Why carbon cap-and-trade would kill future oil sands growth
Ontario Premier Kathleen Wynne announced last month that her province will be joining Quebec and California's carbon trading market. Environmental groups are hailing this as a big step forward for Canada, where a majority of the population now live in jurisdictions with some form of carbon pricing and emissions cap.
Meanwhile back in Alberta, the recent election of an NDP government has many wondering if the federal NDPs could feasibly take over the helm of Canada's economy this fall. Although the Alberta NDPs have not yet stated intentions to price carbon, the federal NDPs clearly support a Canada-wide carbon cap-and-trade system.
Since all of the larger provinces already have some form of carbon pricing already in place, a federal cap-and-trade program wouldn't be too difficult to implement. In fact, provinces like Quebec and Ontario would greatly benefit from the inclusion of Alberta in their existing program.
DEFINING THE PROBLEM
As global oil demand increases, more and more fossil fuels are being burned, releasing an increasing amount of carbon into the atmosphere. Cheap and abundant oil, coal and natural gas offers little incentive to choose lower-carbon alternatives. For those who are fundamentally opposed to the use of fossil fuels, this poses a big challenge.
THE PROPOSED SOLUTION
The simplest solution is to put a price on carbon which slowly creeps higher over time, giving consumers, industries and governments financial incentive to reduce their carbon footprint. This is the basic premise of the Kyoto Protocol enacted in 2005 by the United Nations. Kyoto seemed to have much global support when first introduced. The horrors of Hurricane Katrina and the 2006 blockbuster movie “An Inconvenient Truth” had the whole world believing that humanity was soon coming to a brutal end brought on by an excess of carbon in Earth’s atmosphere. World leaders unanimously decided that global warming was a clear and present danger and something had to be done to curb consumption of fossil fuels. The answer was to put a price on every tonne of carbon emitted, mandate a world emission limit and develop a carbon trading market. In the beginning, almost everyone was on board and the concept of carbon cap-and-trade was born.
In order for cap-and-trade to be truly effective, carbon markets need to be very large and linked across various industries and even countries. Just like the stock market, bigger carbon markets offer more opportunities to buy and sell carbon permits, which supports a healthy carbon price. That's why the UN continues to aggressively coerce all governments around to world to participate in a global, legally-binding carbon market, as mandated by the Kyoto Accord.
But many countries have serious objections to the global cap-and-trade program. Economic competitiveness remains a major concern for most governments. Most companies are mobile and can easily relocate to a country not covered under Kyoto, which initially only applies to developed nations. Kyoto is meant to be legally binding and most governments, particularly the US and China, are strongly opposed to having laws imposed by a foreign governing body.
The next big climate change meeting in Paris is quickly approaching at the end of this year, and most countries have nothing to show for it due to sagging economies and much bigger problems that have popped up around the globe. Many governments have since opted out of Kyoto and instead went on to implement their own form of carbon taxation, offering better control over management of the program and enabling them to keep carbon revenues within their own boundaries.
CAP-AND-TRADE IN 4 EASY STEPS
Cap-and-trade is a market based approach to controlling, and ultimately reducing, greenhouse gas emissions (GHGs) by providing financial incentive to those who pollute less and charging extra to those who pollute more. Here’s how it works:
STEP 1. Define the cap and divide into permits (or carbon allowances)
A government sets a limit (or a cap) on the amount of greenhouse gases that can be emitted annually within its boundaries. The limit is typically benchmarked against an estimate of total emissions for a particular year. The total emissions limit is then divided into emission permits or carbon credits.
STEP 2. Allocate the permits to each industry as required
The government can either sell or freely allocate permits to corporations that emit GHGs. Each corporation is required by law to have enough permits to cover their emissions.
The total number of permits cannot exceed the total cap. Therefore, if a company needs more permits, it must buy them from the carbon market (i.e., from another company that has unused permits). The more you emit, the more permits you need to buy. Companies can also choose to retire permits (much like a company buying back its own stock) or purchase carbon offsets from other industries. A carbon offset is is credit for GHGs not emitted. The common example of a carbon offset would be planting a tree (which sequesters carbon) or protecting a piece of forest from logging.
STEP 3. Lower the cap
Over time, the cap (or the total number of permits issued) declines, reducing the number of permits on the market, therefore reducing the amount of GHGs that can legally be emitted. As the number of permits goes down, the price of carbon should rise, increasing financial incentive to reduce emissions.
