While Canadian market participants are understandably focused on
our own emerging climate-change regulatory framework, it is
important to keep up to date on U.S. developments and their
potential implications for our markets and industries. This short
article provides a high-level overview of key features of current
U.S. federal legislative initiatives and their possible effects
north of the border.
Key features of ACES
On June 26, 2009, the American Clean Energy and Security
Act (H.R. 2454, the Bill or ACES) was narrowly passed by the
U.S. House of Representatives. The passage of the Bill is the first
major step in the U.S. towards the institution of federal climate
change and greenhouse gas (GHG) reduction legislation. ACES'
key policy objectives are set out in its four main titles:
- Clean Energy. Establishes a national renewable energy standard
and promotes renewable energy, carbon capture and sequestration,
and smart grid technology;
- Energy Efficiency. Increases energy-efficiency standards in
household appliances and various industries and public
institutions;
- Reducing Global Warming Pollution. Establishes a nationwide
cap-and-trade program to reduce GHG emissions; and
- Transitioning to a Clean Energy Economy. Supports the transition to a low-carbon, energy-efficient economy for both industry and consumers.
Several features are worth particular mention. The Bill amends the
U.S. Clean Air Act to bring GHG emissions from regulated
sources to 97% of 2005 levels by 2012, 83% by 2020, 58% by 2030,
and 17% by 2050. In connection with its framework for a carbon
market, it provides for the trading, banking and borrowing,
auctioning, holding and retiring of emissions allowances. The Bill
also gives the Commodity Futures Trading Commission jurisdiction
over the establishment, operations, and oversight of markets for
regulated allowance derivatives.
In order to gain the support needed to pass the Bill in the House,
several notable amendments were made:
Credit allocations. The cap-and-trade proposal in the Obama budget
called for 100% of emission allowances to be auctioned. ACES falls
well short of that target by initially allowing only 15% of
allowances to be auctioned, while the other 85% are to be allocated
for free to emitters. Refineries secured a larger allocation than
was originally intended under the version of the Bill first
introduced in the House. These changes are viewed as a necessary
compromise designed to gain the support of congressional
representatives of industrial and coal-burning states.
Agriculture and forestry. In last-minute negotiations during the
drafting of final amendments to ACES, major concessions were
secured by the agriculture and forestry lobby. The final version of
the Bill effectively excluded these industries from the definition
of "capped sectors," while leaving responsibility for
developing a program for the generation of offsets in these sectors
to the United States Department of Agriculture (USDA) rather than
the Environmental Protection Agency (EPA). These changes are
significant because it was originally intended that all sectors of
the economy would be covered by the cap-and-trade regime, and many
suspect that the USDA will be more permissive than the EPA in
developing an offset program for agriculture and forestry.
Senate response to the bill
Democratic Party leaders had set an end-of-summer deadline for
bringing a climate-change bill to the floor for a vote, but because
the Senate has been preoccupied with health care and other
initiatives, that deadline has now been pushed back. According to a
spokesman, Senate Majority Leader Harry Reid "fully expects
the Senate to have ample time to consider this comprehensive clean
energy and climate legislation before the end of the year."
Passage by the end of 2009 would be symbolically significant, as
the United Nations is scheduled to hold a global summit in
Copenhagen in December on the topic of the next steps on
controlling GHG emissions after Kyoto expires in 2012.
Speculation is rampant as to whether the Democratic Party
leadership in the Senate can muster the sixty votes needed to avoid
a Republican-backed filibuster. With some moderate Democrats
joining many Republicans in opposition to the current bill, Senate
Environment and Public Works Committee Chairman Barbara Boxer and
Senate Foreign Relations Committee Chairman John Kerry have
indicated they need time to work out mutually acceptable language.
Among the concerns expressed by some senators who are considered
swing votes is the prospect of price instability as experienced
following the implementation of the European Union Emission Trading
System. Senator Boxer is considering a price collar on emission
allowance prices to provide greater cost certainty. Arkansas
Democrat Blanche Lincoln has described ACES as "deeply
flawed," citing its adverse impacts on smaller oil refineries
such as those in her state. Ten other Democrats, representing
states with significant manufacturing industries, wrote to
President Obama to communicate support for inclusion of a
"longer-term border adjustment" in climate legislation to
ensure that energy-intensive jobs and industries do not leave the
U.S. for non-carbon-constrained countries.1 The fact
that many of the undecided senators come from coal and
manufacturing states (or from Sunbelt states that would experience
the sharpest increases in energy costs under the proposed
legislation) is an indication of the difficulties that ACES may be
facing.
Canadian business under ACES
Canadian businesses will be affected by a U.S. climate-change
regulatory regime, no matter what form it eventually takes. Until
the Senate passes its own version of the Bill, the nature of its
impact will not be understood with any certainty. However, based on
the current form of the Bill, it is clear that Canadian businesses
will be forced to consider the following issues:
Trade
As mentioned above, many senators are insisting that
climate-change legislation include a broad carbon tariff that goes
beyond ACES' more limited tariff on
"carbon-intensive" goods. A carbon tariff would prevent
the occurrence of "carbon leakage" as U.S. industries
lose competitiveness to jurisdictions that do not price carbon to
the same standard. Similarly, the inclusion of subsidies in ACES to
offset the cost increases associated with pricing carbon borne by
U.S. companies may distort the dynamic of cross-border
competition.
Canadian businesses, many of which are reliant on cross-border
trade with the U.S., could stand to win or lose - depending on how
the Senate crafts its final version of the Bill and how Canadian
authorities choose to respond to its impact on trade.
