Blog Dec 15, 2020

The Good, The Bad, and The Unknown of the Government’s Climate Strategy

By: Dr. Aaron Henry, Senior Director of Natural Resources & Environmental Policy

On Friday Dec.11, 2020, the federal government released its long awaited announcement on how the government would achieve its ambitious 2030 climate targets. It is a solid plan with measurable and achievable vision and we congratulate the government on its forward-looking approach while also considering the needs of Canada’s industries. No task is more important, not to mention more difficult, than mapping out an effective climate policy for a resource-producing nation like Canada. Is it perfect? No. Is it workable? With the continued goodwill of industry and government, yes.

There is no question that the redesign of the Clean Fuel Standard (CFS) was a welcome surprise to much of Canada’s business community. Designed to lower carbon emissions across the country by reducing the carbon intensity of fossil fuels, the original Clean Fuel Standard would apply not only to liquid fuel used in transportation, but also to the gaseous and solid fuels used in industrial production and manufacturing. This was widely criticized, as it would significantly increase costs for businesses that used natural gas and other types of fuel in industrial processes (e.g. automakers using natural gas to heat air to paint cars, natural gas used in ironmaking). The regulations were complex, allowing industries to comply through both offset credits that could be traded across liquid, solid, and gaseous fuel streams and, in the case of the gaseous stream, by blending renewable natural gas into their operations. These options made for costly compliance, in excess of $250 C02/tonne in some estimates.

The decision to move away from this approach and instead work towards reducing carbon emissions through a higher carbon price, incentives to encourage commercial retrofits, and the use of funds from the Output-Based Pricing System (OBPS) to support energy-intensive industries like cement makers and refineries is, arguably, a better strategy with more predictable pricing. In short, it was a clear case where the desired results could be achieved but at a lower cost for businesses, and government should be recognized for addressing these industry concerns.

While the CFS will no longer apply to gaseous and solid fuels, there are still outstanding concerns for those companies affected by the liquid fuel regulations. How they can achieve cost-effective compliance under the CFS will need attention in the months ahead.

The plan also sets the stage for Canadians and Canadian industry to fully realize the benefits of zero emission vehicles. The decision to include a 100% tax write off on all commercial zero emission vehicles could help companies lower the carbon emissions of their transportation fleets, and could draw more automakers to Canada. While this write-off on its own is not enough to boost Canada’s appeal to investors, it is a good start and demonstrates a broader strategic vision. Attracting manufacturers of zero emission commercial and retail vehicles, electric motors, or magnets for electric motors, will profit Canada’s mining sector as well. A stronger electric vehicle (EV) market within Canada will create internal markets to support rare earth metal production and other critical minerals and metals used in EV manufacturing. This would position Canada to develop its own zero emission vehicle supply chains, while also expanding our position as a rare earth metals provider in North America, challenging China’s current influence in that market. This approach recognizes the potential of industry cooperation within Canada and carves out a role for Canada’s resource sector in the transition to net-zero.

This collaborative approach is one of the more promising elements of the government’s net-zero plan. For some time now, the government’s commitment of achieving net-zero has seemingly existed in a separate policy universe than the same net-zero goals of a growing number of Canadian companies. The net-zero challenge to large emitters and net-zero accelerator fund to help them lower emissions create a link, albeit a tenuous one, between the government’s net-zero ambition and the net-zero targets stated by members of the business community. Though these propositions are still fuzzy, they do signal something important, namely, the government’s commitment to work alongside major emitters, including oil and gas. This is important given the hostility that has surrounded the discussion of net-zero and the future of Canada’s energy sector, some critics going so far in May as to declare oil “dead”. The plan tabled by the government takes a different view, one that offers far more opportunity for Canadian prosperity, for the momentum in Canada’s clean tech investments, and the transition to our net-zero economy by working with major emitters instead of against them.

Not only that, but the plan recognizes that in terms of greenhouse gas (GhG) inventories, not all emissions are created equal: methane in its first two decades in the atmosphere is 84 times more potent than carbon dioxide. Managing methane emissions effectively is becoming a basis for climate conscious investors and buyers. For example, this fall Engie, one of France’s biggest energy companies, backed out of a $7 billion LNG contract because of its concerns over methane leakages. Providing Canadian oil and gas companies with funds to reduce methane emissions is smart policy. By creating partially repayable, up to 50%, contributions based on technologies that achieve methane reductions at lower costs , this approach could help give Canadian energy exports an edge in a market that may become far more responsive to energy commodities that are marked by their carbon intensity and environmental footprints in the years ahead.

These are important steps and through close collaboration, there is potential for industry and government to move forward. The catch is, there is a small-to-medium-business-sized hole in the plan, and that hole starts to look more like an abyss when you factor in the old chestnut of the carbon tax. As most of us predicted, the carbon tax is going up – way up – to the tune of $170.00 per tonne. This hike has made headlines and will once again be a major issue in the next federal election.

What follows is the good, the bad, and the unknown.

