Emissions Trading and Government Policy: Implications for the Energy Industries of Canada

Transcription

1 Emissions Trading and Government Policy: Implications for the Energy Industries of Canada By Dan Stickney Submitted to Dr. Joseph Doucet BUEC 560 February 27, 2007

2 Abstract Emissions trading (ET) has emerged as a leading mechanism used by corporations and governments alike to provide flexibility in initiatives designed to reduce emissions of environmental pollutants, most notably greenhouse gases (GHGs). Used by the US government in the 1990s to curb sulfur dioxide emissions, ET has been gaining increasing global acceptance and use, especially with the advent of the Kyoto Protocol and its GHG reduction targets. Essentially, ET provides a market-based approach towards either reducing emissions through investment in appropriate technology and other reduction initiatives, or acquiring emissions credits to achieve emission targets. Canadian energy industries, many of whom are headquartered in Alberta, have been actively involved in ET since the late 1990s and have made this practice part of their business strategy. They have become voluntary participants in this market for a variety of reasons, in addition to the fact that many feel emission reduction targets will be legislated in the near future. To this end, both the Alberta and Canadian governments have investigated ET as part of their overall framework to reduce GHG emissions, yet current climate change policies remain unclear at both levels of government. A main concern of government is the possibility of emission reduction having a significant negative impact of Canada s, and in particular Alberta s fossil-fuel based economy. Despite the uncertainty in future direction Canada will take towards climate change and its Kyoto commitment, ET volume is growing globally, with many Canadian firms are proactively becoming participants in a potential solution to a global problem. ii

3 Table of Contents Abstract... ii List of Tables and Figures... iv 1.0 Introduction Emissions Trading and Implications Defining Emissions Trading Other Flexibility Mechanisms Markets and Trading Platforms Motivators for Corporations to Participate in Emissions Trading Government Policy and Emissions Trading Emissions Trading Policies Future Emissions Trading Policy Conclusion References iii

4 List of Tables and Figures List of Tables Table 1. The Tradable Commodities of Kyoto... 7 Table 2. Carbon Market at a Glance, Volumes and Values List of Figures Figure 1. European Member States under the EU-ETS... 9 Figure 2. Canadian GHG Emission Trend and Kyoto Target Figure 3. Total Provincial/Territorial GHG Emissions, 1990 and iv

5 1.0 Introduction In an era where global concern for climate change has never been more prominent, the Canadian energy industry (fossil fuel industries plus heat and electrical generation) faces many challenges and opportunities in reducing their share of greenhouse gas (GHGs) emissions into the earth s atmosphere. According to a report released by the United Nations Intergovernmental Panel on Climate Change (IPCC) in early February 2007, climate change due to global warming is very likely meaning with at least 90% certainty caused by release of GHGs into the atmosphere resulting from human activity. 1 Bound by the terms of the Kyoto Protocol, Canada has committed to an absolute reduction of GHG emissions by 6% of 1990 baseline levels by the end of Of the 758 megatonnes of carbon dioxide equivalent (Mt CO 2 e) of GHG emissions reported by Canada in its 2004 GHG inventory, the energy industry is directly responsible for 36% or 275 Mt of this total. 3 If Canada is to comply with its Kyoto pledge by the end of the first commitment period in 2012, the energy sector will need to evaluate and implement many existing and pioneering methods to reduce their emissions. Canadian energy corporations, in the wake of many uncertainties and differences in federal and provincial government policy, are already pursuing many of these strategies. Despite differences and uncertainties among federal and provincial climate change policies, many energy corporations are proactively educating, experimenting, and preparing themselves for various GHG emission reduction policies they feel governments will inevitably implement in the near future. One principal strategy that many firms are experimenting with, and both levels of governments have investigated, is GHG emissions trading (ET). Furthermore, in recent years the international community has shown 1

6 2 increasing interest and participation in credit trading and complementary flexibility mechanisms sanctioned by the Kyoto Protocol to help participant nations reach their reduction targets. Besides the possibility of future legislation towards emission reduction, there are many other reasons for Canadian energy firms to voluntarily pursue policies of ET that will be explored. The differences that exist between the proposed and implemented policies of the two levels of government has created uncertainty as to what policy route Canada will ultimately follow and whether it will be able to comply with Kyoto at all. This is due in part to recent changes in government, and different stakeholder interests of each government. In particular, the Alberta provincial government has forged its own path to mitigate the effects of climate change as Alberta s economy relies very heavily on the success of the energy sector. This dependency primarily has resulted in Alberta having the highest annual output of GHGs among all provinces, accounting for 31% of national GHG emissions in As a consequence, energy industries in Alberta are among those corporations leading the way in experimentation with GHG ET.

