On January 15, 2018, Environment and Climate Change Canada (ECCC) released draft legislative proposals relating to the proposed federal “backstop” system (Backstop) for establishing, regulating, and enforcing a pan-Canadian price on carbon, as well as the proposed regulatory framework for the output-based pricing system, which is designed to minimize competitiveness risks for emissions-intensive, trade-exposed industrial facilities. The proposed Backstop will apply in provinces and territories that request it and in those that do not have a carbon pricing system in place that meets the federal standard by January 1, 2019. Canada’s overarching objective in establishing this regulatory framework is to ensure a price is placed on carbon across Canada, thereby encouraging a low-carbon economy focused on sustainable development. For industry participants, the impact of the proposals is potentially significant, as they set the baseline expectations for carbon pricing regimes across Canada.

Background

In May 2015, Canada made a commitment under the United Nations Framework Convention on Climate Change to reduce its greenhouse gas emissions by 30% below 2005 levels by 2030. As part of its strategy to achieve this objective, the federal government announced a pan-Canadian approach to carbon pricing in October 2016, which forms part of the broader “Pan-Canadian Framework on Clean Growth and Climate Change” (the Framework). A central component of the Framework is the government’s commitment to pricing carbon pollution across the country.

Currently, four provinces have adopted carbon pricing systems: Alberta, BC, Ontario, and Québec. Alberta and BC have each adopted explicit price-based systems: Alberta has opted for a hybrid system consisting of a carbon levy and a performance-based emissions system, while BC has put in place a carbon tax. Ontario and Québec have each adopted a cap-and-trade system. Together, these four provinces cover more than 80% of Canada’s population. The remaining provinces and territories have yet to put in place carbon pricing systems.

In articulating the pan-Canadian approach to carbon pricing in October 2016, the government established a “benchmark” outlining various criteria that provincial and territorial carbon pricing systems would be required to meet. In creating this benchmark, the federal government also committed to putting in place a federal “backstop”: a federal carbon pricing system that would apply in provinces and territories that do not establish a system that meets federal requirements. For further commentary on the proposed pan-Canadian carbon price, see our earlier blog post here.

In May 2017, ECCC released its Technical Paper on the Federal Carbon Pricing Backstop, which was followed by the Guidance on the Pan-Canadian Carbon Pollution Pricing Benchmark in August 2017. In December 2017, Supplemental Benchmark Guidance was issued and federal Environment Minister Catherine McKenna and Finance Minister Bill Morneau announced a deadline of September 1, 2018 for each province to outline how it is implementing a carbon pricing system that meets the federal standard (the federal government has requested that provinces and territories that choose the federal backstop, in whole or in part, confirm this by March 30, 2018). The federal government will then determine whether the planned systems are on track to meet the standard, or whether the federal approach should be applied in that jurisdiction.

“Batter Up!”: The Backstop

The Backstop centres around the proposed new Greenhouse Gas Pollution Pricing Act (Act), which seeks to put a price on the greenhouse gases listed in Annex 3 of the Act. The Act, which largely mirrors the structure of Alberta’s two-pronged approach to carbon pricing, comprises two key elements:

  1. a levy on fossil fuels; and
  2. an output-based pricing system (OBPS).

Levy on Fossil Fuels

At a high level, salient features of the proposed levy include the following:

  • Levy rates for the years 2018 to 2022 would be established for a broad range of fossil fuels, including liquid fuels (e.g., gasoline, diesel, aviation fuel, methanol), gaseous fuels (e.g., propane, natural gas, ethane), and solid fuels (e.g., coal, coke).
  • Rates would begin at $10 per tonne of carbon dioxide equivalent (CO2e) in 2018 and would increase by $10 annually, eventually reaching $50 by 2022.
  • In general, the levy would apply to fuels that are used in a Backstop jurisdiction, irrespective of whether the fuels were produced in, or brought into, the jurisdiction.
  • Certain persons would be required to register as a “registered distributor”, a “registered importer”, or a “registered user”, among other registration categories.
  • In most cases, the levy would be applied relatively high up in the supply chain, payable by the producer, distributor, or importer. The end user would not generally have to pay any levy amounts – at least, not formally; however it can be reasonably expected that costs will be passed down the supply chain. Payors would be required to file monthly returns and remit the levy payable to the government.
  • Certain exceptions to the levy would apply, including in relation to:
    • fuel used at a facility whose emissions are accounted for under the OBPS (once it comes into effect);
    • fuel used as a raw material, in a manner that does not produce heat or energy and is not burned or flared;
    • fuel used by farmers in certain farming activities; and
    • certain types of fuel imported in small quantities.
  • The federal government would return levy revenues to the jurisdiction of origin or to “persons who are specified in the regulations”. The precise details concerning revenue returns have yet to be determined.
  • The framework would include modern elements of an enforcement regime (e.g., interest requirements, penalties, offences). As proposed in the Act, failure to file a return as required can result in a summary conviction punishable by a fine of between $2,000 and $40,000, up to 12 months’ imprisonment, or both. Stricter penalties apply in cases of false or deceptive statements.

