The Oil and Gas Emissions Cap Explained

Quick links: 

• Regulatory Framework for an Oil and Gas Sector Greenhouse Gas Emissions Cap 
• Annex 5 of Canada’s ERP – Modelling and Analysis (Released in 2022) 
• Discussion questions for further consultation
   

A Brief History of Canadian Climate Policy 

The problem of how to decarbonize Canada was always going to be difficult. The last five federal elections have been defined by competing visions on how to address the issue. With the release of the Oil and Gas cap framework, the Liberal Government has laid out the biggest and most controversial component of their greenhouse gases (GHG) reduction plan.  

A price on industrial carbon was first proposed by Stephen Harper in 2008. At the time, economists considered it the most elegant solution to reducing emissions.  

When Justin Trudeau was first elected in 2015, he sought a grand bargain with the oil patch – accept a price on carbon and the federal government would guarantee that the beleaguered Trans Mountain pipeline would get built. The Alberta Government remained unconvinced, but a carbon price was implemented, and the Trans Mountain pipeline is nearing completion. 

Fast forward to today, and Canada has an economy-wide price on carbon, emissions are increasingly decoupled from GDP, and for most sectors, the trend line is going in the right direction.  

Yet, one area of our economy remains stubbornly difficult to decarbonize – oil and gas.  Unfortunately for Canada, the global consensus regarding the need to fight climate change under the Paris Agreement uses 2005 as the baseline year – predating the global demand for Canadian fuel products which has driven an increase in emissions from the sector, first with the development of the oilsands in Alberta, and then with the establishment of new Liquified Natural Gas (LNG) export facilities on the west coast of British Columbia. While overall emissions intensity has gone down, production is up to meet demand, presenting a major conundrum for policy makers. 

Enter the Oil & Gas Cap 

In 2021, Justin Trudeau’s Liberal Party was re-elected with a minority government on a platform that included a promise to “cap and cut” oil and gas emissions. The following year, Environment and Climate Change Canada released a discussion paper laying out policy options for a regulated cap on oil and gas emissions. The document relied heavily on scenarios laid out in the 2030 Emissions Reduction Plan (ERP).

The ERP made a variety of assumptions about global demand for oil and gas, Canadian GDP growth, and the ability of industry to rapidly decarbonize. It proposed a 42% reduction in GHG emissions from the sector by 2030 compared to 2019 levels.  

The Alberta government and many industry participants expressed strong concern with the proposed plan. They claimed that some of the underlying assumptions were incorrect, including the projected global demand for oil & gas, and the targets outstripped the technically feasible decarbonization pathways available in that timeframe.  

Killing the Golden Goose 

The Canadian government faces a set of conflicting interests with this policy. On the one hand, Canada has committed to achieving net-zero GHG emissions by the year 2050. On the other, Canada’s oil and gas revenues play an outsized role in supporting the Canadian economy and social program spending. 

By some estimates, combined government revenues from the oil and gas sector amounted to roughly $48 billion last year. In Alberta, around one-third of provincial revenues  are attributable to the oil and gas sector. 

Opponents of the policy have suggested that it could result in shutting down production and the premature unwinding of the entire sector, leading to capital flight, job losses and a huge hole in the Canadian tax base.  

Environment and Climate Change officials were left with the unenviable task of trying to reconcile these two competing interests.  

Carbon Leakage 

Another side-effect of overzealous regulation of our oil & gas sector is the threat of carbon leakage.

If the policy goal is only to reduce Canada’s total GHG emissions, there is one easy option: encourage industry to move production, and all of the associated emissions, to some other country. The production emissions then become someone else’s problem, and Canada can say that it achieved its climate targets. 

For both climate and economic policy reasons, this is a bad idea that everyone wants to avoid. 

Any effective cap on the sector needs to account for possible carbon leakage and consider the relative GHG emissions of our exported (and imported) fuel products under the new regulations.  

If lower GHG fuel products from Canada can be used to displace high GHG fuels overseas, then increased production and exports could result in global net reductions in GHGs. 

