Canada: The Role Of Emissions Offset Trading In North American Greenhouse Gas (GHG) Emissions Regimes

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on CleanTech, March 2009

INTRODUCTION

North American companies are presently faced with a myriad of existing and proposed GHG emissions regimes. For example, companies operating in the province of Alberta have been subject to a mandatory GHG emissions regime since July of 2007. Many of the other provinces have proposed legislation on their books with regimes that are quite different from Alberta's regime. Both the Canadian government and the United States government are contemplating the enactment of federal regimes and the idea of a joint North American regime has recently been bandied about. Finally, there are various regional initiatives involving numerous states and provinces. The Regional Greenhouse Gas Initiative (RGGI), which is a collection of northeastern states, implemented a mandatory GHG regime specific to power-producing companies effective as of January 1, 2009. Other regional initiatives such as the Western Climate Initiative (WCI) and the Mid-Western Greenhouse Gas Reduction Accord (MGGRA) contain separate proposals to regulate GHG emissions.

At a macro level, for North American companies to understand if and how a GHG regime applies or will become applicable to them, they need to understand the two types of GHG regimes that are in play in North America: "Cap and Trade" regimes and "Emissions Intensity" regimes. It is important to understand that the distinction between these two types of GHG regimes may also be at the crux of whether Canada and the United States will ultimately regulate GHG emissions on a provincial/state level, on an individual country level or on a bilateral North American level.

Regardless of the nature of the GHG regime to which they are ultimately subject, an essential strategy for compliance will be the trading of emissions offset credits. Now is the time for North American companies to become familiar with the opportunities and risks involved in emissions offset trading and the necessary tools to participate in such trading. Indeed, it makes good business sense for businesses to get involved in emissions offset trading even before they become subject to GHG regulation.

GHG EMISSIONS SYSTEMS IN NORTH AMERICA

The current North American approach to regulating the GHG emissions of businesses is a jurisdictionally driven patchwork of existing and proposed regimes that differ in a number of ways, including the nature and application of emissions thresholds, the targeted industries, timing and volumes of required emissions reductions, the use of technology funds, and the role of carbon capture and storage technology. To exacerbate the situation, the constitutional validity of regulating GHG emissions on a provincial/state level versus a national level is unclear. It is also unclear if Canada and the United States will as countries approach the regulation of GHG emissions in a bilateral, international fashion.

Of note, in North America, Alberta is at present alone in its use of an Emissions Intensity approach to regulating GHG emissions. Alberta's only potential ally in this regard, at least until the fall of 2008, was the Government of Canada. The specifics of Canada's proposed regime have not yet been finalized, but the concepts were set out in its 2007 and 2008 policy documents entitled "Turning the Corner." Pursuant to that policy, Canada had indicated that it intended on regulating GHG emissions via Emissions Intensity, albeit predicated upon different emissions thresholds and reductions than Alberta's. That stated, Canada's position on the matter may have changed. In his recently released budget, President Obama relies on an estimated US$645-billion in revenues generated from the auction of allocated carbon credits under a Cap and Trade system between 2012 and 2019. The Canadian government has indicated that Canada may be prepared to move away from an Emissions Intensity regime towards a joint North American Cap and Trade regime. While it remains to be seen what regime will ultimately prevail in North America, it appears that the momentum regarding GHG regulation is moving towards Cap and Trade.

The adoption by the United States of a unilateral Cap and Trade regime, despite Canada's interest in a bilateral approach to GHG emissions, may impact upon Canada's choice of Emissions Intensity or Cap and Trade as its national GHG regime. If the rest of North America (including Canada at the federal level) eventually adopts a Cap and Trade regime, it will be interesting to see whether or not Alberta will remain as the lone jurisdiction employing Emissions Intensity.

CAP AND TRADE VERSUS EMISSIONS INTENSITY

Nature and Application of the Two Different GHG Regimes

A Cap and Trade regime is predicated upon placing an absolute cap on the volume of GHG emissions permitted of a group of emitters within a set period of time. Affected companies are issued emission permits and are required to hold an equal number of "allowances" or "credits," which represent the right to emit a specific amount of the regulated GHGs. Emitters that exceed the cap will have a number of options to bring themselves back in compliance, including emissions trading, which is discussed below, but the general point is that once the cap is exceeded, the emitter is offside of the regime.

Emissions Intensity as a GHG regime is based upon reducing, over a period of time, the quantity of GHG emissions generated by an emitter per some unit of economic output. In Alberta, Emissions Intensity is calculated at a facility level in terms of the quantity of emissions of a facility per unit of production from that facility (e.g., per barrel of oil). At a country level, Emissions Intensity might be calculated as tons of carbon dioxide emitted relative to that country's GDP. In contrast to a Cap and Trade regime, an Emissions Intensity system may effectively result in no cap on aggregate GHG emissions produced by a company or country, as long as the subject emitter is reducing GHG emissions per unit of production or GDP as required by the applicable Emissions Intensity regime. Again, under a Cap and Trade regime, emissions are capped at a certain amount regardless of how much product is produced or how efficient the production process has become. The differences between the application of an Emissions Intensity regime and a Cap and Trade regime to emitters can perhaps best be explained by way of the following example:

Assume that, in 2006, a facility had an emissions intensity of 100 tonnes of GHG emissions per unit of production and produced 2,000 units. That facility would have emitted 200,000 tonnes of GHG emissions for that year.

