4. Issues and Options for Canada

• 4.1 Regulatory Issues
• 4.2 Non-regulatory Issues

Consultations in developing the Notice of Intent on Cleaner Vehicles, Engines and Fuels showed that all stakeholders supported Canada aligning with U.S. requirements for sulphur in diesel fuel. The federal government confirmed in the Notice of Intent that it would follow that approach. Environment Canada is therefore developing regulations to restrict the level of sulphur in on-road diesel fuel to a maximum of 15 ppm commencing on June 1, 2006.

In the US, the vast majority (> 80%) of on-road diesel fuel will contain less than 15 ppm of sulphur commencing in 2006. During a transitional period, a second grade of 500-ppm on-road diesel will exist in the US in small amounts. Overall, by allowing an extra grade of diesel fuel to exist in the on-road diesel market during the transitional period, the US rule necessarily became extremely complex and lengthy in order to address downstream concerns.

Allowing for a second on-road diesel grade in Canada would result in the same concerns and complexities as those in the US: namely, contamination of low-sulphur diesel and potential for misfuelling of vehicles with high-sulphur diesel. In the US, the EPA addressed these concerns by having numerous provisions requiring segregation, tracking of each batch, labeling at the pump, and a complex "downgrading" process. All these requirements tend to shift costs of compliance away from the refiners and on to parties operating storage and fuel distribution systems (such as pipelines and fuel trucks).

A uniquely Canadian issue is one of legal authority. Whereas the EPA works under a legal regime that allows it broad discretion in setting requirements for fuels, Canadian legislation is more restrictive in what flexibilities can be included in fuels regulations. It is unlikely that Canadian regulations under the Canadian Environmental Protection Act, 1999 (CEPA, 1999) could include all the types of flexibilities afforded to refiners and importers in the US diesel fuel rule. Accordingly, while Environment Canada is committed to aligning with the US on-road diesel fuel rule, the Canadian regime will have to be within the legal framework and enabling provisions of CEPA, 1999.

The main issue, therefore (and being cognizant of Canadian legal constraints), is: should Canada include some flexibility allowing companies to produce and import a small amount of on-road diesel fuel that does not meet the 15-ppm requirement for a short transitional period? In other words, should Canada's regulations for sulphur in on-road diesel fuel be aligned with the US requirements that apply to the large majority (80%+) of its on-road diesel fuel (i.e., 15 ppm in 2006), or should the regulations include the flexibilities included in the US rule (to the extent possible under CEPA, 1999)?

The table below summarizes the advantages and disadvantages of these two options:

Appendix C provides a possible framework for regulations under both options.

Besides the basic conceptual issue of whether or not U.S.-style flexibilities should be included in Canadian regulations, there are other (more technical) issues, particularly if such flexibilities are granted.

One set of issues addresses contamination and misfuelling concerns. Should "downgrading" be allowed in Canada? If so, how should this be handled? What sort of records will need to accompany a batch of low-sulphur diesel throughout the distribution system? Is labeling at the pump sufficient in the Canadian context to avoid misfuelling? Is fuel dyeing needed?

Another issue is whether a sulphur credit trading program would work in Canada given the smaller number of refiners and importers. Under the US rule, sulphur credits must be used in the region that they are generated in. There are seven regions defined by the US rule: the five PADD regions plus Alaska and Hawaii. Most of these regions have more refineries within them than does all of Canada. In Canada, to ensure regional availability of low-sulphur diesel fuel, trading would have to be restricted regionally. Canadian regions would likely follow the general refinery supply orbits; namely, the West, Ontario and the East. There are six refineries (plus Suncor) in the West currently producing on-road diesel, five (plus Petro-Canada's lubrications plant) in Ontario, and six in the East. There are a number of questions regarding a potential Canadian trading program. Are there enough refineries in these regions for a trading program to work? Should other regional groupings be considered? How could a Canadian trading program be designed to ensure that 15-ppm diesel fuel would be available throughout Canada during the transitional period? What are the competitiveness issues around trading of sulphur credits in relatively small markets?