7 3 2.0 Emissions Trading and Implications Over the past 20 years, ET and emissions markets have emerged as a key environmental policy instrument used by both governments and corporations to address impacts on the environment and climate change. Initially used in domestically closed systems, ET has expanded to become a fundamental mechanism to reduce GHG emissions under the Kyoto Protocol. Within the Protocol, there are two other flexibility mechanisms that work with ET known as joint implementation (JI) and the clean development mechanism (CDM), which allows participants greater options for meeting emissions targets. Participating in these types of ET and related projects can help benefit energy corporations in more ways than simply meeting their own enforced or otherwise voluntary emissions targets. 2.1 Defining Emissions Trading GHG emissions that are monitored by Canada to meet obligations of the Kyoto protocol include the naturally occurring carbon dioxide (CO 2 ), methane (CH 4 ), nitrous oxide (N 2 O); and the anthropogenic hexafluoride (SF 6 ), perfluorocarbons (PFCs) and hydro fluorocarbons (HFCs). In Canada, the majority of GHG emissions in 2004 were composed of the three naturally occurring gases with CO 2 contributing 78%, while CH 4 and N 2 O contributed 15% and 6% respectively and the three anthropogenic gases accounted for the remaining 1%, which is consistent with global GHG concentrations. 5 Due to the fact that CO 2 and CH 4 represent approximately 95% of all global GHG emissions and are relatively easy to monitor, the majority of ETs that occur involve the

8 4 reduction of these two gases. The resulting ET convention is that almost all GHG trades of all commodity types are denominated in metric tons of CO 2 e 6. In the context of Kyoto, these units will be referred to as assigned amount units (AAUs), which will be allotted to each country based on their 1990 GHG output minus (or plus) their committed reduction. Accredited by the UNFCCC in 2000, the International Emissions Trading Association (IETA) was created in 1999 to establish a functional international framework for trading GHG emission reductions. 7 Until the first commitment period in 2008 however, credits have been referred to as verified emission reductions (VERs), which are a nonstandardized commodity and have been traded in over-the-counter markets. Essentially, ET provides a flexible mechanism whereby emitters of GHGs or atmospheric pollutants can opt to purchase or sell emissions credits among other emitters against some form of regulatory cap or baseline for allowable emissions. For example, a power generation company who implements cleaner technology in their production processes may lower their annual emissions to a level below that imposed by a regulated government body, thereby qualifying that company to be granted emission credits from the regulator or some other jurisdictional power. In turn, these credits can then be sold to an oil refining company who is unable to comply with their set emissions limits, and may therefore use these purchased credits to offset the amount of emissions they are over-limit. The net effect is that the power generator is able to compensate their investment to reduce emissions through the sale of their credits, while the oil refiner is still able to meet their emission targets.

9 5 The effectiveness of ET has often been called into question by various authorities including environmental groups and governments; however one success was the implementation of the United State s (US) Clean Air Act Amendment (CAAA) in The US CAAA represents not only an early example of ET, but one that was significantly successful as it achieved greater environmental benefits than required by law at a cost of implementation lower than had originally had been anticipated. 8 In essence, the program was a closed cap and trade system that imposed a cap on sulfur dioxide (SO 2 ) emissions from electricity generators in the US. Generators complied with the program by investing in emissions reducing technology, switching to lower sulfur content fuels, or purchasing emissions allowances (effectively credits ) allocated by the government from generators that imposed the former two reduction strategies and thus fell under their targets. As emission allowances became a more expensive option, there was a market force incentive to invest in cleaner technologies and fuel alternatives. An argument against the effectiveness of ET is the potential for participants to purchase what has been deemed as hot air, which undermines the supposed benefit of ET on GHG reduction. An example of this situation occurring would be in the event of an economic downturn, where an emitter s GHG output has fallen relative to its business-as-usual emission target as is the case with Russia and the Ukraine, who s economies and resulting GHG emissions collapsed subsequent to their 1990 levels under the Kyoto Protocol. 9 Unless the emission target is reduced to the emitter s corresponding drop in output, the resulting

