Environment @ Gowlings


		March 13, 2008
	Climate Change Bulletin

Federal Government Unveils Climate Change Action Plan

On March 11, 2008, the federal government released details concerning its strategy to "turn the corner" on climate change. The two main components of this strategy are (1) mandatory emissions targets for certain industry sectors and (2) an offset system enabling non-regulated businesses to earn carbon credits by voluntarily cutting emissions, which could then be sold to regulated businesses to help them achieve their targets. Although the broad contours of this strategy have been known for some time, the announcement provides both regulated and non-regulated businesses with greater certainty and provides a strong impetus to begin taking immediate action in anticipation of the climate change regulations which are expected to come into force at the beginning of 2010.

Regulatory Framework for Industrial Greenhouse Gas Emissions

The centrepiece of the announcement was the "Regulatory Framework for Industrial Greenhouse Gas Emissions" which elaborates on the "Regulatory Framework for Air Emissions" unveiled in April 2007. It is the government's blueprint for achieving the previously announced target of an absolute 20% reduction in greenhouse gas ("GHG") emissions from 2006 levels by the year 2020, which translates into a reduction of 330 megatonnes below projected levels.

The Framework applies to the following industry sectors:

electricity generation
oil sands
petroleum refining
upstream oil and gas
natural gas pipelines
pulp and paper
iron and steel
iron ore pelletizing
base metal smelters
cement
aluminum and alumina
lime
titanium
potash
chemicals
fertilizers

These sectors will be required to reduce their GHG emission intensity (i.e. the amount of GHGs emitted per widget produced) to 18% below 2006 levels by 2010. In every subsequent year, emission intensity must improve by 2%. There will be a three-year grace period for new facilities, i.e. those opening in 2004 or later. After the third year, they will be required to improve their emission intensity by 2% annually. Where an existing facility undergoes a major expansion or transformation in 2004 or later, the expanded or transformed portion of the facility would be subject to the rules for new facilities. The targets for new facilities would be determined in accordance with a "cleaner fuel standard", the details of which have yet to be fully articulated. This is meant to encourage new facilities to adopt the least GHG-intensive fuels.

Both existing and new facilities would have a 0% target for fixed process emissions, which are emissions tied to production and for which there is no alternative reduction technology (the revised Framework now includes a more precise, technical definition of fixed process emissions than what appeared in last year's version).

Regulated industries would have certain options for compliance. In addition to making operational changes to achieve their targets, firms could obtain compliance credits by contributing to a technology fund that would invest in GHG reduction technology. The fund would be administered by "a third-party entity, at arm's length from government". The cost of contributing to the fund would be set at $15 per tonne of carbon dioxide equivalent for the period 2010 to 2012, rising to $20 per tonne in 2013, and subsequently rising annually at the rate of Canada's economic growth. Contributions would no longer be permitted after 2017.

Instead of contributing directly to the technology fund, firms could earn credits by investing in certain large-scale projects that were pre-certified by the government. The Framework states that the government will consider pre-certifying carbon capture and storage projects in Alberta and Saskatchewan. Until 2018, firms in the oil sands, electricity, chemicals, fertilizer and petroleum refining sectors will be allowed to make contributions of up to 100% of their regulatory obligation in these pre-certified carbon capture and storage projects.

As a further alternative to making direct contributions to the technology fund, firms could invest in other funds with an equivalent mandate to the technology fund. These could include funds established by provincial governments and possibly private sector funds. In order for the firm to earn credits for such contributions, the fund would need to be accredited by the federal government for this purpose.

Firms that went beyond their targets would obtain credits which could then be sold to other regulated firms or which could be banked for future use. The Framework also contemplates an offset system whereby non-regulated entities could voluntarily undertake GHG emission reduction programs and earn offset credits which could then be sold to regulated entities. In addition, regulated entities could purchase Clean Development Mechanism ("CDM") credits under the Kyoto Protocol. Each firm would only be allowed to meet up to 10% of its target with these CDM credits. Finally, firms that took action between 1992 and 2006 to reduce GHG emissions could apply for a one-time credit for early action. The purpose is to avoid penalizing firms that voluntarily undertook climate change initiatives before the development of the federal regulatory regime. The government would only allocate 15 megatonnes worth of credits for early action - if demand were greater, the 15 megatonnes would be divided between the applicants in proportion to their contribution to total emission reductions.

The revised Framework includes an important innovation from the original 2007 version. This is the introduction of additional rules that apply only to the oil sands and coal-fired electricity sectors and will effectively require these sectors to establish carbon capture and storage mechanisms for new facilities opening in 2012 or later. Although the details concerning these rules have yet to be released, the government indicates that "growth in the oil sands must occur responsibly", and that the rules "will effectively end the construction of dirty coal-fired plants".

Another new commitment is to establish a "clean electricity task force" to work with provinces and industry to achieve a further reduction of 25 megatonnes from the electricity sector by 2020. The revised Framework is short on details, but does say that:

"Specific measures could include:

development of an East-West transmission grid and sub-sea cable on the Atlantic coast;
development of further major hydroelectric projects, such as Peace River C and Lower Churchill;
introduction of new nuclear reactors; and
retirement of fossil-fuel electricity generation facilities at the end of their expected life."

The revised Framework recognizes the specific challenges faced by the cement and fertilizer sectors. The Framework says that the cement regulations will include an incentive to use waste material from other industries instead of clinker. The Framework also promises a task force comprising a Member of Parliament and an industry representative to make recommendations for fertilizer emission targets that take these challenges into account but are "consistent with the overall framework".

