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Proposed Regulatory Framework: Cap-and-Trade System in the Oil and Gas Sector

On December 7, 2023, the Federal Government (Government) published a Regulatory Framework for an Oil and Gas Sector Greenhouse Gas Emissions Cap (Framework). The Framework supports Canada’s commitment to cap and reduce greenhouse gas (GHG) emissions from the oil and gas sector at a pace it has deemed required to achieve net-zero GHG emissions by 2025. To achieve these goals, the Government proposes a cap-and-trade system to operate under the Canadian Environmental Protection Act, 1999. The cap-and-trade system is proposed to apply to liquefied natural gas (LNG) facilities and upstream oil and gas facilities.

Design Principles & Targets

The proposed emissions cap for 2030 is estimated to fall within the range of 106 to 112 million tonnes of GHG emissions. This number represents a 35 to 38 percent decrease from 2019 emissions. The design of the proposed cap-and-trade system will be guided by the following principles:

  1. GHG emissions to decline at a pace and scale to meet net-zero by 2025: The regulations will be designed to ensure GHG emissions from the upstream and LNG subsectors decline over time to reach net zero by 2025.
  2. Upper bound of emissions targets to account for technically achievable reductions and forecasted oil and gas demand: The legal upper bound on GHG emissions from covered sources would account for technically achievable emissions reductions and for the forecasted global demand for oil and gas.
  3. Minimizing administrative burden: To the extent possible, the regulations must be designed to complement and leverage other federal and provincial regulations and programs to minimize additional administrative requirements.
  4. Regulations must be reviewed: Effectiveness of the cap and trade regulations will be subject to ongoing monitoring and regular reviews, including to assess the legal upper bound on GHG emissions, the quantity of allowances available and the approach to their allocation, and access to compliance flexibility.

Of note, is the acknowledgement in the Framework that the approaches in place to define and regulate smaller facilities for provincial reporting and regulatory purposes in British Columbia, Alberta and Saskatchewan are being examined to support an efficient federal approach to covering smaller emitting facilities under these regulations.

Covered Activities

The proposed activities to be regulated by the cap-and trade system include:

  • bitumen and other crude oil production, including upstream oil gathering pipelines when they are part of a covered facility, — other than bitumen extracted from surface mining and other than petroleum refining, including:
    • extraction, processing, and production of light crude oil (having a density of less than 940 kg/m3 at 15°C)
    • extraction, processing and production of bitumen or other heavy crude oil (having a density greater than or equal to 940 kg/m3 at 15°C)
  • surface mining of oil sands and extraction of bitumen
  • upgrading of bitumen or heavy oil to produce synthetic crude oil
  • production and processing of natural gas and production of natural gas liquids, including upstream gas gathering pipelines when they are part of a covered facility
  • production of liquefied natural gas.

Under the proposed system, all covered facilities will be prohibited from releasing any GHGs resulting from a covered activity unless they have first registered to the system. The regulations would also prohibit covered facilities from releasing GHGs into the environment resulting from the specified industrial activities without remitting a sufficient number of compliance units for such GHG emissions.

Compliance Options

There are two proposed compliance options to allow covered facilities to offset emissions exceeding the cap (up to a specified limit):

  • Offset credits from Canada’s Greenhouse Gas Offset Credit System and from provincial systems, which represent real, additional, and verified projects that reduce emissions.
  • Contributions of a specified amount per tonne to a decarbonization fund, which would invest its proceeds in future GHG reductions (proposed at $50 per tonne CO2e).

It is proposed that each emission allowance will be equivalent to one tonne of CO2e. Emission allowances issued under the cap-and-trade regulations would not be fungible (i.e., cannot be used) with other carbon pricing systems or regulatory instruments. Emission allowances will circulate among covered facilities exclusively within the oil and gas emissions cap-and-trade system. Facilities will not be permitted to use any surplus or performance credits or permits from other regulations or carbon pricing systems. All included facilities must disclose their production and GHG emissions annually. Reporting requirements aim to align with existing programs to minimize administrative overhead.

Treatment of Indirect Emissions and Stored Emissions

The cap-and-trade system will apply to direct (Scope 1) GHG emissions. Scope 1 GHG emissions originate directly from sources that are owned or controlled by an organization (i.e., combustion, process, and fugitive emissions).

The Framework notes that the oil and gas sector uses thermal energy, electricity, and hydrogen in its industrial processes. If a facility does not generate its own thermal energy, electricity, or hydrogen, it can import it from another facility, or in the case of electricity, from the grid. Facilities may also produce these products for sale and export from the facility. The result is that facilities carry out varying levels of these activities with related impacts on their direct GHG emissions – those that import these products tend to have lower direct emissions and those that produce on-site, either for their own use or with excess for export from the facility, have higher direct emissions. Accounting for transfers of captured carbon dioxide (CO2) between facilities for activities including enhanced oil recovery and permanent storage will be required to ensure that emission reductions associated with those activities are taken into account.

The Government is proposing to account for transfers of thermal energy, hydrogen, CO2 and electricity to ensure that all GHG emissions that relate to the production of oil and gas are covered.  As a result, it is proposed that Facilities will be required to report and quantify information related to the purchase/sale, production, use and import/export from the facility of thermal energy, hydrogen, electricity, and transfers of CO2 for storage. Where facility-specific information is not available, a default factor would be provided to estimate emissions.

Timelines & Opportunities to Provide Comments

The Government is seeking input on the Framework to inform the draft regulations. Formal written submissions should be emailed to [email protected] by February 5, 2024.

Following this engagement process, the Government plans to publish proposed regulations in Part I of the Canada Gazette for a 60-day public comment period.  Formal written comments will also be sought as part of that process.

The final regulations are aimed to come into force in 2025. Facilities will need to register by the end of 2025 or before emitting GHGs from covered activities after January 1, 2026. From 2026 onward, annual reporting will be mandated. The gradual implementation of the system between 2026 and 2030 is being considered.

Our team at McCarthy Tétrault is closely observing the implementation of Canada’s Climate Plan, and we remain committed to helping our clients navigate the changing regulatory landscape of decarbonization and net-zero policies. Please contact any of the authors with any questions or for assistance.

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