Energy Probe

Extracting cash from the resource sector

Since the mid-1980s, Norwegian law made it illegal for any corporate entity to extract oil or gas from Norway’s continental shelf other than in partnership with a government-controlled entity. StatHydro owns control of over 66% of Norwegian production capacity. 

Also, Norway completely phased out its resource royalty regime over a 10-year period ending in 2006. Now, every private sector developer of oil or gas pays a 77% tax on income earned from resource production (no royalties). I think Norway got this right, but I would probably be banned from Alberta, BC and the Maritimes if I made this my priority message.

It might be worth noting that the UK went part-way to the Norwegian scheme in 2005 or so. The UK cut (but did not eliminate) royalties and introduced a 55% tax on corporate income from offshore oil and gas production. This was initially supposed to be the first step to full transition to the Norwegian policy (including mandatory domestic ownership, but not necessarily government ownership). But the political scene in Britain is so bad, right now, that this policy shift is now stalled where it is. 

In the meantime, BP’s GHGs in the UK have increased over 24%, BP sits on a big stockpile of freely allocated EU CO2 allowances (in spite of the massive increase in GHGs at regulated installations), and BP’s overall output in the UK is way down.

Many of us have also forgotten that since the mid-1970s the US Congress can sue any US petroleum refinery operator if that operator elects to cut back their US production from historical levels. I am not aware of any application of that law since the mid-1980s, but it is still on the books and could well come into use again in the near future.

Canada’s GHG emissions track record better than most

But this leads me to the real problem in the Kyoto/Copenhagen negotiations. How can Canada agree to a new treaty that allows BP to bank that much free EU quota having increased EU GHGs proportionately more than the Canadian oil-patch has increased?  (As an aside, GHGs/unit of output are up for BP’s and Shell’s Canadian operations, too.) 

While total GHGs are up for all Canadian Oil and Gas producers—at least the others have realized a reduction in GHGs/unit of output. I am not suggesting that reducing the GHG rate is enough, but when two of the largest global producers—BP and Shell—are sitting on surplus European GHG quota stockpiles while they grow their GHGs in both intensity and absolute terms, something is very, very amiss.

Norway has elected not to cover O&G production under their domestic cap and trade regime. And every European refinery—whether or not it is covered by the EU ETS—is 100% exempt from all energy taxes (not just CO2 taxes…ALL energy taxes) in the UK, Denmark, Sweden, Finland, Norway, Germany, France, Spain and Italy.

Obviously, if we properly regulated the O&G sector GHGs in Canada, while Europe continues to freely allocate bankable GHG quota surpluses to and exempt BP, Shell, Total, et al. from 100% of energy taxes, then when we link our Canadian GHG market to the "Kyoto" market all we do is set up Canadian independent producers for a massive asset write-down—BP, Shell, Total, Norsk Hydro, etc. take all at a discount.

The Day After Copenhagen

My guess is that Europe and the developing nations will maintain the Kyoto Protocol through a second commitment period, without the US, Canada or—likely—Japan.  The reason that Canada cannot cooperate with such a proposal is that it would impose on us an obligation to buy GHG allowances covering our full 1st period shortfall, which allowances we would have to source from nations that were over-allocated a free quota in the first place and made no effort to cut GHGs.

There is no way the Canadian population would accept a $6 billion one-time transfer from the Canadian treasury to eastern Europe and Russia—which is what the European negotiators are effectively calling for.

My guess is that the government of Canada (whether Conservative or Liberal) will have no choice but to exercise its option to withdraw from the treaty on one year’s notice.  I am guessing that if Europe presses too hard, that notice will be served in late 2010.  For many years I have asked experts to tell me what the implications are of a withdrawal during the first commitment period. I have not received a clear answer yet.

But after such a withdrawal, I think WTO rules will then dictate that our exports will be vulnerable to sanctions if they are more GHG intensive than the domestic GHG intensity for the production of the same class of goods in the nation that proposes a sanction.  WTO rules do not permit nations to sanction others for not participating in a treaty. The WTO would uphold some new tariffs on some carbon-intensive Canadian exports, but in most classes Canadian production is much less GHG -intensive than the domestic products we compete with in our export markets. So it is in Canada’s best interest that our government leaders get us on to this international trade playing field sooner rather than later.

Canada is making itself irrelevant.

