The “carbon leakage” argument

Part 15 in a series of 18 discussion papers

While our government admits that every additional tonne of CO2 released into the atmosphere from our expanding oil production causes additional amounts of economic loss and damage by worsening climatic impacts (the government measures that loss by what it calls the “social cost of carbon”), it argues that the economic benefits of increased oil production outweigh that loss and damage.

Based on that promised economic benefit, the government justifies the very low carbon price it imposes on oil producers in Canada.  

The Federal Government’s stated 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 (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, “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 government’s argument about the economic benefits of setting a lower carbon price

The explanatory note (found on page 102 of the Output-Based Pricing Regulations) provides us with the results of the government’s “cost-benefit analysis”, which justifies adopting the lower carbon price:

The objective of the Regulations is to retain a price on carbon pollution that creates an incentive for emissions-intensive and trade-exposed facilities to reduce emissions per unit, while mitigating the risk of decreased domestic production and of carbon leakage to other jurisdictions.

— Output-Based Pricing System Regulations, Canada Gazette, June 28, 2019, p. 102

The government acknowledges that the Output-Based Pricing Regulations (OBPS) impose a low carbon price on oil producers in Canada. But the justification offered by our government is that this will ensure that Canada can maintain higher production levels:

However, by imposing a smaller total cost, the OBPS results in higher domestic production. This in turn increases household income, allowing households to increase their consumption to maximize welfare. Increased domestic production also results in slightly more domestic GHG emissions than would have occurred under the fuel charge only scenario. These domestic emissions are expected to be offset by a reduced risk of Canadian production shifting to other jurisdictions and creating carbon leakage.

It is essentially a treadmill argument. We are on a treadmill and cannot get off. If we decrease our oil production, other countries will increase theirs, we are told. So, we must keep increasing oil production in Canada. And the government’s cost-benefit analysis says this will deliver economic benefits to all Canadians:

By 2030, when compared to the Baseline Scenario, the Regulations are estimated to result in an increase in welfare valued at $3.2 billion. Cumulative foregone domestic GHG emissions reductions are estimated to amount to 22 Mt CO2eq, valued at $916 million. … The monetized net benefits of the Regulations to Canadians are estimated to be $2.15 billion.

— Output-Based Pricing System Regulations, Canada Gazette, June 28, 2019, p. 102

The expression “foregone domestic GHG emissions reductions” means that, due to the lower carbon price, Canada’s emissions will be higher. Based on the government’s analysis, the future cost of the higher emissions is “valued” at a modest $916 million*. That number is based on a government formula, referred to as the “Social Cost of Carbon” (“SCC”), which according to the government “measures the incremental additional damages that are expected from a small increase in CO2 emissions (or conversely, the avoided damages from a decrease in CO2 emissions)”. The value of incremental damages used in the government’s 2019 analysis is about $50 per tonne of CO2.

The gist of the government’s 2019 analysis, described in detail under the heading “Regulatory Impact Analysis Statement”, is that if we keep producing and exporting higher levels of oil and other emissions-intensive industrial products for another decade, Canadians collectively have $3.2 billion more to spend on consumption, and we will enjoy a “net-benefit” of $2.15 billion.

The Social Cost of Carbon valuation

For many years serious questions have been asked about the sufficiency of the assigned Social Cost of Carbon valuations used in this kind of cost-benefit analysis, which are very low – in this case just $50 per tonne of CO2. That valuation was adopted in 2019 by the Liberal Government, based on research by U.S. energy economists more than a decade ago. The social cost of carbon estimate purported to provide an accurate measure of the scale of the escalating economic losses and damage being inflicted by climate breakdown – by drought and flooding, forest fires, destruction of transportation infrastructure, and so on.

Canada has now admitted that its social cost of carbon number is woefully inadequate. On April 20, 2023, the Federal Government published a new study, Social Cost of Greenhouse Gas Estimates – Interim Update Guidance for the Government of Canada. The document confirms that the economic cost of each additional tonne of CO2 released into the atmosphere Is now estimated to be $261 – nearly five times higher than the number adopted by our government four years ago.

At a climate conference in Ottawa on April 19, Environment Minister Steven Guilbeault admitted the economic cost is now estimated to be five times higher: “every tonne of carbon we reduce this year saves society as a whole $261”, he declared, putting a positive spin on the new information. Conversely, the new government data shows that every additional tonne of carbon we release into the atmosphere brings damages of $261 from climate change impacts, including “net changes in agricultural productivity, human health effects, property damages from increased flood risk, disruption of energy systems, and the value of ecosystem services”. 

The government acknowledges the new social cost of carbon estimate does not include “other significant but difficult to model effects such as extreme weather events, ocean acidification, and interactions/ feedbacks across sectors”. Feedbacks include, for example, the melting of permafrost land in northern Canada which brings in turn the release of methane gas (itself a potent greenhouse gas) that is driving further warming; and the loss of Arctic Sea ice which, by exposing the darker surface of the sea accelerates the warming of the ocean. The new estimates do not include the loss of marine species and livelihoodsbrought by ocean acidification and ocean heating.

