Canada: Canada Publishes Technical Paper, Reveals Federal Carbon Pricing Plan

On May 18, 2017, Environment and Climate Change Canada released the Technical Paper on the Federal Carbon Pricing Backstop (Technical Paper), which provides an overview of the prospective federal carbon emissions pricing system and insights on how the federal carbon price will take shape.

Canadian stakeholders, businesses and the public have been invited to provide comments on the Technical Paper until June 30, 2017. It is expected that the introduction of new federal legislation and regulations will follow this consultative process.

The Technical Paper follows the publication of the Pan-Canadian Framework on Clean Growth and Climate Change (Pan-Canadian Framework) in December 2016. A central element of the Pan-Canadian Framework and the federal government's approach to addressing climate change is the commitment to pricing carbon emissions across the country by 2018, with increasing stringency over time, while providing provinces and territories flexibility to implement their own carbon pricing systems. Since the publication of the Pan-Canadian Framework, carbon market watchers eagerly awaited details of how the federal carbon price would be implemented and how it would apply to provinces who have already adopted measures to tackle greenhouse gas (GHG) emissions in their territories, in particular in light of the variety of approaches taken by the provinces (for example, a tax in British Columbia, a cap-and-trade system in Ontario and Quebec and emissions-intensity standards, an emissions cap and a carbon levy in Alberta).

TECHNICAL PAPER HIGHLIGHTS

Backstop

The federal carbon pricing system will only be implemented as a backstop in the provinces that do not have a carbon pricing system that aligns with the federal benchmark by 2018. In provinces that have adopted carbon pricing system instruments, but such instruments are not stringent enough to meet the federal benchmark, the backstop will be used to supplement the measures in place. This could include expanding the sources of emissions covered by provincial carbon emissions pricing or increasing the stringency of the provincial carbon price.

According to the Pan-Canadian Framework, the federal carbon price will not apply in jurisdictions where GHG emissions reduction measures meet the following requirements:

  • Price: In jurisdictions with a price-based system (i.e., a tax or levy), the carbon price should start at a minimum of C$10 per tonne in 2018 and moving up by C$10 per year to C$50 per tonne in 2022
  • Cap-and-trade: In jurisdictions that have implemented a cap-and-trade system, the local regulatory framework should include: a 2030 emissions-reduction target equal to or greater than Canada's 30 per cent reduction target from 2005 levels; and declining (more stringent) annual caps to at least 2022 that correspond, at a minimum, to the projected emissions reductions resulting from the carbon price that year in price-based systems

Overview of Federal Carbon Pricing System

The federal carbon pricing system will be composed of two elements: a carbon levy will apply to fossil fuels as of 2018, and an output-based pricing system for industrial facilities will come into effect after January 1, 2019.

Carbon Levy: Fossil Fuels

  • Levy on fuels: Fossil fuels (either in a liquid, gas or solid form) used in backstop jurisdictions will be subject to a carbon levy. Annual rates (from 2018 to 2022) are set forth for each type of fossil fuel subject to the carbon levy, in a way that ensures that they are equivalent to the federal benchmark price and increase substantially each year (i.e., C$10 per tonne in 2018 and moving up by C$10 per year to C$50 per tonne in 2022).
  • Scope of application: The levy will generally be applied to fuels used in backstop jurisdictions, regardless of whether the fuel was produced in or brought into the province, and will generally be applied early in the supply chain and be payable by the producer or distributor. The intent is for the end-user to purchase levy-paid fuel in most cases.
  • Exemptions: Certain exemptions from the carbon levy system will be implemented. In particular, fuels used at industrial facilities subject to the output-based pricing system (see below) will not be subject to the carbon levy. Gasoline and diesel fuel used by registered farmers for specific activities will also be exempted.
  • Registration and reporting: Distributors, importers and users of fuel will generally be required to register and file monthly returns with the Canada Revenue Agency calculating the total amount of the levy payable for each backstop jurisdiction and remit the applicable amount to the Receiver General for Canada. Fuel distributors and importers will generally need to provide information on quantities of fuels produced, brought or imported into each backstop jurisdiction, as well as quantities of fuels used and delivered within each backstop jurisdiction and delivered outside a backstop jurisdiction.

