By Gray E. Taylor, Chair, Climate Change & Emissions Trading Group and Corporate Law Partner, Bennett Jones LLP1
This is a chapter extracted from one of Thomson Reuters Marketing Intelligence Report's: Managing Risk in Global Carbon Markets. For more information or to read the full report, please visit www.ifrmarketintelligence.com.
Canada is due to launch an emission intensity-based emissions trading scheme on 1 January 2010, a scheme that permits access to offsets produced in Canada and/or, on a limited basis, of non-forestry CDM CERS. Risks include the prospect of a US cap-and-trade scheme, likely to be enacted under the first term of the next US president, overtaking and possibly replacing the proposed Canadian scheme, as well as new interest in carbon taxes in the opposition Liberal party. Other planned schemes include an initiative partly implemented in British Columbia and membership in and support for the California-centred WCI from most large Canadian provinces. Alberta, the largest GHG-emitting province, already has the first North American emissions trading scheme.
Speculative investment opportunities are already emerging, for example acquiring futures contracts for credits from the proposed federal scheme on the Montreal Climate Exchange or acquiring cheap GHG emission reductions currently usable only for voluntary purposes, but which may be eligible as compliance instruments in the federal and sub-national schemes.
Canada and market mechanisms
Investors have seen significant volatility in the price of GHG emission allowances under the EU ETS and of related credits from the Kyoto Protocol CDM. In addition, prices for voluntary GHG credits by aircraft travellers and others encompass a broad range, including some surprisingly high levels. Recognising that 'carbon' investing, like other green investment, offers the prospect of an exceptional ROI, investors are interested in opportunities that may exist outside of Europe and the CDM, including in Canada.
Canada is a 'less developed country' (compared to the EU) when it comes to GHG emissions trading and carbon investment structures and entities. However, it should be remembered that Canada was for many years the leading participant in voluntary GHG trading, leaving behind a strong residue of expertise. Support for dealing with climate change through an emission reduction programme built around market mechanisms (rather than a command and control approach) is strong in Canada.
It is important to understand the GHG background against which any Canadian GHG investments would be made.
The Canadian federal government has proposed through its two 'Turning the Corner' policy announcements in 2007 and 2008 a GHG emission intensity reduction system that would be supported by emissions trading between regulated entities and in offsets produced in Canada and/or, on a limited basis, of non-forestry CDM-certified CERS. The scheme is proposed to be launched effective 1 January 2010. Although investors, probably rightly, are concerned about the commitment of the federal government to its plan and fear that the attractiveness of the US-based system likely to be rolled out during the first term of the next US president may deter the 'Turning the Corner' proposals from being implemented. However, the determination of the Canadian public to effect GHG emission reductions and the similarity of the federal government's proposal to the original plan of the official opposition party (which is now enamoured with carbon taxes, however) makes the likelihood of implementation of federal government proposal significant.
For investors, one opportunity tied closely to the 'Turning the Corner' proposal is the ability to trade carbon futures contracts on the Montreal Climate Exchange (MCX). The four MCX-created futures require the delivery in June, September or December, 2011 or March 2012 of one tonne of CO 2 equivalent emission reductions usable in the proposed federal system.
The federal 'Turning the Corner' system also allows entities forced to cut emission intensity to obtain credits by contribution to a technology fund or to invest in CCS technology and projects. However, the credits available from the federal technology investment fund is limited to 70% of a firm's regulatory obligation in 2010, declining to zero by 2018, and prices increase from the same C$15.00/tonne CO 2 e in 2010 to C$20.00 per tonne CO 2 e in 2012 and escalate with the nominal growth in GDP thereafter; the CCS opportunity will be available only until 2018. Consequently a rise in federal offset credit prices would not be surprising over the next decade, including a major jump in 2018 when required reductions in the oil sands will increase dramatically for many facilities, and when credits for CCS and the technology fund are gone.
Alberta, British Columbia and the WCI
Other opportunities exist in Canada as a result of provincial initiatives.
