Aldyen Donnelly: What the Waman-Markey Bill means to Canada

On the Status of Regional Greenhouse Gas Initiatives and the Western Climate Initiative

The Waxman-Markey (W-M) Bill proposes to exchange Regional Greenhouse Gas Initiative (RGGI) allowances for US federal Greenhouse Gas (GHG) allowances at a large RGGI allowance discount. The result of the W-M bill is that RGGI allowance market prices have fallen to US$2.50 to $2.90/TCO2e.  Note that CCX carbon financial instruments are trading at US$0.30 to $).40/TCO2e—well below last year’s peak of US$7.50.
 
It should be noted that recent legislative activity in the states of Washington and Oregon suggest that legislators in those states have already rejected the Western Climate Initiative (WCI) partnership.  So WCI has a questionable future even if no final US climate change bill emerges in the near term.
 
On “…Adoption of a renewable electricity standard could open up new export opportunities for Canadian suppliers of ‘green’ energy.”

I disagree with this assessment.  Under the proposed US federal Renewable Electricity and Efficiency Standard (“REES”)—I believe the final US law will be very similar to the W-M proposal—the US Environmental Protection Agency (EPA) will certify qualified US renewable energy projects and issue US Renewable Energy Certificates (REC) to those projects.  There is no provision to issue RECs to non-US renewable energy projects in the current bill.  The federal REES will not supercede existing state Renewable Energy Standards (RES)—there are 31— as long as the state RESs are at least as stringent as the federal target.  27 of the existing 31 state RESs do not accept RECs from out-of-state, let along out-of-country.  There is no federal proposal to compel states to allow for inter-state or international trading in RECs.
 
Having said this, I believe that it will be much, much easier for the government of Canada to negotiate a common NAFTA market for RECs than it will be to negotiate fair and free trade in GHG allowances and offsets.  (Among other things, the WTO rule basis for free trade in RECs is much stronger than the legal basis for free trade in allowances if/once we agree to trade GHG allowances with the US.)  So I feel that Canada’s top priority should be to: (1) implement a Canadian federal RES and (2) demand that the US treat Canadian RECs as if they originate in the US under WTO and NAFTA (Part 9) rules.
 
Note that under the W-M proposal (I believe this provision will go final) in the absence of contract language that says otherwise, the GHG liabilities arising from power generation are assigned to the Load-Serving Entity (“LSE”) and all US GHGs associated with exported products and services are exempt from the US GHG cap.  This means that under US federal (and existing legislated California and Washington state) GHG accounting procedures, BC is liable for 100% of the GHGs associated with our US power imports.  Based on actual 2002 through 2008 trade, this adds 6 to 12 MTCO2e to BC’s GHG inventory.  Unless Powerex’s contracts with US customers expressly stipulate that BC has retained the environmental attributes associated with our clean energy production, the US procedure stipulates that title to the zero-emission attributes associated with our exports belongs to the US importer.  Also, the US regulators initially propose to assign 1 standard GHG charge to all electricity imports from Canada. 
 
What does this mean?

For purposes of determining what the transborder on every Canadian MWh of exported power, the US will add Canadian power sector GHGs to the GHGs associated with our imports from the US.  They subtract the net GHGs associated with our exports to the US (a very small number relative to the GHGs associated with our imports, because most of our exports are from zero-emission sources).  They divide this GHG emission total by total Canadian power sales (domestic and export) to create a single GHG/MWh factor.  Every US importer of electricity from Canada is obliged to surrender US GHG allowances covering this factor multiplied by their imports.  Please note that there is no free US GHG allowance allocation to “importers” and W-M stipulates that LSEs are obliged to use their free GHG allowance allocations for the benefit of US rate-payers and the US economy.  In other words, the W-M bill combines to hit all Canadian clean power exports with an indirect GHG tariff (the burden on the importer to buy US GHG allowances).
 