If Canada takes no domestic action, or, in fact, aligns the Canadian market with the US in the manner proposed to date by the US Congress, Canada will become irrelevant. But if Canadian regulators promulgated domestic product standards aligned with the policy commitments that the EU member states have agreed to, then we not only remain relevant, we will have mounted the perfect defense against the aggressively protectionist trade measures (and rather ineffective GHG reduction measures) that are the EU and US "cap and trade" proposals.
 
The real risk here is that we will end up with two competing systems and, worst of all, inconsistent systems. A proper mess that moves everything off the climate change mitigation timeline.

If the US Congress proceeds with cap and trade as currently proposed, Canada has to have a different system. US cap and trade imposes compliance obligations in US DISTRIBUTORS (producers and importers) of carbon-intensive goods. The US proposed rule also allocates a free quota to US producers of regulated products and US consumer groups.

The day after the rule is in full effect, every unit of Canadian energy, building products and food exported to the US will be covered by a new tariff even though in most product classes our exports are less GHG intensive than the US producers who hold free allocations covering at least part of their liabilities. This has nothing to do with global GHG reduction, it is about stripping wealth from the nations on which the US and EU are becoming increasingly dependent for energy, building products and food.

The only way to fight this is for Canada to promulgate domestic product standards that are consistent or more stringent than those in place or in development in the EU (20% renewable content mandate for all energy—not just electricity—distributors, new efficiency standards for buildings and vehicles) and the US (new source performance standard for new power generation capacity, 20% renewable content mandate for electricity distributors, conservation/demand-side management standard for electricity distributors, new energy efficiency or equivalent emission standards for buildings and vehicles). 100% of the GHG "reductions" that will be realized in the EU and US over the coming decades will derive from these mandatory product standards—which include credit banking and trading. 

There is no incremental GHG reduction associated with either the EU or US-proposed GHG quota (allowance) allocations. The quota regimes have the sole purpose of imposing an indirect trans-border charge on LESS (not just more) GHG intensive imports.

Once we have our product standards in place we can defeat the protectionist EU and US quota allocations in international and US courts.  Given the equivalence or superiority of our product standards, we can demand, under NAFTA, that the US accept Canadian RECs, RINs and CAFE credits as equivalent to US certificates. This is the best and fastest way to a continental then global market for environmental goods and services that is fair and generates competition for low-carbon technologies.

The only way to fair and free markets is to abandon any consideration of GHG quota allocation and quota-based supply management for energy, building products and food.

We are dead if we say "yes" to quota.  Canada can change the world in a very good way if we take the lead in no-quota market-based regulatory regimes.

The President’s Strategy, Revealed

The K-B bill is seriously lacking and it would not be normal for a US Senate to pass anything that looks like this through 3rd reading. A number of telephone conversations I have completed with Washington insiders suggest that the President has asked Democratic senators to do what it takes to pass K-B in or before December 2009. 

The word being passed around is "don’t worry, the bill does not really commit anyone to anything" but passage of the bill accelerates the movement of Senate and House members into the "committee process". 

White House staff appear to believe that passage of the KI-B bill is in hand. Whether or not this proves out will depend on how much confidence key Democrats have in the committee process to produce a good bill. Everyone I have talked to (on all sides of the climate change debate) agree that the K-B bill lacks substance and expropriates an unacceptable amount of decision-making power from Congress—putting it in the hands of a multiplicity of new unelected boards, committees and new, massively expanded authorities for existing agencies. 

Even most advocates for K-B bill passage in the Senate in the short term could not support final passage of any US law that barely resembles K-B.

The only goals, at this stage, appear to be to: (1) position the US negotiating team to participate in the Copenhagen meetings with climate change bills passed in both the House and Congress, and (2) start the committee process, which process will produce a third bill that has little resemblance to either the W-M or K-B bill.

I question whether or not this White House strategy will backfire with moderate Democrats, who are likely to be very, very concerned about the way a bill like this could sideline Congress and deliver unprecedented economic power to the Executive Branch.

The White House backed up the K-B play by having the EPA post Advance Notice of the agency’s intent to regulate industrial GHGs under the authority of the Clean Air Act on the same day the K-B bill was tabled in the Senate committee. The White House’s intended message is: we are going to do this with or without Congress’s endorsement.

I feel that the EPA Advance Notice may have been a negotiating error on the part of the White House. Any attempt to regulated GHGs under the existing Clean Air Act (CAA) in the manner proposed will spawn multiple, substantive, costly and time-consuming court challenges. The constitutional/legal issue is not whether or not the CAA constitutes authority for the EPA to regulate GHGs—US courts have already found that the EPA has such authority through the CAA.

