Canada: Focus on Climate Change - September 28, 2005

Since the April 13, 2005 release of Project Green: Moving Forward on Climate Change – A Plan for Honouring our Kyoto Commitment (the "2005 Plan"), the Federal Government has been very busy developing the "Large Final Emitter System" and a national greenhouse gas ("GHG") emissions trading system. The following has occurred within the last 90 days:

• both the 2005 Federal Budget and the Budget Implementation Act, 2005 entered into force on June 29, 2005 (the "2005 Budget") providing approximately $5 billion over five years for climate change including the creation of the Climate Fund;

• the Notice of Intent to Regulate Greenhouse Gas Emissions by Large Final Emitters was published in the Canada Gazette on July 16, 2005 (the "Notice of Intent") as a formal announcement of the Federal Government’s intention to regulate Large Final Emitters ("LFEs") under the Canadian Environmental Protection Act, 1999 ("CEPA");

• the Federal Government released the Offset System for Greenhouse Gases: Overview Paper & Technical Background Document on August 11, 2005 (the "Offset System") to generate discussion on the proposed rules for a national emissions trading system; and

• the draft Order Adding Toxic Substances to Schedule 1 of CEPA was published in the Canada Gazette on September 3, 2005 (the "CEPA Draft Order") to formally announce the Federal Government’s intention to add six GHGs to CEPA before the end of 2005.

One of the key components of the 2005 Plan is that LFEs will be collectively required to reduce annual GHG emissions by 45 million tonnes of carbon dioxide equivalent ("CO₂e") for the 2008 to 2012 period. LFEs are the largest industrial producers of GHGs and comprise the following sectors: upstream and downstream oil and gas, electricity generation, mining and selected manufacturing, such as cement plants and iron and steel mills.¹ The concurrent development of the Offset System alongside the LFE System is important because the combination of both systems will capture virtually all GHG emissions in Canada. Under the Offset System, non- LFE project proponents can implement GHG reducing projects that are recognized by the issuance of "Offset Credits". Furthermore, LFEs will be able to initiate projects that are outside the application of LFE regulations and will receive Offset Credits. Each of these new important developments are further discussed below. For more information on the 2005 Plan and the 2005 Budget, please access Focus on Climate Change (May 6, 2005) at www.fmc-law.com.

The Notice of Intent provides further detail to the LFE component of the 2005 Plan. Existing facilites of LFEs will be regulated under CEPA by providing permits ("LFE Permits") for emissions intensity (emissions per unit of production) at a target lower than the current emissions intensity. LFEs will be required to reconcile, at each year end, actual emissions with an equivalent number of LFE Permits (actual emissions = permits = production * intensity target). The same intensity target will apply across an industry sector and will be published in sector-specific regulations which are expected in January, 2006. Fossil fuel combustion-based emissions will require an emissions intensity decrease of 15% (85% of current intensity) and chemical processbased emissions, so-called "fixed process emissions", will require no net increase of emissions intensity (100% of current intensity). However, the maximum reduction in emission intensity for any specific industry will be 12% (88% of current intensity). By regulating in the manner above, an LFE with a high emissions intensity will need to implement greater reductions to reach the sector target than a competitor with a low emissions intensity.

LFEs will have the following options for compliance:

1. reduce GHG emissions;

2. purchase permits from another LFE;

3. purchase Offset Credits from a project proponent under the Offset System as these will be recognized as LFE Permits;

4. implement offset projects to directly obtain Offset Credits;

5. purchase international Kyoto credits;

6. purchase permits from the federal government at $15 per tCO₂e under the "Price Assurance Mechanism"; and

7. investment into the new Greenhouse Gas Technology Investment Fund – such investment will immediately entitle LFEs to permits at $15 per tCO₂e (this Fund will invest in technologies that can potentially reduce emissions).

In addition, the sector-specific intensity target referred to above would not apply to activities carried out in new large facilities or existing facilities undergoing major transformations or expansions. These activities would be subject to a separate intensity target developed on the basis "Best Available Technology Economically Achievable" or "BATEA" (which is currently under being developed).

Important developments to watch for are (1) the discussion draft of the LFE cross-cutting regulation, (2) further refinement of the BATEA concept, (3) development of the $15 per tCO₂e Price Assurance Mechanism, (4) equivalency agreements with provinces² and (5) rules concerning mergers & acquisitions. The LFE cross-cutting regulation is to take the form of an "umbrella" regulation which establishes the compliance requirement, reporting obligations and other general rules which are equally applicable to all the industry sectors of the LFE System. Also important are the possible penalties for non-compliance – the Notice of Intent stipulates that the Federal Government will not seek a penalty of greater than $200 per tCO₂e for emissions in excess of permits.

The purpose of the Offset System is to encourage GHG reductions and/or removals ("R/R") outside what will occur under the LFE System. Project proponents that generate R/R will receive Offset Credits that will be purchased by the Climate Fund³ or by LFEs as a compliance option. Participation in the Offset System is voluntary and will be available to both non-LFEs that develop projects and LFEs when they generate R/R from activities that are not covered by LFE regulatory requirements. For example, an LFE could participate in the Offset System by developing wind energy or sequestration projects. The proposed eligibility rules are as follows:

1. quantifiable – R/R are calculated as the GHG difference between the absence and existence of the project;

2. real – the project must involve a specific and identifiable action that results in net R/R (excluding decreasing production);

3. surplus – the R/R must be voluntary (ie. cannot already be subject to the LFE System or other regulations);

4. verifiable – the R/R must be verified as achieved as claimed;

5. unique – an R/R can be used only once;

6. coverage – the project must result in R/R from sources/sinks that are including in Canada’s inventory for compliance with the Kyoto Protocol (subject to possible exceptions); and

7. timing – the R/R which resulted from the project must have commenced after January 1, 2000 and only the R/R which occur after January 1, 2006 are eligible to receive Offset Credits – the window for R/R to be recognized is 8 years after registration but projects can be re-registered if still ahead of the "business-asusual" baseline.

It is important to note that the concept of "financial additionality"⁴, often considered an eligibility criteria for emissions trading, is not a requirement. The removal of this criteria will streamline the Offset System. Also, it is important that renewable energy projects, such as wind energy, will be able to receive Offset Credits. Furthermore, it is proposed that the participation of renewable energy projects in the Wind Power Production Incentive and the developing Renewable Power Production Incentive will not exclude the Offset System.

The authority for the LFE System will be that GHGs are listed on Schedule 1 of CEPA. The CEPA Draft Order formally announces the Federal Government’s intention to amend Schedule 1 of CEPA (the List of Toxic Substances) to add six GHGs: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexaflouride. These are being added on the basis that they satisfy the criteria in section 64, namely they they "constitute or may constitute a danger to the environment on which life depends." It is anticipated that these six GHG substances will be added to CEPA in late 2005.

The Federal Government has an aggressive goal of implementing the Offset System and having the regulations for the LFE System in place by early 2006 (with the reduction obligations of LFEs to commence on January 1, 2008). Their timeline is as follows:

FMC will provide further newsletters as more detail becomes available.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.