Canada’s Regulatory Framework for Air Emissions: A Business and Environmental Law Perspective

1. The Ontario Bar AssociationWebinar Canada’s Regulatory Framework for Air Emissions:A Business and Environmental Law Perspective Elisabeth (Lisa) DeMarco May 9, 2007

2. Overview • General Principles of Emissions Trading • Voluntary versus Compliance Markets • Canadian Emissions Context • The Canadian Framework for Air Emissions • Framework in International ET Context • Considerations for Business and Environmental Lawyers

3. Canadian based International law firm established 1912 300 lawyers, 420 total staff in 7 global offices Focus: natural resource law (oil, gas, electricity, water, carbon and emission products) MD Climate Change Team: International Team, lead out of Toronto serving domestic and international clients MD Climate Change lawyers at the leading edge of Canadian and international emissions trading policy development since 1996 – more than a decade of proven ET Law experience Member of EMA, IETA, IETA CWGCM MD Climate Change Team has closed more than 50 MT of carbon transactions Macleod Dixon LLP

4. Macleod Dixon’s Offices Calgary, Toronto Moscow Caracas Almaty, Atyrau Rio de Janeiro

5. General Principles of Emissions Trading

6. Environmental Kuznets Curve Enviro. Degradation Personal Income

7. I. The Theory: ET 101 Current emissions of X 150 150 120 120 Total emissions of X = 450 tonnes 90 90 60 60 30 30 0 A B C D E

8. The Theory: ET 101 Government requires 10% reduction 15 162 Total emissions of X = 405 tonnes Total reductions required - 45 tonnes 135 12 9 108 135 81 6 108 54 3 81 54 27 27 0 A B C D E

9. The Theory: ET 101 If the cost of reducing 1 tonne of X is uniform for all emitters and equal to $20/tonne then, the individual and total costs of reduction are: $300 300 $240 Total cost of reducing 45 tonnes of X is $900 240 $180 180 $120 120 $60 60 0 A A B B C C D D E E

10. $240 240 $180 180 $120 120 $60 60 $15 0 The Theory: ET 101 If the cost of reducing 1 tonne of X is not the same for all emitters and A can make reductions for $1/tonne while B,C.D,E make reductions at $20/tonne. Then, the individual and total costs of reduction are: Total cost of reducing 45 tonnes of X is $615

11. The Theory: ET 101 If A can make 42 T of emission reductions at $1/tonne, it can then sell emission reductions at a profit to B,C,D,E at $10/tonne and decrease both individual and total compliance costs. A: $15 compliance cost, $243 profit B: buys 12T from A = $120 compliance cost C: buys 9T from A = $90 compliance cost D: buys 6T from A = $60 compliance cost E: makes 3T reductions itself = $60 compliance cost ___________________________________________ 45T emission reduction goal achieved at $345 compliance cost Total cost of reducing 45 tonnes of X using ET is $345; without ET $900

12. Exercise: Compliance Cost Curve Source Rick Hyndman (CAPP) $60 Emission reduction options identified in Upstream Oil & Gas Options Report, 1999 $50 $40 $30 EmissionCost Curve C$/tCO2e $20 $10 $0 110 115 120 125 130 135 140 145 150 -$10 -$20 Emissions (Mega)tonnes CO2e/year

13. Voluntary vs. Compliance Markets

14. Voluntary vs. Compliance • The Differences • the nature of the “product/rights” • project-based vs. government allocated • generally* contract-based vs. regulatory regime • Examples Compliance: EU ETS, US RGGI, US SO2, units= allowances, permits Voluntary: domestic offsets, CDM and JI units= VERs, offsets, ERs, CERs, ERUs • Significant difference but both have value

15. Example: Compliance MarketReg 397/01 2007 NOx Allocations • OPG – 16993 • Kingston Cogen – 383 • Transalta Sarnia- 1382 • Brighton Beach – 640 • Keele Valley LFG Power – 168 • http://www.oetr.on.ca/oetr/index.jsp

