Written By Tom McInerney, Serge Dupont, Sarah Gilbert, Sharon Singh and Kenryo Mizutani

On March 5, 2021, the federal government released draft Greenhouse Gas Offset Credit System Regulations (Draft Regulations), providing some clarity as to how federal offsets will be created, tracked and ultimately used to satisfy greenhouse gas (GHG) emission reduction requirements for large emitters who are subject to the Greenhouse Gas Pollution Pricing Act (Canada) (the Federal Backstop).

The Federal Backstop, in effect since January 1, 2019, is the key piece of legislation whereby a national price on carbon is established. Currently, that price is set at $40/tonne of CO₂e and will escalate to $50/tonne of CO₂e in 2022. The federal government has announced its intention to further increase this price past 2022 in $15 increments, until it reaches $170/tonne of CO₂e in 2030.

The Federal Backstop is aptly named, as it only applies in respect of provinces that fail to implement carbon pricing schemes at least as stringent as those prescribed federally. It is comprised of two main elements: (i) an output based pricing system (OBPS) applicable to facilities that emit 50,000 tonnes or more of CO₂e annually and those facilities that have opted in to the OBPS system (Covered Facilities); and (ii) a fuel charge (commonly referred to as a carbon tax) applicable to prescribed fuels that are created, imported into or otherwise consumed within the applicable province.

Covered Facilities can achieve their emission reduction requirements under the OBPS by physically reducing their emissions, paying an excessive emissions charge, applying compliance units or a combination of the foregoing.

Compliance units under the OBPS can take three forms:

1. surplus credits: to the extent a covered facility reduces its emissions further than what is required by the OBPS, surplus credits are created in a quantity equal to such incremental reduction (similar to "emission performance credits" pursuant to Alberta's TIER regime);
2. recognized credits: a credit created by a provincial emission reduction regime that is recognized as complying with OBPS criteria (e.g., "emission offsets" created under Alberta's TIER regime pursuant to protocols recognized by the OBPS); and
3. federal offset credits: offset credits created by offset project proponents in compliance with the Draft Regulations.

Federal Offset Credits

By creating a mechanism by which federal offset credits can be created, tracked and used for OBPS compliance, the federal government has created a crucial compliance mechanism for Covered Facility owners who either are unable to achieve their emission reduction requirements through physical means, or are looking for a cheaper alternative to the cost of physical emission abatement or the excess emissions charge. While surplus credits can be used to achieve this end, it is unlikely that the quantity of surplus credits in the market are sufficient to meet the needs of all such Covered Facility owners.

The Draft Regulations create an offset credit system which is very similar to the system that has been in place in Alberta for years, with a few important distinctions. Like Alberta, the federal offset credit system is a voluntary system, allowing project proponents (Project Proponents) the opportunity to be issued offset credits for qualifying offset credit projects (Projects) that adhere to government approved protocols. Project Proponents will assert a quantity of offset credit creation, which must pass verification by an accredited third party before offset credits are issued. Offset credit protocol development is occurring in parallel to the final Greenhouse Gas offset Credit System Regulations, but the following four have been identified for initial development and issuance later in 2021:

1. Advanced Refrigeration Systems: a protocol for reducing or avoiding the use of fluorinated refrigerators such as hydrofluorocarbons that contribute to global warming;
2. Landfill Methane Reduction: a protocol for reducing methane emissions from open or closed landfill sites;
3. Improved Forest Management: a protocol for activities such as increasing rotation ages, thinning diseased trees, managing competing brush, and stocking trees for improved carbon storage; and
4. Enhanced Soil Organic Carbon: a protocol for agricultural activities that reduce GHG emissions and improve carbon sequestration on agricultural lands.

Project Eligibility

The Draft Regulations prescribe the eligibility criteria for Projects, the most important of which is additionality, meaning that a baseline of "business as usual" operation must be established with the reduction or displacement of GHG emissions relative to such baseline, forming the basis for offset credit issuance, and only in respect of actions which are not already required by law or are already the subject of an existing carbon pricing regime.

Crediting Period and Credit for Early Action

Projects may generate offset credits for prescribed periods depending on their type. Forestry Projects have an initial crediting period of 30 years, with all other biological sequestration Projects having 20 years to generate offset credits. All Projects other than biological sequestration Projects have an eight-year period within which to generate offset credits. These periods can be extended, with biological sequestration Projects capable of extension up to 100 years, with the balance of Projects able to have the initial crediting period extended no more than twice.

The Draft Regulations also contemplate credit for early action with Projects registered before December 31, 2023, eligible for credit creation for a Project start as early as January 1, 2017. Any project registered after December 31, 2023, can have a Project start date up to five years prior.

In addition to typical Project reporting requirements, Project Proponents of biological sequestration Projects are required to submit annual monitoring reports in an attempt to mitigate "reversals" (a release into the atmosphere of GHGs removed by the Project or for which offset credits have been issued). Such reports are required for each year of the Project's crediting period and for a period of 100 years thereafter (which obligation, in the aggregate, could go on for as long as 200 years).

Environmental Integrity Account

The Draft Regulations also contemplate the creation of a tracking system that will account for all offset credits issued and will be comprised, at a minimum, of two basic elements: (i) an Environmental Integrity Account (EIA); and (ii) a Project specific GHG offset account (the Project Account). The quantity of offset credits issued to a Project Proponent will be deposited into its Project Account net of a percentage that will be held back and deposited into the EIA. Offset credits deposited into a Project Account are tradable, enabling the Project Proponent to enter into bilateral agreements with parties wishing to acquire them. Offset credits deposited into the EIA are not tradable and are only used by the federal government as a way of addressing reversals. For biological sequestration Projects the percentage of offset credits that are withheld from the Project Proponent and deposited into the EIA is set at three percent plus an incremental percentage that is tied to the particular reversal risks of such Project, and for all other Projects, three percent.

Another notable feature of the Draft Regulations is the persistent liability a Project Proponent has for offset credits it has been issued that are the subject of a reversal, even after they have been sold to another party. In the case of a voluntary reversal (a reversal that is within the control of the Project Proponent or resulting from its failure to implement a Project risk management plan) a Project Proponent can, depending on the circumstances, face revocation of offset credits in its Project Account, a requirement to supply replacement compliance units (failing which the federal government can effect such replacement by drawing on the inventory from the EIA) or even cancelation of its Project. For an involuntary reversal (a reversal that is out of the Project Proponent's control or occurs in spite of it implementing a Project risk management plan) the Project Proponent would not be required to supply replacement compliance units and instead the federal government would draw on the inventory from the EIA to cover the reversal, provided that the Project could face cancellation depending on the magnitude of such reversal.

Implications for the Canadian Carbon Credit Market

The Draft Regulations represent a necessary compliance option for the OBPS system, but has the potential to influence Canadian carbon credit markets more broadly. For the most part, provincial GHG emission regimes, like Alberta's TIER, operate as closed systems, with the credits created thereunder only useable within the context of their particular provincial regimes. The OBPS, through the concept of recognized credits, provides a means by which a provincial GHG credit can be used within the federal OBPS. But whether or not federal offset credits can be used to satisfy a provincial emission reduction requirement remains to be seen, as this will require further agreement between the applicable province and the federal government and amendments to the applicable provincial GHG regime. Accordingly, industry will be watching closely to see the extent to which federal and provincial GHG regimes, and the carbon credit markets that have sprung up to address their respective compliance needs, become more integrated.

If you have any questions regarding the Draft Regulations, please contact a member of the Bennett Jones' Climate Change & Emissions Trading, Power & Renewables or Governmental Affairs & Public Policy practice groups.

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