Canadian Energy Law : Lawyers & Attorneys for Environmental Energy Law

These U.S. developments have considerable significance for Canada. While the federal Minister of the Environment, Jim Prentice, suggested several times this year that the government intended to publish comprehensive climate change regulations prior to the United Nations climate change conference in Copenhagen (December 7-18), Canada seems to have determined that domestic action in advance of an international and U.S. framework would be too risky. As Minister Prentice recently explained: "it is in our interest as Canadians to ensure that we know what the international framework is going to look like. Our continental framework needs to be consistent with that. And our domestic policies need to be consistent with that." The result (in addition to a perception that climate change momentum north of the border has stalled) is that it may be several years before Canada tables regulations aimed at cutting GHG emissions and - perhaps most significantly - that the form and content of those regulations is likely to be heavily influenced by the legislation that emerges from the U.S. Congress.

Cap-and-Trade Provisions in Kerry-Boxer and ACES:
Key Differences and Canadian Impact

GHG Cap

Both bills establish a cap-and-trade regime that would require GHG emission reductions of 83% below 2005 levels by 2050; a 42% reduction below 2005 levels by 2030; and a 3% reduction from 2005 levels by 2012. Kerry-Boxer, however, would reduce emissions 20% below 2005 levels by 2020 - three percentage points more than the corresponding ACES target.

Canada's Turning the Corner climate change plan, which was originally scheduled to take effect in 2011, is based on an intensity-based rather than an absolute emissions cap, as contained in both Kerry-Boxer and ACES. An intensity-based cap, preferred by large emitters such as Alberta oil sands producers, would be less of an impediment on economic growth than an absolute cap. However, in light of Canada's desire for cross-border harmonization of GHG reduction regimes, U.S. targets will surely set a benchmark for those under Canadian GHG regulations in any future climate change regime.

The White House recently clarified its stance, announcing that in Copenhagen, the U.S. will pledge to cut its GHG emissions by 17% below 2005 levels by 2020, in line with the reductions proposed in ACES rather than its successor Bill. Minister Prentice has stated that the White House proposal is almost identical to Canada's stated target to reduce GHG emissions by 20% below 2006 levels by 2020, considering the different base year used as a measure, and Prime Minister Harper has echoed this thought, adding that Canada may only "make some minor adjustments".

Trade

Manufacturers, unions and lawmakers in states that produce energy-intensive products such as steel, cement and glass have called for tariffs on imports from countries that the U.S. perceives as being weak on cutting GHG emissions.

Under ACES, such tariffs would be imposed on certain goods imported from countries that have not instituted sufficiently strong GHG reduction plans. This trade provision would require the purchase of "international reserve allowances" for energy intensive imports.

While Kerry-Boxer includes the title "International Trade", there are no provisions included under it at this time. The Bill does, however, include placeholder language that reads:

It is the sense of the Senate that this Act will contain a trade title that will include a border measure that is consistent with our international obligations and designed to work in conjunction with provisions that allocate allowances to energy-intensive and trade-exposed industries.

The section on international trade has been intentionally left blank due to divisions among the lawmakers who drafted the Bill, and the resulting potential for the issue to be used as a bargaining tool to gain consent from dissenting senators. Indeed, Senator Sherrod Brown (D-OH) and nine of his Democratic colleagues in the Senate have warned they will oppose any climate change bill that does not include such a provision. Conversely, Senator John McCain (R-AZ) has indicated that he is in opposition to any form of carbon tariff, stating that such a tariff is "protectionism and it's going to be passed on right to the consumer."

There have also been calls for the United Nations to create an international body to impose carbon tariffs. Senator Ben Cardin (D-MD), who sits on both the Senate Foreign Relations and Environment and Public Works Committees, proposed that such a body be created in order to take pressure off of U.S. trade officials, who may be wary of imposing tariffs on carbon-intensive goods for the fear of spawning a trade war.

Despite limited opposition to a carbon tariff or its equivalent, the majority of U.S. lawmakers are in support of some form of border adjustment. To be sure, some believe that the tariffs are important if the Bill is to win the votes required to pass in the Senate. While it is trade relations with developing countries that would be primarily complicated by carbon tariffs, such measure would undoubtedly serve as an additional impetus for Canada to institute GHG regulations of a similar stringency to those adopted by the U.S.