Output-based Pricing System

The purpose of the proposed OBPS is, as described by the government, “to minimize competitiveness and carbon leakage risks for activities for which those risks are high, while retaining the incentives to reduce emissions created by the carbon pricing signal.” At a high level, salient features of the proposed OBPS include the following:

  • At least in its early years, the OBPS would apply to industrial facilities that emit at least 50 kilotonnes of CO2e per year, though certain sectors would be exempted.
  • Industrial facilities that emit less than 50 kilotonnes of CO2e per year would have the ability to “opt in” to the OBPS.
  • Facilities in the OBPS would not pay a levy on fuels they purchase. Instead, they would pay the carbon price on the amount they emit above a specified level.
  • In most cases, output-based standards would be set as a percentage of the national average of a sector’s emissions per unit of production. Standards would become more stringent over time.
  • The government would start by developing output-based standards for the following industrial sectors: oil and gas, pulp and paper, chemicals, nitrogen fertilizers, lime, cement, base metal smelting and refining, potash, iron ore pelletizing, mining, iron and steel, and food processing. The government has indicated that, in the future, it may develop output-based standards for additional sectors, such as offshore oil and gas and electricity generation.
  • Facilities that emit less than their assigned limit may be eligible to receive “surplus credits” from the federal government that, subject to certain restrictions, can be banked for future use or traded to another participant in the OBPS.
  • Facilities whose emissions exceed their assigned limit would be required to submit compliance units – surplus credits banked from a previous year or acquired from another facility, or carbon offset credits – or to pay the carbon price set out in the Backstop legislation to make up the difference.
  • Industrial facilities subject to the OBPS would have to register with and submit annual compliance reports (verified by a third party) to ECCC. Each facility would be required to quantify its emissions using prescribed methodologies for each of its activities.
  • The OBPS would be supported by enforcement measures designed to encourage compliance or deter future non-compliance, including written warnings, administrative penalties, compliance orders, and prosecution.

Next Steps

The federal government has identified the following next steps:

  • The government is inviting public comments on the draft Backstop legislation until February 12, 2018, and on the proposed OBPS regulatory regime until April 9, 2018.
  • The government will be engaging provincial and territorial governments, Aboriginal peoples, industry, environmental groups, and other stakeholders on the design of the federal carbon pricing system throughout the winter and spring of 2018.
  • The government plans to introduce legislation for the federal carbon pricing system following consultation. It also plans to publish a detailed regulatory proposal for the OBPS later this year.
  • Any province or territory that chooses to implement the federal system, in whole or in part, must confirm by March 30, 2018, with implementation in those jurisdictions to occur in fall 2018.
  • Any province and territory that intends to establish or maintain its own carbon pricing system must outline its system by September 1, 2018, with the federal government to confirm thereafter whether the system meets federal standards.
  • The federal system would apply, in whole or in part, in any province or territory that voluntarily adopts the federal system or that does not have in place a system that meets federal standards by January 1, 2019. This means that in any given province or territory, the Backstop could apply in its entirety, in part (as a means of “topping up” a non-compliant system – for example, by increasing a non-conforming carbon price), or not at all.
  • Once the federal system goes into effect in a particular jurisdiction, the federal governments intends that it will be kept in effect until at least 2022.
  • From 2019 onwards, the federal government will carry out an annual verification process to ensure carbon pricing systems in Canada continue to meet federal standards.
  • In 2020, the federal government will prepare an interim report assessing approaches and best practices for addressing the competitiveness of emissions-intensive, trade-exposed sectors.
  • By early 2022, the federal government will undertake a review of the overall approach to pricing carbon to confirm the path forward.

Since a number of provinces and territories are still in the process of developing their carbon pricing systems, it is uncertain at this time which provinces and territories will be subject to the proposed federal Backstop. A clear picture of the potential application of the proposed regime will not likely emerge until the fall of 2018. That said, Saskatchewan has indicated that it will not be adopting a carbon price, while BC, Alberta, Manitoba, Ontario and Québec will likely put forward the case that their carbon pricing mechanisms satisfy federal requirements, at least initially.

Canada has expressed its support for more ambitious climate action by endorsing the global goal of keeping rising average temperatures to within 1.5°C above pre-industrial levels; how this ambition will translate into federal, provincial and municipal climate action continues to evolve. As part of efforts to meet its international emission reduction commitment, Canada has sent a clear signal that carbon pricing is essential to protecting the environment, stimulating investments in low-carbon innovation, and fostering a sustainable clean growth economy.