Canada’s carbon pricing regime needs a major overhaul if governments are going to rely on it to drive industrial emitters such as oil sands producers to invest in deep decarbonization projects.
The federal government is reviewing its Output-Based Pricing System (OBPS) as part of an update it must make to its climate plan by the end of March. The OBPS imposes the carbon levy on a small fraction of emissions from large industrial producers in order to protect their competitiveness while encouraging them to cut their greenhouse gas (GHG) emissions. Some environmental groups argue that, to meet emission targets for the oil industry, the OBPS should be supplemented or even replaced by a hard cap that would set explicit GHG limits enforced through fines and even criminal sanctions.
Ottawa’s policy considerations come as oil markets are roiled by Russia’s invasion of Ukraine, with global crude prices spiking toward US$120 a barrel and growing calls for more oil production from western Canada.
Ottawa’s industrial carbon price applies as a backstop in a few provinces and territories that have refused to implement their own pricing systems that meet minimum federal standards. The federal policy accounts for less than 0.5% of national emissions but also sets a benchmark for provincial governments to meet.
As it reviews the OBPS, the Liberal government will have to ensure any increased stringency is demanded of the provinces as well.
It will have to assess industry claims that higher costs will lead to “carbon leakage,” or the shift in carbon intensive production from Canada to elsewhere. However, most global sources of crude have a lower carbon intensity than oilsands so the leakage argument is too tough to substantiate. Up until now, the oil industry in Canada has hidden behind a competitiveness cloak, claiming that paying full rate on the carbon tax would endanger their industry. The reality is that the price of carbon emissions from the extraction of oil is a relatively small part of the value of a barrel of crude, particularly with current oil prices. This is not the case for sectors such as cement or steel, which would have legitimate competitiveness concerns. Paying full freight on the carbon tax would make them uneconomic since they’re so carbon intensive in relation to the value of their products.
Ottawa is updating its climate plan to align with the target set last year of reducing emissions by 40% to 45% by 2030 from 2005 levels and achieving net-zero by 2050.
Under legislation passed last year, Environment and Climate Change Minister Steven Guilbeault is required to release a new plan by the end of March. That plan will implement the Liberals’ promise to impose a cap on oil and gas emissions that will then decline over time to be consistent with federal targets.
The government is currently determining how it will enforce such a declining cap. A more stringent OBPS – coupled with planned price increases to 2030 – could be an important tool for achieving that goal.
As it currently applies, the OBPS is designed to encourage emission reductions at the margin, not the deep cuts that would be required by net-zero plans. The system is designed to protect the competitiveness of Canadian industry and avoid “carbon leakage,” where regulatory burdens drive GHG-intensive economic activity out of the country.
We should close gaps in [the OBPS] to properly price heavy emitters so the private sector invests on their own.
-Richard Florizone, chief executive of the International Institute for Sustainable Development
“The current large emitter programs provide a perverse long-term incentive,” the Canadian Institute for Climate Choices concluded in a 2021 assessment report prepared for the federal government. “They are explicitly rewarding the most emissions-intensive facilities in the country to not make the major investments needed to be prepared to compete in a carbon-constrained market.”
The Climate Choices paper concluded that carbon pricing, coupled with other regulations, “can be a key driver of deep emissions reductions in Canada” provided some key shortcomings are addressed.
“We should close gaps in [the OBPS] to properly price heavy emitters so the private sector invests on their own,” Richard Florizone, chief executive of the International Institute for Sustainable Development, said recently on Twitter.
After months of rising crude prices, “the oil industry is also experiencing a windfall of cash,” Florizone said. “The sector should be using this to invest in emissions reductions and pivot their business models.”
One challenge is the fear among oil companies and other industrial emitters that a new government could render their investments in GHG reduction worthless through a major shift in policy. As a result, there are calls for federal or provincial governments to provide some guarantees against that “stroke-of-a-pen” risk.
Indeed, one of the most important contributions that conservative premiers and federal MPs could make on climate policy would be to commit to a rising price and increasing stringency for industrial emitters, thereby reducing the policy risk that companies confront when they make long-term investment decisions.
The oil sands companies have announced their own climate strategy project that aims to eliminate most GHG emissions from the extraction process by 2050 and to offset remaining emissions with credits.
The companies will be making big capital investments but are looking for support from Alberta and federal government, Martha Hall Findlay, Suncor Energy’s chief climate officer, said in an interview.
“It’s going to take all of us,” Hall Findlay said. She insisted that the companies realize they must have a credible climate plan to meet demands of government and some investors, but added they will have a tough time attracting capital if their climate-related costs are out of line with global competitors.
It’s going to take all of us.
-Martha Hall Findlay, Suncor Energy’s chief climate officer
The producers also have to see a rate of return on their investment, Hall Findlay said. That can come through either greater operating efficiencies that reduce emissions, reduced compliance costs related to carbon pricing and regulatory requirements, or the sale of credits if they outperform their regulatory requirements.
Hall Findlay said the producers would be looking for some sort of price floor on emission credits that could be generated by large investments in carbon capture and storage (CCS) in order to ensure they can sell them and receive a return on their investment.
The industry already faces a carbon price that is due to rise from $50 a tonne currently to $170 in 2030. However, the impact of a carbon price is greatly lessened by the relatively small proportion of emissions that are actually covered by the price.
The federal OBPS and Alberta’s TIER (Technology Innovation and Emissions Reduction) system levy the carbon price on roughly 10% of a large emitter’s GHGs. That marginal price provides incentives for companies to invest in step-change progress but not in across-the-board innovation. At a $50 marginal price, producers pay less than $1 per tonne of CO2 equivalent on their total production.
The TIER system has a very modest ratcheting mechanism – meaning each year it covers a percentage point more of production. The federal system has no such automatic ratcheting.
The OBPS would be a more useful tool for long-term decarbonization if companies could count on the planned increase to $170 per tonne by 2030 that the Liberals have announced, and if it had greater stringency that includes a robust ratcheting mechanism, David Sawyer, an economist with the Institute for Climate Choices, said in an interview.
As it is, investments that resulted in significant GHG reductions would generate large credits that could undermine the intent of the program by driving down both the marginal and the average price.
Under an alliance called Oil Sands Pathways to Net Zero, the six leading producers, who account for 95% of output, have committed to reaching a net-zero goal by 2050 through a combination of efficiency gains, new technology, carbon capture and sequestration, and credits.
The alliance companies say they can reduce emissions from their upstream operations by 22 megatonnes by 2030. However, that is far short of what is required to align the sector with the federal target of a 40 to 45% reduction from 2005 levels for Canada as a whole.
The centrepiece of the alliance’s strategy is the proposal to build a CO2 pipeline and sequester the carbon captured from eight different facilities, including some production facilities near Fort McMurray. Hall Findlay said the first phase of the CCS plan could cost in the range of $10 billion to $14 billion over 20 years, while others have pegged the entire net-zero plan at $70 billion in capital and operating costs.
Although the technology for carbon capture has largely been proven, it remains expensive, and the companies want access to generous tax credits to proceed. However, environmental economist Chris Bataille said a well-designed OBPS could avoid the need for subsidies.
With greater stringency, “there’s no need for the subsidy,” Bataille said. “They can make their money off selling credits to other companies.” He added, however, that the government may have to offer protection against the stroke of a pen.