An Introduction to Emissions Trading for the Commercial Real Estate Sector. February 2009

Transcription

1 An Introduction to Emissions Trading for the Commercial Real Estate Sector February 2009

2 Disclaimer The information contained herein has been compiled by REALpac from sources believed to be reliable, but no representation or warranty, express or implied, is made by REALpac, its affiliates or any other person as to its accuracy, completeness or correctness. Opinions and estimates contained herein constitute REALpac's judgment as of the publication date, are subject to change without notice and are provided in good faith but without legal responsibility. REALpac and its directors, officers, and staff, assume no liability for damage or loss arising from the use of information contained herein. Copyright All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, graphic, digital, electronic or mechanical, including photocopy, scanning, recording or any information storage and retrieval system, without permission in writing from the publisher. Copyright Real Property Association of Canada, 2008 This document is published for information and educational purposes only and should not be considered legal advice. Contact Robert Campanelli, M.U.P., Vice President, Industry Sustainability Real Property Association of Canada One University Avenue, Suite 1410 Toronto, ON M5J 2P1 Canada T F Ext. 222 E. Prepared for REALpac by: Gray E. Taylor Partner & Leader, Climate Change And Emission Trading Practice Group Keith Sutherland Associate Bennett Jones LLP 3400 One First Canadian Place, P.O. Box 130 Toronto, Ontario M5X 1A4 Canada T F About Bennett Jones Bennett Jones is an internationally recognized Canadian law firm founded and focused on principles of professional excellence, integrity, respect and independent thought. Our firm's leadership position is reflected in the law we practice, the groundbreaking work we do, the client relationships we have, and the quality of our people. Climate Change & Emissions Trading Group The Bennett Jones climate change and emissions trading group combines business acumen with global experience and leading knowledge in this complex practice area. Our extensive experience spans continents, industries and levels of government, with our lawyers often at the forefront of world wide climate change and carbon emissions trading, transactions and policy developments. Our clients include leading energy companies (both renewable and traditional), carbon funds, carbon offset originators and aggregators, clean technology companies, private equity firms and project developers operating around the globe. i

3 TABLE OF CONTENTS Introduction... 1 What is Emissions Trading?... 1 Buying Emissions Offsets: Will Commercial Buildings Be Regulated?... 2 Advanced Notice of Proposed Rulemaking... 2 Western Climate Initiative... 2 Selling Emissions Offsets: Capitalizing on Energy Efficiency and Green Building Projects... 2 Alberta... 3 Canada... 3 WCI Partners... 3 Legal Issues for Property Owners... 3 Title to Offsets... 3 Costs of Buying and Selling... 4 Transaction Mechanics... 4 Taxes... 4 Legal Issues: Conclusions... 4 Conclusion... 4 ii

