The Meaning of Copenhagen

Before looking ahead, it’s useful to quickly review what happened at the highly-publicised and over-reported December meeting in Copenhagen of the parties to the UN Framework Convention on Climate Change or “UNFCCC”. This was the 15th meeting of the Conference of Parties to the UNFCCC, the so-called “COP-15.” [1]

The main objective of COP-15 was to try to extend the Kyoto Protocol, an addendum to the UNFCCC that expires in 2012. It’s the Kyoto Protocol that contains individual country targets for reducing greenhouse-gas (GHG) emissions. Canada signed on to the Kyoto Protocol and is legally committed to reducing its emissions by 6% below 1990 levels by 2012. The US is party to the UNFCCC but did not sign the Protocol.

The biggest impediment to extending Kyoto beyond 2012 was the position of the US, the UK, Canada and others that the larger developing countries like China, India and Brazil also had to accept GHG reduction obligations, having been excluded from such in the Protocol. This turned out to be a critical stumbling block.

In the end, no agreement was reached at Copenhagen and there were many recriminations. The media fed on this. However, a conference declaration called the Copenhagen Accord was tabled on 18 December 2009 and while not agreed to by all COP countries, was formally “noted” in the conference’s conclusions.

There is great doubt over the value the Accord. It’s not binding. It contains no fixed commitments for the post-2012 period. However, it at least establishes a policy goal to curb global warming from rising above 2 degrees Celsius (with no deadline) and a “soft” commitment by UNFCCC countries to take steps to meet their own emission-reduction targets by 2020. In Canada’s case, the Government issued an undertaking prior to Copenhagen to reduce GHG emissions by 20% from 2006 levels, far exceeding Canada’s Kyoto target based on 1990 levels but on a par with the position of the United States.

Given obvious public concern and pressure, it's hard to see the Canadian or US or other governments backing off their recognition of the need for urgent action enshrined in the Accord and on their stated reduction undertakings.

Reflecting the position of developing countries for recognition of their differentiated responsibilities, the Accord refers only to a general undertaking to on their part to voluntarily curb carbon intensities.

Although no time-line has been set out in the Accord. there is agreement on the objective of concluding a formal treaty and on the overall nature of the negotiation process within two Ad Hoc Working Groups. How these negotiations will play out is not entirely clear. We may be in for a kind of never-ending process, akin to the extended Doha Round trade negotiations in the WTO.

Climate Change and Trade

One of the most contentious issues at Copenhagen was the interplay between national climate change policies and international trade rules under the WTO Agreement. There are major disagreements in this area.

A main focus of dispute was over the border measures in the Waxman-Markey bill, which passed the US House of Representatives in July as the American Clean Energy and Security Act of 2009 (ACESA). The bill envisages the use of 0complex border taxes and emission allowances needed for carbon-intensive imports. The WTO Agreement, however, generally prevents discriminatory taxes or other measures affecting imported products.

The rationale for border measures in Waxman-Markey is to level the playing field on imports from countries with either no, or less stringent, climate change laws where their industries bear less of a burden. The other objective is to counter “carbon leakage”, where manufacturers move operations to locations where climate change laws are less stringent or non-existent.

The draft legislation has traction. It is now progressing through the Senate - where it is known as the Boxer-Kerry bill. It passed the important Senate Environment and Public Works Committee in December 2009 and is now slated to come before other committees (including the all-important Finance Committee) sometime during the next few months.

The Senate version differs from Waxman-Markey in significant ways (particularly in the more ambitious reductions of GHG emissions by 20% by the 2020 date) and may be changed further through the mark-up process before it gets passed. Even if it's delayed in the Senate, it’s generally accepted that no climate change laws will secure Congressional approval without stringent border measures. These are seen as leveling the playing field and protecting exposed US industries from international competition.

The use of measures of these kind was one of the most controversial subjects at Copenhagen and remains so today. For Canada, this is a particularly troubling matter given the close integration of our economy and that of the United States.

Another central ingredient of the US bill is allocation of free carbon emission allowances and a variety of offsets to carbon intensive industries, easing the transition to full the CO2 reduction requirements under the proposed law. These run up against the restrictions on the use of subsidies for goods that are then exported and injure foreign industries, raising the spectre of trade disputes under the NAFTA and the WTO Agreement unless some kind of agreement is concluded between Canada and the US to forestall trade actions in the context of bilateral climate change arrangements.

