Canada: Constructing Carbon Contracts – The Building Blocks Of An Emissions Trading Contract

Last Updated: May 8 2006

Article by Selina Lee-Andersen, ©2006 Blake, Cassels & Graydon LLP

This article was originally published in Blakes Bulletin on Energy - Oil & Gas, March 2006

Under the Kyoto Protocol, emissions trading is one of the key market mechanisms by which countries can meet their emission reduction targets. With the Kyoto Protocol in force, emissions trading systems are either underway or will be implemented shortly in many countries around the world.

The Canadian Domestic Offsets System, which is backed by the Climate Fund Agency, will be implemented in early 2006. Beginning on March 31, 2006, the Climate Fund Agency will purchase credits created by the Domestic Offsets System as well as international credits sanctioned under the Kyoto Protocol. To date, one billion dollars has been allocated for purchases by the Climate Fund Agency, which could yield reductions of between 75 and 115 megatonnes annually between 2008 and 2012. Canada’s reduction goal under the Kyoto Protocol is 270 megatonnes. For more information on emissions trading, please see Emissions Trading under the Kyoto Protocol: Giving Credit where Credit is Due, Blakes Oil & Gas Bulletin, December 1, 2005.

To ensure clarity and to properly allocate risk, parties to an emissions trade will rely on contractual terms to protect their interests. A transaction for the purchase and sale of emission products carries with it inherent risks and challenges which are unique to the carbon market. The form of contract can be tailored to address these aspects and the following issues are often considered in articulating the terms of the contract:

One. Participants to the transaction
Two. Nature of the commodity being traded
Three. Terms of purchase, sale and delivery
Four. How emission reductions and compliance will be evidenced
Five. Representations and warranties
Six. Potential risks and uncertainties
Seven. Dispute resolution

Setting the Tone

The preamble should clearly set out the purposes of the contract, which will help to ensure that the terms of the contract are consistent with those purposes. Such purposes may include complying with a company’s emission reduction obligations, retiring emission rights, obtaining financing for emission reduction projects, or trading in certain emission markets.

The Players

On the surface, the identification of parties may appear to be a simple task, but the proper identification of parties to the transaction could be complicated by the fact that various entities may have a potential claim to the emission rights being traded. In identifying the parties, regard should be had to any entities with potential claims arising from their involvement with associated land, people, facilities, equipment, services and investments. Where a number of potential claimants exist, the parties may find comfort through representations and warranties as to the title of the emission rights, or through disclosure provisions. Parties may also wish to obtain waivers or assignments of title from third parties with potential interests in the rights.

The Nature of Emission Rights

In emissions trading, the legal nature of the emissions right will depend on the type of emissions trading system being implemented. Broadly speaking, an emissions right may be classified as either a legislative right or a contractual right. A legislative right is one that is allocated under legislation (such as those created under the Canadian Domestic Offset System) or a right generated by an activity approved by a regulatory authority in accordance with a set of rules (such as the "certified emission reduction" under the Clean Development Mechanism of the Kyoto Protocol). A contractual right arises from emissions reduction activities outside of established trading regimes, such as a voluntary trade between two private parties. Attempts to define the nature of emission rights may be complicated by the existence of wide-ranging standards under varying domestic emissions reduction regimes. From a buyer’s perspective, a broad definition of the commodity is preferable; but from a seller’s perspective, a narrower definition is preferable to reduce the risk of open-ended obligations.

Emission rights may be further characterized by the year in which they are created (the so-called ‘vintage’ of the right), the jurisdiction and trading system in which they are created, as well as the kind of compound being addressed. If reference is made to a particular system in the contract, provision should be made for the impact of changes to that system or its rules. Furthermore, it will be necessary to determine which gases will be included under the category of greenhouse gas emissions and whether the trading system limits trading to any particular category of gases. Finally, emission rights will need to incorporate a definition of a baseline from which the emission rights resulting from the project will be measured. Methodologies for calculating baselines can be addressed in the provisions pertaining to reporting and verification, however parties may wish to include a baseline in the definition of emission rights itself in order to ensure greater certainty in the scope of any calculation.

The Terms of the Trade

The terms of an emissions trading contract generally address the following:

Delivery date. The delivery date or trigger event by which the emission rights will accrue to the buyer, which may impact on the potential value of emission rights.

Mechanism for timing and delivery. The mechanism by which the emission rights will be transferred will depend on the type of rights being transferred. Where the right is a legislative one, the requirements of the regime should be taken into consideration as there will likely be pre-defined methods of delivery and transfer of title. If the right is a contractual one, the risks associated with delivery should be taken into account in designing the delivery mechanism. Part of this risk may be shared or minimized through the use of a clearing house or registry. The contract should specify the point at which title is transferred, which may occur upon execution of the contract or upon a change of ownership being registered. If the right does not exist yet, the delivery of such future rights should take into account any legislative changes, whether domestic or international, which may impact on the creation of rights and the transfer process.