STEP 4. Distribute the revenue
The ultimate goal for carbon-trading revenue should always be to facilitate a reduction in carbon consumption over time. The most typical example would be building wind and solar farms to displace power from coal or gas plants. Other examples could include installing electric charging stations in parking lots, building more public transit or providing homeowners with rebates for installing energy-efficient windows.
Much like the stock market, supply and demand should regulate the price of carbon. If there’s a big demand for more permits, then the price goes up, creating a lot of incentive for companies to reduce emissions and sell their unused credits at a higher price. As the government slowly decreases the number of permits available each year, the cost of carbon slowly climbs higher.
A global carbon cap-and-trading scheme was the basic premise of the Kyoto Protocol. Under this accord, each country was allocated an emissions quota in the form of carbon units. Countries that emit less than their quota could sell units to countries that exceed their emission limit. Developed countries such as Canada, the US and Europe would have much tighter emission targets and would need to buy offsets, preferably in developing nations which were largely expected to be the beneficiaries of clean-energy technology.
The European Union set-up an Emissions Trading Scheme (EU ETS), expecting all countries to join in. Although all industrialized nations (except the US) initially signed on to Phase 1 of the program (which has since expired), many countries, including Canada, have since opted out.
Carbon leakage - the big loophole
Cap-and-trade programs come equipped with provisions for Carbon Leakage, which is defined as emissions from businesses that are mobile and in a very competitive sector. These industries are provided with free carbon credits. For example, the steel industry is a major carbon emitter with slim profit margins. If a steel mill in Ontario is now required to buy carbon credits, it will likely shutdown its Hamilton operations and move to another jurisdiction. Therefore, if Ontario chooses to provide its steel industry with free emission permits under the Carbon Leakage rule, that would be perfectly acceptable.
In contrast, a power producer cannot easily relocate to another jurisdiction. Electricity producers are therefore generally not exempted from buying carbon credits under the Carbon Leakage rule.
THE CANADIAN CARBON EXPERIMENT
In North America, several provinces and states have come together to form the Western Climate Initiative (WCI) which is the world's second largest carbon market (after the EU ETS). Only two jurisdictions have so far legally mandated cap-and-trade for big emitters - Quebec and California. Ontario is now the third government to officially join the program.
Alberta's carbon tax
In 2007, Alberta became the first jurisdiction in North America to implement carbon emissions regulation. The province currently requires large emitters to reduce carbon intensity by 12% below their 2003-2005 average levels. Any emissions over that reduction target is charged $15 per tonne. For example, Syncrude did not meet its targets in the year 2012 and purchased $14 million worth of carbon units from the government.
The previous Alberta government had committed to revising its carbon legislation at the end of last year but postponed any announcements due to plunging oil prices. The newly elected NDP government has not yet commented on their support for carbon pricing.
It is important to emphasize that Alberta's commitments towards lowering carbon emissions are intensity-based and not a hard cap, which does not discourage growth of its oil sector.
Quebec's cap-and-trade program
Quebec began its cap-and-trade program in 2013. The province exempted most of its big emitters under the Carbon Leakage rule, providing them with free carbon credits. All funds collected go to the Quebec Green Fund, which is spent in part on public awareness on the dangers of climate change.
Starting in 2015, fuel distributors are required to buy emission permits, which get passed on to consumers in the form of a carbon tax levied on gasoline, diesel and natural gas. This is expected to significantly revenues for the province.
British Columbia's carbon experience
BC implemented carbon cap-and-trade in 2008, under former Premier Gordon Campbell. The province was the first government in North America to declare itself carbon-neutral, forcing all institutions to purchase carbon offset credits. Taxpayers were largely unhappy with the program. Schools and hospitals were paying forestry companies to not cut down trees that were unmerchantable in the first place. Even worse, some public funds actually got redirected to oil and gas companies for emissions capture equipment.
But the final blow to the cap-and-trade program is the province's desire to build an LNG empire, which would significantly increase carbon emissions. The scheme was quietly "parked" by Christy Clark's Liberal government, and instead will be replaced by intensity-based carbon limits. BC is in the process of reworking its cap-and-trade strategy and has declared intentions to restart the program sometime in the future.
The province also levies a carbon tax on all combustion fuels. Priced at $30 per tonne (or about 7 cents per litre of gasoline), the plan is advertised as being revenue neutral with most of the proceeds going towards tax breaks for low income families. The province has since seen a large drop in fuel consumption (as much as 15% in the lower mainland area), as more and more drivers cross the border to gas up.
