Want a discussion about Canada’s climate change policy? Here’s a start

What are we going to do or not do?

Global Warming Minnesota

It has been a month now since the Prime Minister directed us to his frankness on the matter of climate change and government policy. Frankness in our political discourse is to be encouraged. Frankly, there are various questions that remain to be sorted out.

We are now a month closer to the deadline to meet our Copenhagen targets for the reduction of greenhouse gas emissions. The government apparently remains committed to its targets. But Canada remains way short of meeting those targets.

Part of meeting those targets—possibly a big part—will be new regulations for the oil and gas sector. Last week, the Alberta government extended the deadline—previously set for September—for renewal of the province’s carbon levy for major emitters. In April, it was reported that the federal and provincial governments had agreed to a plan to see Alberta double its levy—from $15 per tonne for those who fail to reduce emissions intensity by 12 percent to $30 per tonne and a 24 percent reduction—but such a move has so far failed to materialize and presumptive premier (and former federal environment minister) Jim Prentice now says he won’t raise the levy unless the United States is willing to implement a comparable policy.

This seemingly puts Mr. Prentice in line with the Prime Minister, who believes national oil and gas regulations—though twice promised previously by Mr. Harper’s government—now must wait for the United States so that our two countries can act in concert.

That might be an excuse to put off any further discussion. But if we truly want to be frank with ourselves, here are the questions we might ask.

What is the state of discussions with the United States?

According to a CBC report last fall, Stephen Harper wrote to Barack Obama last August to suggest cooperation on oil and gas regulations. A few weeks ago I asked the Environment Minister’s office for further details: When was the last time the Prime Minister, the Environment Minister or any other representative of the government spoke with a representative of the American government about GHG regulations for the oil-and-gas sector? How often have such discussions taken place over the last four years?

The response: “Given the integration and close trading relationship between our two countries, Canadian and American officials regularly meet to discuss a number of issues. We will continue to work with the United States to advance issues of mutual interest.”

Last week, I asked the Alberta government for its view. When was the last time the Alberta government discussed regulations for the oil and gas sector with representatives of the U.S. government? How often have such discussions taken place over the last two years?

The response, in part: “Premier Hancock; Ministers McQueen, Campbell and Dallas raised this issue in May when they met with Ambassador Heyman … Over the past two years, Alberta has consistently raised our desire for a common approach to emissions reduction during meetings with U.S. federal and state environment and energy policy makers. This commitment was also clearly stated in Alberta’s written comments submitted during the various KXL public comment periods and during speeches delivered by the Premier in New York and Washington in 2012 and 2013.”

If the argument now is that Canada should wait for the United States, this would seem to be an important point: what effort is being made in pursuit of that goal? Presumably, if that goal is meaningful, we should expect to be kept abreast of those efforts.

When might the United States be ready to regulate the GHG emissions of its oil and gas sector?

This seems unclear. I’ve been unable to find an answer to this question, but will continue to pursue one.

I did ask the Alberta government when it thought the U.S. government might be able to act. The response: “We recognize that this is a complex issue for policymakers, but opportunities for progress exist. We have ongoing bilateral engagement with the U.S. at both the federal and state levels and with regional and multi-state organizations.”

Why should Canada have to wait for the United States to act?

A couple weeks ago I spoke with Jim Prentice. Here is part of his explanation for why Canada should act in concert with the United States to regulate the oil and gas sector.

The issue is our competitiveness vis a vis the United States, which in the oil and gas industry has become Canada’s major competitor. My point is that this industry competes across the border, carbon emissions are across the border and we should be moving in concert with the United States to address the challenge. I don’t disagree that we should address it and I’ve given speeches about the importance of Alberta, in particularly, assuming a position of leadership on what needs to be done. But my view, quite strongly held, is that we should not be proceeding unilaterally. For a couple of reasons. I became convinced of this really a number of years ago when I was the chair of the energy and environment committee of the federal cabinet and we did a great deal of modelling on the consequences of imposing carbon costs on one side of the border but not on the other. And I became convinced that even small increments in terms of carbon cost can result in pretty immediate and significant changes in terms of investments and jobs and, in particular, that if you layer on costs on the Canadian side of the border that are not present on the U.S. side, people will make investment decisions that drive capital to a U.S. location with really multi-generational consequences because these are, in many cases, 50-year investments that people are making.

Alex Ferguson, vice president of policy and the environment for the Canadian Association of Petroleum Producers, also stresses “competitiveness” as the primary concern in the context of what other costs and policies are applied to the oil and gas sector.

The Pembina Institute’s Simon Dyer recently argued that adopting the 30/24 plan noted above would be a relatively small concern for oil companies.

The oilsands sector already deals with a large number of factors — wages, royalties, capital costs and oil and natural gas price variances — that are many orders of magnitude more material than the proposed regulations the Canadian and Alberta governments have discussed but not implemented. Those regulations would impose a penalty of 5-to-8 cents per barrel on companies that choose to pay rather than reducing their emissions.

I put Dyer’s estimate to a representative of Suncor and was told that Suncor thinks the per barrel price would be higher than that. But, for its own part, Suncor recently released an analysis of what a $40 price per tonne would mean for its Fort Hills project.

To determine how a change to Alberta’s current greenhouse gas regulation could impact this project, we applied our shadow carbon price. That means, in addition to using the existing penalty of $15/tonne CO2e on 12% of emissions, we also explored various regulatory scenarios.

