An emissions trading bill currently making its way through a committee of the U.S. House of Representatives includes a number of provisions with potential ramifications for cross-border trade. On March 31, 2009, House Representatives Markey and Waxman released the American Clean Energy and Security Act (the “Act”).1 Representative Waxman is the Chairperson of the Energy and Commerce Committee while Representative Markey is the Chairperson of the Energy and the Environment Sub-Committee.

The Act is largely based on a blueprint published by the U.S. Climate Action Partnership, which includes major American businesses and non-government organizations. The Obama administration and Democratic congressional leaders aim to have emissions trading legislation passed in both the House of Representatives and the Senate by December’s Conference of the Parties to the United Nations Framework Convention on Climate Change.

Overview of the Act

The Act is organized in four titles: Clean Energy, Energy Efficiency, Reducing Global Warming Pollution, and Transitioning to a Clean Energy Economy.

Clean Energy

The Act would require retail electricity suppliers to meet six percent of their demand through the supply of renewable energy by 2012. By 2025, fully one quarter of electricity would need to be supplied from renewable sources.

The Act would also impose a low carbon fuel standard (“LCFS”). Such a standard would be based on emissions intensity of fuel over its full lifecycle or from “well-to-wheel.” The Act would require the emissions intensity of fuel to meet 2005 levels from 2014 to 2022. Emissions intensity would then drop five percent below the 2005 baseline by until 2030 and ten percent below the baseline thereafter.

As the emissions intensity of fuel from Canada’s oil sands is up to thirty percent higher than that of conventional crude, it would become increasingly difficult for American oil refineries to market fuel from the oil sands. Minister Prentice has stated he is keen to speak further with his U.S. counterpart on the prospect of a LCFS as part of the “Clean Energy Dialogue” between the two countries.

The LCFS included in the Act is modeled after that of California, which was formally adopted in late April. California’s LCFS adopted Thursday requires refineries, producers, and importers to reduce the carbon intensity 10% by 2020 and more thereafter.

Leading up to its adoption Canada’s Minister of Natural Resources, Lisa Raitt, wrote to Governor Schwarzenegger suggesting that such a measure may constitute an unfair barrier to trade. One concern is that fuel from the oil sands would be treated less favourably than fuels with similar levels of emissions intensity, like those from Venezuela. The Government of Ontario, in contrast, has signed a Memorandum of Understanding committing to follow California’s LCFS.

Energy Efficiency

The Act would authorize funding for building efficiency measures and would delegate to the Administration the authority to set and harmonize efficiency standards for vehicles, appliances, public buildings, and industry.

Reducing Global Warming Pollution

Using 2005 as a base year, the Act calls for GHG reductions of 3% by 2012, 20% by 2020,

42% by 2030, and 83% by 2050. (By way of comparison, using 2006 as a base year, the Government of Canada has pledged to reduce emissions by 20% by 2020 and by at least 60% by 2050). Through a combination of upstream and downstream measures, the Act would cap emissions from sectors covering 85% of the American economy, with entities emitting 25,000 tons or more subject to the cap. The Act does not yet specify how allowances would be distributed between sectors and whether they would be allocated or auctioned; this has been left to the committee.

Offsets would be limited to two billion tons annually, half of which could come from international sources. Acceptance of international offsets would be contingent upon the existent of a bilateral agreement with the host country of the offsets and the Environmental Protection Agency (EPA) would have considerable discretion to limit the use of international offsets. Further, an emitter would need to purchase five tons of offsets to replace every four tons of emissions. According to Point Carbon, only half of the 20 million tons of offsets that will be available in Canada and the U.S. in 2012 would be eligible for inclusion.

There would be no limit on the banking of allowances and there would be a one-year limit on the borrowing of allowances. To provide some price stability, some allowances would be set aside in a “strategic reserve.” The Federal Energy and Regulatory Commission (FERC) would provide oversight of the carbon market. The International Emissions Trading Association has argued that it is the Commodity Future Trading Commission (CFTC), rather, that has the necessary experience. The EPA estimates that the price of a ton of carbon under the system will be in the $17-22 range by 2020.

The Act calls for the pre-emption of regional and state initiatives from 2012 to 2017. The Regional Greenhouse Gas Initiative (RGGI) and California have already stated their general support for such pre-emption. A number of Canadian provinces would be impacted as they are members of regional initiatives. British Columbia, Quebec, Ontario, and Manitoba are members of the Western Climate Initiative (WCI) while Saskatchewan is an observer. Ontario, Quebec, New Brunswick, Nova Scotia, Newfoundland & Labrador, and Prince Edward Island are observers of the Regional Greenhouse Gas Initiative. Manitoba is a member of the Midwestern Greenhouse Gas Reduction Accord. The prospect of suspended regional initiatives would likely increase pressure on the Canadian federal government to institute an emissions trading scheme.

Transitioning to a Clean Energy Economy

To protect trade competitiveness, energy-intensive sectors that produce globally traded commodities would be eligible for rebates. The rebate program would be phased out by 2020. The Act would allow the President, should he find the rebates to be ineffective in preventing leakage, to institute “border adjustments.” Under such adjustments, importers would be required to purchase allowances to cover the carbon content of the imported goods. It has been estimated that 11-13% of allowances would need to be freelyallocated to trade-exposed sectors to protect their competitiveness.2

Canadian manufacturers have expressed concern about the measures potentially being used as a guise for protectionism. “I think the worst thing we could see here is regulatory standards being applied on manufacturing processes to restrict access to the U.S. market. [...] On issues of enforcement, the boundaries get blurred pretty quickly, especially when you’ve got strong, local political pressure saying ‘protect American jobs.’”3

Minister Prentice has also acknowledged the potential impact of the Act if Canada does not have similar measures in place. He has also mused recently that Canada may adopt absolute emissions targets over intensity-based targets, and has stated that the three members of NAFTA are working to strengthen NAFTA’s environmental side agreement. The Obama administration is conscious of the need for the U.S. to stay onside its international obligations in this regard.

Members of the World Trade Organization (WTO) are free to take certain environmental measures that would otherwise be viewed as restraints on trade. Nations are free to take measures (b) “necessary to protect human, animal or plant life or health”4 and “relating to the conservation of exhaustible natural resources.”5 WTO jurisprudence has held that air is such a natural resource. The measures, however, must not be arbitrary or constitute unjustifiable discrimination.6

Conclusion

Representative Waxman has stated that, with the exception of the overall cap, he is open to changes to the Act. The drafters anticipate reporting the bill out of committee by the end of the month. Senator Boxer, Chair of the Environment and Public Works Committee, anticipates introducing Senate legislation in September.

While certain issues remain to be deliberated and decided, particularly concerning the auctioning of allowances, it is becoming very likely that emissions trading will commence in the U.S. within the next few years. Even absent legislative action, the EPA has recently made an “endangerment finding” with regard to carbon dioxide that opens the door for executive action.

In whatever form, the U.S. emissions trading initiatives will have a major impact on Canada’s economy and policy options.