Canada: Plugging The (Competitiveness) Leak: Federal Government Tweaks Carbon Pricing Mechanism For Industrial Emitters

Following in-depth consultations with emissions intensive and trade-exposed industries, the federal government released its preliminary competitiveness assessment on July 27, 2018. Based on its analysis and feedback received, Environment and Climate Change Canada (ECCC) has announced it is tweaking its proposed approach to setting output-based standards under the federal carbon pricing backstop. In particular, ECCC will adjust the benchmark upwards under the proposed output-based pricing system (OBPS) to 80% of an industry's average emissions (up from 70%), and 90% for producers of cement, iron and steel, lime and nitrogen fertilizer. This means that emissions generated above these benchmarks will be subject to the carbon price. The federal carbon pricing backstop is scheduled to come into effect on January 1, 2019, and will be imposed on provinces that do not have a carbon pricing system that meets the federal benchmark. The tax is set for $20 a tonne in 2019 and will rise to $50 in 2022. The federal government has said it will continue to refine the standards in the coming weeks, with a view to releasing a detailed paper on the draft OBPS regulations for comment in fall 2018. 

Currently, the provinces of British Columbia, Alberta and Québec have carbon pricing systems in place. Manitoba and the Northwest Territories will implement a carbon price in 2019, while Nova Scotia will implement its own cap-and-trade system. New Brunswick has decided to shift part of its gasoline tax to a climate fund, Prince Edward Island has said it will reduce the amount of HST (harmonized sales tax) payable on electricity, and Newfoundland & Labrador has not yet announced its carbon pricing plans. Nunavut and the Yukon are still in the process of developing their carbon pricing mechanisms. Ontario recently announced the cancellation of its cap-and-trade program (more details in our earlier blog), and both Ontario and Saskatchewan have mounted legal challenges to the federal government's jurisdiction to impose a carbon price on the provinces.

Overview of the Federal Carbon Pricing Backstop

The federal carbon pricing system has two components: (1) a charge on fossil fuels that will generally be paid by fuel producers or distributors, and (2) the OBPS, a separate pricing system for industrial facilities that are emissions-intensive and trade-exposed. More details on the federal carbon pricing backstop are available in our earlier  blog post.

In January 2018, ECCC released the draft regulatory framework for the OBPS, which set the benchmark at 70% of an industry's average emissions performance.  The OBPS is designed to ensure there is a price incentive for companies to reduce their greenhouse gas (GHG) emissions and spur innovation while maintaining competitiveness and protecting against carbon leakage. Carbon leakage generally refers to the risk that economic activity and its associated carbon pollution are displaced to another jurisdiction with a lower or no price on carbon pollution and/or less stringent GHG regulations, which will ultimately not result in a net decrease in pollution.

Instead of paying the charge on fuels that they purchase, industrial facilities subject to the OBPS will face a carbon price on the portion of their emissions that are above a limit, which will be determined based on relevant output-based standards (emissions per unit of output). The OBPS will apply to industrial facilities located in jurisdictions where the federal carbon pricing system applies and that emit 50,000 tonnes of carbon dioxide equivalent (CO2e) or more per year, with the possibility for smaller facilities (emitting 10,000 tonnes of CO2e or more) to opt in voluntarily. Facilities that emit less than their annual limit will receive surplus credits from the federal government for the portion of their emissions that are below their limit. A facility can trade surplus credits it earns, creating an incentive for facilities to reduce emissions below the limit when cost effective to do so. In May 2018, ECCC released additional details on the proposed compliance options under the output-based pricing system.

Preliminary Competitiveness Analysis

The draft regulatory framework released in January 2018 proposed that output-based standards be set at 70% of an industrial sector's average greenhouse gas emissions intensity as a starting point, with the possibility of adjustments to that starting point based on an assessment of the potential risks from carbon pricing to the competitiveness of the sector and to carbon leakage. In the framework, ECCC indicated that the extent to which the competitiveness of industrial sectors or specific facilities within a sector may be impacted by carbon pricing is largely determined by two factors:

  1. the carbon emissions intensity associated with the production of the products of the sector or facility (the carbon emissions per unit of net output is representative of the cost exposure of the sector or facility to carbon pricing); and
  2. the extent to which facilities in the sector are able to pass on the costs of carbon pricing without significant loss of market share, an indicator of which is its degree of trade-exposure.

As part of its assessment of the relative degree of emissions intensity and trade exposure of each industrial sector, ECCC is undertaking a three-phased approach in order to determine the level at which the output-based standards are set for a given sector:

  1. Phase 1 consists of a "static" test that considers historical data at the national level to calculate sector-level estimates of emissions intensity and trade exposure. These metrics are then combined to provide an indication of competitiveness risk due to carbon pricing. This approach is similar to the quantitative tests used in several other jurisdictions with carbon pricing, including Alberta, Québec and California.
  2. Phase 2 is a "dynamic" test using economic modeling that uses projected emissions and economic data to evaluate the same emissions intensity and trade exposure metrics as phase 1, for the year 2022.
  3. In Phase 3, stakeholders are invited to submit additional supporting information and analyses on aspects of competitiveness to supplement the results of Phases 1 and 2.

ECCC has completed the preliminary analysis of the Phase 1 and 2 tests for the following sectors: base metal smelting and refining, cement, petroleum refining, bitumen and heavy oil upgrading, upstream oil and gas, oil sands and heavy oil, natural gas pipelines, iron and steel manufacturing, lime, pulp and paper, nitrogen fertilizers, ethanol, food processing, potash, mining, and iron ore pelletizing.

Based on stakeholder feedback and its findings from the Phase 1 and 2 analyses, ECCC is making the following two adjustments to the output-based standards:

  1. Four sectors were assessed to be in a high competitive risk category and will have their output-based standard adjusted to 90%of the sector's average GHG emissions intensity:

    • cement
    • iron and steel manufacturing
    • lime
    • nitrogen fertilizers
  2. The starting point for all remaining industrial sectors is revised from 70% to 80% of the sector's average GHG emissions intensity.

ECCC has now initiated Phase 3 of its competitiveness analysis, where it is inviting stakeholders to submit additional supporting information such as evidence of significant facility-level impacts, domestic or international market considerations, and a consideration of indirect costs on sectors associated with carbon pricing. ECCC has noted that further sectors or sub-sectors may see adjustments to their output-based standards based on the results of the Phase 3 analysis. Once Phase 3 of the analysis is complete, ECCC will release a detailed paper on the draft OBPS regulations in fall 2018 for comment.

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