16. Example: Credit Creation Process (Voluntary) 1 5 7 3 9 8 6 4 2 Source: Government of Canada

17. General Characteristics of an Offset • Real • Quantifiable • Verifiable (Verified) • Unique (No double counting) • Surplus (Additional)

18. Direct vs. Indirect Credits Direct Indirect NOx, SO2, CO2 offsets from LFG power offsetting higher emission power relative to system supply mix CH4 reductions at LFG power plant

19. Environmental Attributes • The “Greenness” of power or a product (ethanol) • Both quantifiable (# ERs, RECs) and diffuse (all rights, benefits and interest – akin to goodwill) • Can be sold Bundled/Aggregated or Separately/Disaggregated or partially bundled*** • Quantified units: RECs, TRCs, green tags • Diffuse units: enviro. attributes, benefits

20. Canadian Emissions Context

21. Canada’s GHG Emissions Source: Environment Canada

22. Emissions by Sector

23. The Canadian Framework for Air Emissions

24. The Framework: General Views • The Framework as the First Step Forward • Theory of the Second Best • Framework vs. Kyoto • Framework: 150 MT decrease from estimated 2006 GHG levels (780MT) = 630MT by 2020 • Kyoto: 220 MT reduction from estimated 2006 GHG levels (780MT) = 560 MT by 2012 • Framework is not Kyoto: it continues Canada's move toward a "made-in-Canada" approach to climate change

25. Greenhouse Gas Targets • Short-term: • Emissions intensity targets • Targeted reductions relative to 2006 emissions • 2010 implementation date • by 2010: • -18% (combustion & non-fixed process emissions) • 0% (predefined fixed process emissions) • -2% emission intensity per year (2010-2020) Goal (2020): 20% absolute emissions reduction

26. Greenhouse Gas Targets • Sectorally, basic approach is -18% emission intensity by 2010 • Variable goals for fixed process emissions • New facilities (1st-year operation 2004+) • 3-year grace period to reach normal operating levels • Initial target based on cleaner fuel standards • -2% annual emissions intensity (to 2020)

27. GHG Compliance Mechanisms • Engineered in-house reductions • Energy efficiency and management improvements • Technological advances – e.g., C-capture and storage • Domestic trading • Between regulated Canadian companies • Bankable credits created by a company exceeding its intensity target • Domestic offset system • Regulated purchase from unregulated • Verified Emission Reductions (VERs)

28. GHG Compliance Mechanisms • Kyoto Protocol’s Clean Development Mechanism (CDM) • International CDM credits may comprise ≤ 10% of firm’s total target • Credit for early action (1992-2006) • One-time allocation of credits for verified emissions reductions, to max 15 Mt CO2e

29. GHG Compliance Mechanisms • Climate Change Technology Fund • Companies may pay for not meeting intensity targets • 2010-2012: $15/t CO2e • 2013: $20 • 2013-2020: adjusted at growth rate of nominal GDP • Declining %age of total target: • 70-50% (2010-2014; -5% p.a.) • 40% (2015) • 10% (2016-2017), and 0% thereafter • Purpose funding of emissions reduction technology deployment and related infrastructure

30. Air Pollution Targets • Fixed national emission caps (2012-2015) • NOx (600 kt; -40% ) • SOx (840 kt; - 55%) • Particulate matter (160 kt; -20%) • Volatile Organic Compounds (360 kt; -45%) • Reductions relative to 2006 emissions

31. Air Pollution Targets • Other pollutants in specific sectors, e.g.: • Hg from electricity generation • benzene from refineries & natural gas production/processing • Fixed sectoral caps (2012 and 2015) to be validated by June 2007 J. Kellerman, Environment Canada. National Energy, Environment and Resources Law Summit, 28 April 2007 Montréal, PQ.