The position of US regulators is that it is up to Canada and the provinces to address any regional inequities the US setting of a single nation-wide GHG/MWh factor might create.  This US procedure eliminates any opportunity for hydro-rich Canadian provinces to game the US regulatory regime.  Of course, this US procedure will lead to substantial new conflicts between Alberta, Saskatchewan, Ontario, Nova, Scotia, New Brunswick and the hydro provinces unless our federal regulators anticipate this and implement a highly strategic negotiation with the US.
 
On the US Target and GHG Allowance Supply

It should be noted that the US 2020 and 2030 targets are in hand on a Business as Usual (“BaU”) basis, as long as US industry complies with the REES and Renewable Fuel Standard (“RFS”) that are embedded in Title 1 of the W-M bill.  There is no incremental GHG reduction associated with the proposed US GHG allowance supply.  The distribution of US GHG allowances is a mechanism through which Congress will intervene in the market to shift the economic impacts of the BaU + REES + RFS forecast.
 
This reality derives largely from the following considerations:

  • Over 55% of US 2020 BaU GHG emissions originate in the US power sector.  Over 25% of existing US power supply originates at generation units that are over 50 years old and scheduled for replacement before 2017 on a normal business basis.  These older coal-fired generation plants discharge, on average, 1.35 TCO2e/MWh.  If they were to be replaced with 20 year-old pulverized coal plants, their GHGs would fall to about 0.95 TCO2e/MWh.  So there is a minimum 4% reduction in the US national GHG inventory embedded in the normal US power generation stock turnover rate.  If the aged capacity is replaced with state-of-the art CCGT (natural gas-fired) technology, all other things being equal, an absolute 16% reduction in US national GHGs is in hand.  By comparison, only three coal-fired power generation units in Canada are over 40 years old today, and the average age of Canadian coal-fired power plants is under 20 years.  If Canadians were to eliminate 100% of coal-fired generation in Canada and replace it with state-of-the-art CCGT supply, all other things being equal, Canada’s national GHG emissions would decline about 6%.

 

  • Similar large US stock replacement schedules are in the BaU forecast between 2010 and 2020 in the iron and steel, aluminum and petroleum refining sectors, due to the high average aged of US plant.  As in the power sector, Canada’s younger and more efficient capital stock is at a disadvantage in a North American carbon market designed along the lines of the W-M proposal.

 
Under the US carbon market proposal, a US aluminum plant that cuts supply chain and production GHGs from 12 T per tonne of aluminum (“Al”) produced is treated as the equivalent to a Canadian power plant that cuts GHGs from 6 T/TAl.  The US-dictated standard will oblige US aluminum smelters to cut GHGs to 10T/TAl by 2020 and Canadian smelters to cut, on average from 6T/TAl to 5TCO2e/TAl.  It costs, roughly, 1/3 as much to cut US smelter GHGs from 12 to 6TCO2e/TAl as it cost to cut Canadian smelter GHGs from 6 to 5 TCO2e/TAl.  Under the proposed US cap and trade rules, US smelters will receive 4 surplus allowances and offset credits when they get their GHG rate down to 6TCO2e/TAl, while Canadian aluminum exports will be assigned a 1TCO2e/TAl transborder charge if they fail to cut GHGs to 5TCO22/TAl.
 
Please also note that critical impact on the balance of trade associated with the US legislators’ agreement that US GHGs associated with US exports are exempt from the US GHG cap.  Congress recognizes Canada’s right to assign GHG-related import charges to US exports that are exempt from US GHG limits.  However, this procedure, by definition, puts any energy, food and building product exporting nation at a competitive disadvantage relative to a net importer.  This is, of course, why US legislators support the procedure.  This procedure is not only unfair, but threatens Canadian unity.  Canadian import tariffs will have a much more inflationary impact in Ontario and Quebec than in, say, BC, Alberta or Saskatchewan.  The government of Canada cannot afford to take our nation down this path.
 