ALBERTA - THE MISSING LINK IN THE CARBON CHAIN
The North American cap-and-trade system currently in place under the Western Climate Initiative (WCI) now generates most of its revenues from gasoline taxes collected at the pump. The problem is that drivers can't purchase offsets or trade carbon permits. This does nothing to support the price of carbon.
Based on lessons learned from other countries, the WCI carbon market has set a floor price of $11 per tonne to avoid a collapse of carbon prices. Current prices are stuck near that minimum, at about $11.35 per tonne. The problem is that there just aren't enough buyers. Power grids in Quebec and Ontario are largely carbon-neutral (hydro and nuclear power) and therefore have no need to purchase carbon permits. Too many big carbon emitters in those jurisdictions are issued free permits under Carbon Leakage rule.
And that's where Alberta comes into play.
What cap-and-trade would mean for the Alberta oil sands
If the federal government enacts a national carbon cap-and-trade program, the government of Canada would have to set a hard, legally-binding emissions cap for the whole country, which cannot be exceeded. That number would be in the order of 700 million tonnes of carbon per year, divided into 700 million carbon permits. The total number of permits issued by the government would be reduced by 1% each year (for example), forcing the price of carbon higher. Ideally, this would encourage companies to aggressively look for ways to reduce emissions.
Every oil producer in Alberta would have to purchase enough carbon permits to cover their expected emissions. The cost of buying these permits would be an added cost per barrel, much like royalties or taxes. However, carbon permits need to be purchased regardless of profitability, and can only be avoided by buying offsets.
Consider for example that Suncor emits approximately 20 million tonnes of CO2 equivalent (CO2e) per year. In the first year, they would need to buy 20 million carbon credits from the government. At the current price of about $11 per tonne on the WCI carbon market, that equates to $220 million per year in added operating expenses. For an integrated oil sands mine, that works out to just under $1 per barrel of oil produced.
In the subsequent year, the government would allow them to purchase 19.8 million carbon permits, since the number of permits allocated to each company would declines by 1% annually. Ideally, the company would need to find a way to reduce emissions by 1% per year. If not, they'll have to purchase those extra 0.2 million credits on the carbon market or buy offsets.
Suppose Suncor then decides to start-up a small SAGD facility, which emits an extra 1.5 million tonnes of CO2e per year. They would have to buy those extra 1.5 million permits from other companies that have extra permits to sell. Alternately, they could offset the 1.5 million tonnes by building a wind farm in Lethbridge or buying a very large piece of forest in northern Alberta. That extra cost would have to be factored into the cost of bringing new production online.
But what if the company decides to build a large oil sands mine with an estimated carbon footprint of 5 million tonnes CO2e per year? That's a huge number of extra permits that need to be bought from the carbon market, provided there were enough permits available. That would cause the price of carbon to rise. The higher the carbon price, the greater the operating expenses (since new carbon credits need to be purchased every year). Purchasing offsets would also be difficult on such a large scale.
To put the numbers into perspective, a carbon capture facility that sequesters (or offsets) 1 million tonnes of carbon per year would cost an estimated $1.3 billion to build. If using wind power as an offset, 5 million tonnes of CO2e per year emitted by a large oil sands mine would require a 2,000 MW facility, or the construction of 600 new wind turbines!
Why Quebec and Ontario desperately need Alberta to join in
Quebec has granted free permits to virtually all of its industries under the Carbon Leakage rule, and there's a good chance Ontario will do the same. That leaves a lot of carbon permits floating around that desperately need to find a buyer.
And that's why Alberta's inclusion in the carbon market would be a big score for the whole carbon trading program. Alberta should have a lot of carbon buyers as it continues to grow its oil production. And most importantly, they would likely be buying those credits from Quebec and Ontario, who have an excess of carbon credits to sell.
Of course, many would argue that this would never happen. If Canada actually did implement a meaningful cap-and-trade program, it is highly unlikely any major expansion of the oil sands would take place unless oil prices were very high or a step-change was made in technology (like building a nuclear power grid in the middle of the prairies). BC's LNG empire would also be at risk of going out the window. And that's exactly the point of carbon cap-and-trade. It's meant to discourage growth in carbon emissions.