For instance, if the existing carbon penalty were to increase to $40/tonne CO2e (or $55/tonne when considering inflation over the life of the project) on a steadily increasing percentage of project emissions, the projected change to the project’s internal rate of return (IRR) would be 0.10%. Now, if we apply the same $40/tonne CO2e as a flat carbon tax on all Fort Hills GHG emissions, the expected change in IRR is 0.39%.

Suncor estimated a 13 percent rate of return when it approved the Fort Hills project last fall.

I suggested to Suncor that an impact of 0.1 to 0.39 percentage points was rather small and while the company didn’t quibble with my adjective, it did offer the following.

Please do keep in mind that this is one of many items that can affect resource development and operating costs. Canada’s oil sands are being developed within one of the most strict regulatory systems in the world. And while we’re certainly willing to comply with regulations – and often go above and beyond compliance – it’s still worth noting that the commodities we produce have to compete globally.

CAPP’s Alex Ferguson, meanwhile, argued that a $40 price per tonne would have a negative effect on the sector.

That marginal difference may appear on that specific project to be pretty low and minor, but in terms of overall movement of capital goods across countries, slimmer margins effect bigger change in many other instances.

Cenovus, another major producer, tells me that it tests its business models at $15 per tonne and at $65 per tonne and that it believes the company is “well positioned to compete, even at $65/tonne.” But, a spokesman adds, “Whatever regulations government comes up with, we favor a system that: creates a level playing field across industry, across the country, and preferably across North America; will stimulate innovation and investment in technologies that will help us minimize GHG emissions.”

To that last point, Cenovus points to Alberta’s system, which has producers pay into a technology fund.

I asked my colleague Andrew Leach for a few thoughts on the costs involved here and he sent along the following.

How important are the competitiveness challenges imposed by acting alone? At the stringency levels of any policy proposed by the federal or Alberta governments, the effects would be small (the exception here is the Harper Government’s Turning the Corner Plan, which would have had serious competitiveness impacts on oil sands projects). Consider the so-called 40-40 approach which was proposed by the Alberta government under then-premier Alison Redford. This policy would have required oil sands facilities to reduce their emissions per barrel by 40% relative to the emissions intensities observed once the facility was up-and-running (the current Alberta policy uses a 3rd year benchmark). In other words, each facility is judged against its own history, not against its peers. If the facility were not able to reach its targeted emissions intensity reduction, they would be able to comply either through trading with other firms who have over-complied, through the purchase of emissions offsets, or through contributions to a fund devoted to developing new technologies for climate change mitigation. If you assume that a facility operates at the same emissions intensity for its entire life, and complies only through financial contributions, you’d expect them to pay an average cost of $16 per tonne of emissions, or for an average oil sands site, somewhere in the $0.60-1.50 per barrel range, depending on the facility. However, it’s not quite that simple.

To understand the impact of new policies applied to oil sands, you’d also want to consider what’s in place now and how the change interacts with tax and royalty policies. Let’s look at a new mine with characteristics similar to Suncor’s Fort Hills project, now in construction. The mine would be expected to have production emissions somewhere in the range of 0.045t/bbl bitumen, which would imply cash costs per barrel produced at the low end of the range above – about $0.72/bbl in today’s dollars. The average costs would be lowered by the fact that the mine would not pay anything in its first three years of operation, and then the compliance requirement would likely only reach 40% after a few years (the current Alberta regime scales up from a 2% reduction requirement in year 4 to a 12% eventual requirement which must be met from year 9 onward. Assuming that a similar schedule would apply to the 40-40 case would reduce the average costs per barrel to $0.58c/bbl in today’s dollars if we assume that the $40 cash cost is indexed to inflation, and about 0.33c/bbl if we assume that it remains at $40 forever as has been the case so far with Alberta’s $15/tonne policy. By contrast, the average cost of today’s policy for a similar project would be $0.03c/bbl on average, so it’s a big increase in percentage terms. Most importantly, costs are deductible for calculation of project payout and project net revenues for royalty purposes, as well as for calculation of net revenues for corporate income tax purposes. As a result, while the change in policy would increase GHG compliance costs by $0.55/bbl, it would lead to a $0.22/bbl reduction in royalties and a $0.08/bbl reduction in taxes, meaning that the increased compliance costs lead to a reduction in profits of $0.25/bbl – less than half the pre-tax and pre-royalty costs. Over the life of the project, this change in costs would likely reduce the return on investment by less than 0.1% relative to the current policy – hardly a change which we’d expect to cause a massive flight of capital.

Other policies which have been proposed, either by CAPP who reportedly supported a 20% reduction requirement coupled with a $20 per tonne compliance fee, or more recently in the Alberta government’s reported double-double proposal would have had even more modest impacts. Using the same assumptions, the impact of the double-double policy would be less than a Timbit per barrel – a $0.10/bbl impact on average profits – while the impact of the CAPP proposal would be even smaller still.

Possibly the only way this particular issue gets sorted is if everyone puts their numbers on the table. Never mind what anyone thinks should or could be done, let’s see the analysis that underpins those assertions. That, frankly, would seem like the only way to be frank about this.

There is, of course, much more to be discussed here (Is our lack of emission regulations hindering our ability to export oil? Was Stephen Harper correct to assume, as reported, that new regulations wouldn’t have helped get Keystone XL approved? What would get us to our Copenhagen targets? What are the Liberals and New Democrats going to propose in 2015? What are the projected impacts on Canada of climate change?), but these three questions might serve as a basis for any frank discussion about where Canada’s policies on climate change are headed.