The methodology relied on by the Federal Government in 2019 to justify the very low carbon price on oil production activities in Canada is therefore deeply flawed. If we rely on the new social cost of carbon numbers, it is impossible to argue that based on the current low carbon price on oil production Canadians are receiving any “net monetized benefit” by continuing to extract and export large (and still increasing) volumes of oil. Based on the new measure of the social cost of carbon, the climate impact costs are exceeding the supposed economic benefits.

But there are now far more serious reasons to reject this simplistic and reductive kind of economic analysis, where everything including the peril of imminent climate breakdown is “monetized”. Given the findings of recent authoritative studies based on climate science, for example the IPCC Special Report on Global Warming to 1.5°C released on October 7, 2018 and the UN Emissions Gap 2022 Report published on October 27, 2022, any government analysis that assumes we can still, in 2023, make a rational choice or “trade-off” to accept a higher level of future emissions in return for a promise of “higher household income” from expanding oil production is ignoring the scientific evidence. We have run out of time to keep trading higher emissions for immediate economic gain.

The promised economic gains now, during this decade, will be swallowed in the 2030s and 2040s by catastrophic future losses from the impacts of climate breakdown.

The Special Report warned on October 7, 2018, that the remaining carbon budget to stay within the 1.5°C will be entirely exhausted before 2030. The IEA “Net-Zero Scenario” warned on May 18, 2021, that we need a 25% cut in global oil consumption by 2030 to stay on a path to meet the 1.5°C goal. If we do not achieve those required deep reductions within the next eight years, warming will irreversibly exceed the  1.5°C threshold. A small amount of “increased household income” will be no recompense for the escalating losses and destruction that will follow over the next 20 and 30 years and after if the earth exceeds those limits. The Social Cost of Carbon economic analysis does not acknowledge or admit the possibility of that kind of breakdown of the natural systems that support human life.   

The truth is that if the world’s major oil producing countries that have large enough oil reserves to substantially increase their production levels during the next 10 or 20 years all decide to do so (there are about six very large producers, including Canada, that easily have the capability to do that) the world will have no chance of keeping the increase in global temperature below the 2°C threshold, let alone the 1.5°C limit.

The “carbon leakage” argument has never once been scrutinized by any independent science -based public inquiry in Canada. Yet it surfaces, again and again, in Federal Government documents. Six years ago, the Federal Government’s Review of Related Upstream Greenhouse Gas Emissions Estimates (which was not an independent inquiry but rather an internal review by the government known as the “upstream emissions assessment”) declared in the draft version of its report published on May 19, 2016, that even if Canada were to curb the expansion of its oil sands production, “investments would be made in other jurisdictions and global oil consumption would be materially unchanged in the long term….”

The argument might have had some merit twenty years ago, when there was still time to attempt to persuade all the major oil producing countries to act together. But that did not happen. Instead, Canada moved aggressively to increase its own oil production from 2.6 million bpd in 2005 to 4.9 million bpd by 2019. There is now no prospect at all, no plausible chance of any immediate or early agreement by all the world’s large oil producers to jointly agree to reduce their oil production levels. But there is no time to wait for others to act.

We are now down to a handful of years left to avert a terrible outcome. Continuing along the present path, frozen into inaction by the “carbon leakage” argument, is a pathway to monumental self-destruction.

* This $916 million represents the increased loss and damages that will be caused (estimated at the nominal cost of $50 per tonne of CO2) by the cumulative amount of all the increased emissions (22 Mt) emitted between 2020 and 2030 by the emissions-intensive industries in Canada exempted from the higher carbon price, not just the increased emissions from the oil industry. The oil industry’s share of the $916 million covers only the estimated additional damages caused by increased upstream (domestic) emissions resulting from the higher level of oil production that is enabled by having the lower carbon price. It does not include any amount for damages caused by the increased “downstream emissions” resulting from Canada’s higher oil production levels.

Government of Canada, Social Cost of Greenhouse Gas Estimates – Interim Update Guidance for the Government of Canada, April 20, 2023:
“Cost of Carbon Emissions nearly five times greater than previously thought: analysis”, National Observer, April 20, 2023, Mia Rabson:

Trans Mountain Pipeline ULC – Trans Mountain Expansion Project Review of Related Upstream Greenhouse Gas Emissions Estimates, Draft for Public Comments, Environment & Climate Change Canada (May 19, 2016): When the final text of the report was released on November 25, 2016, it contained a revised wording of the government’s “carbon leakage” argument, but the substance of the government’s claim remained unchanged: see final report B.4.5 and Conclusion, pp.40-43: