Canada’s Regulatory Framework for Air Emissions:

A Business and Environmental Law Perspective

Elisabeth (Lisa) DeMarco May 9, 2007

The Ontario Bar AssociationWebinar

Overview• General Principles of Emissions Trading• Voluntary versus Compliance Markets• Canadian Emissions Context• The Canadian Framework for Air Emissions• Framework in International ET Context• Considerations for Business and

Environmental Lawyers

Macleod Dixon LLP• Canadian based International law firm established 1912

• 300 lawyers, 420 total staff in 7 global offices

• Focus: natural resource law (oil, gas, electricity, water, carbon and emission products)

• MD Climate Change Team: International Team, lead out of Toronto serving domestic and international clients

• MD Climate Change lawyers at the leading edge of Canadian and international emissions trading policy development since 1996 – more than a decade of proven ET Law experience

• Member of EMA, IETA, IETA CWGCM

• MD Climate Change Team has closed more than 50 MT of carbon transactions

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Calgary, Toronto

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General Principles of Emissions Trading

Environmental Kuznets Curve

Personal Income

Env

iro.

Deg

rada

tion

I. The Theory: ET 101

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A B C D E

Total emissions of X = 450 tonnes

Current emissions of X

The Theory: ET 101

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8 813

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A B C D E

Total emissions of X = 405 tonnesTotal reductions required - 45 tonnes

Government requires 10% reduction

The Theory: ET 101

A B C D E

$300

$240

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$60

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A B C D E

If the cost of reducing 1 tonne of X is uniform for all emitters and equal to $20/tonne then, the individual and total costs of reduction are:

Total cost of reducing 45 tonnes of X is $900

The Theory: ET 101

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$240

$180

$120

$60

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If the cost of reducing 1 tonne of X is not the same for all emitters and A can make reductions for $1/tonne while B,C.D,E make reductions at $20/tonne. Then, the individual and total costs of reduction are:

Total cost of reducing 45 tonnes of X is $615

The Theory: ET 101

If A can make 42 T of emission reductions at $1/tonne, it can then sell emission reductions at a profit to B,C,D,E at $10/tonne and decrease both individual and total compliance costs.

A: $15 compliance cost, $243 profitB: buys 12T from A = $120 compliance costC: buys 9T from A = $90 compliance costD: buys 6T from A = $60 compliance costE: makes 3T reductions itself = $60 compliance cost___________________________________________45T emission reduction goal achieved at $345 compliance cost

Total cost of reducing Total cost of reducing 45 tonnes of X using ET 45 tonnes of X using ET is $345; without ET is $345; without ET $900$900

Exercise: Compliance Cost Curve

-$20

-$10

$0

$10

$20

$30

$40

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$60

110 115 120 125 130 135 140 145 150

Emissions (Mega)tonnes CO2e/year

C$/

tCO

2e Emission Cost Curve

Emission reduction options identified in Upstream Oil & Gas Options Report, 1999

Source Rick Hyndman (CAPP)

Voluntary vs. Compliance Markets

Voluntary vs. Compliance

• The Differences• the nature of the “product/rights” • project-based vs. government allocated• generally* contract-based vs. regulatory regime

• ExamplesCompliance: EU ETS, US RGGI, US SO2, units= allowances, permitsVoluntary: domestic offsets, CDM and JIunits= VERs, offsets, ERs, CERs, ERUs

• Significant difference but both have value

Example: Compliance MarketReg 397/01 2007 NOx Allocations

• OPG – 16993• Kingston Cogen – 383• Transalta Sarnia- 1382• Brighton Beach – 640• Keele Valley LFG Power – 168

• http://www.oetr.on.ca/oetr/index.jsp

Example: Credit Creation Process (Voluntary)

Source: Government of Canada

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General Characteristics of an Offset

• Real• Quantifiable• Verifiable (Verified)• Unique (No double counting)• Surplus (Additional)

Direct vs. Indirect CreditsDirect Indirect

CH4 reductions at LFG power plant

NOx, SO2, CO2 offsets from LFG power offsetting higher emission power relative tosystem supply mix

Environmental Attributes

• The “Greenness” of power or a product (ethanol)

