Carbon pricing: compliance options under the federal output-based pricing system

Industries in Canada that are covered by the federal carbon pricing system will have an emissions limit. If they are above this limit, they will need to pay the carbon price, or use certain credits. This paper lists the proposed rules on which types of credits are allowed. We are asking for feedback from the public until July 6, 2018.

Introduction

Carbon pricing is a central component of the Pan-Canadian Framework on Clean Growth and Climate Change (PCF). Carbon pricing is an efficient way to reduce greenhouse gas (GHG) emissions at the lowest cost to businesses and consumers, while stimulating innovation and clean growth.

In October 2016, the Government of Canada published the Pan-Canadian Approach to Pricing Carbon Pollution (the benchmark) to ensure that carbon pricing applies to a broad set of emission sources throughout Canada in 2018 with increasing stringency over time.  Under the benchmark, provinces and territories can implement the type of carbon pricing system that makes sense for their circumstances.  As part of the benchmark, the federal government also committed to implement a federal carbon pricing backstop that will apply in any province or territory that requests it or that does not have a carbon pricing system in place in 2018 that meets the benchmark (referred to as “backstop jurisdictions”).

In May 2017, the federal government released a Technical Paper on the Federal Carbon Pricing Backstop outlining the federal carbon pricing backstop’s two elements:

  • a charge on fossil fuels, that is generally payable by fuel producers or distributors, with rates for each fuel that are equivalent to $10 per tonne of carbon dioxide equivalent (CO2eFootnote 1  ) in 2018, rising by $10 per year to $50 per tonne CO2e in 2022
  • an output-based pricing system (OBPS) for industrial facilities

In January 2018, the federal government released a Technical Paper on the Regulatory Framework for the Output-Based Pricing System outlining the design of the system, including the need for, and the design of, rules to enhance market liquidity.

In March 2018, the government introduced Bill C-74, the Budget Implementation Act, No. 1 in Parliament. Part 5 of Bill C-74 would implement the Greenhouse Gas Pollution Pricing Act, which establishes the legal framework for the federal carbon pricing backstop.

The aim of the OBPS is to minimize competitiveness risks for emissions-intensive, trade-exposed industrial facilitiesFootnote 2 , while retaining the carbon price signal and incentive to reduce GHG emissions. Industrial facilities that are registered under the OBPS will have a compliance obligation for the portion of their emissions that exceeds an annual output-based emissions limit. Facilities that emit less than the annual limit will receive surplus credits for the portion of their emissions that are below the limit. A facility’s ability to bank or trade credits when it performs below its limit maintains the full carbon price incentive on all emissions.

Compliance flexibility is an important feature of the OBPS design, as it reduces overall costs of compliance to OBPS facilities. It broadens the carbon pricing signal across the economy and supports investment in emission reduction solutions. Offset credits can also help reduce GHGs from sectors not covered under specific regulations or emission caps.

This document provides additional details regarding compliance units and their use in the OBPS and seeks input from Indigenous Peoples, stakeholders, and the public on key technical issues related to the criteria and considerations for the OBPS system to provide opportunities for emission trading while ensuring environmental integrity is maintained. Further information regarding next steps and timelines is provided below.

Compliance obligations under the federal output-based pricing system

In jurisdictions where the federal OBPS applies, it will include industrial facilities that emit 50kt CO2e or more annually as reported to Environment and Climate Change Canada’s Greenhouse Gas Reporting Program (GHGRPFootnote 3  ), with ability for smaller facilities to opt-in starting in 2020.

Compliance periods will be on a calendar year basis (i.e., January 1 to December 31).  After the end of each compliance period, OBPS facilities will be required to submit annual third party verified compliance reports to Environment and Climate Change Canada. An OBPS facility’s annual GHG emissions limit, expressed in tonnes of CO2e, will be established based on the prescribed output-based standards (OBS) for the production activities that the facility undertakes.

A facility that emits less than its annual limit will receive surplus credits from the Government of Canada for the difference between its limit and its reported emissions, where each surplus credit represents one tonne CO2e. A facility that emits more than its annual limit will have a compliance obligation equal to the difference between its annual limit and its reported emissions.

