Compliance at the lowest cost:‎ The opportunities provided by the proposed ‎Greenhouse Gas Offset Credit System Regulations

On March 6, 2021, the Government of Canada published the proposed Greenhouse Gas Offset Credit System Regulations (the “Regulations”). The proposed Regulations are made under the Greenhouse Gas Pollution Pricing Act (“GGPPA” or the “Act”) and are available for a 60-day comment period which ends on May 5, 2021.

The purpose of the proposed Regulations is to build upon the carbon pollution pricing system, which sets out emission requirements for large emitters, by implementing a federal greenhouse gas (“GHG”) offset credit system (the “Offset Credit System”) and incentivizing activities that lead to GHG reductions.

The Offset Credit System would consist of three main elements:

• Regulations made under the Act to implement the operational aspects of the system;
• Federal offset protocols to establish the methods for quantifying GHG reductions for given project types; and
• A credit and tracking system to register offset projects, issue and track offset credits, and share key information through a public registry.

Background

Under the GGPPA, large emitters in jurisdictions that do not have an emissions-pricing system for industry that meets the minimum price-stringency standards set by the GGPPA are required to reduce emissions by a facility-specific amount during the applicable compliance period or pay a price. This pricing mechanism, known as the Output-Based Pricing System (the “OBPS”) applies to industrial facilities that emit 50,000 tonnes of carbon dioxide equivalent (“CO₂e”) or more per year, putting a price on emissions that exceed each facility’s individual emissions limit. The credit and tracking system that is proposed by the Regulations will give facilities regulated under the federal OBPS another option for providing compensation when they exceed their emissions limits. Thus, if the Regulations are approved, the facilities to which the OBPS applies (“Covered Facilities”) will be able to provide compensation for excess emissions through one or a combination of the following:

• paying an excess emissions charge;
• using surplus credits previously earned by emitting less than the Covered Facility’s emissions limit or purchased from another Covered Facility operator; or
• remitting federal offset credits or recognized units (eligible provincial or territorial offset credits).

Generating offset credits

In the Offset Credit System, offset credits will be generated by those who voluntarily take on project activities that reduce GHG emissions or remove them from the atmosphere by an amount that is measured against its business-as-usual operations. These credits can be used by the generator or traded to other facilities subject to the OBPS. Each offset credit represents, and therefore can set off, one tonne of CO₂e.

Offset projects

Environment and Climate Change Canada (the “ECCC”) has identified and prioritized four project types for its initial protocol development, which it plans to begin in early 2021:

• Advanced refrigeration systems: A protocol for activities that reduce or avoid the use of fluorinated refrigerants. These activities may include installing new refrigeration systems with low-global warming potential or substituting GHG-intensive refrigerants with less GHG-intensive alternatives.
• Landfill methane management: A protocol for activities that reduce methane emissions from open or closed landfill sites, such as the installation and operation of equipment to capture and destroy methane.
• Improved forest management: A protocol for activities that may include thinning diseased trees and stocking trees to maintain or enhance carbon storage.
• Enhanced soil organic carbon: A protocol for sustainable agricultural land management activities that reduce GHG emissions and enhance soil carbon sequestration on agricultural land.

Each protocol would define, or provide the methods for determining, a baseline for project activities, as well as the methods for quantifying GHG reductions incremental to the baseline. The protocols would also set requirements for project planning and implementation, including requirements for reporting and verifying GHG emissions reductions, assessment of risks specific to the offset project, and monitoring of biological sequestration projects to ensure that there are no releases of GHGs previously removed by such projects from the atmosphere.

Project proponents

In all cases, project proponents would voluntarily participate in the Offset Credit System. To be registered in the system, projects will have to satisfy eligibility criteria to ensure they achieve real, quantified, verified and permanent GHG reductions. These eligibility criteria include:

• the project proponent must reside in Canada or have a place of business in Canada;
• project activities cannot be required by law or be subject to any policy or regulatory instrument that places a price on GHG emissions;
• project emissions reduction activities must exceed a baseline “business-as-usual” scenario, which is to be quantified in accordance with the applicable federal offset protocol;
• the project must be registered on a yet-to-be established credit and tracking system; and
• the GHG reduction activities cannot be simultaneously registered under another offset credit program that issues credits for the same GHG reductions.

The proposed Regulations will specify the length of the periods during which offset projects are eligible to generate credits, as well as the number of times these crediting systems may be extended. They will also establish the frequency and content for the reports that project proponents must submit to the ECCC to receive offset credits.

Project proponents would assume all costs in generating credits. Upfront costs could include those associated with feasibility studies, business development, acquiring capital and labour, and legal services. There would also be costs associated with verification from accredited bodies and ongoing costs associated with monitoring the permanence of GHG reductions.

Project proponents will generally only choose to develop projects under the proposed Regulations if they anticipate to profit from the sale of offset credits, i.e., make more from the sale of these credits than the cost to generate them.

Covered Facilities

On the other hand, it is assumed that Covered Facilities will only acquire federal offset credits if they expect to realize a net financial gain through credit use. The two kinds of ways Covered Facilities can use offset credits to reduce costs associated with excess emissions are:

(1) as a substitute for more costly measures that the facility could carry out to reduce its excess CO₂e emissions by one tonne; or

(2) as a substitute for paying the excess emissions charge or providing another type of compliance unit as compensation for one tonne of excess CO₂e emissions.

The key assumption underlying (1) is that a Covered Facility would acquire offset credits through private trading at a cost that is below the cost of measures that the facility could undertake to reduce emissions — a Covered Facility would likely choose this option if it lowers the overall costs that the facility assumes, or expects to assume, as a result of carbon pollution pricing. A Covered Facility might also find it profitable to acquire offset credits through private trading, increasing its level of production, and providing these credits as compensation to offset its excess emissions associated with the increased level of production.

The key assumption underlying (2) is that a facility in the OBPS may be able to acquire offset credits through private trading for a price per credit that is below the charge associated with excess emissions. Net financial gains could be achieved by using federal offset credits acquired through trade as compensation, rather than by making the equivalent excess emissions charge payment or by using another type of compliance unit as compensation. A Covered Facility would generally only choose this option if it lowers the overall costs that the facility assumes due to carbon pollution pricing relative to its baseline scenario. 

Trading and using credits

Trades of offset credits would be privately negotiated between project proponents and interested buyers including, but not limited to, Covered Facilities. Trades would be formalized through contracts, and transfers of offset credits from one party to another would be tracked in the ECCC’s credit and tracking system. Third parties, such as carbon trade exchanges or brokerage services, may play a role in facilitating transactions and may reduce the transaction costs associated with trading activity. Lower prices for offset credits could result from the negotiation of contracts for bulk quantities of credits or agreements to buy or sell credits at predetermined prices at a specified time in the future.

Anticipated impacts

As Canada aims to reduce its carbon emissions, with the goal to transition to a net-zero economy by 2020, the Offset Credit System is intended to incentivize activities leading to GHG reductions that are not required under existing regulations or covered by other measures relating to carbon pollution pricing. While GHG reductions might not be made by the large emitters themselves, and may instead be made by a project that was designed to remove GHG from the atmosphere, the idea is that it does not matter where the emissions reductions are coming from, so long as there is an overall net reduction. Given this objective to promote GHG reductions at the lowest marginal costs, the proposed Offset Credit System may represent a real opportunity for the operators of Covered Facilities to reduce their costs of compliance with the OBPS and should be examined closely by such operators to determine how best to meet their obligations under the federal carbon pricing system.

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