Canada’s very low carbon price on oil production

Part 14 in a series of 18 discussion papers

Despite the Supreme Court of Canada’s important decision on March 25, 2021, affirming that the Federal Government has the constitutional power to impose a carbon price on all emitters, the carbon price on oil producers in Canada has in fact been set at a level so low that it provides no disincentive to ongoing rapid oil production increases.  

The Federal Government’s approach to imposing a carbon price on GHG emissions released at major industrial sites across Canada, including at oil sands production sites, is detailed in the Output-Based Pricing System Regulations, published in 2019. The 147-page document sets out the key features of this pricing scheme and explains the government’s rationale for adopting it (see:

An explanatory note that accompanies the Regulations (starting at page 101) provides the government’s explanation why the carbon pricing system that applies to Canada’s most emissions-intensive industries is designed the way it is. It begins with a very brief statement that describes, in a simplistic way, why rising emissions are a problem:  

Greenhouse gas (GHG) emissions are contributing to a global warming trend that is associated with climate change, which will lead to changes in average climate conditions and extreme weather events. It is widely recognized that economy-wide carbon pollution pricing is the most efficient way to reduce GHG emissions.

The explanatory note continues:

However, not all jurisdictions around the world are putting an equivalent price on carbon pollution. This creates a risk for industrial facilities that are emissions-intensive and that compete in international markets. If these Canadian facilities face costs on their GHG emissions that their international competitors do not, they may lose market share to facilities in other jurisdictions with lower carbon-related costs.

This can result in a phenomenon known as carbon leakage, in which production is simply displaced to another location, with domestic emissions “leaking” out of Canada to other jurisdictions. Without appropriate measures for industrial facilities, it is also likely that competitiveness impacts and carbon leakage leading to production losses could lead to corresponding impacts on the welfare of Canadian households.

Output-Based Pricing System Regulations (emphasis added)

The government therefore claims that if oil producers in Canada lose their “competitiveness” due to their increased costs of production per barrel (because of the additional carbon price costs imposed on producers in Canada), oil producers in other countries may increase their production to displace our “market share”. As a result, the explanatory note to the Regulations claims, “global GHG emissions may not decrease, undermining the purpose of the carbon pollution pricing policy.” Following that logic, the government’s answer is to set the carbon price that applies to oil producers at a very low level, so that the Canadian oil industry does not lose any market share.

The output-based pricing system

The Greenhouse Gas Pollution Pricing Act, which the Supreme Court of Canada upheld as fully within the constitutional authority of the Federal Government, comprises two different schemes that empower the government to impose a carbon price on Canadians, including on large-scale industrial emitters. In this discussion, the focus is on how the Act applies to the oil and gas sector.

Part 1 of the Carbon Pricing Act establishes a “fuel charge” against producers, distributors, and importers of various greenhouse gas (“GHG”) producing fuels and on virtually all other kinds of economic activity that release GHGs into the atmosphere (i.e., on heating in commercial buildings and households). The fuel charge applies to a wide range of fuel products distributed to businesses and consumers, including retail gasoline sales. The fuel charge under Part 1 was increased to $50 per tonne in 2022. It has been rising since 2018 by increments of $10 per year and will in 2023 and after increase by $15 annually and rise to $170 per tonne by 2030.

However, Part 2 of the Act allows the executive (the cabinet) to designate a facility (for example, an oil sands extraction operation or a natural gas processing site) as a “covered facility”, thus exempting it from paying the fuel charge. Similarly, the Act allows the government to exempt a long list of other kinds of industrial activities (fertilizer producers, iron and steel production, chemicals, cement, etc.) from the “fuel charge” provisions. To qualify for that exemption, those industries must demonstrate that (i) their operations are “emissions-intensive”; (ii) that they are dependent on exporting their products to foreign markets (or are exposed to competition from low-cost foreign imports); and (iii) that if they are obliged to pay the full amount of the “fuel charge” prescribed under Part 1, they will become less “competitive” and are at risk of “losing market share”

Therefore, Part 2 creates an alternate carbon pricing scheme for these “trade-exposed” industries. It dramatically lowers the carbon price that would otherwise be applicable to their operations under Part 1.  This alternate carbon price scheme is called the “output-based pricing system” (OBPS). Under the OBPS scheme, an oil producer is assigned an “annual facility emissions limit”. It pays no carbon price at all on the portion of its emissions that fall within its allowed emissions limit. Subject to the specific features of an individual facility that make its emissions higher or lower than the industry average, this scheme exempts about 80% of the facility’s entire emissions from any need to pay a carbon price. Here is how it works:

First, the government calculates the average emissions intensity for all the production facilities involved in that specific industry. In the case of heavy oil producers, emissions intensity is measured in kilograms of carbon dioxide per barrel of crude oil (kg CO2). For heavy oil production, the average was determined to be about 68 kg CO2 per barrel.The actual level varies significantly between producers. For one company, it might be higher at around 90 kg CO2 per barrel (or above that) or lower in the range of 50 kg CO2 per barrel.

The government then establishes a “performance standard” or numerical “output-based standard” for that industry. For the heavy oil industry, it is set at 80% of the industry average: the standard is set at a level 20% below the average emissions intensity for that industry (the performance standard for most other industries in Canada is also set at 80% of the average for the industry).

Under Part 2 of the Greenhouse Gas Pollution Pricing Act and the current regulations, the “output-based standard” for heavy oil/bitumen is currently set at 54.4 kg CO2 per barrel. Accordingly, an oil sands facility that operates with a higher level of emissions intensity – for example, if it operates at the industry average of about 68 kg CO2 per barrel – it will be obliged to pay the carbon price, which in 2022 was set at $50 per tonne (or $50 per 1000 kg), but in that example it pays the carbon price only on the 14 kg CO2 by which its emissions per barrel exceed the “output-based standard”.

In that example, the operator would pay a carbon price of 70 cents on that barrel, which covers just the 14 kg CO2 (calculated using the current $50 price per tonne). If the same operator were obliged to pay the full carbon charge on the entire 68 kg CO2 emitted during the production of that barrel, it would pay $3.40. Under the OBPS scheme about 80% of the facility’s emissions are “free of charge”. For each operator, its “annual facility emissions limit” is calculated based on the facility’s total production multiplied by the applicable output-based standard.  It pays the reduced carbon price on the amount by which its total annual emissions exceed its annual facility limit.  A typical oil sands facility may produce 50,000 or 150,000 barrels per day (bpd). Given those numbers, the difference between paying 70 cents per barrel and $3.40 on each barrel is enormous.

Enabling continued expansion of Canada’s oil production

The Federal Government’s justification for this very low carbon price on oil production is that if the oil industry in Canada loses its “competitiveness” due to increased costs of production per barrel in Canada, oil producers in foreign countries may increase their production to displace our “market share”. But no evidence-based review process in Canada has ever examined the truth of this claim.

No publicly available study by the Canadian government has ever examined the implication of this policy (which encourages higher oil production levels to 2030) in terms of Canada’s commitment under the Paris Agreement in December 2015 to act to limit the increase of the earth’s average surface temperature to less than 1.5°C.

Rising global oil production to 2030 and meeting the 1.5°C goal cannot be aligned.