Compliance instrument usage

A facility whose emissions are above its limit will calculate the excess emissions above the annual compliance limit, such amount being the annual “compliance obligation”, and have the following options to meet its compliance obligation:

  • paying an emissions charge to the Government of Canada, set at the same level as the fuel charge ($20 per tonne CO2e owed in 2019, increasing by $10 per tonne CO2e each year to $50 per tonne CO2e in 2022)
  • submitting OBPS surplus credits issued by the federal government
  • submitting eligible offset credits
  • submitting a combination of any of the above three compliance options

These flexible compliance options allow for regulated facilities with higher abatement costs to reduce emissions by purchasing lower cost surplus credits or eligible offset credits, thereby reducing the overall costs of compliance. In addition, accepting eligible offset credits for compliance encourages voluntary emission reductions from activities that go beyond common practice and promote innovation.

Surplus credits

A facility that emits less than its annual emissions limit will receive surplus credits from the Government of Canada, for the difference between its limit and its reported emissions. Each surplus credit represents one tonne CO2e. These credits can be banked for future use or traded.

A facility that emits more than its annual emissions limit may submit surplus credits to meet its compliance obligation. The Government of Canada will only accept federal OBPS surplus credits issued by Environment and Climate Change Canada for compliance under the federal OBPS.  In future, the Government of Canada may consider the potential to accept government-issued units from provincial/territorial carbon pricing programs.

A system to track issuance and use of OBPS surplus credits will be developed by Environment and Climate Change Canada.  Each OBPS facility will be required to open an account in the tracking system.

Offset credits

Offset credits represent GHG emission reductions or removal enhancementsFootnote 4  generated from voluntary, project-based activities that are not subject to carbon pricing and that would not have occurred under business as usual conditions (i.e. the reductions go beyond legal requirements and standard practice). Each GHG offset credit typically represents one tonne of CO2e.

Offset projects range in scope but typically involve implementation of new management practices, new technology, fuel switching and/or new emissions control systems. In principle, each offset credit generated by an offset project represents one tonne of CO2e reduced or removed compared to what would have happened in the absence of the project. As a result, a facility with an emissions target that submits an offset credit for compliance can release an extra tonne of CO2e without increasing the total level of emissions.

The Government of Canada will allow certain GHG offset credits from provincial/territorial programs to be submitted for compliance in order to support availability of offset credits in the immediate term (2019 onwards).  Eligibility of offset credits will be determined based on assessment of offset programs and protocols against criteria defined in this paper. In future, the Government of Canada may consider the potential to establish a federal offset program or support jurisdictions that are implementing their own offset programs (e.g. in the creation of protocols).

Some First Nations, Inuit and Métis groups and organizations have expressed interest in exploring carbon offset opportunities in their communities and territories. The Government of Canada is committed to working with First Nations, Inuit and Métis to enable access to offset markets, encourage activities to reduce GHG emissions and promote local economic development.

Offset program design criteria

To support Canada’s actions to reduce GHG emissions, eligible offset credits must be generated by programs that are designed in such a way to ensure integrity and credibility of the emission reductions or removal enhancements.

A federal-provincial-territorial project team working under the Canadian Council of Ministers of the Environment (CCME) is currently developing a pan-Canadian GHG offsets framework. This framework is considering design criteria to ensure offsets are real, additional, verifiable, permanent and enforceable. Building from the work of the CCME, the federal OBPS program design criteria include:

  • governance and oversight requirements
  • transparency
  • uniqueness and avoidance of double-counting
  • program infrastructure and tracking systems
  • permanence
  • third party verification
  • robust compliance and enforcement

These criteria are described in further detail in Annex I.

Provincial/Territorial offset programs

Offset programs currently established in Alberta, British Columbia, Ontario and Quebec generate credits that can be used by organizations and companies for compliance with their provincial carbon pricing systems. The design of these provincial offset programs is generally consistent with the program criteria presented above.

The ability to submit offset credits issued by provincial/territorial offset systems for compliance with the federal OBPS will provide additional compliance options for OBPS facilities. To ensure environmental integrity, an offset credit can only be used once, either for compliance with a provincial regulatory system or for compliance with the federal OBPS. In addition, the project may generate more than one type of credit for the same activity, provided the credit types reward different environmental attributes. The key is to avoid double counting or issuing more than one credit for the same environmental attribute (e.g., a renewable energy project can generate either renewable energy credits or offset credits – not both).

Environment and Climate Change Canada will work with provincial/territorial Program Authorities, from programs deemed eligible for use in the federal OBPS, to develop arrangements for the tracking, use and assurance of offset credits from their programs  to ensure that there is no double counting or double use.

Other provinces and territories are developing their own carbon pricing systems and may decide to implement an offset system. If new compliance offset systems are developed in Canada, Environment and Climate Change Canada will assess their designs against the above criteria.