There are some unique aspects to fuel distribution in the Arctic. Often only one shipment of a fuel is sent to a northern community each year. Shipments in the winter can be difficult or impossible. For these reasons, and because of the relatively short time between the finalization of the regulations and the coming into effect of the limit on benzene at the point of sale (22 months), the Benzene in Gasoline Regulations, provided a extra nine months for the limits on benzene at the point of sale in the Arctic (three months was allowed elsewhere in Canada, as it is in the US diesel rule). However, Canada's Sulphur in Gasoline Regulations did not provide more time for arctic gasoline, due to the longer time between the finalization of the regulations and the coming into effect of the limit on sulphur at the point of sale (54 months) and the nature of the interim 2½-year averaging provisions. It is foreseen that companies should have about 48 months between the finalization of the upcoming diesel regulations and the coming into effect of the limits on sulphur. Is extra time required for the Arctic's diesel distribution system to prepare for the 15-ppm requirement?

Another arctic issue is that, under the US diesel rule, the State of Alaska has the option of applying to the EPA for its own 15-ppm diesel transition program. If it does not make an application, the transition program applicable in the rest of the US will also apply in Alaska. The state has until April 2002 to make this application. If Alaska makes such an application, it could be several months later until EPA makes a determination on Alaska's application (shortly after it is foreseen that the Canadian regulations would be finalized). It is expected that even under a state program there would be a considerable portion of Alaska on-road diesel fuel production meeting the 15-ppm level (although possibly less than the 80% portion in the rest of the US). Some of Canada's diesel supply comes from Alaska refineries, particularly in the Yukon¹⁰. Working within the legal constraints of CEPA, 1999, how should Canadian regulations handle imports of on-road diesel from Alaska during the US transition period?

Yet another issue is how should sulphur levels be measured. The US rule specifies method ASTM D-6428-99 for measuring sulphur in diesel fuel. Should Canada adopt this method, or should Canada develop its own method? Should alternative methods for the purposes of record keeping and reporting be allowed? If so, what alternative methods should be allowed? In the past, Environment Canada has relied largely on advice from the Canadian General Standards Board and its own internal experts on such matters.

The Notice of Intent on Cleaner Vehicles and Fuels commits Environment Canada to "explore complementary measures to regulations, such as economic instruments and other measures, to promote the early introduction of cleaner fuels including low sulphur fuels".

Tax differentials for promoting the introduction of low-sulphur diesel in advance of the European Union's 2005 mandatory 50-ppm standard are being widely and successfully used in many European countries: namely, Finland, Denmark, Britain, Germany, Sweden, Norway and Hong Kong, with Austria, Netherlands, Switzerland and Australia seriously considering a tax differential for low-sulphur diesel. For example, in Britain the tax differential switched the market to over 99% low-sulphur diesel fuel - 5½ years ahead of the regulated requirement; in Denmark 100% of the diesel pool switched literally overnight, with ambient levels of particulate matter in Copenhagen consequently dropping significantly. The tax differentials vary between countries, ranging from 2 to 6 Canadian cents per litre¹¹.

Canada has some limited experience with tax differentials for clean fuels. In 1989, the federal government set a tax differential of one cent per litre for unleaded versus leaded gasoline (British Columbia and Ontario also had such a tax differential in 1987 and 1988). In addition, the federal government exempts the ethanol portion of ethanol-blended gasoline from the federal excise tax.

¹⁰ Based on data from Customs Canada, 31 249 m³ of 500-ppm diesel and 17 135 m³ of regular diesel were imported into Yukon in 1998. This represents roughly 40% of the diesel sales in the Arctic.
¹¹ Environment Canada. "A review of international initiatives to accelerate the reduction of sulphur in diesel fuel" (PDF 255 kB). Prepared for Oil, Gas & Energy Branch by B. Olvastri and M. Williamson, December 2000, 47 p.