Clearly, Canadian negotiators have to oppose the US-proposed carbon market proposal and present an alternative.  The appropriate Canadian strategy is to formally propose a set of North American GHG product standards for the eight critical carbon-based products.  Should any entity that distributes aluminum in North American demonstrate that their sales portfolio average supply chain GHGs are, say, 10TCO2e/TAl in 2015, or less?  The only way to develop a fair and free North American carbon market is to establish product standards (where distributors are obligated parties and the standard applies to all sales, regardless of country of origin).  Any distributor that beats the regulated product standard can earn bankable, tradable GHG allowances equal to the difference between their sales multiplied by their actual portfolio average GHG/unit of product sold rate and the regulated product standard.
 
Canada’s GHG regulations must establish this product standard approach, whether or not the US agrees to this procedure in pre-Copenhagen negotiations.  The government of Canada must not allocate or distribute Canadian GHG allowances ex-ante and allowances should be issued only to distributors who beat the regulated product standards.  This regulatory strategy has great environmental integrity.  With this kind of regulation in place (along with an REES that is superior to the W-M proposal), Canada can efficiently provoke industry to reduce emissions at the same time our federal government can launch a successful challenge to the US cap and trade and GHG allowance allocation in WTO, NAFTA and (most importantly) US courts.
 
On “comparable” and “similar” climate change programs…

Note that the US proposes to hit Canadian exports with transborder adjustments if we fail to meet any one of the following “comparability” tests:

Are Canadian facility-level air pollution and GHG reporting standard comparable to the US reporting rules? 

The answer is: absolutely not, a complaint the US EPA has repeatedly registered under the Canada-US Air Quality Agreement since 1991.  W-M stipulates that Canada’s mandates will not be deemed “comparable” until we promulgate facility-level reporting rules similar to the US’s and share the raw data that Environment Canada collects from Canadian facilities directly with the US EPA.  Environment Canada’s other top priority has to be to promulgate Canadian facility-level emission reporting mandates that are “comparable” (but not identical) to the US reporting standards
 
Is Canada’s GHG Offset System comparable in scope and stringency to the US system? 

If Environment Canada implements the Offset System as it is currently proposed, the answer is: absolutely not (see below).  W-M does not allow US regulated entities to import Offset Credits from developed nations (i.e. Canada).  But W-M does say that the US has to determine that a developed nation’s Offset System is “comparable” to the US system as a pre-requisite to US approval of transborder trade in Canadian GHG allowances.  I do believe that our negotiators will succeed in getting the US agree to trade in Canadian offset credits, but only if Canada’s offset system exactly parallels the US system.
 
The US will not allow cross border trade in either Canadian allowances or offset credits if Environment Canada implements the offset system that is currently proposed.  The key issue is that Environment Canada proposes to issue offset credits to renewable power, CCS and biofuel projects, all of which are under the regulation under the US system and not qualified to earn GHG offset credits.  There are a range of other projects that Environment Canada proposes to award offset credits that are also not acceptable to the US EPA, but these are the most critical (more below on this matter).
 
Is Canada’s 2020 target “comparable” to the US target? 

This is a very important and potentially difficult part of the Canada/US negotiation.  The US will define “comparable” as 17% below actual 2005 GHG levels, NOT 620 MTCO2e.  I know…620 MTCO2e equals 17% below Canada’s 2005 GHG levels.  But there is substantial legal difference between an agreement that commits Canada to a % reduction from a 2005 baseline and one that commits Canada to a 620 MTCO2e cap in 2020.  Which term we agree to will significantly impact our ability to defend against protectionist US carbon market measures.  Our negotiators must be very, very clear that we are not agreeing to any % reduction from a base year.  If we are willing to agree to an absolute 620 MTCO2e cap for 2020 the US negotiators might be willing to accept it because it happens to equate to 2005 levels minus 17%.  But we must not formally agree to the base year or percent reduction target.
 
On the US-proposed “very permissive offset regime”

I disagree that the US-proposed offset system is very permissive.  Environment Canada’s currently proposed offset system is more permissive (but likely to prove administratively more costly).  This is a significant liability for Canadian exporters.
 
