Climate Change Policy and Confederation

Robert Lyman

Contributed by Robert Lyman © August 2017

Robert Lyman is an Ottawa energy policy consultant with 27 years of experience as a public servant and prior to that, 10 years of experience as a diplomat.

In May 2017, I gave a speech to a conference organized by the Friends of Science in which I attempted to answer the question, “Can Canada Survive Climate Change Policy?” I acknowledged then that many people would be surprised to hear the question phrased that way. However, I went on to explain why the political controversies surrounding climate change policies now and in the future might pose challenges to national unity. As time passes, I have become even more convinced of the risks.

The actual and potential stresses on national unity related to climate change policy arise from three sources: promotion by governments and environmental advocates of overly ambitious greenhouse gas emission (GHG) reduction targets; the consequent large burden of costs placed upon resource industries in certain regions; and the forthcoming controversy about the disparity in regional effects of the carbon tax vs. cap-and-trade approaches to pricing carbon dioxide emissions.

The Consequences of Emission Reduction Targets

Canadian governments have been participating in international discussions on climate change since the late 1980’s, largely under the auspices of the United Nations and its subsidiary organizations such as the World Meteorological Organization (WMO) and the Intergovernmental Panel on Climate Change (IPCC). There have been 22 conferences of the Parties under the U.N. Framework Convention on Climate Change. As a result of Canada’s participation in that process, successive federal governments have committed to accept targets for emissions reduction. At present, these targets are political, not legally binding, commitments; they are to reduce GHG emissions by 17% from 2005 levels by 2020, 30% by 2030 and at least 50% (and up to 80%) by 2050. Various provincial governments have also adopted emission reduction targets, different from, and sometimes more demanding than, those adopted federally.

The emission reduction targets apply in absolute terms; they are not, in other words, commitments to reduce the emissions intensity of the Canadian economy, but rather commitments to absolute reductions, ignoring the consequences of increasing population and national income. In a sense, they constitute a gamble that, by taking extraordinary policy and regulatory measures, Canada will be able to accelerate the application of new, more energy-efficient technologies fast enough to more than offset the emissions increases normally resulting from population and economic growth.

The ready acceptance of ambitious goals for transforming today’s energy economy are often based on a misunderstanding of how long it takes for such transitions to occur, plus very optimistic claims of imminent technology breakthroughs. The evidence of history, as well documented by Professor Vaclac Smil of the University of Manitoba, is that energy transitions take a long time. He conducted a comprehensive study of energy transitions in which he measured how long it typically takes for a particular energy source to go from 5 per cent of the market to claim a large share (25 to 30 percent) of total supply. The repeated answer is that it takes decades, even in wealthy countries where there is a high rate of investment and a generally open attitude towards new technologies. He notes, “Energy infrastructure is the world’s most elaborate and expensive, and the longevity and inertia of many large energy enterprises make it impossible for any large, complex national system (to say nothing of the global level) to reconfigure itself even in three or four decades.” Cars typically have useful 10-year lives, industrial equipment 20-year lives, residential buildings 50-year lives, and major infrastructure like bridges or even nuclear power plants longer still. It is even less believable that governments, rather than competitive market forces, could manage to quickly increase the market share held by one or two energy commodities, let alone achieve the complete changeover of the energy system.

Given this inertia, the current pattern of emissions by economic sector is likely to continue for some time. In Canada, the emissions associated with oil and gas production have the highest share, and constitute 24% of the total. Those resulting from transportation account for 23%, from buildings 12%, from electricity generation 11%, from heavy industry 10%, from agriculture 10% and from waste and other sources 7%. Achieving the 2020 target is challenging enough, but it might be attainable through reductions in each sector. The 2030 target will be a significant stretch, especially if the Canadian economy grows faster than expected. The 2050 targets, however, would essentially entail eliminating all emissions from electricity generation, oil and gas production, heavy industry and most of transportation. All of that would have to occur within 33 years.

The regional consequences of this would be devastating for Canada’s resource and manufacturing sectors. The elimination of coal, oil and natural gas as sources of electricity generation would significantly increase electricity rates in Alberta, Saskatchewan, Nova Scotia, Prince Edward Island and Newfoundland and Labrador, just as it has in Ontario. Blocking oil and gas development and production would remove the largest source of income and economic growth in Alberta, Saskatchewan, Newfoundland and Labrador and the northern territories. Shutting down heavy industry would mean closing the manufacturing plants that have long been the sources of much income and employment in central Canada – mining and metals, petrochemicals, auto and parts manufacturing, iron, steel, and cement to name a few. It is very difficult to believe that the people affected and the provincial and territorial governments would accept this without sharp resistance.

Already today, the opposition from environmentalist groups and their supporters in British Columbia, Ontario and Quebec to the construction of new oil and natural gas pipelines has demonstrated how ferocious can be the political conflicts over climate policy. In the case of projects like the Trans Mountain Expansion Project, already approved by the National Energy Board and the federal Cabinet after a lengthy and rigorous regulatory review, the opponents in British Columbia have made clear their willingness to erect interprovincial trade barriers that would harm Alberta’s producers. Such actions are probably illegal, as will be tested in the courts; they certainly are contrary to the principles of fair interprovincial trade that have long been understood to be part of the Confederation “bargain.”

The Imposition of Large Costs on Fossil Fuel Production and Consumption

In the near term, the greatest stresses from climate policy on Canada’s regional economies will probably result from the use of taxes and other fees to increase the cost of fossil fuel use and the thus discourage emissions. British Columbia and Alberta have already imposed carbon taxes and the federal government has announced a national carbon tax. The federal tax will be applied at the rate of $10 per tonne of carbon dioxide equivalent starting in 2018, rising by $10 per year until it reaches $50 per tonne in 2022. Of course, the tax increases will not stop there, but will probably continue indefinitely. Ten dollars per tonne is equivalent to 2.3 cents per litre of gasoline, so $50 per tonne would equal 11.5 cents per litre. That would raise several billions of dollars per year in revenues.

The former National Roundtable on the Environment and the Economy, in a 2012 report, projected that a carbon tax of at least $300 per tonne would be needed to meet the 2050 target. Even that seems inadequate to the task. In Norway, automotive fuel (mostly diesel oil) already costs CDV (Canadian Dollar Value) $2.29 per litre. One would need a carbon tax of over $500 per tonne to raise Canadian gasoline prices that high. Yet, car fuel consumption in Norway continues to rise.

The incremental effects of raising carbon taxes will be to reduce the returns to the fossil fuel exporting companies, as Canadian producers have to sell their output in competition with sources from other countries, including the United States, where such taxes will not apply. They cannot pass the costs of the taxes on in the form of higher prices. Over time, this will progressively diminish the profitability and ultimately the economic viability of production here. Ironically, by disadvantaging Canadian fossil fuel producers, governments would be depriving themselves of one the largest current sources of corporate income tax and royalty revenue.

At which point would such taxes produce strenuous pushback from the populations and governments of the affected provinces? I doubt we will have to wait long to see.

Interprovincial Disparities

The federal carbon tax will apply on all provinces that are not already pricing carbon at an equivalent rate. Thus, British Columbia and Alberta will be exempt so long as they meet or exceed the federal rate. Also exempt will be provinces operating a cap-and-trade system, provided certain conditions are met. Quebec is now a partner with California in a cross-border carbon trading system called the Western Climate Initiative (WCI), and Ontario plans to join the WCI soon. Nova Scotia has announced that it will set up its own stand-alone cap-and-trade system.

As Quebec’s cap and trade system is closely integrated with California’s, the price of an emissions permit goes up and down with the supply and demand for such permits in California, the larger market. The carbon permit price is currently about CDN $17 per tonne, well above the Canadian federal carbon tax rate of $10 per tonne in 2018.

The California cap-and-trade system has been very unpopular with industries there, even though the state went to considerable lengths to create an oversupply of emissions permits and to establish other flexibility mechanisms that would keep permit prices relatively low during the first few years the system operated. It now faces a potentially serious legal problem. The legislative authority for the system is set to expire at the end of 2020. Reportedly, any extension that includes government-run auctions of the emissions permits – a critical element in political terms there – would likely require a two thirds “supermajority” under Proposition 26. If the state attempts to proceed without new legislation, it will undoubtedly be challenged in the courts. This adds considerable uncertainty as to whether and how the California cap-and-trade system will work in future.

Assuming the political and legal issues in California are resolved, the forces that will drive the price of carbon under the California system will likely remain quite different from those governing the Canadian carbon tax. According to projections by CaliforniaCarbon.Info, an online carbon market research firm, there will be an increasing gap between the WCI carbon prices and the Canadian tax, as illustrated in the following table:

So, we may face a situation where, as early as 2020, there will be a large and growing difference between the carbon charges paid by the provinces that are part of the WCI and those that are not. One can imagine the displeasure of people in Alberta and Saskatchewan if, by 2022, they are paying much higher taxes than people in Quebec and Ontario, especially if by then the central provinces still oppose the construction of pipelines to deliver western oil to the east coast.

Under the federal government’s carbon tax policy, provinces with cap-and-trade systems will only be exempted from the minimum tax rate if two conditions are met. The first is that the province’s 2030 emissions reduction target must be in line with the federal target of a 30% reduction from a 2005 base. This is true for Ontario and Quebec. The second is that a cap-and-trade province must have annual emissions targets for 2022 that “correspond, at a minimum, to the projected emissions reductions resulting from the carbon price that year in price-based systems.” So permit prices and carbon taxes have to produce the same result. This seems to mean that they have to be the same, but it is not clear. The standard has been left deliberately vague.

In this vagueness lies the potential for much political negotiation behind the scenes. Would Justin Trudeau, the current Prime Minister, force Quebec and Ontario to accept higher prices than these provinces had thought they had guaranteed for themselves by participation in the WCI? Would the other provinces, especially in western Canada, accept any less than equal tax treatment, however that was achieved? Such extremely sensitive political issues could become constitutional issues if they gave to secessionist forces in any part of the country the justifications they seek.

The risks of growing disparities between federal carbon prices and WCI cap and trade prices, further, do not run in only one direction. In an August 9, 2017 article in the Financial Post, Peter Shawn Taylor pointed out that, over time, California’s commitment to reduce state GHG emissions by 40% below 1990 levels by 2030 exceeds the targets set by Ontario and Quebec. In order to obtain legislative approval of this goal, which will involve sharply reducing the supply of emissions permits over time (i.e. raising the price), California Governor Jerry Brown agreed to provide substantial tax breaks to farmers and other state businesses. By 2025, when the state’s permit surplus is expected to largely disappear, the WCI permit prices could be pushed above $70 per tonne, which could be higher than the federal Canadian carbon tax. Thereafter, there may be a race between WCI permit prices and rising federal carbon taxes, with the WCI permit prices driven by California policies and economy, and the federal carbon tax determined by whichever party is in power in Ottawa.

Conclusion

It bears remembering that GHG emissions in Canada constitute a mere 1.6% of the global total. For those who view with skepticism the entire controversy over alleged human influences on the climate, it beggars the imagination that the people of Canada might willingly imperil its economy, and potentially its unity, over the question of how much to reduce emissions of a gas when the global effects of whatever Canada does can only be negligible.

Sadly, the risks are far greater than most people know.