The Canadian government has made it clear that carbon pricing is here to stay and will be a key factor in fighting climate change and reducing Greenhouse Gas (GHG) emissions in order to meet our goals set by the Paris Agreement. With this in mind, it is crucial that the ins and outs of carbon pricing are understood by all Canadians, especially commercial and industrial business owners as these groups will feel the greatest impact of carbon pricing and have the most to lose/gain from its implementation. Carbon markets and pricing are set to become increasingly important in the coming years and companies must do their due diligence in order to remain ahead of the curve. This raises the question: What are carbon offsets and how do they work?
Carbon Offsets:
A carbon offset credit represents the reduction, removal or avoidance of GHG emissions measured in tonnes of CO2 equivalent (CO2e) from a sector/region that is not otherwise regulated. These credits work like any other kind of natural commodity where the price fluctuates based on the supply and demand of the asset. Offset credits are generated by cutting emissions beyond what is required by regulation and are voluntary. This could change in the future as more regulations come into place and some of the current offsets fall under regulation requirements, therefore, no longer being classified as offsets.
Offsets must meet the following criteria:
• Real: Reductions that have already occurred.
• Additional: Need to be in additional to what would have otherwise occurred.
• Permanent: Non-reversible or sequestered for a set number of years.
• Verifiable: Sufficient data quality and quantity to be verified by an established methodology or protocol.
• Quantifiable: Must be able to reliably measure or estimate the reductions.
• Enforceable: Ownership is indisputable and enforcement systems exist to ensure program rules are followed and market integrity remains.
Compliance vs Voluntary Offsets:
A key distinction must be highlighted between compliance and voluntary offsets before we proceed further into the general topic of carbon offsets. Compliance offsets are for use under government mandated GHG emission reduction systems. Comparatively, voluntary offsets are for use by individuals, groups and organizations to meet voluntarily committed GHG reduction targets. It is key to note that credits can be used and can apply under different systems (i.e., provincial and federal government). Offset prices will vary under these different systems and some actions can fall under multiple systems. A final key point is that credits do not go both ways, meaning compliance credits can be used for voluntary targets but voluntary credits cannot be used for compliance targets.
Offsets vs Renewable Energy Credits:
Renewable Energy Credits (RECs) are certificates issued by a government agency to a power company that utilizes environmentally friendly methods to generate electricity. The RECs can, in-turn, be traded and sold on the open market, providing an incentive to companies which produce “green” power. A REC is created for every MWh of electricity that is generated and delivered to the grid from a renewable energy resource. Electricity cannot be considered renewable without a REC to substantiate its “renewable-ness”. These credits can be bundled and sold with the power itself or decoupled and sold separately. Renewable energy projects can also generate voluntary carbon offset credits. Although RECs and carbon offsets both represent the environmental benefits of certain actions that can help mitigate GHG emissions, they have key differences:
Emission Scopes:
As mentioned above, carbon offsets can be applied to scopes 1, 2, and 3 whereas RECs can only be applied to scope 2, but what are these scopes and what activities fall under each of them?
Scope 1: GHG emissions from sources owned or controlled by the organization (i.e., on-site equipment and vehicles)
Scope 2: GHG emissions from generating electricity, heat or steam from equipment not owned by the organization (i.e., purchasing electricity)
Scope 3: GHG emissions not owned or directly controlled but related to the value chain and organizations activities (i.e., business travel, employee commuting)
Regulation:
The main regulation overseeing carbon pricing in Canada is the Greenhouse Gas Pollution Pricing Act (GGPPA), also known as the federal backstop, which imposes the minimum requirements on provincial carbon pricing programs. Where provinces fall short of the federal standard, the backstop will apply a charge on fossil fuel producers, distributors and importers OR an output-based pricing system (OBPS) for industrial facilities. The OBPS sets a level of emissions for the year, if the facility emits less than that level they can generate credits, if they emit more they’ll have to pay the excess charge directly or use compliance credits sold by other emitters. The OBPS addresses emissions from heavy-emitting industrial sectors (i.e., Oil and Gas, Mining, Metal Manufacturing, etc.) while balancing competitive pressures from external jurisdictions that do not have a carbon price in place. In 2019, the OBPS was implemented in Manitoba (MB), New Brunswick (NB), Prince Edward Island (PEI), Saskatchewan (SK), Ontario (ON), the Yukon (YK), and Nunavut (NV). However, since then NB, SK and ON have been approved for alternative programs.
Pricing:
As of 2021, the carbon price is set at $40 per ton. Back in 2016, the price was originally set at $20 per ton and was set to increase by $10 per ton per year until 2022. After this point it will then increase by $15 per ton per year until 2030 resulting in a price of $170 per ton. This price will be implemented differently in each province based on equivalency, which will be difficult as some places like Quebec have cap and trade programs vs BC where there’s a carbon tax in place.
Upcoming Changes:
In March 2021, Environment and Climate Change Canada (ECCC) proposed the Greenhouse Gas Offset Credit System Regulation. The main goal of this proposed system is to encourage emission reductions in sectors not covered by the OBPS. This system will contain regulations that will outline system operations, offset protocols and a credit tracking system to register offset projects and track credits through public registry. The details of this system are set to be finalized by the end of 2021. Four offset protocols have already been proposed to be applied under this system based on active systems available around the world. These first four protocols are:
Advanced refrigeration systems (phase out HFCs)
Landfill methane management
Improved forest management
Enhanced soil organic carbon
Current Ontario System:
Ontario was approved to develop and implement its own GHG regulation system to replace the OBPS, their proposed system is the Emission Performance Standard (EPS) program. The EPS came into effect on July 4th, 2019, prior to this date the OBPS was still being used in Ontario. The EPS is very similar to OBPS; it sets emission reduction standards for large industrial facilities to meet and if they don’t meet the standard they have to pay, if they exceed the standard they will generate credits. Large industrial facilities that emit 50,000 tonnes of CO2e or more per year are required to participate and facilities that emit 10,000 tonnes of CO2e or more in certain sectors can also apply to participate voluntarily. These emission limits are set for qualifying facilities, processes, and equipment, and will differ based on sector, industry and facility. A stringency factor will also be applied to further incentivize energy efficiency and GHG reduction. Amendments are being made on an ongoing basis to the EPS to ensure it is equivalent to the OBPS. These amendments include changes and updates to benchmarks, pricing escalations and stringency. The key difference between EPS and OBPS is that the use of offset credits to fulfill compliances under the EPS is not permitted. This idea was contemplated but did not make it into the approved program back in July 2019 when the program was initially approved. However, this is not the end of the story for compliance offset credits in Ontario. Recently, ECCC has built a pathway for provinces to access federal offset credits and use them for compliance as part of their system reliant on the individual province allowing it. This is being included in the continuing conversation between the federal and Ontario governments to allow the use of offset credits in the EPS system.