• Both quantifiable (# ERs, RECs) and diffuse (all rights, benefits and interest – akin to goodwill)

• Can be sold Bundled/Aggregated or Separately/Disaggregated or partially bundled***

• Quantified units: RECs, TRCs, green tags• Diffuse units: enviro. attributes, benefits

Canadian Emissions Context

Canada’s GHG Emissions

Source: Environment Canada

Emissions by Sector

The Canadian Framework for Air Emissions

The Framework: General Views

• The Framework as the First Step Forward• Theory of the Second Best• Framework vs. Kyoto

• Framework: 150 MT decrease from estimated 2006 GHG levels (780MT) = 630MT by 2020

• Kyoto: 220 MT reduction from estimated 2006 GHG levels (780MT) = 560 MT by 2012

• Framework is not Kyoto: it continues Canada's move toward a "made-in-Canada" approach to climate change

Greenhouse Gas Targets

• Short-term:• Emissions intensity targets• Targeted reductions relative to 2006 emissions• 2010 implementation date

• by 2010:• -18% (combustion & non-fixed process emissions)• 0% (predefined fixed process emissions)

• -2% emission intensity per year (2010-2020)

Goal (2020): 20% absolute emissions reduction

Greenhouse Gas Targets

• Sectorally, basic approach is -18% emission intensity by 2010• Variable goals for fixed process emissions

• New facilities (1st-year operation 2004+)• 3-year grace period to reach normal operating

levels• Initial target based on cleaner fuel standards• -2% annual emissions intensity (to 2020)

GHG Compliance Mechanisms

• Engineered in-house reductions• Energy efficiency and management improvements• Technological advances – e.g., C-capture and storage

• Domestic trading• Between regulated Canadian companies• Bankable credits created by a company exceeding its

intensity target

• Domestic offset system• Regulated purchase from unregulated• Verified Emission Reductions (VERs)

GHG Compliance Mechanisms

• Kyoto Protocol’s Clean Development Mechanism (CDM)• International CDM credits may comprise ≤ 10%

of firm’s total target

• Credit for early action (1992-2006)• One-time allocation of credits for verified

emissions reductions, to max 15 Mt CO2e

GHG Compliance Mechanisms

• Climate Change Technology Fund• Companies may pay for not meeting intensity targets

• 2010-2012: $15/t CO2e

• 2013: $20• 2013-2020: adjusted at growth rate of nominal GDP• Declining %age of total target:

• 70-50% (2010-2014; -5% p.a.)

• 40% (2015)

• 10% (2016-2017), and 0% thereafter

• Purpose funding of emissions reduction technology deployment and related infrastructure

Air Pollution Targets

• Fixed national emission caps (2012-2015)• NOx (600 kt; -40% )• SOx (840 kt; - 55%)• Particulate matter (160 kt; -20%)• Volatile Organic Compounds (360 kt; -

45%)

• Reductions relative to 2006 emissions

Air Pollution Targets

• Other pollutants in specific sectors, e.g.: • Hg from electricity generation• benzene from refineries & natural gas

production/processing

• Fixed sectoral caps (2012 and 2015) to be validated by June 2007

J. Kellerman, Environment Canada. National Energy, Environment and Resources Law Summit, 28 April 2007Montréal, PQ.

AP Compliance Mechanisms

• Domestic emissions trading system• Cap-and-Trade for SOx and NOx

• regions that do not meet national air quality objectives will have limits on use of credits from elsewhere

• On-going discussions with USA on cross-border trading system (SOx & NOx)

• Verification and enforcement under CEPA 1999

Framework in International ET Context

Global Carbon Market• Kyoto came into effect and became international law February

16, 2005 creating binding obligations (Canada must reduce 6% from 1990 by 2012)

• EU pre-compliance market: EU ETS started January 2005• Two main markets: EU ETS and Kyoto Mechanisms with links• Commodities:

• EU allowances, CDM (CERs), JI (ERUs), and AAUs• all generally traded in units of CO2 equivalents

• International Carbon market activity (CDM and JI) has increased dramatically since Fall 2004, related prices also rose very sharply and dropped sharply in April 06 and are rising again

• Prices: EUA @ 19 Euros for 2008 (crash on 2007); Volumes: significant increase in last 12 months

• Current prices and volumes published by a number of emission brokers (Evolution, Natsource, Point Carbon)

Global Performance (based on 2004 inventories)

sourceEnvironment Canada

Market Dynamics: Volumes (2006) * based on volume estimates from Point Carbon, Natsource and extrapolations based on completed

transactions. 2006 Figures significantly higher.