Please note that under the “cap and trade” provisions of W-M, US producers and importers of electricity, natural gas, fossil-based and biofuels and refrigeration chemicals must account for some supply chain, all production and US consumer end-use GHGs.  In other words, the cap and trade regulations cover roughly 85% of US GHG emissions.  US legislators have made it clear that they will not accept a combination of Canadian cap and trade and offset rules that cover only 31% of the Canadian GHG emissions with regulation and 70% of the inventory with an offset system.
 
W-M proposes to impose transborder adjustments on exports from developed nations that issue offset credits to activities/sectors that are included in the first table below.  In other words, the Offset System currently proposed by Environment Canada exposes Canadian energy, food and building product exporters to significant potential tariff liabilities.
 
US Offset Credit Generation: Only 1 billion US offset credits allowed 15% of US GHGs.  W-M also allows for up to 1 billion offset credits originating in developing nations only.  For Canada’s Offset System to be comparable, we must theoretically limit Canadian Offset Credit supply to 112 MTCO2e/year.  Environment Canada proposes no limit.
 
Activities Qualified for US Offset Credits: But only unregulated sources/activities can earn GHG Offset Credits under the US offset system.  These sources/activities are limited to:

Activites/Sectors that Can Receive          Canadian GHGs in 2007
Offset Credits Under W-M-comparable
GHG Regulation    
 
                                                                  ktCO2e
ag, direct soils                                              14,684
ag, enteric fermentation                                22,637
ag, indirect soils (fertilizer use)                      10,633
ag, manure management                              4,791
industrial process aluminum production            5,097
industrial process, ammonia production           6,240
industrial processes, adipica acid production     1,491
industrial processes, cement production           7,253
industrial processes, iron & steel                     6,033
industrial processes, magnesium production    325
industrial processes, other                             13,096
LULUCF, converted to wetlands                       766
LULUCF, forest land remaining forest              5,936
LULUCF, forest loss                                      29,688
LULUCF, land converted to cropland                7,283
LULUCF, land converted to settlements           7,849
waste disposal on land                                  20,200
total unregulated GHGs                                 164,002
regulated GHGs as % of total Cdn GHG inventory    22%
 
The offset system candidate sources/activities discharged only 164 MTCO2e in 2007.  If we could imagine voluntarily cutting emissions in these sectors, absolutely, by 33%, that means the effective limit on Canada’s offset credit supply is 54 MTCO2e/year or less.
 
W-M stipulates that imports from Canada that originate in a sector or relies on activities that are regulated under the US scheme but receive offset credits under the Canadian scheme will be assigned transborder charges.  The activities that are regulated and cannot earn offset credits under the US rules include but are not restricted to: renewable power projects (wind, solar, PV, etc.); CCS projects, biofuels.
 
On Offset Credit Imports from Developing Nations:

The Obama administration intends to use this provision in the future to indirectly partially meet its new international aid commitments.  The value of US regulated entity purchases of developing nation offsets will be included in the US accounting for its international aid spending.  Canadian negotiators should consider the implications of this.
 
Offset Credit Use:

Regulated entities’ rights to use offset credits to comply with their regulated GHG caps are limited. “The ability to demonstrate compliance with offset credits shall be divided pro rata among covered entities by allowing each covered entity to satisfy a percentage of the number of allowances required to be held under subsection (b) to demonstrate compliance by holding 1 domestic offset credit or 1.25 international offset credits in lieu of an emission allowance, except as provided in subparagraph (D)… The percentage referred to in subparagraph (A) for a given calendar year shall be determined by dividing 2 billion by the sum of 2 billion plus the number of emission allowances established under section 721(a) for the previous year, and multiplying that number by 100.” 

So, in 2012, for example, US regulated entities can use offset credits to cover 30% of their reported GHG emissions and must use US GHG allowances to cover the remaining 70%.  In 2017, the limit on offset use is 27% of total reported emissions.

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