A rewards program for the oil sands

Illustration by Benoit Tardif

It’s been nearly a year since Alberta Premier Rachel Notley announced an ambitious set of policies to cap oil sands emissions, phase out coal-fired power generation and implement an economy-wide carbon tax in Canada’s “dirty” province.

Since revealed last November, Alberta’s climate plan has received widespread praise, including kudos from U.S. President Barack Obama during an historic speech this June in the House of Commons. It has also been embraced by some of the province’s biggest oil sands producers. Cenovus Energy, Canadian Natural Resources (CNR), Shell Canada and Suncor Energy all endorsed the plan, with Suncor CEO Steve Williams even calling it a “game changer.”

But why do they endorse it? What convinced the top executives of these particular companies to stand up on stage with Notley, as they did last November, and publicly disclose their support for a plan that takes aim at the heart of their business – of their very existence?

In a word, it comes down to efficiency. Notley’s plan, if structured and implemented as proposed, would for the first time reward companies in a sector that emit the least emissions per unit of output (i.e., per barrel of oil) relative to their peers. Simply put, Cenovus, Suncor, Shell and CNR likely stood behind Notley because they believe they are – or can be – the most efficient operators in the oil sands.

“As a general rule, this is a smart thing to do, especially when you have an emissions-intensive and trade-exposed sector that is going to incur a lot of carbon costs,” says Chris Ragan, chair of Canada’s Ecofiscal Commission, which has been closely tracking Alberta’s progress. “I would say Alberta is going about this the right way.”


Decade of ineffectiveness

Context is important to fully appreciate why Alberta’s proposed approach is so “smart.”

Currently, Alberta prices GHGs from oil sands producers and other large emitters using its Specified Gas Emitters Regulation (SGER), which came into force in 2007. (Large emitters, under the rules, are defined as industrial facilities that emit more than 100,000 tonnes of CO2 or equivalent annually.)

SGER was designed around the concept of carbon intensity, which, when talking about the oil sands, equates to the amount of emissions that result from the production of a barrel of oil. Government officials use historical data to establish a carbon intensity benchmark for each oil sands facility, and under the regulation producers are required to reduce annual emissions intensity to 12 per cent (15 per cent in 2016 and rising to 20 per cent in 2017) below their respective per-barrel benchmarks.

If a company didn’t hit its target in a given year and needed to make up the difference, it had the option of using emissions reductions banked from previous years or purchasing credits from other firms that beat their targets. It could also purchase offsets elsewhere in Alberta. Alternatively, it could pay $15 (pre-2016) into a government fund for every tonne of emissions in excess of its target.

The approach, while obviously better than nothing, has its problems. Sure, carbon until recently carried a price at $15 a tonne, but since that price only applied to emissions over-and-above established intensity targets at 100 or so industrial facilities (oil sands, power plants, chemical plants, etc.), it didn’t capture a whole lot. The Pembina Institute calculated that only 4 per cent of Alberta’s total emissions were affected.

In fact, divide the total revenue collected through the carbon levy by total emissions from big emitters and you’ve effectively got a carbon tax of less than $2 a tonne, not nearly enough to drive down industry emissions. “After more than six years in operation, the regulation has not resulted in a reduction of Alberta’s total emissions,” Pembina analyst Andrew Read concluded in a July 2014 report.

At the same time, without an absolute cap on GHGs there has been nothing discouraging industry emissions from rising. For example, a facility that met its compliance target of 12 per cent reduction in carbon intensity could still see overall emissions rise 76 per cent by doubling its oil output.


Rewarding the most efficient

Last November, the Alberta government’s climate change advisory panel recommended a new approach. Led by University of Alberta economics professor Andrew Leach, the panel urged Notley to ditch the SGER and replace it with a new Carbon Competitiveness Regulation.

Assuming Notley’s government implements the recommendations, and there’s every indication it will, here’s what we expect will happen: Come 2018 all industrial facilities with more than 100,000 tonnes of CO2-equivalent emissions will, like the rest of the economy, be required to pay a carbon price of $30 per tonne. This economy-wide carbon tax is expected to generate roughly $5 billion a year for Alberta, according to the Ecofiscal Commission.

pullqoute_leach1For obvious reasons, Alberta is concerned about placing too much of a burden on the industrial geese that lay the province’s golden eggs. Piss off the geese and many will fly to a place with less stringent carbon policies. And good luck attracting new geese.

“By pricing carbon it’s going to increase the cost of production, and that will make investors less willing to locate their operations in the province,” explains Trevor Tombe, a professor of economics at the University of Calgary. Economists refer to this effect as carbon leakage, and it’s a serious concern in a province highly dependent on emissions-intensive, trade-exposed industries like the oil sands.

To address this threat to competitiveness, the Leach panel recommended that some of the revenues collected through the carbon tax – at least $2.5 billion, by some estimates – be returned to big emitters by way of a subsidy tied to how much they produce, whether it’s barrels of oil or kilowatts of electricity or some other sector-specific output. The plan refers to these as “output-based allocations” of emissions credits.

This is where things get interesting. As Leach explained to Corporate Knights, the idea would be to take all oil sands operations in the province and sort them by emissions per barrel, with steam-assisted gravity drainage and mining projects evaluated separately. “Every facility would get an output-based allocation of credits per barrel equal to the 75th percentile,” said Leach. (In the electricity sector, the comparable benchmark for determining allocations would be “good as best gas” performance.)


Winners and losers

Tombe says such a design means 75 per cent of oil sands firms can be expected to pay more in carbon taxes than what they receive back in subsidies – i.e., emissions credits. A snapshot of emissions intensity at 19 oil sands operations suggests that projects majority owned by Shell, Cenovus and Suncor are likely to make the top quartile of performers. In other words, they run the most efficient and least GHG-intensive operations in the industry.

“What this policy does is eliminate preferential treatment to higher emitting firms,” Tombe says. “It absolutely will benefit those that are more efficient, and does so in a way that’s market-based. That is, creating a level playing field where the same output subsidy is provided to everyone.”

Looking at Cenovus and Nexen, for example, Tombe calculates that emissions from Nexen’s Long Lake operation are four to five times more intensive than Cenovus Energy’s Christina Lake and Foster Creek projects. “Cenovus is going to make money. It will receive more in effective subsidies than it will pay in carbon taxes, whereas Nexen will pay a lot,” he says. “I suspect that’s the business motivation for Cenovus getting behind the plan.” It could also explain why Nexen was noticeably absent from Notley’s November announcement.

Ragan says the proposed plan will do a better job of pushing emissions-intensive industries in Alberta to become more efficient. “There’s now an incentive for them to get better,” he says. “If you can get yourself into that (top quartile) club, then you’re better off.”

To make sure this club continues to up its game, output-based allocations would decrease at about 1 to 2 per cent annually “to reflect expected energy efficiency improvements,” according to the Leach panel’s report. This approach, combined with the intention of capping total annual oil sands emissions in the province at 100 megatonnes, could set the industry on a more sustainable path.

There’s already evidence it has. In July, Suncor’s Williams told analysts on a conference call that the company has asked the Alberta government if it could “strand” reserves that cost more to extract and carry relatively high emissions intensities. He cited the potential of saving 10 to 20 per cent on project operating costs.

The numbers are consistent with a Carbon Tracker report released in May which argued that seven major oil and gas companies could create $100 billion (U.S.) in value by avoiding high-cost development.

It may seem counter-intuitive, but in a carbon-constrained world such an analysis increasingly makes sense.

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