Offset protocol design criteria

For eligible provincial/territorial offset programs, Environment and Climate Change Canada will evaluate existing GHG offset protocolsFootnote 5   for eligibility under the federal OBPS.

At the outset, Environment and Climate Change Canada will maintain a narrow focus on protocols for activities that occur across multiple jurisdictions and that are not covered by carbon pricing. Offset protocols covering activities in the Agriculture, Waste, and Land Use Land-Use Change and Forestry (LULUCF) sectors will be considered first.  Assessment of protocols will begin in summer 2018.

While existing protocols in these sectors may meet the needs of the provincial offset programs, to be eligible for use in the federal OBPS, a protocol must also meet the federal protocol design criteria listed in Table 1. These criteria are informed by the pan-Canadian GHG offsets framework currently under development and ensure the environmental integrity of offset credits used for compliance by OBPS facilities.

Eligible protocols will need to be reassessed when the Government of Canada reviews the OBPS in 2022 (see Review and Update section below) and regularly thereafter to ensure they continue to meet the criteria. Additionally, a protocol should be reassessed whenever the federal design criteria are updated, or if the protocol is amended.  New protocols will be assessed as they are developed and approved for use in a provincial/territorial offset program.

In a regulatory program such as the OBPS, it is important that project and verification documents are reviewed by Program Authorities to provide assurance that offset credits accepted for compliance represent real, additional, verified and unique reductions. Offset system Program Authorities in British Columbia, Quebec and Ontario conduct these reviews on all projects before they issue offset credits.  Alberta’s Program Authority conducts these reviews when offset credits are submitted by a regulated entity for compliance. Recognizing the difference in assurance processes, Environment and Climate Change Canada will work with Alberta’s Program Authority to develop arrangements for application of supplementary assurance of Alberta’s offset credits in order for them to be eligible for compliance with the federal OBPS.

Table 1: protocol design criteria
Protocol design considerationsFootnote 6 Assessment criteria
Eligibility
(emission sources and activities, project types, sectors, gases, GWPs)

The protocol:

  • ensures that the emission reductions/removals are generated in Canada from an activity not required by law or captured by carbon pricing (i.e. landfill gas capture, reduction in enteric fermentation emissions from livestock, etc.)
  • results in reductions or removals of one or more greenhouse gases that are reported in Canada’s National Inventory Report (NIR) : carbon dioxide (CO2), methane (CH4) nitrous oxide (N2O), hydrofluorocarbons (HFCs), perfluorocarbons (PFCs), sulphur hexafluoride (SF6), and nitrogen trifluoride (NF3)
  • specifies the use of GHG global warming potentials (GWPs) that are less than or equal to those in the latest NIRFootnote 7
Additionality The protocol is based on reasonable, conservative and justifiable baseline condition assumptions. Any legal requirements in the jurisdictions where the protocol is applicable have been considered, as well as whether the technology or project activity is in common use or is considered business-as-usual (as appropriate).
Crediting period

The length of a crediting period is determined based on time span over which the baseline is expected to remain valid and over which avoided emissions/emission reductions are quantified. The protocol specifies:

  • an initial crediting period of not more than 10 years from the project's start date for non-sequestration projects, with renewal possibilities based on a rigorous and full evaluation of all requirements established in the quantification protocol, chiefly a vigorous re-evaluation of the baseline scenario at each renewal
  • an initial crediting period of not more than 30 years for sequestration projects, depending on project type as identified in the quantification protocol, with a possibility of subsequent renewals as identified in the quantification protocol
Accurate quantification method

GHG reductions/removals resulting from the offset project are calculated in accordance with a reliable and replicable methodology set out in the protocol that ensures:

  • net emission reductions/removals are capable of being measured or modeled in a reliable and repeatable manner that includes all relevant sources and sinks
  • uncertainty considerations are taken into account to ensure quantified or estimated reductions are accurate and within scientifically-established standards or acceptable statistical precision for the project or equipment type
  • the conservativeness principle is taken into consideration in the quantification of the GHG reductions/removals to ensure they are not over-estimated
Permanent For projects that sequester carbon in sinks or reservoirs through biological and geological carbon sequestration projects, the protocol stipulates requirements for monitoring permanence, provisions to mitigate the risk of reversal, and ensures environmental integrity in the event a reversal occurs.
Verifiable The protocol outlines requirements that will allow for verification to a reasonable level of assurance by an independent third party. This includes incorporation of best practices for measurement and monitoring of data and information, establishment of data management procedures and record keeping, as well as quality assurance/quality control activities.
Guarded against leakage The protocol takes into consideration the likelihood of leakage, which is that emitting activities are shifted from the location of project implementation to another site due to the project’s implementation (creating a situation of no net emissions reductions). If leakage is expected or possible the protocol requires specific actions, including assessment and mitigation, to be undertaken by the Project Developer to ensure this is minimized.Footnote 8