4 AN INTRODUCTION TO EMISSIONS TRADING FOR THE COMMERCIAL REAL ESTATE SECTOR Introduction Emissions trading is a powerful tool that uses the market incentives so well understood by the private sector to accomplish greenhouse gas ("GHG") management on a costeffective basis. In an "environment" where climate change is a critical issue and where many see the "green economy" as the way back to prosperity, owners of commercial properties and their tenants should be aware of the potential costs and opportunities that GHG emissions trading can bring. This article: i. provides an overview description of emissions trading; ii. iii. iv. discusses the possibility that commercial property owners will be subject to the regulation of GHG emissions from their buildings; discusses the opportunity presented by the potential to sell emissions offsets generated in or by a building; and identifies some legal and business issues for property owners or tenants who want to sell building related emissions offsets or buy emissions offsets for "green" purposes. What is Emissions Trading? Emissions trading is a mechanism to achieve reductions in GHG emissions cost effectively. From a business perspective, emissions trading is desirable because it allows the cost of emissions reductions to be allocated efficiently, that is, for reductions to occur where the cost is lowest. From a policy perspective, a market for emissions implies a demand for reductions in GHGs (which can arise from a legislated reduction requirement or from a reputational enhancement desire) and puts a price on GHGs. The effect is to provide an incentive for investment in actions and projects that result in fewer GHG emissions, as well as innovation in the development of longer term technological and behavioural solutions to mitigate GHG emissions and therefore, hopefully, climate change. In a regulatory environment, emissions trading is often part of a "cap and trade" system. 1 Generally speaking, in a capand trade system the government places an absolute limit, or cap, on emissions in a given jurisdiction. Allowances representing the right to emit a certain amount are then allocated to regulated entities (usually large industrial emitters). Allowances are denominated in tonnes of carbon dioxide equivalent ("CO 2 e") and the aggregate of all allowances is equal to the emissions cap. At the end of a specified compliance period (e.g. a calendar year) regulated entities are required to return to the government allowances equal to their emissions for that compliance period. If a regulated entity has emissions that are greater than its allowances in a compliance period, it can purchase allowances from another regulated entity that has allowances in excess of its actual emissions hence the "trade" in cap and trade. 2 In an efficient market the entities for whom reducing emissions is the least expensive will undertake reductions and sell their excess allowances to entities for whom purchasing allowances is cheaper than achieving reductions in house. Cap and trade systems may also contemplate flexible compliance mechanisms such as the use of allowances from other regulatory regimes and the use of offsets from inside the jurisdiction or, in some cases, outside the jurisdiction, for compliance purposes. 3 Offsets are emissions reductions or removals resulting from projects undertaken by nonregulated entities. As with allowances, offsets are measured in tonnes of CO 2 e e.g. the European Union Emission Trading Scheme at the facility level and the Kyoto Protocol at the country level. As well, Ontario has a nitrogen oxides (NO x ) and sulphur dioxide (SO 2 ) cap and trade emission management and trading system. The U.S. also has a NO x and SO 2 cap andtrade system as well as, in the Regional Greenhouse Gas Initiative, a functioning GHG cap and trade system for electricity generators in the North east of the U.S. Alberta has an "emissions intensity" GHG reduction system that imposes an obligation on large emitting facilities to reduce their GHG emissions per unit of production, a system that also creates a demand for GHG reductions but does not involve allowances. Rather, after the compliance period is over, a calculation is made of the extent to which facilities achieved the required emissions intensity reductions, and "over achievers" can trade their "surplus reductions" to those that need them. Offsets (referred to in the next paragraph) are also allowed. Canada is considering implementing a similar system. The Alberta system referred to in footnote 2 allows only offsets generated in Alberta whereas the proposed Canadian system would allow offsets generated in Canada and to a limited degree offsets generated in developing countries and certified under the Kyoto Protocol's Clean Development Mechanism. 1