Under the Alberta emissions intensity GHG regime, a facility that exceeds an emissions threshold of 100,000 tonnes is required to reduce its emissions intensity by 12% per year.

Assume that, in 2008, that same facility reduced its emissions intensity by 12% to 88 tonnes of GHG emissions per unit of production, but its production increased to 4,000 units. The facility would be emitting 352,000 tonnes of GHG emissions for 2008.

Although the facility would be in compliance with its emissions intensity reduction requirements, its overall GHG emissions would actually increase.

In contrast, if that same facility were subject to a Cap and Trade system, and so had its GHG emissions capped at a specific amount, such as 200,000 tonnes of GHG emissions, it would always have to comply with that overall limit, regardless of its future production volumes.

Critics of Emissions Intensity regimes often base their criticism on the assumption of production increases. Their censure is that although the production process may become more efficient under an Emissions Intensity regime with less GHG emissions produced per unit of production, there is no restriction or cap on the absolute amounts that are emitted. These critics point out that the build-up of GHGs in the atmosphere and its associated impacts is, after all, based on absolute emissions. During times of production decreases, however, such as the current global financial crisis, an Emissions Intensity regime would still require facilities that exceeded the emissions threshold to decrease their GHG emissions intensity. This would result in lower overall aggregate GHG emissions. There is no concomitant reduction incentive under Cap and Trade regimes.

TRADING EMISSIONS OFFSET CREDITS AS A KEY COMPLIANCE STRATEGY

Generally speaking, the term "emissions trading" refers to two main types of systems: the first is a cap and trade system and the second is an "offset trading" or "credit trading" system. It should be noted that cap and trade and offset trading systems are not mutually exclusive. Indeed, the Kyoto Protocol provides for both types of trading systems at the national and international levels. Beyond these compliance trading markets, there has been an increase in the number of corporate and voluntary offset buyers who have developed Voluntary Carbon Markets (VCMs). The main driver behind VCMs is the use of project-based emission reductions by proactive corporations seeking to achieve self-imposed carbon reduction commitments. For a more in-depth description of emissions trading in general, please see Blakes Bulletin on Energy – Oil & Gas, March 2007: Managing Emissions: Tools for Surviving and Thriving in a (Low) Carbon World.

Regardless of whether an emitter of GHGs is subject to a Cap and Trade regime or an Emissions Intensity regime, a key strategy to achieve compliance will be the trading of emissions offsets credits. Indeed, companies should strongly consider getting into emissions offset trading even before they become subject to a GHG emissions regime. Most, if not all, of the mandatory and proposed North American GHG emissions regimes allow for the storing or banking of offset credits, which may then be used in future years. As the demand for such credits increases in the future, companies who have already initiated a trade and locked in their future supply will have insulated themselves if overall future supplies become inadequate to meet future demand. Furthermore, assuming that the cost of carbon increases over time, companies that perform a trade today will have the benefit of using that cheaper credit during times of increased costs.

Emitters involved in an offset trading system can meet their emissions obligations or otherwise reduce their carbon footprint by purchasing GHG emissions offset credits. These offset credits, which are tradable, are created when an entity that emits less GHGs than the emissions threshold (i.e., a non-regulated entity) produces a product or completes a process in a manner that releases less GHGs than the business-as-usual or baseline case. In general terms, the difference between the GHG actual emissions and the business as usual case represents an emissions offset credit. To assist in calculating the business-as-usual or baseline case, and thus calculating emissions offset credits, many jurisdictions either have, or are contemplating the enactment of, various emissions quantification protocols. For example, Alberta has enacted the following 24 emissions quantification protocols:

Regulated emitters who cannot otherwise meet their required reduction requirements can purchase emissions offset credits and use those credits to offset their GHG emissions. This requirement creates a demand, the effect of which is that an emissions offset credit becomes a saleable asset, able to be traded.

For a discussion on the contracting involved in effecting emissions credit trading, and more specifically, risks and mitigation that may arise in trading offset credits in particular, please refer to Blakes Bulletin on CleanTech, March 2009: Making Sense of Carbon Transactions: The Nuts and Bolts of an Emissions Trade, and also Blakes Bulletin on Energy – Oil & Gas, March 2006: Constructing Carbon Contracts – The Building Blocks of an Emissions Trading Contract.

THE TIME TO ACT IS NOW

The imposition of mandatory GHG emissions regimes has already occurred in some North American jurisdictions and is continuing to occur. While differences exist between various existing and proposed GHG regimes, all of them will necessarily involve emissions trading as a means of achieving regulatory compliance. Indeed, given the impending imposition of such regimes and the bankable nature of emissions offsets credits, it makes good business sense for companies not yet subject to GHG regulation to get involved in emissions offset trading.

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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