The issue is that the EPA proposes to differentiate GHGs by sector, region and corporate polluter. It is widely held among US exports in whom I have confidence that if the EPA elects to use its authority, the EPA does not have the discretion to differentiate on other than materiality and measurability grounds. So while they agree that the EPA does have a general authority to regulate GHGs under the CAA, most legal experts in this area I have interviewed lack confidence that US courts could uphold any variation on the actual approaches to regulating industrial discharges that have been explored by Congress to date and/or is outlined in the EPA Advance Notice of Proposed rule-making.

Therefore, members of Congress who want more time to consider the US’s path forward on this file might well attempt to block passage of any new bill and actually call the Administration’s bluff on GHG regulation through the existing CAA.

All Process, Little Outcome

I had to admit that I was surprised by the bill. I had expected the senators to table a bill that was their best attempt to resolve some of the key issues raised by the House-passed ACES ("Waxman-Markey" or "W-M" bill). But K-B could not be farther from that.

K-B adopts the same US national GHG targets that are proposed in W-M, but slightly different US GHG Allowance Supply budgets for 2015 through 2025. The K-K-B proposed Allowance Supply budget difference is statistically insignificant (smaller than the estimation error inherent in these budgets), but allows the Senate to claim that they are proposing tougher targets than the House passed into law.

K-B establishes dozens (I stopped counting at 40) new boards, advisory committees and authorities for agencies to research, develop and implement new programs and at least 20 new regulations, each of which could have a material impact on US economic development and trade.  The bill appropriates operating budgets or estimates taxpayer costs for only a few of the measures it contemplates—making it impossible for the Government Accounting Office to complete any reasonable economic impact analysis of the suite of proposals. 

K-B adopts the W-M-proposed 2012 through 2050 nation-level GHG targets, and it also stipulates an overall US GHG allowance budget for "cap and trade"-covered sources that is only slightly different from the House W-M proposal.

K-B leaves the question of the distribution of the free allocation of 60% (in 2012, declining to 50% by 2017) of the proposed total US GHG quota supply to the agencies and committees who are authorized, if the bill becomes US law, to develop regulations within 1 to 3 years of the enactment of the law. K-B allocates 40% (in 2012, increasing to 50% by 2017) of the total US GHG allowance supply to two annual auctions.

The Market Stability Fund Auction

Fifteen percent (15%) of the US GHG allowance supply is allocated to the Market Stability Fund ("MSF") Auction for 2012 through 2016.  In 2017 and thereafter this increases to 25%. Only entities that operate GHG-regulated facilities in the US will be permitted to participate in this auction.  It is a single, sealed-bid, "uniform price" auction. 
This form of auction favours large emitters with high relative emission control costs over smaller emitters with lower relative control costs. US GHG allowances offered at this auction will have a minimum bid price of US$28/TCO2e (in 2005-equivalent dollars).  This floor price increases at a rate of 5% per annum plus inflation (the CPI) through 2016 and then 7% per annum plus inflation, thereafter. Bill drafters state that this auction will establishes a US GHG allowance market price "cap". In fact, it likely establishes a US GHG allowance market price floor.

No auction participant or combination of participants acting together can win more than 20% of the total GHG allowances sold at auction, and there is a limit to the proportion of the obligated parties’ compliance obligations that can be covered by retiring MSF allowances.

The revenues from the MSF auctions will finance a plethora of proposed programs to finance the development of new technologies, energy conservation programs, energy cost rebates to low- and medium-income families, etc.  The bill does not answer the following question: how will these government-run subsidy programs be financed if revenues from MSF auctions are insufficient to meet the programs’ funding needs?

The Deficit Reduction Fund Auction

Twenty-five percent (25%) of the US GHG allowance supply is allocated to the Deficit Reduction Fund ("DRF") Auction in 2012 and thereafter.

This auction is open to all bidders (including foreign entities). It is a single, sealed-bid, "uniform price" auction, again favouring large emitters with high relative emission control costs over smaller emitters with lower relative control costs. US GHG allowances offered at this auction will have a no minimum bid price..

No auction participant or combination of participants acting together can win more than 5% of the total GHG allowances sold at auction, but there is no limit to the use of DRF allowances towards compliance with regulated GHG caps. Offset project proponents are permitted to offer up to 200,000 TCO2e/year of US offset credits to the general public through the DRF auction. To execute this option, the project proponents retire US GHG Offset Credits which the DRF administrator exchanges for US GHG allowances—meaning all bidders at the DRF auction receive GHG allowances.