5 There are two possible markets for offsets: they may be recognized by regulatory regimes and marketable to regulated entities to use for compliance purposes, or they may be created pursuant to a voluntary standard and marketed to voluntary buyers. Voluntary buyers are emitters of GHGs who are not regulated but who want to offset their emissions for reasons such as wanting to reduce their carbon footprint or to appear "green" in order to generate goodwill or gain a competitive advantage. REALpac has previously published an article titled "An Introduction to Carbon Offsets" 4 that provides an excellent overview of the subject, and this Introduction to Emissions Trading for the Commercial Real Estate Sector will be most helpful if read with reference to that article. Buying Emissions Offsets: Will Commercial Buildings Be Regulated? If commercial buildings are caught by a regulatory regime, then building owners will likely have to either reduce their GHG emissions or purchase offsets or allowances from another entity in order to comply with their legal obligations to reduce emissions. At the current time commercial buildings are not covered by any GHG regulatory regime in North America, and are not a sector included in the Canadian government's proposed regulations. 5 This means that presently building owners interested in emissions trading are more likely to be sellers than buyers. However, there have been some developments, discussed below, that indicate GHG emissions from buildings may be regulated in the future. Advance Notice of Proposed Rulemaking In the U.S., the Environmental Protection Agency ("EPA") published an Advance Notice of Proposed Rulemaking ("ANPR") on regulating GHG emissions under the Clean Air Act in July The ANPR describes a regulatory regime that, if implemented, would regulate aspects of nearly every sector of the economy. The Administrator of the EPA states in the preface to the document that relatively small stationary sources, such as apartment buildings, schools and hospitals, could be regulated by the contemplated regulation. It notes that large buildings heated by gas or oil could potentially be caught by the "Prevention of Significant Deterioration" permit requirements, as well as other Clean Air Act provisions. While many critics argue that the Clean Air Act was not designed to regulate GHG emissions and would be a cumbersome and complex law to enact a regulatory regime for such emissions, President Barack Obama's top energy advisor promised during the election campaign that Mr. Obama would move to regulate GHG emissions under the Clean Air Act after taking office. Even if the U.S. does not regulate GHG emissions under the Clean Air Act, a significant body of technical and research work is contained in the ANPR, much of which will likely work its way into whatever regulatory scheme the U.S. ultimately adopts. It is unclear what the ANPR means for landlords in Canada, but there are at least two possible relevant impacts: first, the ANPR may be a bellwether, and the Canadian parliament may take cues from it and future U.S. legislation when determining how to regulate GHG emissions; and second, U.S. legislation regulating emissions may have cross border effects, for example by attempting to minimize "leakage" from companies choosing to site GHG emitting operations (e.g. buildings) across the border in Canada in order to take advantage of a lack of regulation here or regulations that are more favourable than in the U.S. Western Climate Initiative The Western Climate Initiative ("WCI") is a partnership between seven U.S. states, led by California, and four Canadian provinces (British Columbia, Manitoba, Ontario and Quebec). The WCI partners have committed to reducing GHG emissions to at least 15% below 2005 levels by 2020, and to establishing a regional cap and trade system. The WCI's Design Recommendations 7 for the cap and trade program set a threshold of 25,000 metric tonnes of emissions of CO 2 e per year, above which entities or facilities will have a regulatory compliance obligation under the program. It is unlikely that commercial buildings will exceed this threshold. However, the scope of the WCI's cap and trade program is capable of being expanded over time (including adjustments to applicability thresholds), and reporting obligations are to be imposed at 10,000 tonnes of emissions of CO 2 e per year. Thus, buildings that are not caught by the regulations initially may be caught in the future ICF International and REALpac, "An Introduction to Carbon Offsets", (May 2008); Online: ntocarbonoffsets_apr08.pdf Environment Canada, "Regulatory Framework for Industrial Greenhouse Gas Emissions" (March 2008); Online: 03/pdf/COM 541_Framework.pdf. United States Environmental Protection Agency, "Advance Notice of Proposed Rulemaking: Regulating Greenhouse Gas Emissions Under the Clean Air Act", United States Federal Register, (30 July 2008) Vol. 73, No. 147 at 44354; Online: Selling Emissions Offsets: Capitalizing on Energy Efficiency and Green Building Projects If commercial buildings do not have regulatory obligations to reduce their GHG emissions, there may be an opportunity to create and sell offsets. Some buildings will have more opportunity than others, and the size of the opportunity 7 Western Climate Initiative, "Design Recommendations for the WCI Regional Cap and Trade Program", (23 September, 2008); Online: 2