However, countries have yet to arrive at a global framework for how to account for the theoretical displacement of these emissions (sometimes referred to as Scope 4). Expect to hear a lot more about this topic in 2024.  

Jurisdictional Squabbling 

Another challenge for this policy concerns a dispute over jurisdiction.  

In 2021, the Supreme Court of Canada ruled that the federal government does have jurisdiction when it comes to regulating GHG emissions. It stated that because GHG emissions are a national and international problem, the Greenhouse Gas Pollution Pricing Act was constitutional. This led the federal government to believe that it was on solid footing to proceed with a cap on emissions from the oil and gas sector.

However, in 2023, this confidence was challenged by another Supreme Court of Canada decision, which ruled that many aspects of the federal Impact Assessment Act encroached on provinces jurisdiction to regulate their own resource sectors.  

The 2023 ruling led to a re-examination of the scope and mechanisms available to the federal government to regulate activities from specific industries. Any new law would have to be extremely careful to avoid encroaching on provincial jurisdiction with respect to natural resource production. 

Well in advance of any review of the policy design of the oil and gas emissions cap, the governments of Alberta and Saskatchewan have promised to fight the federal policy using every legal and political tool available to them. The ongoing political fight between Premiers Danielle Smith and Scott Moe and Prime Minister Justin Trudeau is red meat not just for the Conservative base, but for the Liberal base as well, where climate conscious voters have swung past federal elections.  

Canada Net Zero: Energy Supply and Demand Projections  

An important precursor to the release of the Oil and Gas Cap was the Canada Energy Regulator’s latest “Canada’s Energy Future” report, which modelled three different scenarios for oil and gas production in Canada. The “Current Measures” scenario demonstrates what would happen if no new climate policies were introduced beyond those that are currently implemented. The “Global Net Zero” scenario demonstrates the decline in Canada’s oil and gas production in a world where emissions will decrease to zero by 2050.  Finally, under the “Canada Net Zero” scenario, the regulator assumes that global demand for oil and gas will decline less gradually, while Canada still achieves net zero emissions by 2050. 

The federal government used the Canada Net Zero scenario to craft the new oil and gas emissions cap. Under this plan, significantly more emissions are abated using carbon capture and storage technology than under the global net zero scenario, due to sustained oil and gas production. This scenario reflects commitments by China to reach net zero by 2060 and India by 2070.   

The Regulatory Framework for an Oil and Gas Sector Greenhouse Gas Emissions Cap  

This brings us to the December 7, 2023, release of the long-awaited regulatory framework for the Oil and Gas cap, which will be subject to another round of consultations before the draft regulations are published in mid-2024. 

The new cap applies to upstream oil and gas production, covering 85% of total sector emissions, plus LNG. While LNG is downstream, as it is a net new development, the government has chosen to include LNG in the Oil and Gas cap to help meet its Paris targets which uses 2005 as a baseline.  

The new framework addresses some of the hurdles laid out above, first by creating room for growing LNG exports, provided that the emission intensity of the gas production improves over time. The framework also provides some flexibility for the oilsands companies, allowing them enough time to construct their $16.5 billion dollar carbon capture, utilization, and storage (CCUS) infrastructure. 

The proposed policy has several key features: 

• A new emissions cap with a “legal upper bound”: The framework includes two sets of targets. The first is the emissions cap, which is 35-38% below 2019 levels. The government, however, has also set a new “legal upper bound” which accounts for the estimated technically achievable reductions by 2030. This second target is 20-25% below 2019 levels.  The gap between these two targets is 25 MT of GHG emissions – accounting for the increase in production between the 2019 baseline and the Canada Net Zero scenario, assuming there was no abatement.  
• Bridging the gap: To achieve compliance with the stricter emissions cap, which is required for Canada to meet its 2030 targets, and to bridge the gap from the more realistic legal upper bound, the government is considering giving producers access to three mechanisms:
  • Domestic offset credits: Producers will be able to remit offset credits from the federal Greenhouse Gas Offset Credit System and from provincial systems, up to 20% of a facility’s GHG emissions. 
  • Internationally Transferred Mitigation Outcomes (ITMOs): The government may allow a portion of the 20% of GHG emissions that can be covered by offset credits to be used by ITMOs as a compliance option. While Canada wants to prioritize investment in domestic offset projects, this could allow the use of GHG reductions in other countries towards achieving Canada’s climate targets.  
  • Decarbonization fund: Instead of offset credits, producers can contribute to a “decarbonization fund” for up to 10% of a facility’s emissions. The decarbonization fund would be used in the oil and gas sector. It remains to be seen what projects would be eligible for this fund, given that “technically achievable” reductions are already included in the legal upper bound. 