32. AP Compliance Mechanisms • Domestic emissions trading system • Cap-and-Trade for SOx and NOx • regions that do not meet national air quality objectives will have limits on use of credits from elsewhere • On-going discussions with USA on cross-border trading system (SOx & NOx) • Verification and enforcement under CEPA 1999

33. Framework in International ET Context

34. Global Carbon Market • Kyoto came into effect and became international law February 16, 2005 creating binding obligations (Canada must reduce 6% from 1990 by 2012) • EU pre-compliance market: EU ETS started January 2005 • Two main markets: EU ETS and Kyoto Mechanisms with links • Commodities: • EU allowances, CDM (CERs), JI (ERUs), and AAUs • all generally traded in units of CO2 equivalents • International Carbon market activity (CDM and JI) has increased dramatically since Fall 2004, related prices also rose very sharply and dropped sharply in April 06 and are rising again • Prices: EUA @ 19 Euros for 2008 (crash on 2007); Volumes: significant increase in last 12 months • Current prices and volumes published by a number of emission brokers (Evolution, Natsource, Point Carbon)

35. Global Performance(based on 2004 inventories) source Environment Canada

36. Market Dynamics: Volumes (2006)* based on volume estimates from Point Carbon, Natsource and extrapolations based on completed transactions. 2006 Figures significantly higher.

37. Market Dynamics • Estimated Global Supply • 250 MT to 350 MT/ year over 2008 to 2012 • compliance instruments • other • Estimated Global Demand • 2.5 BT to 4BT over 2008 to 2012 • contingencies • EU NAPs and Phase II, Canadian commitment and position (300 MT/yr swing); Japan DET • Second Commitment Period • Asia Pacific Partnership and US position • AAU trading

38. Pricing Differences • Prices currently showing an upward trend • Higher prices for compliance-grade commodities • Differences between CER and ERU prices reflect greater risk in less developed countries (JI projects are in Eastern Europe) • Other price determinants: • Creditworthiness and experience • Confidence in counterparty and project • Structure of contract • Cost of validation and certification • ER vintage and seniority • Regulatory Risk*** • Additional environmental benefits

39. Market Pricing (January 2005-2006 in US$/tCO2e) Source: IETA

40. EUA Prices Sources: IETA, PowerNext, ECX

41. International GHG Emissions Trading Annual volumes (Mt CO2e) of project-based emission reductions transactions Source: State and Trends of the Carbon Market 2007.

42. Increases in volumes and values of transactions on the Main International Allowances Markets State and Trends of the Carbon Market 2007.

43. Considerations for Business and Environmental Lawyers

44. Domestic Regulatory • Host of new regulatory obligations for clients • is facility/corp. a large industrial emitter? • can it create offsets? • what 2006 data/analysis required under s. 71? • what is GHG sector-based intensity target applicable to facility? • what fixed AP caps apply to sector? facility? allocation? • what emissions covered (fixed process vs. non- fixed process? • compliance strategy (short and long term)? • provincial equivalency (AB, ON, QC) • treatment of any emissions book under CEA? • new facility, timing of implementation of GHG control measures

45. Domestic Commercial (Emissions Transactions) • Scenario planning to determine likely market boundaries (provincial? national? US? Mexico?) • Facility based cost compliance curves • Forward price curves for GHG and AP • Compliance strategy in light of evolution and integration of Tech Fund • Offset purchasing strategy • Impact on existing ERPAs and future ERPA language • CDM portfolio (?) • Trading in Tech Fund credits? • Arbitrage on existing CEA book? • Cross border trading? (DeMarco et al. 2002)

46. International Trade and Treaty • Impacts of CDN Kyoto non-compliance • NAFTA / WTO vs. Kyoto • Product impact (import taxes and duties) • Cross border emissions trading in NOx and SO2 – extra-territorial incompetence • Legality of limits on types (jurisdictions?) of CDM projects and interpretation of supplementarity • Impact on inter-provincial trade and AIT (DeMarco et al. 2004) • International carbon market impacts (alters 2008 to 2012 demand by at least 250 MT/yr) • Pricing impacts

47. Contact Information Elisabeth (Lisa) DeMarco Partner, Macleod Dixon LLP Head International Climate Change & Toronto Energy Groups Direct Telephone: (416) 203-4431 Facsimile: (416) 360-8277 Email: elisabeth.demarco@macleoddixon.com