6 depends primarily on two things: (i) the quantity of offsets that the building is able to generate from a project that reduces the building's GHG emissions; and (ii) the cost of undertaking the project. For example, the prospect of creating offsets may appeal to the owner of an older building who is able to take relatively inexpensive steps that achieve large reductions in emissions relative to a business as usual scenario. REALpac's "Introduction to Carbon Offsets", mentioned above, discusses the prevalent voluntary market standards that a property owner could use to create offsets for sale to voluntary buyers. In addition to these standards, the following are prospective avenues for creating offsets for sale to compliance buyers in regulatory systems: Alberta The only jurisdiction in North America that regulates GHG emissions, Alberta's Specified Gas Emitters Regulation, provides for offsets to be used by regulated entities to meet their compliance obligations. 8 Alberta Environment has approved an offset quantification protocol to be used for energy efficiency projects, 9 and is working towards a protocol for commercial and industrial green buildings, both new and retrofit. 10 Canada Environment Canada's guidance document "Canada's Offset System for Greenhouse Gases" 11 describes the process for creating and registering offsets under the proposed Canadian GHG regulations, which are intended to come into effect at the start of Various private sector entities are currently working to develop quantification protocols for approval by Environment Canada. Project proponents will be able to use approved protocols to create offsets that will be recognized in the federal offset system, if and when established. The government has published a draft "Guide for Protocol Developers" 12 that provides for "Fast Track" approval of recognized protocols from other systems, including the Alberta Environment, "Offset Credit Project Guidance Document" (February 2008); Online: Offsets_v1.2_Feb_08.pdf. Climate Change Central, "Quantification Protocol for Energy Efficiency Projects" (September, 2007); Online: _v1_sept_07.pdf. See Alberta Environment's Carbon Offsets Solutions web site: ml. Environment Canada, "Canada's Offset System for Greenhouse Gases" (March 2008); Online: corner/ /526_eng.htm. Environment Canada, "Canada's Offset System for Greenhouse Gases: Draft Guide for Protocol Developers" (August 2008); Online: offsets/7cad67c6 B798 4B BD7F1F74B2CB/DRAFT%20Guide_for_Protocol_Developers.pdf. energy efficiency and commercial green building protocols published by Alberta Environment. While the future of the planned Canadian regulatory system is murky, there is a distinct possibility that any system that is adopted will use or borrow from protocols that Environment Canada approves. WCI Partners As members of the WCI, British Columbia, Manitoba, Ontario and Quebec are all committed to putting provincial cap andtrade systems in place. The WCI cap and trade system design recommendations provided that WCI partner jurisdictions will include an offset system within the cap and trade program. Legal Issues for Property Owners The following are a few of the legal issues that should be considered by property owners who want to engage in emissions trading, whether buying offsets in anticipation of compliance obligations or to gain a competitive advantage, or selling offsets to compliance or voluntary markets. Title to Offsets Possibly the most important thing to consider when engaging in emissions trading is who has title to the product being bought and sold. In a compliance system, regulated entities will need to be able to prove that they have title to the offsets or allowances they use to meet their obligations. 13 In certain compliance systems, such as trading of Certified Emission Reductions under the Kyoto Protocol, there is a system in place for ensuring title. However in other compliance systems, such as the Alberta offset system, there is no such mandated system in place, and therefore no guarantee that offsets will be accepted for compliance. Buyers and sellers will need to address title risk through contractual provisions. Absent such provisions, the person who pays for and takes the actions that reduce or remove GHG emissions has the best claim to title to the reductions or removals. It is easy to see how, in the commercial building context, this principle could lead to a number of entities having claims on title to offsets. Thus buyers will want appropriate representations from sellers and indemnities or other remedies to be available if they do not get good title to the offsets they purchase. For their part, sellers will want to identify other potential claimants (for example tenants) and contract with such potential claimants to ensure that sellers are able to transfer good title to the offsets they sell. 13 For example, Environment Canada's guidance document "Canada's Offset System for Greenhouse Gasses" provides that Project Proponents are responsible for resolving any disputes over entitlement to GHG reductions, and unresolved disputes may delay the issuance of offsets to the parties involved. Alberta's "Offset Credit Project Guidance Document" provides that there must be clear, legal claim to the GHG reductions or removals achieved from a project in order to be eligible for use in Alberta's offset system. 3