Offset credit eligibility requirements

An offset credit generated from a project using an eligible GHG offset protocol will be considered eligible for compliance use under the federal OBPS if it meets the following additional requirements:

  • The project start date (i.e., the date at which the first GHG reductions occur from a new or re-registered project) must be after the date that the Government of Canada published the pan-Canadian approach to pricing carbon pollution 
    • Therefore, to be eligible, offset credits must have been generated from a project with a start date of October 2016 or later.
  • The offset credit has been verified by a Third Party Verification Body that is accredited to ISO 14065 by either the American National Standards Institute (ANSI) or the Standards Council of Canada (SCC) in a technical scope consistent with the project type.

A list of eligible offset protocols will be developed and included in the OBPS Regulation. This list will be updated periodically, for example, if new protocols are approved or existing protocols are amended.

Voluntary offset programs

Offset credits can be generated and used for compliance within a regulatory program (compliance offsets), or created through voluntary offset programs. Voluntary carbon offset programs generate credits that are purchased and used by individuals and organizations to achieve voluntary GHG emissions reduction commitments. For example, some individuals purchase credits from voluntary programs to offset their air travel.  A voluntary offset program is under development by the Government of Ontario to help achieve its commitment to make Ontario’s government operations carbon neutral beginning in 2018.

Voluntary offset programs are distinct from compliance programs because they are created for a different purpose and are largely unregulated. Credits issued by voluntary offset programs are not usually accepted for compliance with regulatory programs and will not be eligible for compliance use under the OBPS.

International offset credits

The Government of Canada aims to enhance opportunities for emissions trading across Canada and internationally. In the Pan-Canadian Framework on Clean Growth and Climate Change, First Ministers agreed that the priority is to first focus on emission reductions within Canada, but part of Canada’s approach to climate change could also involve acquiring emission trading units from other parts of the world as a complement to domestic emissions reduction efforts.

Negotiations under the United Nations Framework Convention on Climate Change (UNFCCC) related to international transfers from market mechanisms under Article 6 of the Paris Agreement are ongoing.  These negotiations include the complexities and legalities with trading units between countries.  Environment and Climate Change Canada may consider rules to determine whether foreign compliance units (referred to as “internationally transferred mitigation outcomes” or ITMOs) would be accepted for compliance under the federal OBPS once negotiations under Article 6 are complete.

Emissions trading

Based on experience from emissions trading systems, such as the European Union Emission Trading System, the Regional Greenhouse Gas Initiative and Alberta’s compliance program, it is important to achieve the right balance between stringency of regulatory requirements and the degree of compliance flexibility.  An over-supply of credits makes it difficult to maintain a carbon price that will encourage emission reductions. The proposals made in this section are based on the proposed output-based standard (OBS) basis of 70% of weighted production average for all sectors, and may need adjustment depending on the final stringency of the OBPS.

Use and expiry of compliance units

There will be no limit to the use of any type of compliance instruments in a given year.Footnote 9  A facility may comply through any combination of payment of the emissions charge, use of surplus credits, use of offset credits.

To ensure that reductions continue to be achieved towards Canada’s 2030 emission reduction target, surplus credits issued for the 2019 to 2022 compliance periods can only be used to compensate for excess emissions that occurred within a 5-year period following the year for which the credits were issued.  For example, surplus credits issued for the 2021 compliance period can be used to compensate for excess emissions that occurred in any year up to and including 2026.

The federal OBPS system will be reviewed in 2022. Expiry dates for eligible offset credits in future compliance periods may be considered at this time.

Retirement of remitted compliance units

Facilities with a compliance obligation may choose to pay the emissions charge or to remit eligible compliance units annually, on or before the compliance deadline. As part of Environment and Climate Change Canada’s annual compliance review process, it will retire any units used for compliance so that they cannot be traded or used again.

Revocation or replacement of compliance units

In the event that an error is detected in a facility’s compliance report after surplus credits have been issued and the corrected report indicates that the quantity of GHGs emitted exceeds the emissions limit for the facility, the responsible person for the facility must provide compensation.

If, as the result of an error, a facility received too many surplus credits and the excess credits are in its account in the tracking system, Environment and Climate Change Canada will revoke the excess surplus credits so that they can no longer be traded or used.