• Distributed allowances: The regulator will issue a quantity of emission allowances, equal to the amount of emissions in the cap. Regulated entities are prohibited from emitting GHGs without remitting one emission allowance or other eligible compliance unit for each tonne of GHG emissions, up to the legal upper bound. This structure allows for some flexibility, permitting emissions to exceed the cap up to the upper bound​​. 

• A cap-and-trade market among covered facilities: Within the oil and gas sector, emission allowances and certain types of compliance units can be bought and sold on an emissions trading market. This market is designed to prioritize lower-cost abatement opportunities, allowing for economic efficiency in achieving emission reduction targets​​. Theoretically, this would allow producers to develop projects in regions where electrification or CCUS are not feasible – provided that they trade for emissions reductions in other regions where it is feasible.  

• Methane does the heavy lifting: Unlike in the 2022 discussion paper, under the new framework, reductions in methane emissions account for the majority of emissions reductions. This can be attributed to forthcoming regulations that seek to reduce methane emissions by 75% below 2012 levels by 2030 – producing 37 MT of emissions reductions under the Canada Net-Zero Scenario. In addition to methane reduction, the oilsands will be required to reduce emissions by 20 MT to reach the targets – which is under the 22 MT target set by the Pathways Alliance. Likewise, the natural gas production and processing sub-sector will be required to find an additional 6 MT in reductions beyond methane. 

• Scope and compliance: The regulations will identify regulated parties, establish terms and conditions for registering to the system, and for the issuance, use, and trading of emission allowances. They will also set out criteria for the creation and use of eligible compliance units, as well as the information that must be quantified, verified, and reported by those required to register in the system​​
• Multi-year compliance periods: It is proposed that compliance periods will have a length of three years, offering facilities more time to plan and implement emission reduction strategies​​
• Reporting, quantification, and verification: All covered facilities will be required to submit annual reports, including reporting facility GHG emissions, production, and indirect GHG emissions. Facilities must use quantification methods specified in the regulations.  

Next Steps 

Despite significant modifications made to the original proposal and modelling, do not expect to see support from industry or the Government of Alberta for this policy.   

Critics will contend that existing GHG abatement schemes like Alberta’s TIER program provide a sufficient carrot-and-stick approach to reward best practices while penalizing laggards.  

Environmentalists have welcomed the proposed policy but have urged the government to go much further in the prescribed GHG reductions. They would like to see industry decarbonize faster, alongside much larger public investments in green technology.  

The government has initiated another round of consultation, inviting responses to the proposed framework to be submitted in writing prior to February 5, 2024. They have committed to publish draft regulations in 2024, with publication of the final regulations in 2025, before the new regime is put into effect in 2026. This makes the implementation of the oil ana gas emissions cap an election issue, assuming that the Liberal-NDP Supply and Confidence Agreement remains in place until an election in the fall of 2025.  

ECCC is soliciting feedback on a variety of outstanding matters, including: 

• How should allowances be allocated; 
• How changes in production and new projects should be considered; 
• If, when and to what extent, some compliance flexibilities should be phased in or phased out; and 
• What administrative approaches can be used to define and regulate facilities with GHG emissions below 10 kt CO2e per year. 

Further questions? Counsel’s Federal team is always happy to talk. You can reach us at:

Sheamus Murphy
smurphy@counselpa.com

Ben Parsons
bparsons@counselpa.com