Greenhouse gas offset market – the missing piece in Canada’s carbon economy – is here

Team North

The Canadian federal government has published draft regulations on its proposed greenhouse gas federal offset regime. The 60-day comment period closes on May 5, 2021. Keep reading for details on the proposed offset regime.

Background

In December 2020, the federal government introduced its long-awaited plan to address the climate crisis. Among the goals set in the Pan Canadian Framework on Clean Growth and Climate Change (the Climate Plan) was a promise to meet Canada’s commitment under the Paris Agreement and achieve net-zero greenhouse gas (GHG) emissions by 2050. This means reducing annual GHG emissions from approximately 742 Mt (i.e., 742 million tonnes) to 523 Mt by 2030. Although the Climate Plan was formally tabled in December 2020, the federal government had put a price on GHG pollution as early as 2018, when the Greenhouse Gas Pollution Pricing Act (the Act) became law.

The Act is divided into two parts. Part 1, administered by the Canada Revenue Agency, provides for 12 types of registrations and applies a fuel charge on 21 types of fuel and combustible waste. Part 2, administered by Environment and Climate Change Canada, introduces an output-based pricing system (OBPS) and its regulations (the OBPS Regulations) for industrial facilities (a Covered Facility) that emit at least 50,000 tonnes of GHG pollution per year.¹

Taxing pollution creates a market for offsets

The OBPS is a federal backstop system, meaning it only applies in provinces that do not have their own price on GHG pollution equal to or greater than the federal charge (the GHG Pollution Tax). This year, the federal charge is $40/tonne CO2e (carbon dioxide equivalent), set to go up to $50/tonne in 2022. In December 2020, the federal government announced that part of its plan to address the climate crisis is to increase the GHG Pollution Tax to $170/tonne CO2e by 2030.

Under the OPBS Regulations, Covered Facilities are prescribed an annual baseline GHG emissions amount. In the event the Covered Facility exceeds its GHG baseline amount, owners/operators have three options:

1. Pay the GHG Pollution Tax on excess emissions;
2. Trade in compliance units; or
3. Purchase certified federal offsets (Federal Offsets).

Compliance units are surplus credits it has earned by emitting below its baseline in years past, or purchased from another Covered Facility, or provincial or territorial offset credit formally recognized under the OPBS.

The third option – Federal Offsets - has been missing until now. On March 6, 2021 the federal government tabled the Greenhouse Gas Offset Credit System Regulations (the Offset Regulations). The principle behind offsets is to encourage activities that sequester GHG pollution by compensating project proponents. Carbon or GHG offsets have been part of the international landscape for decades. But without a price on GHG pollution in place, their marketability and economic value is limited.

With a GHG Pollution Tax in place, the federal government can now develop a viable offset regime. The Federal Offset regime consists of two parts:

1. A credit and tracking system to register Federal Offsets; and
2. Federal offset protocols (a Protocol) that establish which activities will be eligible to generate Federal Offsets, and quantify GHG pollution reductions based on the project.

The Offset Regulations mandate the operational aspects of the Federal Offset regime.

Creating federal offsets

Participation in the Federal Offset market is voluntary. In order to create a Federal Offset, the GHG pollution reduction activity must be a project type that falls under a Protocol. The federal government is working on four separate Protocols in 2021 as described below (with more to come in the future):

1. Advanced refrigeration systems: A protocol for activities that reduce or avoid using fluorinated refrigerants such as hydrofluorocarbons (HFCs), which have high global warming potential (GWP). These activities may include installing new low-GWP refrigeration systems or substituting GHG-intensive refrigerants with less GHG-intensive alternatives by replacing or retrofitting existing refrigeration systems.
2. Landfill methane management: A protocol for activities that reduce methane emissions from open or closed landfill sites, such as installing and operating equipment to capture and destroy methane.
3. Improved forest management: A protocol for activities may include increasing rotation ages, thinning diseased trees, managing competing brush and stocking trees to maintain or enhance carbon storage.
4. Enhanced soil organic carbon: A protocol for sustainable agricultural land management activities that reduce GHG emissions and enhance soil carbon sequestration on agricultural lands.²

Each Protocol will provide the means for determining the baseline for the project’s activities and the methods for quantifying GHG pollution reductions that would be incremental to such baseline. The incremental reductions of GHG pollution will qualify as Federal Offsets. The Protocols will also contain requirements related to project planning and implementation activities, including monitoring, reporting and risk assessment and management.