International Offsets

Both ACES and Kerry-Boxer allow two billion tons of offsets to be used by capped entities annually to meet their compliance obligations. Under ACES, those entities are allowed to source up to 50% of carbon offsets internationally, while requiring at least 50% to be sourced domestically. If domestic offsets are not available to meet the 50% domestic requirement, then another 500 million tons of international offsets will be allowed. However, Kerry-Boxer differs in that it allows a maximum of 25% to be sourced internationally. Under the Bill, an additional 750 million tons of offsets will be permitted in the event that the domestic offset supply is insufficient to meet the required threshold.

At first glance, this appears to limit the potential for a Canadian export-economy in carbon offsets. However, it should be recognized that such an export-economy may not be a potential reality at all. The Canadian government has called for a 20% reduction in GHGs below 2006 levels by 2020. While Canadian GHG emitters will necessarily have to offset their own GHG emissions in order to maintain their current levels of output without undergoing drastic changes to their current methods of production, many warn that the domestic supply will not be able to meet demand.

Gerry Ertel, manager of regulatory affairs at Royal Dutch Shell, has said that Canadian businesses will only be able to meet approximately half of the proposed target without using offsets. Ertel also noted that Canada does not have enough domestic offset production capability to meet demand, making the inclusion of an international offset regime necessary for compliance.

If Canadian emitters were forced to rely heavily on offsets sourced internationally, the majority of such offsets would arguably come from low-cost producers in developing countries. Yet, such scenario is cause for concern, as the UN's clean development mechanism, a program designed to produce carbon offsets in developing countries for industrialized nations subject to the Kyoto regime, has only produced 340 million credits in the past four years.

Accordingly, as offsets produced in the U.S. will surely be consumed domestically and the ability for Canadian emitters to rely on developing countries as a supply of offsets is limited, any cap-and-trade regime in Canada will need to facilitate the domestic production of offset credits.

Pre-emption of State-level GHG Cap-and-Trade Programs

Under Kerry-Boxer, provided that the federal cap-and-trade program holds its first auction of allowances by March 31, 2011, no state may implement or enforce a comprehensive GHG limitation program that covers any capped emissions during the years 2012 through 2017. If the initial auction is delayed, then state pre-emption would not begin for at least 9 months after the date of that auction. While ACES also has a pre-emption provision, the House bill does not provide for the postponement of pre-emption if the initial federal auction is delayed. It should be noted that these provisions do not pre-empt states from instituting command-and-control regulations such as targeted efficiency standards.

This pre-emption is significant for Canadian provinces because several (British Columbia, Quebec and Ontario) are party to the Western Climate Initiative (WCI), a regional GHG cap-and-trade regime that would be affected by the pre-emption. WCI would cover nearly 90% of GHG emissions in WCI states and provinces upon its complete proposed implementation in 2015. However, reliance on WCI by Canadian jurisdictions may be in jeopardy if the program cannot remain viable without a U.S. membership base. Consequently, pre-emption of state-level cap-and-trade programs may force Canadian legislators to accelerate the creation of a federal or provincial cap-and-trade regime in Canada, as there may not be a cross-border regional substitute available.

Going Forward

The road ahead for passage of Kerry-Boxer is not without obstacles. Senator Boxer recently announced that the Bill, which cleared a controversial Environment Committee vote in early November, will not be debated and amended in the Finance Committee (one of numerous committees that must still weigh in before the Bill goes to the Senate floor) until early 2010. Similarly, Senate Majority Leader Harry Reid announced that the full Senate may vote on climate change legislation some time in the spring, ending hopes that the U.S. would pass meaningful legislation before Copenhagen. Moreover, while similar to ACES in many respects, Kerry-Boxer will likely be more difficult to pass, as it requires a Senate supermajority of 60 votes rather than the simple majority required in the House.

If and when U.S. climate change legislation will pass is therefore still unclear. What is certain, however, is that any progress south of the border will have a very significant effect on developments in Canada. While not necessarily the final word, Kerry-Boxer is a key step in the development of a U.S. contribution to an international framework that - in the words of Minister Prentice - "all needs to knit together".

¹ For a description of ACES, please refer to the following Stikeman Elliott Emissions Trading and Climate Change Update: "Canadian implications of U.S. climate change regulation: U.S. House passes American Clean Energy and Security Act", dated September 2009.