Alberta implemented in 2007 a system similar to the federal government's 'Turning the Corner' system, through a legally binding regulation enacted in June 2007, the Specified Gas Emitters Regulation. It is expected that this emissions intensity regulation will be in place for the foreseeable future and it authorises the use of offset credits created by projects in Alberta outside of the regulated industries as well as emissions trading between regulated entities that reduce their emissions intensity to below the target prescribed by the regulation – i.e., 12% below the emission intensity on average in 2003, 2004 and 2005. As Alberta also permits regulated entities to purchase offset credits by contributing C$15.00 per tonne of CO 2 e to a technology investment fund (which the government indicates will then invest in technology that will reduce GHG emissions), the practical limit on Alberta offset credit prices is C$15.00 per tonne CO 2 e; it would not be surprising, however, to see that price forced higher by the public over time.
British Columbia has an entirely different system built on a carbon tax which applied as of 1 July 2008 and which is soon to incorporate a cap-and-trade system which permits offsets and other initiatives, some of which have trading elements.
British Columbia, Manitoba, Ontario and Quebec all belong to the WCI, an initiative centred on California but being aggressively implemented in British Columbia and publicly strongly supported by Ontario and Quebec. The WCI calls for hard caps on GHG emissions and a trading system amongst the members (seven US states and the four Canadian provinces) with the intent of reducing GHG emissions on an absolute basis by 15% below 1990 levels by 2015. A first draft of the design requirements for an emissions trading system for the WCI was published in July 2008 and there is some cause for optimism that the WCI programme will be rolled out effective in 2012, perhaps in addition to or even in substitution for the 'Turning the Corner' system. Under the draft WCI design, offset credits and allowances from other WCI and non-WCI jurisdictions will be usable to meet WCI requirements.
The uncertainty related to the actual implementation of the 'Turning the Corner' plan and the levels of emission reductions to be required in Alberta have made rational decision-making by affected businesses difficult. However 'first-mover' advantage, particularly if flexibility can be built in and capital costs minimised, has been sufficient to ensure that those businesses that know they have a long-term GHG emission problem (e.g. oil sands producer Suncor, fossil fuel producer Encana and coal-fired electricity generators like TransAlta, Ontario Power Generation and SaskPower) as well as aggressive niche players (e.g. financial institutions like Front Street Capital and RBC, credit aggregators and on-sellers like Terra Verde, Zerofootprint and Blue Source and service providers like Deloitte, PWC, ICF, and the MCX) and a few informed industrial entities like Invista have been prepared to take some steps to participate.
Yet where massive amounts of capital are required such as for CCS and clean coal, initiatives have been slow (e.g. the plans of ICON and ASAP), halting (SaskPower's cancellation and then recommencement of its CCS project) or delayed (the announcements by Sherritt and Nexen of their coal-fired electricity generator and upgrader, respectively, being put on hold, pending resolution of the GHG regulatory issues). RBC Capital Markets recently announced that it has opened a carbon trading desk, thereby presumably giving access to Canadians who wish to participate in GHG trading markets wherever they may be. As indicated, to date that is largely a European (EU ETS and CER/ERU) phenomenon but with the MCX in existence and other exchanges such as Nymex and BlueNext perhaps coming on line to permit trading in carbon credits, access to the Canadian markets should be broadened.
Investors should be open to the possibility that by purchasing good-quality GHG emission reductions before these are accepted as credits in any regulatory system, they may have the opportunity to convert the emission reductions into a higher value compliance credit or, if not converted, still be able to sell the reductions in the voluntary market to corporates that want to be 'green', or to air passengers, etc.
It is getting easier to predict what reductions can be made acceptable as compliance credits. For example, the WCI's draft system design identifies a priority list of offset project types for development as follows:
- Agriculture (soil sequestration and manure management);
- Forestry (afforestaton/reforestation, forest management, forest preservation/conservation, forest products); and
- Waste management (landfill gas and wastewater management).