10 6 credit issued in response to the emitter exceeding their target, when purchased from the emitter, would be classified as hot air because it would lead to higher GHG emissions than if these credits had not been traded. Another potential issue regarding ET effectiveness is that imposed caps or baselines must be stringent enough that emitters simply do not achieve or exceed their targets by practicing business-as-usual. To avoid these scenarios, credible regulatory systems must be put in place to ensure that emission targets are challenging to achieve and that action must be taken on behalf of the emitter to achieve or exceed their targets. If these safeguards are not in place, emission credits and markets will not follow the laws of supply and demand that are critical to the success of an effective ET system. 2.2 Other Flexibility Mechanisms Within the bounds of the Kyoto Protocol, JI and CDM mechanisms work in conjunction with ET as they increase the flexibility of countries and their corporations committed to reducing their GHG emissions. The JI process allows Annex I countries (developed) such as Canada to collaborate with other Annex I countries to transfer emission reduction units (ERUs) among themselves resulting from projects that reduce emissions or enhance carbon sinks. 10 An example would be a Canadian gas-refining firm supplying a Dutch refining firm with technology to reduce the Dutch firm s GHG emissions. As a return on their investment, the Canadian firm would be allotted the ERU (1 ERU is equal to 1 tonne of CO 2 e) or emission credit from the Dutch firm who now benefits from reduced emissions. Table 1 on the overleaf summarizes the tradable commodities of Kyoto.

11 7 Table 1. The Tradable Commodities of Kyoto (Source: < MECHANISM UNIT TYPE IET - International Emissions Trading JI - Joint Implementation CDM - Clean Development Mechanism AAUs - Assigned Amount Units ERUs - Emission Reduction Units CERs - Certified Emissions Reductions QUOTA CREDIT CREDIT Similarly, the CDM mechanism allows for collaboration between industrialized Annex I countries and economies in transition (EIT) countries (former Warsaw Pact countries with less restrictive GHG reduction targets than Annex I countries) and developing countries (countries not bound by the absolute GHG reduction levels that Annex I countries are). The logic behind the CDM is to encourage increasing investment and the transfer of environmentally-friendly technologies to EIT and developing countries, thereby decreasing the cost of domestic emissions reductions from the resulting certified emission reductions (CERs) that are transferred to the Annex I country. 11 An example of a CDM project would be a Canadian gas refiner supplying a non-annex I country with solar panels to offset GHG emissions from a GHG emitting electricity generation facility. Similar to a JI project, the resulting ERUs from the project would be transferred to the Canadian firm in return for the investment in the solar panels.

12 8 2.3 Markets and Trading Platforms Many different ET markets have emerged in the past 20 years, spurred by such initiatives as the US s CAAA of the 1990 s and more recently the ratification and implementation of the Kyoto Protocol. In particular, under the provisions of Kyoto, member countries are largely left to their own discretion as to how they wish to implement their own domestic trading schemes. As Kyoto is yet to become truly international in scope with the exclusion of such large GHG emitters as the US and Australia, there has yet to emerge a formalized international ET market, which would likely have clearly defined ET regulations and rules for those wishing to participate in ET. Nonetheless, a number of different markets have been initiated, each having different levels of scope, objectives, and inclusion of participants and are described as follows. The most notable and largest ET market to have emerged is the European Union Emissions Trading Scheme (EU-ETS), which includes all 25 EU countries and covers approximately 12,000 installations in 6 major industrial sectors as shown in Figure 1 on the overleaf. The EU-ETS represents the world s first largescale GHG trading program compared to other markets created in the past such as the US s SO 2 market. 12 Started on January 1, 2005, the EU-ETS is to go through a warm-up period until the beginning of 2008, which coincides with the beginning of the first commitment period of the 25 EU states with Kyoto. During this initial phase, only CO 2 (accounting for roughly 80% of all GHG emissions) reductions will be targeted, whereupon the inclusion of other GHGs may occur during the second phase of the market implementation in 2008.