Offset project proponents will receive the lesser of the average market price for US Offset Credits in the previous calendar year or the uniform price for the auction at which the Offset-backed allowances are sold. So Offset Project proponents will only be motivated to offer their credits at auction if they feel the market price for US GHG allowances/Offset Credits is in long-term decline.

The revenues from the MSF auctions will finance a plethora of proposed programs to finance the development of new technologies, energy conservation programs, energy cost rebates to low- and medium-income families, etc. The bill does not answer the following question: how will these government-run subsidy programs be financed if revenues from MSF auctions are insufficient to meet the programs’ funding needs?

Based on my interviews to date, I anticipate that any final US climate change bill will dedicate at least 30% but not more than 50% of total US GHG allowances to auction, through one or multiple auction platforms. But closer to 80% of total auction-able US GHG allowance supply will be dedicated to operators of US regulated facilities (as in the MSF auction design outlined above). Each iteration of the bill will include increasing barriers to non-US regulated entity participation in US GHG allowance auctions.

Gaming the National Inventory or a Big Mistake?

US legislators present both the W-M and K-B bills as proposals to cap US nation-wide GHG levels at 17% to 20% "below 2005 levels by 2020". However, that is not technically what either bill proposes.

Both bills use as the 2005 baseline the US GHG inventory without land use change and forestry ("LUCLUCF"). US national GHGs in this baseline totalled 7.082 billion TCO2e.  Therefore, the 2020 targets in the two US bills range from 4.9 to 5.6 billion TCO2e.

But both bills propose to promulgate a domestic GHG Offset System that relies heavily on projects of inventories which only appear in the LUCLUCF accounts in the national GHG inventory—which accounts are not included in the 2005 baseline. In 2005, the US GHG inventory totaled just under 6 billion TCO2e including the LUCLUCF accounts. Relative to this more comprehensive national GHG baseline, a 20% reduction equates to a 4.8 billion TCO2e national target for 2020.

By using the first baseline (without LUCLUCF) to establish the US’s national 2020 target but including LUCLUCF accounts for national compliance progress reporting, the US creates a potential reserve of 1.1 billion "anyway" domestic Offset Credits—representing business as usual land use change and forestry activity-related carbon sequestration—that are immediately available for magnetization and application towards the US 2020 target without any change in long-standing US energy consumption and/or land management practices.

There is little in the bills’ definitions of sustainable biomass and GHG Offset Credit to block the magnetization of the lion’s share of the carbon value of long-standing practices.  The potential supply of "free Offset Credits" inherent in this proposal is roughly 1.1 billion TCO2e/year from US domestic sources—roughly equal to the domestic GHG Offset Credit supply targeted in both bills.

This proposed procedure fails to comply with UNFCCC, IPCC, Kyoto Protocol, US Climate Registry or any other recognized and accepted set of national GHG baseline and progress-reporting accounting guidelines. This is most curious, given that both bills endorse US Climate Change  Registry and its GHG inventory accounting and progress reporting guidelines, but then fail to reflect the Climate Registry’s disciplines in nation-level GHG accounting.

The governments of Canada should take note that the application of this US-proposed national GHG inventory and progress-reporting accounting method in Canada will—in and of itself—put Canada and Canadian energy, building product and food exporters at an extreme and perpetual competitive disadvantage relative to US-based producers of value-added products in the carbon-intensive classes.

My guess is that the US-proposed national GHG baseline and progress-reporting accounting practice will be strongly opposed by the EU member states, and Canada should consider aligning with the EU in this opposition.

As mentioned above, this anomaly appears in both the W-M and K-B bills. I did not bring it to your attention in the W-M case, because (largely based on conversations I had with US experts) I thought that in the context of the House bill this was just an error. I was assured that it would be corrected in the K-B bill.

Of course, the implications of the error are material, so for the drafters of the K-B bill to address this error they would have had to build completely new US national GHG budget and allowance allocation proposals.

I have repeatedly asked the question: does the K-B bill reflect the US’s real intention to game the Copenhagen process with their baseline/progress-reporting proposal, or is this simply an accounting error that the Senate members did not have time to address before tabling the K-B bill? To date, the individuals to whom I have addressed this question are split 50%/50% in their responses.