GHG emissions reductions from the oil sands and electricity sectors are expected to account for 55% of the total reductions from industry by 2020. The reductions from industry as a whole will only go halfway towards meeting the national 20% target by 2020. The rest of the reductions will come from other regulatory initiatives, including new fuel consumption standards for cars, light trucks and sport utility vehicles, and new energy efficiency requirements for certain commercial and consumer products, such as dishwashers and commercial boilers.

In addition to GHGs, the initial version of the Framework in 2007 also addressed emissions of air pollutants such as sulphur oxides, nitrogen oxides and particulate matter. The revised draft deals exclusively with GHGs, saying only that the regulatory framework for other air pollutants will be finalized in spring 2008 and that the regulations will reflect this.

It is important to recognize that the revised Framework is still just an outline. The actual draft regulations will be published in the Canada Gazette in the fall of 2008. The regulations are expected to be finalized the following year and to come into force on January 1, 2010. The full impact on industry, including the penalties for missing emission targets, will not be known until the regulations are unveiled.

Canada's Offset System for GHGs

In addition to the final Regulatory Framework, the government has released a discussion paper regarding the design of the offset system. This indicates that the offset system will be administered by Environment Canada under the authority of the Canadian Environmental Protection Act, 1999. The paper outlines the basic requirements for registering an offset project, reporting and verifying the emissions reductions, issuing the offset credits, and trading the credits.

The paper enumerates five principles on which the offset system is built:

"1. Environmental benefits - Offset Projects achieve greenhouse gas reductions and a net environmental benefit.
2. Reductions occur in Canada - greenhouse gas reductions are domestic.
3. Maximum scope - the system promotes projects in as many sectors and for as many project types as practical.
4. Administratively simple - the system is as simple and cost-effective to administer as possible, and the burden for participants is minimized.
5. Build on experience - the system builds on the experience gained from the Canadian pilot projects and project-based crediting systems in other jurisdictions."

The proponent of a GHG reduction project will be responsible for steering the project through the offset process. The fist step will be to register the project with Environment Canada. Before accepting the project for registration, Environment Canada will ensure the project meets eligibility requirements and will post information about the project on an offset system website. Next the proponent will implement the project and measure the actual GHG reductions that ensue. These reductions must be verified by an independent third party. Environment Canada will then issue electronic offset credits which are deposited into the proponent's account. The proponent can then sell the credits to a regulated entity (e.g. a fertilizer company) which could apply it towards its mandatory GHG target or bank it for future use. Alternatively the proponent could sell the credits to any willing buyer, such as a bank or investment fund, which could treat the credits much like any other tradable financial instrument or else "cancel them (withdraw them from circulation) for the benefit of the environment".

The value of offset credits will be determined by supply and demand. The actual transfer of credits from one person to another will take place electronically - every participant in the carbon market will have an account in the "unit tracking system". Initially, the offset system will not be linked to other carbon markets (e.g. the EU Emission Trading Scheme). However, the offset paper notes that:

"If formal linkages are established with other regulatory-based systems in North America or abroad, arrangements will seriously be considered for the transfer of credits among systems. Especially, if a greenhouse gas regulatory regime and offsets system is developed in the United States, cross-border trading in emissions credits and offsets will be pursued."

Only projects that comply with an approved quantification protocol will be eligible to earn offset credits, and only for reductions achieved after January 1, 2008. A project proponent may submit a protocol for any given type of project (e.g. landfill gas capture) for approval. Protocols will be expected to comply with the international standard developed by the ISO, namely ISO 14064 Part 2. One of the principles enshrined in this standard is the use of conservative assumptions to ensure that GHG reductions are not overestimated. The paper also notes that "Where possible, quantification approaches should build on best practices. Existing peer-reviewed protocols (for example, Clean Development Mechanism methodologies) may provide a good basis on which to build a Base Protocol."

Registration of an offset project is effective for eight years, beginning from the date the project is actually registered or the date the project is commissioned, at the proponent's option. The registration can be renewed for a further eight years. In order to register a project, the proponent must satisfy the following six eligibility criteria:

1. Scope

the project must take place in Canada;
the project must achieve reductions in one or more of the following greenhouse gases: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulphur hexafluoride
the activity must be included in the federal GHG inventory which is prepared annually in accordance with the United Nations Framework Convention on Climate Change (forest management projects that are not included in the inventory will nonetheless be considered)

2. GHG reductions must be real

the project must result in a net reduction of GHGs
each quantification protocol will contain guidance on this criterion

3. The project must be incremental

the project must have started on or after January 1, 2000
credits may be issued for reductions achieved after January 1, 2008
reductions achieved must go beyond the baseline defined for the project type in the quantification protocol
reductions must be surplus to all legal requirements (e.g. provincial operating permits)
reductions must be beyond what is expected from receipt of other governmental climate change incentives

4. The GHG reductions must be quantifiable

the reductions must be quantified in accordance with an approved quantification protocol

5. The GHG reductions must be verifiable

the reductions must be verified by a recognized third party verifier

6. The GHG reductions must be unique

offset credits will normally not be issued for GHG reductions that have already earned credits through another mandatory or voluntary system
each credit will be assigned a unique serial number

The paper says that "proponents may aggregate similar projects and bundle projects with similar effects (for example, projects that together impact total fuel consumption)". This will provide an incentive to invest in multiple small projects that, on their own, might not attract carbon financing.

There is intended to be an active Canadian carbon market to propel GHG reduction projects outside the directly regulated industry sectors. The types of projects that could potentially earn offset credits include, among many others, carbon capture and storage projects, renewable energy projects, energy efficiency and demand-side management projects, and projects to convert vehicle fleets to hybrids.

A number of guidance documents concerning the offset system will be published later this year. In the meantime, comments on this general scheme are being solicited by Environment Canada.