The Good
For those segments of industry who would be facing Clean Fuel Standard regulations on gaseous and solid fuel, the carbon tax is definitely a preferred alternative. The benefit it enjoys, and the reason why the Canadian Chamber supports a carbon price in principle, is that the costs for businesses are not only predictable, but compliance is flexible. The CFS is more prescriptive, offering energy-heavy industries very few options when it comes to complying with regulations, whereas the carbon tax allows them to get creative and find their own ways to lower emissions, ideally taking advantage of deep commercial retrofits and energy efficiency opportunities built into the government’s plan. 

As it stands, it is more economical for businesses to pay the price of the carbon tax than it is to use the clean technologies necessary to combat climate change. By raising the carbon price to $170.00 C02/t, these technologies become the more cost-effective option, helping to drive their development and wider use.  Carbon Capture Utilization and Storage (CCUS) and carbon scrubbing come to mind. In fact, three of the four pathways outlined in the IPCC report on keeping global warming below 1.5 degree Celsius, involve the large-scale use of CCUS technologies. While the costs of CCUS vary, when it comes to industrial sectors that will be more difficult to decarbonize, such as petroleum refining or cement, steel, iron and aluminium production, the costs range from $50-200 (USD) per one tonne of C02. Canada could benefit in this area as CCUS technology matures and the costs drop, while the price of carbon rises. This price incentive matched with a strategy to enhance Canada’s leadership and commercialization of CCUS could see Canada regain its edge in this technology, which over the last four years it has ceded to the US.

The same is true of carbon scrubbing, a technology that removes existing emissions from the atmosphere. Carbon Engineering, an innovative company currently working on carbon scrubbing, is trying to scale this technology for commercialization, but the cost point is high up at $1000/ CO2/t. They believe they can get its operations down to $94 a ton, making it more competitive and affordable to use. These technologies, and others, will become more appealing to businesses as the carbon price increases.

The Bad
A carbon tax must have a good behavioral feedback loop to be effective. The whole concept is dependent on people and businesses changing their behaviour to lower emissions, and thus, avoid paying the tax. There needs to be tools that businesses and people can use to do this. The government recognizes that implementing a tax that hurts households, especially low-income homes, is likely to be wildly unpopular, and so have promised to rebate people the cost of the carbon tax, to the point where some homes will get more back than they paid. The problem is that these rebates are not large enough to incentivize Canadians to do things that would help them truly avoid the carbon tax in the first place, like buying an electric vehicle, or making significant retrofits to their houses or putting solar panels on their roof. Higher-income households may do this, but the rebate will not be the reason they decide to do so.

As such, most Canadians will be reliant on businesses to invest and innovate to reduce the emissions associated with their goods and services so that everyday activities like heating homes and commuting to work, no longer contribute to emissions. The problem is that carbon tax rebates go to individual homes instead of funding businesses to help them make these investments. In short, the revenues from the carbon fuel surcharge are spread thin across many households, and in the end, neither businesses nor households have the resources they need to reduce their emissions. What this means is it becomes unnecessarily expensive for small and medium businesses to adapt. It would be encouraging to see government reconsider this approach and give small and medium businesses the revenue recycling model they have adopted for large emitters covered by the Output Based Pricing System (OBPS), where funds collected through the OPBS are returned to large emitters to help them innovate to reduce their emissions.

The Unknown
Perhaps one of the more encouraging elements of the government’s plan is the commitment to work with Canada’s trade partners and allies to create shared approaches to climate action. In many cases, the Canadian government has found itself in the position of leading the charge on climate policy alone. This leadership led to Canadian businesses often enduring economic costs that our close trading partners did not, such as new regulatory burdens. While these costs may eventually turn into competitive advantages, in the short to medium term it has hindered our economic competitiveness and made Canada a challenging investment environment, especially for our resource sector.

In particular, the criticism levelled at the carbon tax is that the Nobel Prize-winning economists who proposed it assumed a universal system that would see carbon pricing applied globally. When Canada’s carbon tax went into force in 2018, the assumption that all other countries would follow suit was not realistic. Canada’s trade revealed that energy intensive industries had legitimate concerns that a carbon tax would leave them less competitive than countries that did not put carbon-pricing regimes in place. This could mean job losses for Canadians as well as industries and investment leaving Canada to operate in cheaper jurisdictions (a process known as “carbon leakage”). This issue is not over, but there are signs that by 2030 we might be operating in a world where Canadian businesses could enjoy an advantage for being climate policy early adopters. In particular, a key part of the government’s plan is to pursue the creation of a carbon border adjustment (CBA) regime and work with allies to get all of North America on the same page. With the Biden Administration newly minted and under political pressure to show off its climate policy credentials, a CBA with the US is a real possibility. Given that 76.3% of our total exports go the US, Canadian producers may not face the same competitiveness drag on their exports from a carbon tax that they legitimately feared in 2018. As such, if the US were to follow suit on a similar carbon pricing model, or followed a carbon border adjustment regime that awarded the higher price in Canada, some of the concerns around a high carbon price may be lessened. That, however, remains an unknown and clarity on this will be crucial in helping Canada’s business community see their path to 2030.