Shortfall or failure to deliver. Appropriate arrangements should be included to address the management of shortfalls under the contract. These may include: physical replacement of the volume of shortfall of emission rights from other projects or from future years; payment to the buyer in the form of repayment of any up-front payment funds or the cost to the buyer of purchasing replacement rights; and a frustration clause in the event that the emission rights never materialize.

Terms and method of payment. The price of the emission rights should be set out in the contract, and can be tailored to the vintage of the rights or the nature of the rights involved. In addition, the terms of payment should be clearly stipulated in the form of full payment, an option, or a payment on the occurrence of a future event (e.g., such as the issuance of a certificate from the relevant regulatory authority).

Representations and Warranties. Apart from the standard commercial warranties of corporate power, creation and capacity, the parties should include warranties relating to title to the emission rights, security over the rights, creation of the rights, validity of the rights, compliance with environmental regulations, and the undertaking of emission reduction activities.

Security. Forms of security or guarantees, where applicable.

Financial penalties. Penalties for shortfalls or failure to deliver should include provisions for timing, calculation methods and responsibility.

Taxes, levies and charges. Provisions should be included for any current or future taxes, fees, levies or charges (including calculation methods and responsibility).

Default, termination and remedies. The parties should specify what constitutes an event of default and the consequences of such a default. In addition, the parties may wish to consider the consequences of the seller failing to comply with verification obligations or failing to secure host country government approval. The range of remedies can include immediate termination of the contract, the right to a reduction in purchase price, the repayment of amounts paid upfront or the payment of liquidated damages.

Evidencing the Validity of Emission Rights

The main obligation under an emissions trading contract is the delivery of the product. As a result, one of the most significant issues to be agreed between the parties is how delivery will be evidenced. In the current market, the evidentiary burden is usually discharged by demonstrating that real and measurable reductions of GHG emissions have been achieved when measured against a baseline. Where legislative rights are concerned, the form of evidence will likely come in the form of government issued certificates that can be traded or tracked through a central registry. The validation of contractual rights involve more steps and require independent verification of emission reductions. There should be clear provisions for who will be responsible for carrying out initial and ongoing validation of the project, as well as who will be responsible for the costs of verification. If a third party will be involved in verifying the emission reductions, the criteria for such verification should be specified.

The nature of emissions is unique in that the scientific processes which are used to quantify emission reductions are not static and are being improved continuously to produce more accurate results. Scientific uncertainties can be addressed by including a clause which permits the calculation of tonnes to be revisited if different numbers or methodologies are developed or adopted by the relevant authorities.

Managing the Risk

Given the uncertainties associated with the nature and measurement of emissions, certain inherent risks exist. These risks may be categorized as follows:

Project or delivery risk. Any emissions trading transaction carries with it the risk of a shortfall in delivery. The incorporation of remedy clauses can help to alleviate concerns about shortfalls or issues with verification.

Scientific risk. The science of measuring emission reductions is evolving, and changes in baseline calculations or the quantification of emissions may affect the ultimate number of reductions in a project. To mitigate this risk, parties may consider binding themselves to fixed standards or agreeing to re-assess the methodologies at regular intervals.

Counter Party Risk. Over the term of the contract, risks associated with a party’s credit rating or ability to provide credit support may intensify, particularly in the case of small businesses. Parties may wish to include terms of access to financial reports and criteria for prudential requirements, customize financial representations and warranties, define conditions of assignment and survivability, or define events that would constitute a force majeure.

Sovereign and regulatory risk. Where the parties operate outside established systems, there is no certainty that the emission reductions will be recognized or valued. Sovereign risks include expropriation of emission rights by host governments, unilateral actions taken by governments that have a direct effect on the transaction, and the imposition of additional taxes on a project by a host government. While there is little the parties can do to prevent the impact of sovereign and regulatory risks, the contractual terms may be drafted to anticipate regulatory change and limit the liability of the parties in the case of such extraordinary event.

Dispute Resolution

An emissions trading transaction is fraught with uncertainty, and the contract should set out clear dispute resolution procedures in the event that the transaction does not unfold as anticipated. This is particularly important in cross-border transactions where differences in legal systems make it impractical for parties to resolve disputes through domestic courts. International commercial arbitration has become the preferred dispute resolution mechanism for international business transactions and international resource development contracts. The Permanent Court of International Arbitration encourages the use of the Optional Rules for Arbitration of Disputes Relating to Natural Resources and/or for the Environment for settling emissions trading disputes.

Looking Ahead

With a newly-minted Conservative minority government in Ottawa, the fate of the Canadian Domestic Offsets System, as well as funding for climate change initiatives, is uncertain. However, emissions trading is already taking place in jurisdictions around the world within both regulated and voluntary systems. With the Kyoto Protocol in place – and until a new process for commitments beyond 2012 is adopted – emissions trading will continue to be one of the key mechanisms by which countries will achieve their Kyoto targets.

A well-drafted contract, designed to anticipate certain externalities which are peculiar to the carbon market, can serve to mitigate risks while creating economic and environmental benefits to all those involved.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions