Compliance routes in Alberta's carbon markets: a look at past trends and future possibilities.
In previous blog posts, we have used animated bar charts to examine different aspects of greenhouse gas emissions in Alberta (specifically, the changing sources and size of the provincial GHG inventory in Alberta, as well as the sources and size of its Offset Credit supply). Presenting animated data is fun, so we decided to do it again! This time we are looking at how regulated emitters in the province have met their GHG emissions compliance obligations, and thinking about how this might change into the future. Let's get straight to it:
OK, so what does this graph actually show? Well, Alberta's carbon market has been functional since 2007 and is based on regulations that affect the province's largest industrial emitters of GHGs. Although the details of the regulated carbon market have changed over time - the Specified Gas Emitters Regulation (SGER) was replaced by the Carbon Competitiveness Incentive Regulation (CCIR) for 2018 and 2019 which was then replaced by the (current) Technology Innovation and Emissions Reduction (TIER) Regulation - the fundamentals have remained the same: covered facilities are set a baseline level of emissions, which is calculated on an emissions intensity basis. They are then set a reduction target, which ratchets over time, gradually becoming more stringent. This is intended to allow emissions to fluctuate with changes to production but also to gradually increase the incentive to reduce GHG emissions at each facility.
Where facilities cannot reduce their emissions to the required emissions intensity, they are offered three routes to come into compliance:
1. pay the government by purchasing a Fund Credit (FC) at a set price or
2. purchase an Offset Credit (OC) from a non-regulated facility that has reduced its emissions or
3. purchase an Emission Performance Credit (EPC) from a regulated facility that has reduced their emissions BELOW their requirements.
The graph shows which of these 3 routes was taken each year since the SGER was introduced up until 2019, the most recent year for which data is currently available. (Note that the substantial increase in 2018 and 2019 was due to the more stringent requirements introduced by the change in regulation when the SGER was replaced by the CCIR).
Clearly, the most popular compliance route in most years has been for entities to purchase FCs. OCs have generally been the second most popular option.
The second graph (below) shows the cumulative total over the same time period, showing that over half of all compliance has been met via payments into the Technology Fund (FCs), and slightly under one-third has been met with OCs.
This raises multiple questions relating to the functioning of the carbon market. The most obvious is why have FCs been the most popular compliance option, when they are also the most expensive? At least part of the answer has been supply - there simply haven't been enough OCs created to service all the demand. But that raises the secondary question of why not, given that there is clearly a market to be serviced? Political/regulatory uncertainty? Administrative complexity? Lack of expertise? Inadequate financial returns?
It's likely all of these things. Although tens of millions of OCs have been successfully created and sold, the offset system has been subject to continuous political and regulatory uncertainty, is administratively complex, faces restricted access (it doesn't allow for some types of projects that could service the demand - for example, AB doesn't have any Protocols for forestry based projects), does require knowledge and expertise to navigate and it is likely the historic price for OCs has simply been too low to provide an incentive for smaller, aggregated projects or more difficult/innovative project types to be financially viable.
So, what can we expect in the future? Will the same pattern of compliance be seen in the Alberta carbon market, despite expectations of rising carbon prices in line with the Federal Fuel Charge?
Although a rising carbon price might imply both that a) demand for OCs will increase as more companies seek cheaper compliance routes and b) that more OC projects will become economical and thus be brought forward, the changeover from CCIR to TIER introduced a key change to compliance routes, which is that facilities are now restricted to using OCs/EPCs to a maximum of 60% of their compliance obligation. In turn, this means emitters have to either pay 40% of their compliance obligation into the Tech Fund, or to make internal reductions to reduce their emissions intensity and thus come into compliance. Furthermore, the rising carbon price also means many internal reduction projects will become more economically attractive than before. So we may see EPCs beginning to play a larger role, as increasingly ambitious corporate GHG emission reduction targets combine with a rising carbon price to encourage more and more internal reduction projects.
So, my crystal ball is a bit blurry...but it does seem clear that whether we see more or fewer OCs or EPCs in the marketplace, compliance activity will continue to be a combination of all three routes. And I think that's a good thing, as it means the impact of industrial emissions regulations will continue to provide an incentive to decarbonize whole sections of our economy, regulated or not.