proposed emissions trading scheme may undertake projects that remove or reduce GHG emissions and generate emissions credits. These credits are later sold to scheme participants. The generated credits must meet a number of criteria to be accepted.
    • For example, the waste sector is a notable exemption for the proposed emissions trading scheme. Firms or facilities in this sector may undertake projects for the collection of methane from waste dumps and use it to generate electricity. Projects of this type would generate an emissions credit under the Offsets Scheme that could later be sold to scheme participants.

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Assessment—Emissions Intensity Approach
The major feature of the proposed Canadian scheme is its use of emissions intensity per unit of economic output as the chief measure for controlling GHG emissions. There are some apparent advantages in this approach:

  • Theoretically, an emissions intensity based regime, based on emissions intensity per unit of Gross Domestic Product (GDP), may reduce the overall economic costs of an emissions trading scheme.
    • One of the arguments put forth in favour of relative caps is based on the uncertainty on business-as-usual output—if the firm's production level is higher than expected, so will be business-as-usual emissions, hence reaching a given level of emissions will be more costly than expected. As a consequence, it is argued, a higher emission level should be allowed if the production level is greater than expected.

  • An intensity based target is more flexible, thus can accommodate a wider range of participants in any global agreement.
  • A well designed general intensity approach may reduce the uncertainty in the outcome of emissions reductions efforts, but only where future GDP is relatively certain.

However, an emissions intensity approach may have some disadvantages:

  • A 2005 mathematical simulation of this approach suggested that it was more suited to developing countries than developed ones like Canada.
  • A scheme based on the emissions intensity approach may be difficult to integrate with other emissions trading schemes based on a set upper annual GHG emissions limit, such as the EU Emissions Trading Schemes and the regional North American emissions trading schemes.
  • Emissions intensity based schemes are more complex to administer than the already complex cap and trade schemes based on a set limit of GHG emissions.
  • They are far more complex to design than conventional cap and trade schemes. The margin for error in their design is greater than for a conventional cap and trade scheme.
  • Well-designed emissions intensity based schemes may not produce a very different result to that of a conventional cap and trade based scheme. One study found that effective emissions intensity schemes had to be coupled with a very restrictive emissions target. In these circumstances, the policy design was close to that of a conventional cap and trade scheme.
  • Another study suggested that a cap and trade based scheme would produce a better result, in terms of the overall cost of emissions regulation, than an emissions intensity based scheme.
  • They are less transparent, in that it is less clear that each emitter has actually reduced their emissions.
  • The is some uncertainty over whether emissions will actually reduce if economic growth and output is strong.

It is a well and often made point that the control and reduction of GHG emissions requires widespread international cooperation. To date the conventional cap and trade approach has been more widely adopted for this task.

It is interesting to note that Canada regards the emissions intensity approach as a stopgap measures on its way to adopting a conventional cap and trade style scheme. Thus the strong concerns expressed by domestic Canadian groups over the adoption of the emissions intensity approach may be overdrawn.

It may be argued that the emissions intensity approach may be a better basis for rapidly developing countries such as China and India to adopt in order to include them in an international emissions trading scheme. In view of the relatively more complex design and administration tasks involved with this approach, and the suspected limited administrative capacity of these countries, implementing an emissions intensity based approach in these countries may not be effective in controlling their GHG emissions.

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Assessment—Other Matters
There are a number of other concerns raised by the proposed Canadian emissions trading scheme, such as:

  • To date there have been few successful baseline and credit emissions trading schemes. Their major weakness is that the economic incentives are to create additional credits, rather than reduce emissions. If the emissions credits or offsets are ineffective such schemes end up increasing emissions rather than reducing them.
    • Ensuring that the emission offsets/credits are effective is a substantial administrative burden of the proposed scheme.

  • The price of emissions credits/offsets under a baseline and credit systems potentially have a higher volatility than emissions permits and offsets under a conventional cap and trade scheme.
  • The option for a participant to meet their obligations in the first few years by contribution to the Technology Fund, at a rate of C$15 per tonne/CO2-e does provides a very weak incentive to invest in emissions control equipment at the firm level. Only when this option is restricted in later years will the incentive for participants to control their own GHG emissions be high enough to stimulate any investment by a firm in additional emission control technology. It is likely that any useful impact on Canada's GHG emissions will be delayed.
  • The option to contribute to the Technology Fund may also restrict the market for offsets/credits. It is likely that scheme participants will prefer to contribute to this Fund, rather than purchase offsets/credits. The liquidity and development of the offset/credit scheme is thus potentially restricted by the operation of the proposed Technology Fund. This may lead to a very low price for those offset/credits that are created, again leading to weak incentives to actually reduce emissions.
    • If in turn this also leads to a less than desirable number of offsets/credits being offered for sale the development of hedging instruments, such a forward contracts, will be restricted or not occur. This will further restrict the overdevelopment of an emissions trading market in Canada.

Linkage
In the Canadian Speech from the Throne of November 2008 the Canadian Governor-General stated that:

We will work with the provincial governments and our partners to develop and implement a North America-wide cap and trade system for greenhouse gases and an effective international protocol for the post-2012 period.

[Source: M Jean (Governor-General of Canada),'Protecting Canada's Future', Speech from the Throne, 19 November 2008, viewed 2 July 2009, http://www.sft-ddt.gc.ca/eng/media.asp?id=1364]

It is important to note that section 2502 of the current US Climate Security Act requires that US firms only purchase emissions allowances (not offsets/credits) from foreign emissions trading systems that impose mandatory absolute tonnage limits on GHG emissions. This is exactly what the proposed Canadian emissions trading scheme does not do. Thus the Canadian scheme may have to be substantially modified to have any meaningful linkage with any US national emissions trading scheme.

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