13 9 Figure 1. European Member States under the EU-ETS (Source: Kruger J. and W. Pizer. The EU Emissions Trading Directive: Opportunities and Pitfalls. Discussion Paper Resources for the Future. Washington, DC: 2004.) The development of regulated ET markets such as the EU-ETS provides many benefits to emissions traders. To begin, they provide a more rigid guarantee of the value of credits that are traded as their value is recognized by the government and regulatory bodies that back the market. Secondly, it provides a cost-effective means of conducting transactions between buyer and seller; in the absence of such organized markets, the buyer and seller are left to their own devices to ensure the transaction is legally recognized and meets the needs of the parties involved. Furthermore, if a buyer is motivated to obtain credits by virtue of future emissions compliance (presumably under Kyoto) versus voluntary participation, they will be more encouraged to conduct ET in an international

14 10 market that guarantees certification. This is particularly the case in JI and CDM projects that are now occurring across international boundaries. Other examples of ET markets include private and project-based initiatives such as the Chicago Climate Exchange (CCX) and Ontario s Pilot Emissions Reduction Trading Project (PERT), where unlike the EU-ETS, participation is voluntary in nature. The CCX represents the creation of a nongovernmental organization (NGO) backed by private investment and corporate participation to achieve voluntary GHG reductions. Similarly, participation in the PERT initiative is voluntary, yet it fundamentally differs from the CCX as it is a joint industry and government initiative designed to promote voluntary GHG and other air-borne pollutant reduction initiatives and to provide a framework for participants to learn-by-doing. Perhaps the earliest form of ET that was most prominent in light of the highly fragmented ET markets is over-the-counter trading. Typically this involves a corporation as a buyer, another corporation or entity responsible for carbon offsetting as a seller, and an agreed upon broker as an intermediary. In particular, a number of energy industries located in Alberta such as Epcor, Transalta, and Suncor have participated is such trades since the late 1990 s. 13 Although there was and still is no legal requirement for these companies to have participated as such, there are many incentives that motivate corporations to implement emissions trading into their policies.

15 Motivators for Corporations to Participate in Emissions Trading There are many motivating factors that have prompted corporations to participate in ET, particularly in Canada, despite the absence of any legislation enforcing them to do so. To this end, many corporations believe they will be bound by imposed GHG limitations in the near future despite regulatory uncertainties, and therefore wish to hedge risk by implementing corporate GHG offset portfolios and at the same time, learn-by-doing. Another principal reason is over public concern for the environment and more recently, climate change. By showing active engagement in ET activities, corporations can serve to improve public perception and demonstrate social responsibility. Perhaps most importantly, corporations who gain practical experience in ET can increase their opportunity to influence public policy, as their insight into trading will provide them with credibility when participating in forming policies on climate change. 14 Corporations such as Transalta have integrated an emissions reduction strategy into their company policy, where they actively solicit opportunities to purchase CERs. 15 In 2004, Transalta signed a deal with Agricola Super Limitada, a large Chilean agricultural firm for the purchase of 1.75 million tonnes of GHG reduction CERs. By investing in new technology, Agricola was able to reduce their GHG emissions by 400,000 tonnes per year, which qualified them for a CER offset under the Kyoto Protocol CDM. Although the Protocol has yet to take legal effect, a special provision allows approved CERs to be earned and bankable. 16

16 Government Policy and Emissions Trading Governmental policy on climate change has been evolving at both the federal and provincial levels particularly during the past decade in light of Canada s commitment to the Kyoto Protocol. Due to the very nature of Canada s federalist system, jurisdictional power over the control of GHG emissions falls under the responsibility of both the federal and provincial governments. 17 As a result in October 2002, the Alberta government released its own plan to reduce GHG emissions entitled Albertans & Climate Change: Taking Action, while shortly thereafter the federal government published its Climate Change Plan for Canada (CCPC) in November This has resulted in a disjointed approach towards exactly how Canada will reach its increasingly challenging Kyoto GHG reduction target of 563 Mt CO 2 e by 2012, as shown in Figure 2 below. Figure 2. Canadian GHG Emission Trend and Kyoto Target (Source: Canada. Environment Canada. National Inventory Report: , Greenhouse Gas Sources and Sinks in Canada. Ottawa: EC, p. 3 <

