Taxing Carbon

Confederation isn’t easy when it comes to drawing together Provincial, Territorial and Federal carbon tax proposals

WHEN PRIME MINISTER JUSTIN TRUDEAU announced in December 2016 the “historic” Pan-Canadian Framework on Clean Growth and Climate Change to meet the country’s 2030 emissions reduction targets, there was a quintessentially Canadian element to the varied reactions by the political parties. As the Toronto Star would later note, for federal Minister of Environment and Climate Change Catherine McKenna, it would be like “herding cats to get all Provinces and Territories on board.”

Under a primary component of the framework, the provinces and territories would agree to impose a carbon price of, at minimum, $10 a tonne on GHG emissions starting in 2018, which would rise by that same amount each year until it reached $50 a tonne by 2022. How they met those requirements would be left up to each jurisdiction. “Practical implementation will be a huge challenge,” the Organization for Economic Co-operation and Development said in a December 2017 report that referenced the framework.

For Canadian lawyers practising in the Energy and Climate Change sectors, the introduction of the framework meant that clients would be turning to them for advice on issues related to the new carbon-pricing landscape. It also meant that lawyers would have to monitor and help explain the complex political developments that, ultimately, would have an impact on their advice.

“One of the areas that lawyers who assist clients with carbon-pricing issues, possible statutory exemptions, risk assessments, commercial transactions and other matters have to closely follow is what’s happening in the political scene both federally and regionally,” says Selina Lee-Andersen, a partner in the Vancouver office of McCarthy Tétrault LLP and co-author of the firm’s 2018 report, “Climate Change Essentials.” “As lawyers, we can help companies navigate the many nuances of climate-related policies.”

At the moment, the nuances are, to say the least, still being worked out among the nation’s political stakeholders. “We see that [lack of unanimity] in lots of different areas of practice and businesses in Canada because we have 10 provinces and three territories and a federal government, so we often have 13 or 14 different solutions to things,” says Jason Kroft, a partner in the Emissions Trading & Climate Change practice at Stikeman Elliott LLP in Toronto. Evan Dixon, a partner in the Calgary office of Burnet, Duckworth & Palmer
LLP and co-author of the article, “Challenging times for the competitiveness of Canada’s oil & gas industry,” published in Financier Worldwide magazine, concurs. The seemingly eternal political toing and froing “is both the reality of Canada and one of the obstacles of actually doing things on these kinds of topics.”

As of late winter 2018, all governments had signed on to the federal framework except for Saskatchewan, which opposes the federal imposition of a carbon-pricing plan. Manitoba, which had initially declined to sign on, came on board in February 2017. It agreed to set a flat carbon emissions tax of $25 a tonne, which exceeds the federal government’s requirement for the first two years. After that, however, Manitoba said it saw no need to raise the price higher, meaning the province would not reach the federal government’s $50-a-tonne threshold for 2020.

British Columbia opted for an explicit price-based system, such as a carbon tax. “The main thing clients want help with,” Lee-Andersen says, “is compliance. But there is a whole slew of other issues. Carbon pricing is not the only climate change tool being implemented. It’s a key tool but not the only one, so there are many other matters to assist clients with. For example, we recently assisted a client with assessing the potential impacts of the proposed federal output-based pricing system on their facilities, which are located in multiple provinces, some of which will likely be backstop jurisdictions.”

Alberta - which is responsible for approximately one-third of Canada’s total
GHG emissions - chose to impose a carbon levy and performance-based emissions system. It did not mark, however, Alberta’s first foray into combatting GHGs.

“Alberta is the leader [in Canada] in terms of climate change legislation, policy development and implementing legislation,” says Tom McInerney, a partner in the Calgary office of Bennett Jones LLP and co-head of its Climate Change & Emissions Trading team. “Alberta was the very first jurisdiction, before the federal government, that came out with binding climate change legislation in the form of ‘Alberta’s Specified Gas Emitters Regulation’ enacted in 2007.”

Since Alberta signed the framework, a lot of McInerney’s focus, he says, “has been on helping clients understand the latest elements of Alberta’s climate change policy. This includes the carbon levy and the new output-based allocation system of the Carbon Competitiveness Incentive Regulation
(CCI), which replaces the old Specified Gas Emitters Regulation.”

CCI, which was announced in December 2017 and is expected to generate $500 million to $800 million in provincial revenue annually, “applies to any facility emitting more than 100,000 tonnes of carbon a year, of which there are 110 in Alberta,” Reuters reported. “The oil sands make up 24 per cent of Alberta’s total emissions. Most industries will have a benchmark set at 80 per cent of production-weighted average emissions. Any facility producing at a higher intensity than the benchmark will be subject to ‘compliance obligations’, which can be met by paying for emissions at C$30 a ton, reducing emissions or buying offsets. Those producing at a lower intensity than the benchmark will accumulate credits that can be used to offset future costs.”

