Update on the output-based pricing system: technical backgrounder

Context

The Government of Canada remains committed to ensuring that carbon pollution is priced throughout Canada. Carbon pricing is key to Canada’s climate plan because it’s a cost-effective way to reduce emissions while driving clean innovation and creating new jobs.

The federal carbon pricing system will apply on January 1, 2019 in each province or territory that requests it, and in any jurisdiction that does not have a carbon pricing system that meets the federal benchmark.

The federal system has two components: a charge on fossil fuels that will generally be paid by fuel producers or distributors, and a separate pricing system for industrial facilities that are emissions-intensive and trade-exposed, known as the output-based pricing system (OBPS).

Based on extensive engagement, we are updating our proposed approach to setting the output-based standards. We will continue to refine the standards in the coming weeks, and are publishing this preliminary assessment to seek feedback from stakeholders.

Overview of the output-based pricing system

The output-based pricing system is designed to ensure there is a price incentive for companies to reduce their greenhouse gas emissions and spur innovation while maintaining competitiveness and protecting against carbon leakage.^{Footnote 1}

Instead of paying the charge on fuels that they purchase, industrial facilities in the system will face a carbon price on the portion of their emissions that are above a limit, which will be determined based on relevant output-based standards (emissions per unit of output).

The OBPS will apply to industrial facilities located in jurisdictions where the federal carbon pricing system applies and that emit 50 kilotonnes of carbon dioxide equivalent or more per year, with the possibility for smaller facilities (of 10 kilotonnes and above) to opt in voluntarily.

Facilities that emit less than their annual limit will receive surplus credits from the Government for the portion of their emissions that are below their limit. A facility can trade surplus credits it earns, creating an incentive for facilities to reduce emissions below the limit when cost effective to do so. More detail on the proposed compliance options under the output-based pricing system is available.

Preliminary competitiveness analysis

In a regulatory framework paper released in January 2018, Environment and Climate Change Canada proposed that output-based standards be set at 70% of an industrial sector’s average greenhouse gas emissions intensity as a starting point, with the possibility of adjustments to that starting point based on an assessment of the potential risks from carbon pricing to the competitiveness of the sector and to carbon leakage.

The extent to which the competitiveness of industrial sectors or specific facilities within a sector may be impacted by carbon pricing is largely determined by two factors:

• the carbon emissions intensity associated with the production of the products of the sector or facility (the carbon emissions per unit of net output is representative of the cost exposure of the sector or facility to carbon pricing); and
• the extent to which facilities in the sector are able to pass on the costs of carbon pricing without significant loss of market share, an indicator of which is its degree of trade-exposure.^{Footnote 2}

Assessing emissions intensity and trade exposure

ECCC is undertaking a three-phased approach that takes into account the relative degree of emission intensity and trade exposure of each industrial sector, as well as other factors that may lead industry to be at risk to competitiveness due to carbon pricing. This analysis will help inform the level at which the output-based standards are set for a given sector.

We are now reporting out on the preliminary results of the first two phases of this assessment.

Phase 1 consists of a “static” test that looks at historical data at the national level to calculate sector-level estimates of emissions intensity and trade exposure.^{Footnote 3}  These metrics are then combined to provide an indication of competitiveness risk due to carbon pricing, an approach similar to the quantitative tests used in a number of other jurisdictions with carbon pricing, including California, Alberta and Quebec.

Phase 2 is a “dynamic” test using economic modeling that uses projected emissions and economic data to evaluate the same emissions intensity and trade exposure metrics as phase 1, for the year 2022.

Preliminary analysis of the Phase 1 and 2 tests is complete for the following sectors^{Footnote 4} : base metal smelting and refining, cement, petroleum refining, bitumen and heavy oil upgrading, upstream oil and gas, oil sands and heavy oil, natural gas pipelines, iron and steel manufacturing, lime, pulp and paper, nitrogen fertilizers, ethanol, food processing, potash, mining, and iron ore pelletizing.

Updated approach based on preliminary analysis

Based on the Phase 1 and 2 analyses, combined with the input received to date, Environment and Climate Change Canada is making the following two adjustments to the output-based standards:

First, four sectors assessed to be in a high competitive risk category will have their output-based standard adjusted to 90% of the sector’s average greenhouse gas emissions intensity. They are:

• cement
• iron and steel manufacturing
• lime
• nitrogen fertilizers

And second, the starting point for all remaining industrial sectors is revised from 70% to 80% of the sector’s average greenhouse gas emissions intensity.

Next steps

Environment and Climate Change Canada will now begin Phase 3 of competitiveness analysis.

In Phase 3, stakeholders are invited to submit additional supporting information and analyses on aspects of competitiveness to supplement the results of Phases 1 and 2. This information could include, for example:

• evidence of significant facility-level impacts
• domestic or international market considerations
• consideration of indirect costs on sectors associated with carbon pricing

Further sectors or sub-sectors may see adjustments to their output-based standards based on the results of the Phase 3 analysis.

After Phase 3 of the analysis is complete, a detailed paper on the draft output-based pricing system regulations will be released in fall 2018 for comment.