17 13 The Alberta government has been particularly reluctant to coordinate its GHG reduction strategy with that of the federal government, as approximately one-third of the province s revenue is generated from the energy industry. 18 The main concern is that Canada s GHG reduction strategy under Kyoto is too stringent and will significantly curtail the economic benefit Alberta currently receives from its energy industries. This concern stems from the fact that Alberta contributes to 31% of Canada s annual GHG emissions as shown in Table 3 below, and would therefore be required to reduce emissions by the same proportion. Compared to the CCPC s advocacy of meeting Canada s absolute Kyoto target of a 6% reduction of GHG emissions below 1990 levels, Alberta s plan states an intensity-based reduction with a goal of cutting GHG emissions in the province relative to gross domestic product (GDP) by 50 per cent below 1990 levels by This would actually result in an absolute increase of 39% in Alberta s GHG emissions compared to 1990 levels. 20 Figure 3. Total Provincial/Territorial GHG Emissions, 1990 and 2004 (Source: Canada. Environment Canada. National Inventory Report: , Greenhouse Gas Sources and Sinks in Canada. Ottawa: EC, p. 12 <

18 Emissions Trading Policies Despite differences between the CCPC and the Alberta Plan in GHG reduction goals, both plans mention the use of ET schemes; however both are vague in this regard as the CCPC briefly mentions the creation of a domestic offset system, 21 while the Alberta Plan briefly refers to establishing a GHG offset registry to be compatible with domestic and international trading systems. 22 To this end, both government levels have previously investigated the feasibility of implementing domestic ET systems including the federally supported National Round Table on the Environment and the Economy s (NRTEE) 1999 study Canada s Options for a Domestic Greenhouse Emissions Trading Program ; and the Alberta government s 2003 Alberta Environment Emission Trading Project study. The NRTEE study evaluated five domestic ET trading program design options and concluded generally that ET can play a useful role in Canada s climate change action plan. 23 Comparatively, Alberta s feasibility study included emissions trading provisions for sulfur oxides (SO x ) and nitrous oxides (NO x ) in addition to GHGs, and recommended that such an ET scheme would work given specific regulatory regulations including the establishment of appropriate baselines or targets. Additionally, the study recommended that a GHG ET program be flexible to allow for trading among other jurisdictions, and that there is a provision to be integrated into a national GHG program if one is implemented. 24 Currently, no such ET programs have been implemented provincially or federally.

19 Future Emissions Trading Policy The future outlook on ET policy in Canada remains uncertain at this time. With the election of a Conservative Government in January 2006, a new direction in climate change policy has emerged as the new government s proposed Clean Air Act leaves room for ET; 25 however now focuses on an intensity-based target rather than absolute target under Kyoto. To this end, the federal Conservatives have widely opposed Canada s Kyoto commitment for similar economic reasons as the Alberta government and at present have indicated they will not be attempting to meet this obligation. 26 This change in policy undoubtedly leaves corporations and their own GHG reduction strategies in limbo as Canada s future role in ET both domestically and internationally is yet unclear. Regardless, the global demand for ET has increased exponentially in the past few years. Closed compulsory markets such as the EU-ETS have shown the largest gain in trading, as illustrated in Table 2 on the overleaf. As well, the CCX has also shown healthy gains in trade volume, although not near as significant as the EU-ETS due to its voluntary participation. Most notably, project-based mechanisms such as the Kyoto-spawned CDM show huge growth in trade activity. Although Canada has yet to clearly define their ET intentions, many other entities including both countries and corporations are demonstrating their leadership in this emerging marketplace.

20 Table 2. Carbon Market at a Glance, Volumes and Values (Source: Capoor, Karen and Philippe Ambrosi. State and Trends of the Carbon Market: Update: (January 1 September ). Washington, DC: World Bank, p. 1. < 16