The issues clients in Alberta are bringing to him vary, says McInerney. “Large emitters facing new compliance requirements may need to source emission offsets and/or emission performance credits as part of their compliance strategy. Renewable project developers may need to monetize any environmental attributes generated by their project.”

Dixon cautions clients that there are still a number of critical issues that need to be addressed “to ensure the alignment and equivalency of provincial and federal policies, especially as it affects provincial competiveness within and outside Canada.” He noted, in “A New Era of Carbon Pricing in Canada and another East-West Divide,” published by Burnet, Duckworth & Palmer, that “perhaps the greatest question remains is how these policies will fare given the interconnected nature of the North American economy and what appears to be a divergence on carbon policy under President Trump.”
The east-west divide Dixon alludes to is clearly seen in how most provinces east of Manitoba have decided to meet the framework’s requirements.

Ontario and Quebec have both opted for a cap and trade approach, under which their governments set a cap on the amount of emissions allowed and permit companies that exceed the limits to purchase allowances, through auctions, as they are called, from those that did not. In 2017, the two provinces signed a linking agreement with California, as part of the
US Western Climate Initiative, which allowed all three to use carbon allowances issued by any of their governments, interchangeably, and to hold joint carbon auctions.

There are reasons why Ontario, as an example, was able to choose a different solution than a province such as Alberta or Saskatchewan, says Kroft. “In Ontario, there’s been a lot of progress on the emissions intensity and emissions aspects of power and electricity. We are off coal and we have a very clean power grid with non-emitting power, which is wind and solar and nuclear, [the latter of which] is very clean.”

Keeping up with the complexities of the various initiatives across the country and in the
US - and bear in mind that all the governments had existing plans to combat emissions prior to the announcement of the framework - is a critical service Kroft says he brings to his clients.

“At Stikeman Elliott, which is a national firm, we often find ourselves having to understand the cost and opportunities to businesses presented by the difference carbon pricing and cap and trade regimes that apply, and often involve cross-border or cross-jurisdictional issues,” he says. “So, in the case of carbon and climate change, we need to know the current legislative and regulatory regime in Ontario and elsewhere in Canada and also have a good working knowledge of the regimes in key foreign jurisdictions. I have been helping clients in the power business, for instance. Non-emitting power in Ontario may be desirable in certain US states that have renewable portfolio standards and may place a value on the clean emission attributes of our power. Part of the analysis is looking into the eligibility in certain states of Ontario power: how is [it] treated, is it eligible and how are the environmental attributes treated? Similarly, if you import electricity in Ontario, there is an emission factor added and the importer is required to acquire a specified amount of allowances.”

In reference to carbon pricing, he says, one question that is often asked is, how does the province price the cost of emissions from business? “This is a function of understanding who is captured in the cap and trade, carbon tax or similar regime, what are the requirements, who is covered, who is required to acquire allowances at auction or in the secondary market [in a cap and trade regime], can the costs be passed on to end-users, and so forth,” he says.

It also requires, he adds, “advising on the availability of exemptions from the cap and trade or similar reporting and procurement processes and the availability, in the case of the Ontario cap and trade program, of free allowances. It also means understanding how our clients who do business in other jurisdictions may be treated.”

Meanwhile, political change can happen quickly. In Ontario, for instance, Doug Ford was recently elected leader of the province’s Conservative Party. If his party were elected to form a government, would it effect a change in the province’s previously announced carbon tax plan?

Clients involved in large projects that take time to develop, construct, implement and run, says Kroft, “require some consideration of what the rules are now, what they might be 20 years in the future and what they are in relevant jurisdictions. Because, increasingly, carbon and the cost of carbon will be a component of whether your project is feasible, profitable and whether it can be completed on time and on budget.”

They ask a range of questions, he says, that are largely centred on one primary concern: do I have a carbon liability or carbon asset? If a liability, how do I satisfy it and factor it into the diligence, viability or financeability of my project? If an asset, how do I monetize it and what are the constraints, opportunities or limits on transfer and trade? “Those are the types of questions we’ve been getting.”

While it has been argued that a carbon tax is economically more efficient than cap and trade, “some jurisdictions find the political implications of a taxation system unacceptable and prefer cap and trade because it is market-based,” says Paul Manning, the principal of Manning Environmental Law in Toronto. “Not only is cap and trade not a taxation system, it is not a ‘command and control’ system that simply legislates emissions reduction back by sanctions. Cap and trade allows regulated parties, such as the large final emitters, to spread the pain of implementing emissions reductions through the ability to buy and sell emissions credits.”

Cap and trade needs large markets “to ensure sufficient liquidity and fungibility of its credits,” he says, but cautions against the risk of an economic downturn producing an artificial reduction in emissions, “as happened in the EU Emissions Trading System.”

For Jacob Sadikman, a partner in the Toronto office of Osler, Hoskin & Harcourt LLP, the current cap and trade programs in Ontario and Québec are somewhat of a disappointment. In the late 90s, before going to law school, he worked in the industry of emissions trading in New York City for one of the over-the-counter energy commodities brokerages in the US. “This is not a new concept,” he says. “We’ve been chasing the dream of wide-scale GHG emissions trading for well over 20 years at this point.