If the Senate passes a version of ACES that does incorporate
tariffs, subsidies or other trade barriers, those barriers would
certainly be challenged in an international forum such as the World
Trade Organization (WTO), the General Agreement on Tariffs and
Trade (GATT) or the North American Free Trade Agreement (NAFTA).
However, the U.S. could potentially assert a right to implement a
tariff or subsidy through an exception under GATT or NAFTA. For
example, pursuant to Article XX of GATT, WTO members are authorized
to adopt measures that are (i) necessary to protect human, animal
or plant life or health, (ii) relate to the conservation of
exhaustible natural resources, or (iii) secure compliance with
national law, so long as such measures are made effective in
conjunction with restrictions on domestic production or
consumption. These exceptions are subject to the requirement that
such measures are not applied in a manner that would constitute a
means of arbitrary or unjustifiable discrimination between
countries where the same conditions prevail, or a disguised
restriction on international trade. NAFTA also contains similar
provisions that can potentially be used to justify a carbon
tariff.
A possible response to an import tariff under U.S. federal
cap-and-trade legislation by the Canadian government, apart from a
WTO/NAFTA challenge in the short term, would be to implement its
own equivalent regime to address climate change. In this event, the
Canadian government would become the recipient of the tariff
revenue (or equivalent) that would otherwise flow to the U.S.
government.
Oil sands
Canada has the second-largest proven oil reserves in the world.
Many view the viability of the Alberta oil sands as a major
determinant of overall Canadian prosperity. However, the extraction
and refining of tar sands is an energy-intensive process that
produces substantial amounts of GHGs, and any attempt to curb GHG
production will inevitably have a dampening effect on the overall
economic activity in the oil sands and Alberta as a whole.
Earlier versions of ACES threatened Alberta oil directly,
reflecting sentiments expressed publicly by President Obama that
the U.S. would seek to avoid fuels with large associated
environmental impacts. Early drafts of ACES provided for a
low-carbon fuel standard, similar to that created by Governor
Schwarzenegger in California, requiring that annual average
lifecycle GHG emissions from transportation fuel not exceed the
annual average lifecycle GHG emissions from transportation fuel in
2005. While this proposal would have significantly reduced the
viability of Alberta oil as a marketable fuel source in the U.S.,
it has since been dropped - although a less-targeted carbon tariff
on Alberta oil could still emerge in the Senate bill.
Agriculture and forestry
As GHG emissions in the U.S. agriculture and forestry sectors
would not be regulated under ACES, there is obviously no
significant concern that trade barriers would be erected by the
U.S. to compensate for an ACES-related reduction in U.S.
competitiveness. It also seems likely that any cap-and-trade regime
instituted in Canada would follow the U.S. lead by not regulating
these sectors. However, in the event that Canadian officials were
to implement a cap-and-trade or other GHG reduction regime that did
include agriculture and forestry, concerns over competitiveness
would be felt domestically. This could lead Canada to impose its
own version of an import tariff designed to prevent carbon leakage
from Canada to the U.S. Such a move would undoubtedly subject
Canada to attack through the WTO, NAFTA etc., as discussed above,
and could create grounds for the imposition of countervailing
measures by Canada's trading partners. Canada's regulatory
approach on this matter will therefore be critical to the prospects
of the domestic agricultural and forestry sectors.
International offsets
ACES would permit capped entities to hold an international
emission allowance in lieu of a domestic emission allowance,
subject to certain conditions. Were Canada to create a
cap-and-trade regime, therefore, Canadian entities would be able to
sell or transfer their unused allowances to U.S. entities,
including their U.S. subsidiaries and parents. The transferability
of allowances provided for in ACES would make Canada/U.S. carbon
regulation a cross-border exercise.
The Senate version of the Bill currently provides for the
differential treatment of international offsets as compared to
offsets generated within the U.S. Each entity subject to an
emissions cap may satisfy a percentage of the number of allowances
required to be held by holding 1 domestic offset credit or 1.25
international offset credits in lieu of an emission allowance. This
differential treatment takes effect in 2018. Until then, domestic
and international offsets will be accepted at par.
Whether this is a step to protect the integrity of the
cap-and-trade regime from non-compliant offsets or whether it is
designed to protect and foster a domestic offset project market in
the U.S. is not clear. In either case it is a key regulation that
will materially affect the growth of the Canadian offset market.
All else being equal, if passed by the Senate such a provision will
make it likely that only short-term Canadian projects (i.e. five
years or less) that can take advantage of the at-par treatment
between 2012 and 2017 will be competitive with U.S. projects, if
the offsets generated by them are to be marketed in the U.S.
Conclusion
What should be apparent from the foregoing is that the climate
change initiatives in the U.S. need to be carefully followed by the
Canadian marketplace, as it is highly likely that U.S. legislation
would have significant consequences for Canada.
Stikeman Elliott's Emissions Trading and Climate Change Group
is watching the progress of the debate in the U.S. Senate closely
in order to help our clients respond effectively to U.S.
developments wherever it is advisable to do so.
Footnote
1. Sens. Sherrod Brown (D-OH), Debbie Stabenow (D-MI),
Russ Feingold (D-WI), Carl Levin (D-MI), Evan Bayh (D-IN), Bob
Casey (D-PA), Robert Byrd (D-WV), Arlen Specter (D-PA), John
Rockefeller (D-WV), and Al Franken (D-MN).
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.