BLG will follow each of the Protocols closely as they develop, and our experts will be available to assist clients in making submissions.

In addition to qualifying under a Protocol, each project must meet certain eligibility criteria, which includes:³

• For a project with a start date prior to the publication date of the applicable Protocol, the registration application must be made within 18 months of the Protocol publication date; and
• For any registration application made on or before Dec. 31, 2023, the project start date must not be earlier than Jan. 1, 2017;
• For any registration application made after Dec. 31, 2023, the project start date must not be more than five years before the application is made.
• For a project with a start date following the publication date of the applicable federal offset protocol, the registration application must be made within 18 months of the project start date.
• The project must be located in a single province or territory in Canada. The project proponent is an individual who lives in Canada. If the project proponent is not an individual, they must have a business location in Canada.
• Project activities that generate offset credits cannot be required by law when the registration application is filed, or at the time of credit issuance – these projects must be voluntary.
• Project activities cannot be subject to any policy or other risk management instrument that places a price on carbon pollution, either directly through a carbon charge or tax, or indirectly through the issuance of emission credits or allowances (e.g., in a cap-and-trade or performance-based system).
• The GHG reductions quantified for the project cannot be registered in any other program that credits those same GHG reductions.
• If the project was previously registered in the federal offset system, it has not previously been cancelled due to a reversal of GHG reductions determined to be in the project proponent's control (i.e., a voluntary reversal), nor has it already reached the end of its maximum crediting period.
• The project proponent is able to demonstrate exclusive entitlement to, or ownership of, all GHG reductions resulting from the project.

Registration, crediting and reporting

The Federal Offset regime will include a registration and reporting mechanism for all Federal Offsets. Once registered each project will have a crediting period, during which time they can apply for Federal Offsets:

All project proponents must submit an initial report within six months of the first year of the initial crediting period, in addition to the minimum reporting cited above. The number of Federal Offsets issued by the government will be based on the GHG pollution reduction statement submitted by the proponent. An accredited third party must verify this statement.

Environmental integrity account

The federal government will also establish an environmental integrity account as part of the offset regime. This account will be “funded” by a certain percentage of the Federal Offsets that are issued to proponents. The purpose of this account is to act as a form of insurance for environmental integrity of the Federal Offset system.

For example, if there is a reversal of GHG reductions (consider a forest fire) outside the control of the proponent, the government will retire an equivalent number of Federal Offsets in the environmental integrity account. For biological sequestration projects, the percentage of Federal Offsets that will be deposited into the environmental integrity account will be set out in the applicable Protocol. For all other projects, it will be three per cent of the Federal Offsets issued.

Making money using Federal Offsets

The principal buyers market for the Federal Offsets are owners/operators of the Covered Facilities in the OBPS regime. As long as the Federal Offset ($/tonne CO2e) is lower than the GHG Pollution Tax ($/tonne CO2e), there will be buyers. Additionally, companies looking to “green” their operations by offsetting GHG pollution may also be potential purchasers.

Although the trades will not be facilitated by the federal government (the government will not act as a broker or provide a trading platform), the Federal Offsets will be tracked in the Federal Offset credit and tracking system. Each proponent will only have to open one account in the Tracking System, even if they have multiple projects. Smaller projects under the same Protocol can also be aggregated into one project. Importantly, the Offset Regulations place accountability for the validity of the Federal Offsets with the seller. Any credit that is not found to be valid has to be replaced by the seller, not the buyers.

Comment period

The comment period for the Offset Regulations closes on May 5, 2021. It is also expected that the federal government will publish one or more of the four Protocols in the near future.

BLG’s energy, Indigenous and environmental law experts are available to provide advice and answer any questions regarding the Federal Offset regime.

¹ Facilities operating in a backstop jurisdiction and an industrial sector considered at risk of competitiveness impacts from carbon pollution pricing, and emitting at least 10,000 tonnes of GHG emissions per year can apply to opt into the OPBS.

² Canada Gazette, Part 1, Volume 155, Number 10: Greenhouse Gas Offset Credit System Regulations (Canada).

³ Canada Gazette, Part 1, Volume 155, Number 10: Greenhouse Gas Offset Credit System Regulations (Canada)