Output-based Pricing System: Industrial Facilities

  • Threshold: Industrial facilities emitting 50,000 or more tonnes of carbon dioxide equivalent per year will be covered. It will not apply to facilities in sectors such as buildings (including municipal buildings, hospitals, universities, schools and commercial buildings), waste and wastewater, regardless of the quantity of emissions. Industrial facilities that emit less than the 50,000 tonne threshold will have the option to "opt in" to the output-based pricing system (so as to not pay the carbon levy).
  • Sources of emissions covered: The output-based system will apply to emissions from fuel combustion, solvent use and emissions of synthetically produced GHG from industrial processes and product use.
  • Emission limit: For facilities covered by the system, an annual emissions limit will be set, which will be based on the total output from a facility and the emission-intensity standards set out by the government for a type of activity or product. The emissions-intensity standards will be set as a level that represents "best-in-class performance" (top quartile or better).
  • Exceedance of emission limits: Facilities that exceed their annual emission limits will have three options, to be used individually or in combination, in order to comply with their obligations under the output-based pricing system: (i) payment to the federal government of an amount based on the federal price benchmark; (ii) use of carbon offset credits; and (iii) use of surplus credits banked or bought from another participant.
  • Compliance units: The output-based pricing system will include the allocation of surplus credits, which may be banked for future use (subject to certain rules) or traded to other participants. It will also be possible for eligible offset credits to be generated through voluntary activities and the federal government will develop rules to determine which offset credits will be acceptable for compliance.

The Technical Paper also provides an overview of the specific monitoring, book maintenance and enforcement provisions that will be required to fully implement the federal backstop. We also note that direct revenues levied by the federal government will be returned to the jurisdiction of origin. Particular mechanisms to that effect have not been included in the Technical Paper.

PROVINCIAL IMPLICATIONS

The Technical Paper is sure to attract interest from the provinces, whether they have adopted carbon-reduction measures or not. Saskatchewan is currently the only jurisdiction that does not plan to adopt carbon pricing policies and the federal backstop could therefore apply to its full extent. Provinces, such as Quebec, Ontario, Alberta and British Columbia, which have adopted various carbon pricing approaches, could also be impacted by supplemental (or "top-up") federal backstop measures. Finally, certain provinces could challenge the constitutional validity of the federal carbon pricing system and at least one province has publicly stated that it would consider doing so.

Provinces that have adopted a cap-and-trade system, such as Ontario and Quebec will be interested in ensuring that reductions made in other jurisdictions that are part of harmonized systems (such as Quebec and California, and soon Ontario) will be considered when determining whether a cap-and-trade system is equivalent to the federal benchmark price. There is also sure to be interest in how the federal offset rules will compare to those that are currently in place in certain provinces, how federal offsets will interplay with provincial offsets in light of variations in provincial offset rules (and whether provincial offsets will be able to be used to meet the requirements of the federal output-based pricing system) and whether there will be other opportunities for additional offset projects.

Quebec, for its part, has a GHG reduction target by 2030 of 37.5 per cent below 1990 levels. The regulation implementing the cap-and-trade system currently provides decreasing annual caps on GHG emissions up to 2020 and the system will need to be extended, and annual caps will need to be set, until at least 2022 in order to comply with the Technical Paper's equivalency requirements.

In addition, Quebec and Ontario will also be required to demonstrate that their annual caps correspond to the projected emissions reductions resulting from the carbon price in any given year in price-based systems that meet the federal benchmark price. The shadow of the federal backstop will therefore need to be accounted for by provincial governments when setting the annual caps (and the post-2020 cap in the case of Quebec). As an aside, we note that the last joint Quebec-California auction was held on May 11, 2017, and that the average price of an allowance for the current period (corresponding to one metric ton of GHG carbon dioxide equivalent) was C$19.74, and the minimum price was C$18.51. During this auction, all of the allowances for the current period offered for sale were purchased. Similarly, all of the 2017 allowances offered for sale at the March 2017 Ontario auction were sold, at a settlement price of C$18.08.

Under current provincial carbon measures, British Columbia and Alberta have carbon levies that will be set at C$30 in 2018 and maintained at C$30 thereafter. Unless these levies are increased in 2021 to meet the federal benchmark price, the federal backstop would begin to apply in these provinces under the federal government's current proposal.

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.

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