Parallel Action by US Agencies and States

As climate-change legislation is being debated the Senate, the Obama Administration is taking parallel action to reduce CO2 emissions through the Environmental Protection Agency (EPA), which issued a milestone finding in 2009 that GHG emissions endanger public health, giving the Agency the power to regulate emissions under the Clean Air Act. This authority would cover a range of large GHG emitters and, importantly for Canada, could be used by the EPA, among other things, to boost the low carbon fuel standards (LCFS) for motor vehicles.

Either way, this proposed EPA action, in combination with a possible ground-breaking American climate-change law in 2010 or 2011, will have major repercussions for international trade, including Canada’s trade and business relations with the United States. In terms of legal issues, it’s doubtful that the proposed subsidies and border-related climate change measures could be sustainable under the NAFTA or the WTO Agreement. Without some kind of common agreed approach between the two countries, major and disruptive trade litigation could be the result.

The situation is more complicated for Canadian business in that a number of US states have agreed to develop their own common LCFS, following the California approach. One of the more immediate threats to Canada-US business is that these state-endorsed standards could come into effect as early as 2010 without regard for the bilateral trading relationship.

Emissions Trading Markets

International trading of carbon emission credits is a key element under the Kyoto Protocol. Kyoto member countries with emissions less than their permitted limits can sell credits to other countries. The Protocol also allows carbon credits or offsets to be earned through investments in emission-reduction (“green”) projects, either in industrialized countries through the Joint Implementation (JI) mechanism or through the Clean Development Mechanism (CDM) involving investments from developed to developing countries.

Robust international carbon trading markets have developed under these various Kyoto mechanisms. A joint WTO/UNEP report (2009) says that the global carbon market will reach almost 6 giga-tonnes of carbon dioxide equivalent in 2009, up 20% from the previous year.

Among the regional and local trading schemes that have emerged as a result of Kyoto, the most advanced is the EU’s Emissions Trading Scheme (EU-ETS), introduced in 2005 and covering some 10,000 installations that comprise about half of the EU’s CO2 emissions – power generation, iron and steel, glass, cement, pottery, bricks and others. While lack of agreement in Copenhagen affected the market price (carbon currently trades on the ETS at about €14 per tonne, down from its €20-25 per tonne range in 2008) it is expected to recover over the near term.

In the Canada-US context, at bilateral meetings in September 2009, Prime Minister Harper and President Obama agreed to cooperate on developing joint climate change policies. Whether this will lead to joint recognition of carbon credits and the creation of a single Canada-US emissions-trading market, akin to NAFTA’s free trade in goods and services, remains to be seen. The condition sine qua non for such a regional market is mutual recognition and certification of each others’ credit issuing agencies.

In the meantime, in the absence of government regulation, voluntary carbon markets have been developing in North America. While these are in the formative stages, in the US, credits issued by through the Regional Greenhouse Gas Initiative (RGGI) trade on the Chicago Climate Exchange, currently North America’s largest voluntary exchange. Plans are underway under agreement among seven western US states and four Canadian provinces under the Western Climate Initiative (WCI) to launch a regional cap-and-trade system in 2012, which will involve cross-border trading in these credits.

One of the challenges in Canada-US trade is to ensure that agreed bilateral mechanisms are in place to maintain open markets in this cross-border trade so to ensure that credits issued in one country can have fair and non-discriminatory access in the market of the other. So far, insufficient attention has been given to this issue on either side of the border.

Conclusions

Canadian business should be able to draw several conclusions from this brief review.

First, climate change efforts will not cease in Canada, the US and elsewhere, even with the setback in Copenhagen. The fact that a major piece of cap-and-trade legislation passed the US House of Representatives in 2009 is an indication of the degree of support this has in Washington.

Second, even if the Senate bill is delayed in 2010, Canadians should be attentive to the dangers of potential border measures facing exports to the US. While a number of sectors may be excluded from border requirements in any US law, for non-excluded sectors to qualify will require Canadian CO2 reduction measures to be at least as stringent as those in the United States.

Third, with pressure off under the Kyoto process and with possible further legislative delays in the US Senate, the action on climate change may shift to US agencies such as the EPA or the individual US states.

Fourth, with respect to the often neglected benefits of carbon trading, it would seem in the mutual interest of business on both sides of the border to ensure non-discriminatory access and free trading of credits in each others’ markets.

Given these factors, Canadian business should be preparing contingencies and strategies and looking for ways to protect their interests under any one of the above scenarios.