7 Costs of Buying and Selling Property owners who see an opportunity to undertake a project and monetize the GHG reductions should consider how costs of the project will be allocated. If the property owner wants to pay and then pass the costs on to tenants as operating or other costs, it will need authority to do so in the lease between the owner and tenants. Further, if the revenue from generating offsets is less than the costs of undertaking the project, it may not make sense to pass the costs along to tenants unless they are willing to accept such costs in order to gain the reputational benefit of being green. There are alternatives to the landlord paying the costs and passing them on to tenants; for example, landlords could devise a cost sharing mechanism for those tenants who want to participate in the costs and benefits of a project that will generate offsets. The property owner should consider its individual circumstances in order to maximize the gain from engaging in emissions trading. Transaction Mechanics In emissions trading transactions there may be a lag time between when the buyer's obligation to pay for offsets first arises and when it will actually receive offsets. For example, the payment obligation usually arises when the offsets are created and issued into an account in a registry. 14 However, offsets may only be transferred from the seller's account into the buyer's account at a later time. In this case buyers and sellers may want to use intermediaries, similar to the role of escrow agents in real estate transactions, to facilitate flows of money and offsets. For example, a "custodian" can be appointed to have a registry account and hold title to offsets on behalf of the seller when the offsets are issued into the registry account. An escrow agent can also be appointed to hold the money deposited by the buyer to pay for the offsets. Once the custodian receives confirmation that the buyer has deposited the full payment amount for the offsets with the escrow agent, title to the offsets transfers to the buyer. When title transfers to the buyer, the escrow agent releases payment to the seller. Taxes Property owners who sell offsets should be aware that GST may apply to the sale, and will want to allocate responsibility for taxes: first, between the buyer and seller, and second, between the tenants who may benefit from the purchase or sale of offsets. Legal Issues: Conclusions It may be desirable to use green lease provisions, adopting or modifying those in the National Standard Green Office Lease 14 For example, the Voluntary Carbon Standard Board has approved four registries to issue and hold VCU ("Voluntary Carbon Unit") offsets issued pursuant to the VSC. The Alberta Offset System also has a registry to register and retire Alberta offsets. published by REALpac, 15 in order to deal with the issues discussed above. In addition, because leases often run for long periods of time, it may not be feasible to enter into green leases with tenants or to amend existing leases to add green lease provisions. In light of this, the City of London's Better Buildings Partnership has suggested that landlords enter into a binding memorandum of understanding ("MOU") with tenants in order to get all parties on the same page with respect to green initiatives. 16 An MOU could be a good framework for property owners to deal with legal issues relating to emissions trading that would have the benefit of being applicable over time. It would not only enable landlords to avoid a piecemeal approach to green lease provisions, but also reduce transaction costs by laying the groundwork for participation in emissions trading on a going forward basis. Conclusion Commercial buildings are significant GHG emitters. The commercial building sector accounts for 13% of Canada's carbon emissions and 14% of end use energy consumption. 17 Further, there is pressure on all businesses to deal with their contribution to GHG emissions and climate change, from stakeholders ranging from consumers, employees, regulators and the public. The significance of the issue and the pressure to deal with it creates a need to be proactive in dealing with it and gives an advantage to those who are. There are a number of reasons why emissions trading could be especially beneficial to property owners: first, there is a great deal of potential in the commercial building sector to achieve GHG reductions. 18 Second, emissions trading is seen as a politically acceptable way to regulate GHG's (unlike carbon taxes), and the private sector understands the market incentives involved, thus making it appropriate to welcome emissions trading systems and prepare to use them. Third, getting involved in carbon markets at this early stage presents the opportunity to gain experience and while the competitive advantage from potential revenues is an obvious upside, the experience gained will have intrinsic value by enabling first movers to be prepared for the future. Lastly, as scientific consensus increasingly indicates that climate change presents a significant threat to humanity that can be mitigated by GHG emissions reductions, participation in emissions trading is likely not only good business, but also the right thing to do Real Property Association of Canada, "National Standard Green Office Lease for Single Building Projects ; Online: Better Buildings Partnership, "Guidance on Green Leases" (November, 2008); Online: % v1 BBP_Green_Lease_Guidance_Nov_2008.PDF. National Round Table on the Environment and the Economy and Sustainable Development Technology Canada, "Geared for Change: Energy Efficiency in Canada's Commercial Building Sector"(January 2009); Online: trnee.com/eng/publications/commercialbuildings/commercial buildings report eng.pdf. Ibid. 4

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