Many energy supply agreements currently in place were drafted at a time when it was uncertain what regulatory measures - if any - provincial or federal governments might take to reduce greenhouse gas (GHG) emissions. It is now clear that carbon pricing will be one of the primary tools that Canadian governments, as well as other jurisdictions around the world, will use to incentivize emissions reductions and generate revenue to pay for mitigation and adaptation. How an energy supply agreement may be affected by a price on carbon must be assessed on a case-by-case basis. However, we have identified a number of key provisions that should be reviewed in order to properly assess these questions:
- Who will bear the cost of compliance?
- Who will benefit from any revenue generated by the sale of off-sets?
- Could increasing carbon prices result in the termination of energy supply agreements?
The global trend toward carbon pricing
Carbon pricing is a financial tool to reflect the economic, social and environmental costs of climate change. Placing a price on emissions creates incentives to move from high-carbon to low-carbon energy sources, technologies and processes, and to use energy more efficiently. In the context of government regulation, carbon pricing generally refers to an explicit price, like a carbon tax or an emissions trading system (ETS), such as a cap and trade regime.
As reported by the World Bank in its annual report, State and Trends of Carbon Pricing 2016, approximately 40 national jurisdictions and more than 20 sub-national jurisdictions - covering approximately 13 percent of global GHG emissions - have already put a price on carbon. Following the Paris Climate Change Agreement (Paris Agreement) coming into force in November 2016, the number of jurisdictions with a carbon pricing regime is likely to increase. Approximately 100 of the Parties to the Paris Agreement – accounting for 58 percent of global GHG emissions – are planning or considering carbon pricing instruments. In addition, the Paris Agreement includes provisions intended to facilitate cooperative carbon pricing approaches which may fuel further expansion of these regimes. The World Bank anticipates that “2017 could see the largest ever increase in the share of global emissions covered by carbon pricing initiatives in a single year.”
Carbon pricing in Canada
Canada is also moving toward a national price on carbon, although the method of implementation will likely vary by province and territory. On December 9, 2016, Canada's First Ministers released the Pan-Canadian Framework on Clean Growth and Climate Change (the PCF). Under the PCF, a federal carbon tax would act as a backstop that would come into effect if any province or territory does not implement either a carbon tax or cap and trade program by 2018. If, as in Ontario, a province chooses to use cap and trade to put a price on carbon, the emissions reductions targets used to determine the number of emissions allowances available for purchase must be in line with the federal government’s 2030 emissions reduction target. The Liberal government confirmed its adoption of the 2030 emissions reduction target set by the previous Conservative government of 30 percent below 2005 levels by 2030.
Common energy supply agreement provisions which may be triggered by carbon pricing regimes
Change-in-law provisions are intended to allocate the cost of complying with new legal obligations between the parties to the agreement. For example, as set out in the sample clause below, where the seller’s costs increase as a result of a change in law, it is authorized to pass on the increase to the buyer.
Change-in-law clause: Increased Costs If a Change in Law occurs which results in a net change in the Owner’s revenues, fixed costs or variable costs associated with the provision of power services pursuant to this Arrangement, such changes resulting from such Change in Law shall be passed on to the Buyer, effective from the date of such Change in Law, as a change to amounts otherwise payable pursuant to this Arrangement by way of a change to the monthly payments between the parties, if practical, or otherwise as a separate payment from the Buyer to the Owner as necessary to keep the Owner in the same financial position as if the Change in Law did not occur.
However, the definition of the term “change-in-law” may have a limited scope that makes change-in-law provisions inapplicable to the cost of participation in a mandatory ETS. For example, as in the sample clause set out below, some change-in-law definitions only encompass changes to: taxation regimes; administrative provisions; and the requirements associated with obtaining the necessary government approvals. It is open to argument whether the requirement to purchase emissions allowances in an ETS is a “tax,” and whether these allowances are requirements or conditions of a government approval. In contrast, a carbon tax would generally fall within the scope of a change-in-law definition.