“To say it has been a little bit disheartening to watch the pace at which this has actually developed and the opportunities coming out of it is a bit of an understatement. This is cap and trade in name only. That’s my cynical perspective.”

According to Sadikman, there is not, so far at least, any “genuine secondary market activity for mission allowances in these jurisdictions. What you’re not seeing is an actual vibrant secondary trading of these products where you have energy marketers and trading businesses coming in and making markets in these things.”

There are no real buyers and sellers, he says, just quarterly auctions run by the governments. “You have compliance buyers lining up to participate in these auctions, and, basically, calling it a day.”

Nonetheless, Sadikman says he’s been assisting a number of clients whose commercial contracts in the energy and infrastructure sector have provisions and mechanics relating to carbon pricing or similar environmental attributes, such as fuel and steam supply and service contracts and power purchase agreements.

“In many cases, these contracts had anticipated some form of carbon pricing in Ontario, or at the federal level, for many years and there is a fair amount of legal work at present in helping clients sort through the implications of the carbon pricing regime we now have in Ontario for these commercial contracts.”

In Atlantic Canada, the Nova Scotia  government indicates that it plans to implement a cap and trade system, while New Brunswick has indicated it would adopt a carbon-pricing approach, although it was unclear whether its plan to repurpose gas tax revenues would satisfy the federal requirements. Prince Edward Island and Newfoundland and Labrador plan to announce their programs some time in 2018. As for Nunavut, the Yukon and the Northwest Territories (the latter says its emissions will likely grow faster than anywhere else in Canada), they all agreed to work with the federal government to establish carbon-pricing mechanisms to meet the requirements of the framework.

Interestingly, some companies are not waiting for their lawyers to help them navigate the myriad rules, permutations and regulations as they get sorted out. In fact, says Lee-Andersen, many have already imposed their own internal carbon pricing, some as far back as the turn of the century. “Shell started using an internal carbon price in the early 2000s,” she says, adding that Suncor and Cenovus have also done the same.
The Center for Climate and Energy Solutions, in a September 2017 publication entitled “Companies set their own price on carbon,” reported that “more than 1,200 companies worldwide are either pursuing internal carbon pricing or preparing to do so soon, up 23 percent from 2015.”

In this publication, the Center, too, cited Shell as an example. “It has used an internal carbon price of $40 to $80 per metric ton since 2000 to evaluate investment decisions.”

As most companies that emit
GHGs have accepted the inevitability of some form of carbon pricing throughout Canada, the issue of disclosure becomes increasingly important.

Public companies, of course, are compelled to disclose their emissions, while private companies face a different obligation often from their investors. By addressing climate change, and disclosing what they’re doing about emissions,” says Sadikman, Canadian oil and gas companies “could enhance their attractiveness and appeal to investors, a message I try to convey to clients.”

Lee-Andersen agrees. “I think these initiatives provide Canada with an opportunity to innovate and really be a leader on these kinds of issues. Given the type of industries we have, the world really looks at us to walk the talk if you will.” She also believes that despite the challenges, “there are a lot of opportunities that flow from putting a price on carbon.”

Sadikman says that emissions are easier to measure in some plants than in others. “Facilities with large smokestacks have a device at the top called a continuous e-monitoring system that measures the emissions going through the stack and the CO2 composition. That technology has been around for a long time.”

Paul Manning does not see disclosure “as such a big issue. Carbon pricing has been on the horizon and companies have been required to report on carbon emissions for some years now. They have had ample opportunity to plan for carbon pricing and the disclosure that will be required. The companies that have to worry are those who haven’t been improving their carbon footprint in anticipation of regulation.”

Although there is no question that some politicians and industry leaders oppose any form of carbon pricing as being a costly and crippling tax - the Calgary Herald said in December 2017 that the price tag for large industrial emitters would “be a total of $1.2 billion a year by 2020” - many accept that it is not only an inevitable component of doing business in Canada but the right thing to do.

“Industries that are most affected by climate change policy are by and large a sophisticated group and are aware that climate change is an issue that is not going away,” says McInerney. “What they want is rational, fair, predictable policy and legislation that accounts for the challenges they face and, above all, does not render them uncompetitive.”

While the federal government continues to grapple with herding the cats, it’s hard to believe that some form of a national plan will not, ultimately, be arrived at in one form or another, despite the different voices across the country. The negotiations, to date, “have laid bare not only the complexities of balancing federal and provincial interests while meeting our international obligations, but also the varied, and at times clashing, approaches to reducing GHG emissions,” says Lee-Andersen.

At any time, elections and overall politics in Canada and the US could play a role that might upset the carbon-pricing applecart. But whatever happens, and whomever comes to power, it’s unlikely they’ll be able to completely derail the initiative. “Dealing with carbon is the new reality,” Kroft says. “It’s not a fashionable policy thing that will go away, regardless of what parties win elections. It just can’t be scrapped.”