If a surplus credit that was issued on the basis of an erroneous compliance report has been transferred to another entity or used for compliance, the facility to which the unit was issued must replace it. That facility would be required to replace the surplus credit by remitting another credit that is eligible to be used for compliance with the OBPS or by paying an emissions charge to be specified in the regulations.

Requirements, if any, to replace provincial/territorial offset credits that are later found to be invalid by the provincial/territorial government that issued them will be developed in consultation with each provincial/territorial government. These requirements may differ by jurisdiction and will be set out in the OBPS regulations.

Voluntary cancellation of compliance units

An OBPS facility may choose to voluntarily retire surplus credits or offset credits at any time to benefit the environment.

Review and update

The Pan-Canadian Framework on Clean Growth and Climate Change includes a commitment to review the overall approach to carbon pricing by early 2022 to confirm the path forward. An interim report will be completed in 2020. Concurrent with the 2022 review, the Government of Canada will also be reviewing the OBPS design, including provisions for emissions trading.

Next steps and engagement process

Environment and Climate Change Canada is currently undertaking structured engagement on the OBPS. This includes engagement with provincial and territorial governments, Indigenous Peoples, environmental non-governmental organizations, industry and business. Engagement on the proposed emission trading approach will be included as part of the engagement underway.

Parties wishing to comment on any aspect of this proposal are invited to provide written comments to Environment and Climate Change Canada, on or before July 6, 2018: at: ec.tarificationducarbonecarbonpricing.ec@canada.ca.

Annex I: offset program design criteria

Governance and oversight requirements

The offset program establishes clear rules and operational procedures for implementation of the offset program (including defined roles and responsibilities) with regards to:

  • overseeing the program’s ongoing operation
  • providing regulatory guidance documents and ongoing education to program participants
  • ensuring clear ownerships
  • overseeing offset protocol development, review and approval
  • registration of projects
  • issuing verified offset credits
  • providing compliance and enforcement structures and processes including dispute resolution mechanisms
Transparency

The offset program establishes clear rules and operational procedures for public disclosure of information related to:

  • offset protocols (e.g., protocol development processes, protocols under development, approved protocols, protocols under review, invalidated protocols)
  • projects (registered projects with year, crediting period of projects, projects under review for renewal, de-registered projects; projects under investigation, and identity of the project developer, etc.)
  • reporting of offset credits by type (protocol), year (vintage) and quantity, including active and retired units in publicly accessible registries
Uniqueness and avoidance of double-counting
  • The offset program establishes clear rules and operational procedures to ensure that a GHG emission reduction or removal is issued an offset credit only once and each offset credit is assigned a unique serial number upon its creation in a program registry/tracking system.
  • Transparent procedures for issuance/transfer/retirement of credits have been implemented which ensure that the credit can only be used once to meet a compliance obligation or to fulfill a voluntary commitment (i.e., not double-issued, double-sold or double-used).
  • Checks are undertaken to ensure that the project/units have not been registered in other systems.
Program infrastructure and tracking systems

The offset program establishes clear rules and operational procedures for the establishment and maintenance of an electronic/automated registry and tracking system that enables robust record keeping, detailed and reliable compliance units tracking (including serialization and tracking of transfers, surrenders and retirements of units) and transparent reporting of information to market participants and regulators, to ensure market efficiency and environmental integrity, including the avoidance of double-counting (double-issuance, double-selling and double-use).

Permanence

The offset program establishes clear rules and operational procedures for consideration of reversal risks and require the implementation of effective: (i) monitoring systems, (ii) risk mitigation approaches, and (iii) contingency plans which address how, in the event of a reversal that is the result of proponent intention or negligence, any affected offsets will be replaced if reversal is post-retirement of credits, or returned if reversal is pre-retirement of credits, including how unintentional reversals would be handled.

Third party verification

The offset program establishes clear rules and operational procedures for third party verification of emission reductions including a requirement that the GHG reductions/removals must be verified to a reasonable level of assurance.

Robust compliance and enforcement

The offset program establishes clear rules and operational procedures in regards to regulatory oversight to ensure that program officials have the appropriate authority and resources to carry out compliance and enforcement functions (as necessary), such as inspections, audits, compliance verifications, and enforcement actions. Penalties for intentional non-compliance should be designed in ways that ensure the benefits of non-compliance are less than the costs non-compliance entails. The offset program should also establish who is liable in the case that the offset credits are deemed ineligible after they are issued as well as after they are used for compliance.

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