“Change in Law” means: The adoption, enactment, promulgation, modification, amendment, or revocation of any laws applicable to the Owner or Buyer which relate to the following:
- Taxes, including any charge or tax related to the use or consumption of fossil fuels or the production of any related by-products from any such use or consumption;
- Any interpretation, reinterpretation or administrative provision relating to the Laws referred to above by any Governmental Authority;
- Any material requirements or condition in connection with the issuance, renewal, extension, replacement or modification of any Governmental Approval required in connection with the energy contract;
Alberta’s provincially-mandated Power Purchase Arrangements (PPA) include a “right to terminate” provision, such as the one set out below from the publically-available Sheerness Generating Station PPA, that allows the buyer to terminate the PPA if a change-in-law is likely to make the arrangement “unprofitable”:
Notwithstanding any of the foregoing, to the extent that a Change in Law … could reasonably be expected to render continued performance by the Parties to this Arrangement for the balance of the Effective Term unprofitable to the Buyer in respect of a Unit … then the Buyer may terminate this Arrangement and shall not be liable for, nor entitled to any Termination Payment.
In 2015, Alberta’s new NDP government increased both the emissions intensity reduction targets that regulated emitters (including coal-fired generating plants such as Sheerness) would be required to meet, and the compliance price for excess emissions if these targets were not met. When these changes came into effect, several buyers notified the province that they would be terminating their PPAs under the change-in-law provision, returning them to the Balancing Pool which manages the revenue from the auction of PPAs and any unsold PPAs. In 2016, the Alberta government launched a legal action asking the Court of Queen’s Bench to void the regulation that approved the PPAs, on the basis that it was “unlawfully enacted”, and block the termination of the PPAs.
The Alberta government has announced settlement agreements with Capital Power Corp. (Capital Power), Trans-Canada Energy Ltd. (TransCanada) and Alta Gas Ltd. (AltaGas)2. Under the terms of the settlements, the government has agreed to discontinue its legal actions against the companies and arranged for the Balancing Pool to accept the return of the PPAs. Capital Power and its syndicate partners have agreed to pay the Balancing Pool CA$39 million. AltaGas will contribute 391,879 self-generated carbon offsets and pay CA$6 million to the Balancing Pool. TransCanada will also contribute offset credits, the value of which will be reflected in its year-end financial statements. Discussions with ENMAX are reportedly ongoing.3
Force majeure clauses
The term “force majeure” refers to causes or events beyond the reasonable control, and without the fault or negligence, of the party claiming that the cause or event has, in fact, occurred. In some agreements, this includes the adoption or change in any rule or regulation, or judicial decision lawfully imposed by federal, provincial, or local government bodies. The force majeure provisions of an agreement may relieve the parties from liability for any delay or failure in performance due to condition or events of force majeure, so long as certain conditions are met, and may allow for termination of the agreement if the event of force majeure continues for a certain length of time.
At this point in time, it seems unlikely that the impact of any carbon pricing regime could be so severe as to constitute force majeure. However, if a producer were forced to curtail energy output from the energy facility in order to meet an emissions cap, it is possible the producer could seek to rely upon these provisions.
Environmental attributes clauses
Some energy supply agreements anticipate potential climate change regulatory regimes that might be implemented by the federal or provincial governments. Some of these “environmental attributes” provisions specifically address which party will bear the cost or benefit of any emissions allowances or offset credits. In other cases—as in the example below—the details are left to future negotiations and, failing agreement, determination by a third party.
The parties to this energy contract acknowledge that the Government of Canada and Government of the Province of Ontario may propose regulations covering greenhouse gas emissions that may be applicable to this energy contract, including permits, credits and other allowances. If these regulations are imposed by either Government, or both, the Buyer agrees to propose amendments to this energy agreement. If the parties are unable to agree on the Buyer’s proposals within thirty (30) days after the applicable date of such regulations are published, then the amended provisions proposed by the Buyer and not agreed upon by the other parties will be determined by mandatory and binding arbitration, from which there shall be no appeal.
Under the PCF, a national carbon price will come into effect in 2018. Where there is uncertainty regarding the effect of carbon pricing on the terms of an energy supply agreement, the parties should consider beginning discussions earlier, rather than later, to avoid potentially costly arbitration or litigation.
The recent Alberta litigation, even if it does not reach the court, sends a clear signal to energy producers and purchasers that climate change regulation could significantly impact the profitability of energy supply agreements. How these impacts will be distributed among producers, buyers and end users will depend on the terms of each agreement and the directions of provincial energy regulators.
For additional information on the PCF, please see Pan-Canadian framework on climate change announced.
This article was co-authored by Marvin Coleby (Student at Law) of Dentons' Toronto office.