Canada's Clean Fuel Standard: Competitiveness and gaseous fuel considerations

In late 2016, the Government of Canada announced that it would develop a national low carbon fuel standard called the Clean Fuel Standard (CFS). The CFS will have wide-reaching and potentially significant financial impacts for all Canadian businesses. The CFS will have three main objectives:

1. Achieving annual GHG reductions of 30 million tons by 2030 throughout the lifecycle of fuels
2. Enabling low-cost compliance
3. Encouraging investments and innovation in low-carbon-intensity fuels

 This is the last in a series of blogs where we detail the proposed CFS regulation. In previous blogs, we recapped the CFS development process [1], outlined CFS reduction and reporting requirements [2], detailed the credit creation process [3], and highlighted program design elements to facilitate trading and market development [4]. In this update, we outlined some of the competitiveness considerations of the proposed CFS regulation and recap what is known about the regulatory design for the gaseous fuel section of the CFS.
 

A Pause for COVID-19

In spring 2020, ECCC announced that the publication of the proposed regulations for the liquid fuel class would be delayed from spring until fall 2020 due to the COVID-19 pandemic. Figure 1 outlines the revised timeline for the development of the liquid fuels portion of the CFS program. It is expected the development of gaseous and solid fuel regulations will follow a similar timeline as the liquid fuel class regulations, plus 12 months.

Figure 1 – Regulatory development timeline for the liquid fuels portion of the CFS program

Considerations for emissions-intensive and trade-exposed sectors

Unlike low carbon fuel standards that have been implemented in other jurisdictions, the Canadian federal government’s CFS would extend beyond transportation fuels and require low carbon fuels to be used in industrial operations. This requirement will have significant implications for emissions-intensive and trade-exposed sectors. Industries that exports products to global markets will be in a weaker position relative to their international competitors given the incremental compliance costs associated with the CFS program. The adverse competitiveness impacts could lead to “carbon leakage”.

Carbon leakage refers to the situation where businesses relocate their production facilities to other countries that have less stringent climate policies. Businesses that stay put, face higher compliance costs and will be at a competitive disadvantage. We detailed issues associated competitiveness exposure and protection measures related to carbon pricing in a previous blog [5]. Given these concerns, we examine the question: What is ECCC doing to address the issues of competitiveness-driven carbon leakage in the proposed CFS regulation?

In their Proposed Regulatory Approach released in June 2019 [6], ECCC lists the parties and activities currently exempted from the CFS program:

• Fuels used from non-combustion purposes
• Feedstocks that are used for non-combustion purposes in industrial processes
• Fuels used for scientific research
• Fuels used by remote communities
• Liquid fuel used for international marine or aviation use

While the list of exempted activities offers little protection for most industries, ECCC mentions the possibility of expanding its list of parties that are exempted from the CFS program to account for the following considerations:

• impact on GHG reductions;
• impact on market signal for investment and innovation in low-carbon-intensity fuels and technologies;
• availability of other compliance flexibilities within the CFS that can address or mitigate the issue of concern;
• adverse impacts on compliance cost and industry competitiveness;
• impacts on household costs;
• technical feasibility and supply logistics considerations; and
• interaction with carbon pollution pricing and other GHG mitigation regulations

It is promising to see that ECCC would consider expanding the list of exempted parties based on industry competitiveness. However, competitiveness impacts appear to be more of an afterthought rather than part of the core regulatory design. The fact that ECCC is charging ahead with implementing a CFS obligation on gaseous fuels used in industrial operations may lead observers to believe that reducing industry competiveness is a feature, not a bug. The CFS regulation will impose a cost on trade-exposed sectors and that cost cannot be flowed through to consumers. Compliance cost must therefore be borne by Canadian industries. This is a cost that other jurisdictions simply do not have. All else being equal, the gaseous CFS will reduced the competitiveness of Canada’s emissions intensive industries and will likely result in carbon leakage.

ECCC acknowledges that emissions-intensive and trade-exposed sectors have expressed concerns that the cost of the CFS could impact competitiveness. To address this concern, ECCC has introduced design features to increase credit supply and is facilitating low-cost compliance by incorporating flexibility design parameters. These policy design features are highlighted in Figure 2.

Figure 2 - Design features to increase credit supply and compliance flexibility

Emissions-intensive and trade-exposed sectors may argue that features designed to increase credit supply and compliance flexibility are not sufficient to address adverse competitiveness impacts. That might be a fair point. However, future compliance costs for industry are still very uncertain. Ultimately compliance costs will depend on supply and demand dynamics in the CFS credit market. Ensuring that a sufficient volume of low-cost credits is available will depend on the private sector’s response to invest in low carbon technology that is eligible to generate CFS credits. Predicting the private sector’s future investment patterns requires a view on market, technological, and political factors. With no crystal ball to know what the future may hold for the CFS credit market, the best industry can do is seek to understand the single piece of the CFS program that will likely have the most significant and direct implications for future compliance costs: the gaseous fuel compliance obligation.
 

Regulatory Design for Gaseous Fuels

While the Proposed Regulatory Approach primarily addresses the liquids fuel class, the document offers some hints regarding compliance requirements and policy design under the gaseous fuel class. It is expected the development of gaseous and solid fuel regulations will follow a similar timeline as the liquid fuel class regulations, but 12-months behind. Regulations for gaseous and solid fuels are expected to come into force mid-year 2023.
 
Under the gaseous fuel class, a “fossil fuel primary supplier” will be responsible for meeting carbon intensity reduction requirements. This primarily includes natural gas producers, importers, and natural gas pipeline companies. For natural gas producers that use self-produced fuels on-site in their facility operations, the carbon intensity reduction requirement will be the same as the baseline carbon intensity values. Further, the CFS regulation will not differentiate between sour or sweet natural gas. A Canadian average carbon intensity value (which reflects the average fossil fuel carbon intensity value) will be used to set the baseline carbon intensity. The baseline carbon-intensity values for gaseous and solid fossil fuels are outlined in Table 1. Beyond these details, little is known about the regulatory design for gaseous fuels. Given the materiality of this regulation, parties should watch this space with a keen eye for future developments.
 
Table 1 - Baseline carbon intensity values for gaseous and solid fossil fuels

Conclusion

This is the last in a series of blogs providing in-depth analysis of the CFS regulation. While the CFS program will present some significant challenges to the competitiveness of emissions-intensive and trade-exposed sectors, there are some policy design features that will help to offer compliance flexibility and hopefully, lower compliance costs. It is important that industry understand these compliance flexibility mechanisms (in additional to the broader regulatory design) in order to prepare a CFS compliance strategy that allows obligated parties to mitigate the potential for high compliance costs. This is particularly important for large industrial users of natural gas. While detailed policy design on the gaseous fuel class has not yet been published, industry would be wise to keep an eye on the evolution this emerging regulation.
 

References

[1] https://us12.campaign-archive.com/?u=9260b91e2aab82400d1bb3232&id=495be97354
[2] https://mailchi.mp/fb41d2084fd7/canadas-clean-fuel-standard-requirements-and-reporting
[3] https://mailchi.mp/d8c7150d15ed/canadas-clean-fuel-standard-credit-creation
[4] https://mailchi.mp/7ce775a359fb/canadas-clean-fuel-standard-credit-trading-and-markets
[5] https://us12.campaign-archive.com/?u=9260b91e2aab82400d1bb3232&id=b380adf899
[6] https://www.canada.ca/en/environment-climate-change/services/managing-pollution/energy-production/fuel-regulations/clean-fuel-standard/regulatory-approach.html