21 17 Conclusion ET has the potential to provide a plausible framework to help organizations and countries wishing to comply with voluntary or compulsory GHG reduction targets. Initiatives such as the US s CAAA illustrate that ET can be an effective economic driver to mitigate environmental pollution. More recently, the growth in the EU-ETS and CDM indicate global awareness and moreover, the global acceptance of ET as a GHG reduction strategy. As ET is still in its infancy, more time will be required to make accurate assessments to its contribution towards global GHG reduction and resultant cleaner technology. Clearly, the interest for ET is evident in Canada and is growing at an accelerated rate globally, and Canada will need to define and commit to a policy route on ET sooner rather than later. Despite absence of clear policy, many Canadian corporations have been actively involved in ET, and more recently in the project-based CDM. As part of their corporate policy, these firms have voluntarily chosen to become participants in an emerging market that does not yet necessarily guarantee a return on their investment. Regardless, these firms wish to become involved for many reasons including public concern for climate change, to learn-by-doing, hedge risk, and gain credibility and knowledge in the practice of ET, should they have the opportunity to influence future public policy. Canada s reluctance to define a clear policy on ET or wholeheartedly commit to its GHG reduction obligation under Kyoto can largely be attributed to economic uncertainty when considering its economic dependence on fossil fuels and associated GHG emissions. Global concern for climate change and the mitigation strategies chosen

22 18 by other nations will likely have a large influence on the direction Canada chooses provided their domestic economic concerns can be reassured.

23 19 References 1 United Nations. Intergovernmental Panel on Climate Change Secretariat. Climate Change 2007: The Physical Science Basis. Geneva: UN, pp < 2 United Nations. Framework Convention on Climate Change Secretariat. Kyoto Protocol Reference Manual on Accounting of Emissions and Assigned Amounts. New York: UN, p. 8. < col/application/pdf/rm_final.pdf >. 3 Canada. Environment Canada. National Inventory Report: , Greenhouse Gas Sources and Sinks in Canada. Ottawa: EC, pp. 2, 30. < 4 Canada. Environment Canada. National Inventory Report: , Greenhouse Gas Sources and Sinks in Canada. Ottawa: EC, pp. 2, 395. < 5 Canada. Environment Canada. National Inventory Report: , Greenhouse Gas Sources and Sinks in Canada. Ottawa: EC, p. 5. < 6 Rosenzweig, R. et al. The Emerging International Greenhouse Gas Market. PEW Center on Global Climate Change, p IETA. Sustainable Market Solutions for Global Environmental Problems. < 8 Ellerman, A. et al. Emissions Trading Under the U.S. Acid Rain Program: Evaluation of Compliance Costs and Allowance Market Performance. MIT: Center for Energy and Environmental Policy Research, p < 9 Laycock, B. R. Bringing Rio and Kyoto to Canada: Evaluation of the Greenhouse Gas Emissions Reduction Strategies of Canada and Alberta. Edmonton: UofA, p See UNFCCC web site at < 11 See UNFCCC web site at < 12 PEW Center on Global Climate Change. The European Union Emissions Trading Scheme (EU- ETS) Insights and Opportunities. < ETS%20White%20Paper.pdf> 13 Koch, George. No Need for a Treaty, They ll Trade on Spec: Big Companies Hustle to Beat the Rush for CO2 Emission Credits. Alberta Report. Edmonton: March 23, Vol. 25, Iss. 14, p Rosenzweig, R. et al. The Emerging International Greenhouse Gas Market. PEW Center on Global Climate Change, p. 10.

24 20 15 TransAlta < 16 UNFCCC < 17 Laycock, B. R. Bringing Rio and Kyoto to Canada: Evaluation of the Greenhouse Gas Emissions Reduction Strategies of Canada and Alberta. Edmonton: UofA, p Government of Alberta < 19 Alberta. Government of Alberta. Albertans & Climate Change: Taking Action p. 2. < 20 Laycock, B. R. Bringing Rio and Kyoto to Canada: Evaluation of the Greenhouse Gas Emissions Reduction Strategies of Canada and Alberta. Edmonton: UofA, p Government of Canada. Climate Change Plan for Canada. Ottawa: Government of Canada p. 31. < 22 Alberta. Government of Alberta. Albertans & Climate Change: Taking Action p. 20. < 23 Canada. NRTEE. Canada s Options for a Domestic Greenhouse Gas Emissions Trading Program p. 7. < Options_E.pdf> 24 Alberta. Alberta Environment. Alberta Environment Emission Trading Project: Major Feasibility Study pp. v-viii. 25 Mertyl, Steve. Interest in Global Warming Puts Renewed Focus on Carbon Trading. Canadian Press. February 19, February 25, < 26 Canada-Kyoto Timeline. CBC News online. Last Updated February 14, February 25, <