SystemEstimated Total Volume (MT)

Estimated Financial size (million Euros)

EU ETS 1100 25,000

CDM (CERs) 475 5260

JI/AAU 16 141

Other 30 200

Total 1621 30,601

Market Dynamics• Estimated Global Supply

• 250 MT to 350 MT/ year over 2008 to 2012• compliance instruments• other

• Estimated Global Demand • 2.5 BT to 4BT over 2008 to 2012• contingencies

• EU NAPs and Phase II, Canadian commitment and position (300 MT/yr swing); Japan DET

• Second Commitment Period• Asia Pacific Partnership and US position• AAU trading

Pricing Differences

• Prices currently showing an upward trend• Higher prices for compliance-grade commodities• Differences between CER and ERU prices reflect

greater risk in less developed countries (JI projects are in Eastern Europe)

• Other price determinants:• Creditworthiness and experience• Confidence in counterparty and project• Structure of contract• Cost of validation and certification• ER vintage and seniority• Regulatory Risk***• Additional environmental benefits

Market Pricing (January 2005-2006 in US$/tCO2e)

Source: IETA

EUA Prices

Sources: IETA, PowerNext, ECX

International GHG Emissions Trading

Source: State and Trends of the Carbon Market 2007.

Annual volumes (Mt CO2e) of project-based emission reductions transactions

State and Trends of the Carbon Market 2007.

Increases in volumes and values of transactions on the Main International

Allowances Markets

2005 2006Volume

(Mt CO2e)Value

(MUS$)

Volume (Mt CO2e)

Value (MUS$)

EU ETS 321 7,908 1,101 24,357

New South Wales 6 59 20 225

Chicago Climate Exchange 1 3 10 38

UK ETS 0 1 na na

TOTAL 328 7,971 1,131 24,620

Considerations for Business and Environmental Lawyers

Domestic Regulatory• Host of new regulatory obligations for clients

• is facility/corp. a large industrial emitter?• can it create offsets?• what 2006 data/analysis required under s. 71?• what is GHG sector-based intensity target

applicable to facility?• what fixed AP caps apply to sector? facility?

allocation?• what emissions covered (fixed process vs. non-

fixed process? • compliance strategy (short and long term)?• provincial equivalency (AB, ON, QC)• treatment of any emissions book under CEA?• new facility, timing of implementation of GHG

control measures

Domestic Commercial (Emissions Transactions)

• Scenario planning to determine likely market boundaries (provincial? national? US? Mexico?)

• Facility based cost compliance curves• Forward price curves for GHG and AP• Compliance strategy in light of evolution and

integration of Tech Fund• Offset purchasing strategy• Impact on existing ERPAs and future ERPA

language• CDM portfolio (?)• Trading in Tech Fund credits?• Arbitrage on existing CEA book?• Cross border trading? (DeMarco et al. 2002)

International Trade and Treaty• Impacts of CDN Kyoto non-compliance• NAFTA / WTO vs. Kyoto• Product impact (import taxes and duties)• Cross border emissions trading in NOx and SO2 –

extra-territorial incompetence

• Legality of limits on types (jurisdictions?) of CDM projects and interpretation of supplementarity

• Impact on inter-provincial trade and AIT (DeMarco et al. 2004)

• International carbon market impacts (alters 2008 to 2012 demand by at least 250 MT/yr)

• Pricing impacts

Contact Information

Elisabeth (Lisa) DeMarco

Partner, Macleod Dixon LLP

Head International Climate Change & Toronto Energy Groups

Direct Telephone: (416) 203-4431

Facsimile: (416) 360-8277

Email: elisabeth.demarco@macleoddixon.com