Why Quebec exempted its mining industry but Alberta can't do the same
Exemptions allowed under the Carbon Leakage rule are fuzzy at best. Oil sands operators cannot easily relocate to another jurisdiction and therefore should not be issued free credits. Quebec did exempt its mining industry, which is also not considered "mobile". However, its mining sector is already struggling to survive under low commodity prices and relentless opposition from environmental groups. Therefore, no one was surprised that Quebec issued free carbon permits to its mining industry.
But it is highly unlikely the oil sands would get the same degree of sympathy from the voting public. A federal cap-and-trade program would need to include all the major emitters, including the Alberta oil sands, coal-fired electricity producers in the prairies and any new LNG plants built on the West Coast. Unless there are big industries willing to buy credits, cap-and-trade doesn't work as intended.
BIG WINNERS IN THE CARBON GAME
Like all government initiatives, there are many winners and losers. Cap-and-trade requires big government to develop, regulate, monitor and enforce carbon trading regulations. Billions of dollars are transferred from the private sector (and ultimately consumers) to elected officials, for them to distribute as they see fit. But the other big winners in the carbon game might not be so obvious.
Carbon regulators & financial institutions
Carbon trading is the fastest growing segment of the financial services industry. Since Kyoto was first introduced, numerous carbon-trading exchanges have popped up around the world, where carbon permits, offsets and abatements are bought and sold. At the peak of the global warming frenzy, the Chicago Climate Exchange estimated the world carbon market to be worth a staggering $10 trillion, assuming every country in the world could be convinced to opt-in.
Not surprisingly, a majority of carbon credits are not actually bought or sold by companies that emit GHGs, but instead are traded by investors who buy and sell permits and offsets for profit, much like stocks and derivatives. Carbon could potentially become the world's largest, and most lucrative, trading commodity.
Solar and wind power
One the biggest winners in the climate change debate is the renewable energy sector. Governments around the world, including Ontario, have spent billions financing the construction of solar and wind farms. Although no one disputes the viability of solar and wind energy, their reliability is quite low and requires back up from a more stable power plant. This leads to grid instability and drives up electricity costs.
Solar and wind power producers therefore win on multiple fronts - their capital is paid off by the taxpayers, the electricity they generate earns much more per kilowatt than conventional forms of electricity, and they can make lots of money selling carbon offsets to other industries.
WHAT CAN POSSIBLY GO WRONG
Cap-and-trade and carbon pricing programs have resulted in some serious unintended consequences in other jurisdictions.
The European Union - first out of the gate
When first launched in 2005 as part of their Kyoto commitments, the EU Emissions Trading Scheme was hailed as a major step forward in the fight against climate change. But the program quickly fell victim to fraud and mismanagement. When determining the appropriate cap, companies over-reported the amount of carbon emitted in order to ensure they were allocated enough credits. Too many carbon permits were freely issued, putting downward pressure on carbon prices.
As part of EU's commitment to combat climate change, hundreds of billions were diverted to clean energy power generation, which caused electricity rates to skyrocket. Crumbling under the weight of a sluggish economy, high taxes, expensive power and the added expense of carbon compliance, many manufacturers opted to shutdown their operations and instead generated millions from selling unused carbon credits. The price of carbon, which was initially set at $30 per tonne, fell to zero in 2007 when there were no buyers left.
Australia first introduced a carbon pricing scheme in 2012 which started as a simple carbon tax priced A$23 per tonne. Electricity producers passed on 100% of the added costs to consumers and didn't bother trying to offset emissions. The tax actually failed to generate any revenue since many companies simply packed up and left town. Unhappy with the state of the economy and the rising cost of living, the people of Australia swiftly voted out the ruling Labor Party. Australian Prime Minister Tony Abbott won a landslide victory on a single promise - repeal the carbon tax, which he did in 2014.
Japan's nuclear disaster
In 2009, Japan announced aggressive plans to reduce carbon emissions through the construction of nuclear power plants. But their efforts went out the window after the tragic Fukushima disaster forced the government to shutdown all 48 nuclear reactors and fire up the old coal and natural gas power plants. In order to appease environmentalists, Japan’s pro-nuclear government is presently attempting to restart its reactors. The move is proving very unpopular with the Japanese public who are far more concerned with public safety than any climate change risks.