Alberta has approved (or is close to approving) protocols for the following types of projects: acid gas injection; afforestation; beef feeding (edible oils); beef feeding (reducing days-on-feed); beef lifecycle; biofuel; biogas; biomass; compost; energy efficiency; enhanced oil recovery; landfill bioreactor; landfill gas; modal freight shift; pork; solar thermal; industrial and commercial green building projects; waste (non-incineration); low-impact water-powered electrical energy; road rehabilitation; run-of-the-river electricity; solar electricity; tillage; waste heat recovery and wind-powered electricity.
The Canadian federal government on 9 August 2009 indicated that 40 protocols for offset projects would be eligible to be 'fast-tracked' to facilitate their use in 2009 (with credits issuable back to 1 January 2008 for projects operating before protocol approval as follows: edible oils in cattle feeding regimes; reducing days on feed of cattle; reducing the slaughter age of cattle; decomposition of agricultural materials; capturing and combusting methane from manure management systems; manure management systems; innovative feeding of swine and storing and spreading of swine manure; tillage system management; waste gas or waste heat or waste pressure-based energy systems; energy efficiency for buildings – commercial; energy efficiency for buildings – residential; waste heat recovery; energy efficiency; afforestation; forest management; industrial fuel switching from coal or petroleum fuels to natural gas; switching from coal and/or petroleum fuels to natural gas in existing power plants for electricity generation; acid gas injection; enhanced oil recovery; coal-bed methane; coal mine methane and ventilation air methane capture and use for power (electrical or motive) and heat and/or destruction by flaring or catalytic oxidation; aerobic composting; aerobic landfill bioreactor; water treatment methane capture and destruction; biomass to energy from biomass combustion facilities; electricity generation from biomass residues; run-of-river power generation; solar power generation; wind power generation; new primary district heating systems; grid-connected electricity generation from renewable sources; gravel and lightly surfaced road resurfacing; freight modal shifting; recovery and utilisation of gas from oil wells that would otherwise be flared; non-incineration thermal waste management; catalytic reductions of N 2 O inside the ammonia burner of nitric acid plants; biofuels productions and usage.
Finding projects to invest in is not particularly easy. One source of information is the CleanProjects Registry of the Canadian Standards Association where frequently projects are listed. Although the Clean Projects Registry is not an exchange, the opportunity to identify buying opportunities and to make arrangements outside of the Clean Projects Registry to acquire the GGH emission reductions is substantial. Given the growth of willingness of investment dealers and others to acquire such credits, a 'buy-and-hold' or 'buy-and-flip' strategy could be a good one.
GHG Emission Credit Participation Corp filed a preliminary prospectus in 2007 seeking to raise approximately $100m in Canada to invest in carbon credits and projects. Its failure to close may have been the result of attempting to market in the summer but may also have been a result of the very limited understanding of carbon investing in Canada. In the current circumstances, does another opportunity exist?
Given that there is a significant risk of the federal plan not being implemented, could investors play that risk by shorting MCX futures (which are likely to be significantly diminished in value if the system does not succeed), particularly if hedged by the acquisition of low-cost offsets which could be converted into credits through the 'Turning the Corner' offset system in the event the federal plan is implemented.
Direct participation in public companies with carbon upside but with attractive value even in the absence of carbon credits is also an option. Renewable energy, biofuels, energy efficiency, waste management and agricultural technology improvements may make sense in any event and the carbon credit component could thus be seen as icing on an already sweet cake. For example, the market may place little value on the carbon sequestration opportunity available to large timber companies which can increase the CO 2 sequestration aspect of their assets through forest management and thereby generate value. Faced with the market price and the mountain pine beetle epidemic (an insect infestation that is causing widespread mortality of commercial pine tree species) that is causing CO 2 emissions from forests in Canada to increase regularly, investors might find such entities as deserving of attention.
While Canada is clearly in a risky early stage of GHG emissions control regulation and market development, the above may show that shrewd investors have opportunities to apply their hard-won knowledge and skills learned from other GHG systems and in other jurisdictions in Canada and profit from the exercise.
1 Article completed 23 September 2008
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.