The Government of Canada recently published its Discussion Paper on options to cap and cut emissions from the country’s oil and gas sector. The Discussion Paper is the latest step from a federal government that has been very active in introducing and implementing measures intended to curb Canada's greenhouse gas (GHG) emissions as part of the overall effort to meet its international commitments and to achieve "net-zero" emissions by 2050.

Discussion proposals

The Discussion Paper begins by noting the federal government's legal obligation, set out in the Canadian Net Zero Emissions Accountability Act, to develop credible emissions reduction plans in order to meet its medium- and long-term emissions reduction objectives. It provides a relatively detailed background on Canada's oil and gas industry which stresses the important role (directly and indirectly) the industry plays in the Canadian economy and that of various provinces, as well as its importance for Canada's energy security and trade relationships. It also acknowledges GHG emission reduction successes by many companies, identifying several by name. At the same time, the Discussion Paper highlights challenges caused by the high direct emissions from Canada's oil and gas sector (representing 27% of all GHG emissions in the Canadian economy in 2020) and states that, in order to achieve Canada's GHG emission targets and international commitments, these emissions need to be reduced.

To that end, the Discussion Paper presents two different approaches for capping and cutting emissions from Canada's oil and gas sector and invites input on their design and implementation:

1. Development of a new cap-and-trade system (Cap-and-Trade Option) under the Canadian Environmental Protection Act, 1999; and
2. Modification of existing carbon pollution pricing (Pricing Option) systems under the Greenhouse Gas Pollution Pricing Act (GGPPA).

The Discussion Paper makes it clear that the intent is for the chosen regulatory option to apply broadly to direct emissions from upstream oil and gas production. Notably, it would not apply to emissions from natural gas distribution, oil pipelines, or end-users. The government is specifically seeking feedback on whether to include refineries and natural gas transmission pipelines under the emissions cap.

The Cap-and-Trade Option would likely be modelled after those implemented in Québec, Nova Scotia, and the European Union. The federal government would establish a total "quota" of GHG emissions for businesses caught by the cap. It would then issue emissions permits or "allowances" for each tonne emitted, requiring emitters to remit one "allowance" for each tonne of GHG emissions. Those allowances would be distributed via an auction process and potentially through "free allocation" to mitigate competitiveness and carbon leakage concerns. Importantly, the Discussion Paper explains that allowances from the cap-and-trade system would not be available for use in other regulatory or carbon pricing regimes. Similarly, surplus credits or performance credits from other regimes (e.g., provincial carbon pricing frameworks) would generally not be used within the cap-and-trade system.

The Pricing Option essentially builds off the existing federal "backstop" implemented under the GGPPA by proposing an "oil and gas carbon price”. The federal government would also establish what the Discussion Paper calls the "emissions cap trajectory”. The federal government would then adjust the oil and gas carbon price, as necessary, requiring provincial carbon pricing systems to adjust accordingly to maintain equivalence. Similar to the Cap-and-Trade Option, the Discussion Paper explains that the Pricing Option would need to ensure that surplus credits under other systems (e.g., provincial GHG pricing and offset schemes) could not be traded between the oil and gas sector and other sectors. The concern reflected in the Discussion Paper is that allowing oil and gas industry participants to acquire offsets from other sectors would undermine the regulatory objective by allowing participants to achieve compliance at a lower cost, avoiding the intended price signal and not taking steps to actually cut sector-specific emissions.

Considerations

As the number of GHG emissions reduction-related frameworks grows, a common question from regulated participants that fall within the scope of different schemes is the extent to which they can rely on activities or credits generated by compliance with a given scheme in order to achieve compliance with the other schemes. In other frameworks, such as the Clean Fuel Regulation, the federal government has encouraged reliance on credits generated under provincial schemes, explaining that it is indifferent about where emissions reductions take place, so long as they take place. In contrast, the Discussion Paper is focused on ensuring the desired emissions reductions happen within the oil and gas sector. For that reason, the Discussion Paper repeatedly explains the need for there to be restrictions that prevent trading credits or allowances between different sectors. Restrictions on the availability of credits or allowances decreases flexibility for participants trying to achieve compliance. Paradoxically, it is easy to see how this could affect compliance costs and place additional pressure on smaller participants in less emissions-intensive parts of the sector (e.g., conventional production) instead of large oil sands operators who may be better positioned to absorb the incremental compliance costs.

The Discussion Paper also raises topical questions about the ability of the federal government to target specific industries with a carbon pricing regulatory framework. The GGPPA, upheld by the Supreme Court of Canada (SCC) in the Carbon Pricing Reference, imposed a broad, economy-wide backstop price. The majority of the SCC found that legislation to be a valid exercise of the federal government's "national concern" power, partly on the basis that the GGPPA does not permit the federal government to regulate specific industries other than by setting national GHG emissions limits and prices (see para 76). The dissenting justices in that case expressly raised concerns that the GGPPA would allow the federal government to target specific industries (see paras 232, 240 and 249). The Discussion Paper appears to validate those concerns.

More recently, the majority opinion of the Alberta Court of Appeal in the Impact Assessment Act Reference found the federal Impact Assessment Act to be beyond Parliament's constitutional power to the extent that it allowed the federal government to regulate GHG emissions from specific projects. Both the majority and dissenting opinions in that case discussed federal jurisdiction over GHG emissions regulation and construed those powers narrowly. The federal government has appealed these findings to the SCC and most of the provinces have filed for intervenor status. The appeal creates another opportunity for the SCC to consider and clarify limits on the federal government's ability to regulate GHG emissions, including from specific projects or sectors. Any such findings might influence whether the federal government ultimately proceeds with attempting to cap oil and gas emissions and, if so, its chosen mechanisms.

Next steps

The Discussion Paper concludes by inviting formal written submissions on the guiding principles, policy design considerations, and regulatory options presented in the paper. To guide submissions, the Discussion Paper poses 22 different questions on a variety of topics, including the scope of the emissions cap, trajectory of the cap, competitiveness and carbon leakage, interaction with other federal and provincial climate measures, and the challenges with implementing the different regulatory options.

Formal submissions must be made by September 30, 2022. In the meantime, the Government plans to hold online engagement sessions to receive public input.

Once formal submissions and broader consultation are completed, the federal government will need to decide on the preferred regulatory approach. Depending on which approach is taken, it would need to introduce new legislation to amend the Greenhouse Gas Pollution Pricing Act or begin the process of drafting new regulations under the Canadian Environmental Protection Act, 1999.

Dentons Canada will continue to monitor developments arising from the Discussion Paper and the evolution of the proposed Cap-and-Trade Option and Pricing Option, and provide updates as they are announced. Please reach out to a member of Dentons’ Energy Innovation and Transition group if you would like assistance with the preparation of comments and submissions related to the Discussion Paper, or if you have questions regarding the Discussion Paper and how it may integrate with other existing emission reduction regimes.