The United States - lots of talk and little action
The Chicago Climate Exchange was set-up in the year 2000 in anticipation of the US joining EU's carbon market. At its peak, US carbon emission permits were selling at $7.40 per tonne. Banks, businesses and investors flocked to the program which disintegrated in 2008 after it was rejected by the US Senate. The Environmental Protection Agency (EPA) then moved to declare carbon a hazard to human health, in a failed attempt to give governments more power to enact carbon-curbing legislation. Since cap-and-trade in the US was not legally binding, carbon prices collapsed to $0.10 per tonne and never recovered. Despite making numerous claims on being tough on carbon, not one federal regulation on carbon emissions has ever been approved by the US Congress.
How California dipped its toe into the carbon waters
In 2006, Republican Governor Arnold Schwarzenegger passed the Global Warming Solutions Act, which was highly unpopular within his own Republican party. The money generated from the sale of carbon permits get funnelled into a Greenhouse Gas Reduction Fund which has been mired in numerous lawsuits from all sides of the debate.
In 2013, the government took $500 million from the GHG fund to pay off state debt. The state courts recently decided that 25% of the carbon revenues should go to social housing, 10% to local businesses and 25% for environmental justice lawsuits. Although California failed to reduce GHG emissions, they succeeded in generating a lucrative stream of cash flow that the state badly needs.
WHY CAP-AND-TRADE DOES NOTHING TO REDUCE GHG EMISSIONS
Cap-and-trade has its numerous critics, on both sides of the carbon fence. Admittedly, the system has some very serious flaws. Interestingly, the most vocal opponents of of the system is actually from environmental groups.
- It's not aggressive enough: For those who truly believe that carbon is pushing humanity to the brink of extinction, a carbon trading market isn't the answer. That's because companies can pollute more just by buying more credits or offsets.
- Friends of the government always get free permits: The program requires elected officials to distribute permits, some freely and others not. The whole system is very susceptible to corporate lobbying and corruption. Industries located in voter-heavy regions of the country tend to reap all the benefits. Hmm, that sounds oddly familiar . . .
- A tonne of carbon offset is not equivalent to one less tonne of carbon emitted: Carbon offsets are a major sticking point with many environmentalists. There's no guarantee that a tonne of carbon offset will never be re-released. For example, a protected forest is still subject to disease, decay and wildfire, which will eventually result in the release of all carbon stores. The offset market is very difficult to control and regulate, particularly on an international scale.
- The money doesn't get to the right place: A true carbon pricing scheme can only be effective in lowering global GHG emissions if strung across political boundaries. This not only prevents polluters from moving out to another jurisdiction, but more importantly encourages them to purchase offsets in developing countries, where the cost of offsetting emissions is cheaper. Carbon emissions in industrialized nations are actually already on the decline due to slow rates of growth and strict environmental regulations already in place. Significant reductions in GHG emissions can only come from the rapidly expanding economies in developing countries, such as China, India and Africa.
Of course, libertarians, capitalists and the general voting public hate carbon taxes since it’s basically just another tax, levied on top of other taxes. Although every tax and government service fee has its merit, you can't help but wonder where the line will be drawn on how many taxes are imposed on the average Canadian. More taxation can't always be the answer to every problem.
Sadly, the climate change debate is so highly politicized, it’s becoming increasingly difficult to distinguish fact from fiction. The business of climate change is now a trillion dollar industry, with governments, corporations and non-profit agencies all lobbying for a piece of the action.
SO WHAT ARE THE ALTERNATIVES?
Intensity-based emission targets offer a more common-sense approach to lowering carbon emissions. Each industry is benchmarked against its competitors. The BC government, for example, has studied emission rates from various LNG operations around the world and is mandating BC operators to be on the low end of the carbon scale. That approach has worked very well for sectors such as the automotive industry, which has steadily improved vehicle fuel efficiency over the years. The same could be easily done for every steel mill, every dairy farm, every power plant, every office building and even every oil sands mine.
Many politicians and environmentalists will argue the case that Canada can continue to grow its economy under a mandated carbon pricing program and emissions cap. They will paint a romantic picture of big oil companies happily paying billions into "Green Funds" that will be funnelled to the elusive Green Economy, with plenty left over to hand out generous tax breaks for families, seniors and university students.
But this has never been shown to be the case. The whole point of cap-and-trade is to stunt the growth of high carbon-emitting industries, such as oil extraction or LNG. Carbon pricing will effectively kill-off any growth in Canada's energy sector. And most importantly, shutting down every carbon-emitting plant in Canada will do nothing to lower global GHG emissions. Those products will just be produced in another country, taking thousands of good-paying, middle-class jobs with them.