Clean Fuel Standard Regulations released for consultation – Lexology

On December 18, 2020, Environment and Climate Change Canada (ECCC) released a draft of the Clean Fuel Regulations (Regulations). The proposed Regulations are intended to complement the federal carbon tax regime to help meet Canada’s greenhouse gas reduction commitments under the Paris Agreement.

The CFS is the result of ongoing consultation efforts with stakeholders over the past four years, and will be open for public comment until March 3, 2021.

The draft Regulations have several changes from the iterations detailed in past discussion documents. We have previously written about the anticipated features of the Clean Fuel Standard and highlight some of the significant changes below.

New Clean Fuel Standard – What you need to know

The Clean Fuel Standard targets the reduction of the lifecycle carbon intensity of fuels, from production to combustion, calculated in grams of carbon dioxide equivalent per megajoule (gCO2e/MJ). The proposed Regulations accomplish this objective by calculating the baseline carbon intensity of fuels as of 2016, and then imposing mandatory year-over-year reductions to that baseline carbon intensity beginning in December 2022.

The proposed Regulations require “primary suppliers” of liquid fossil fuels (producers, refiners, and importers of more than 400 m3 of liquid fossil fuels annually) to satisfy the annual reduction criteria by creating credits through emission reduction or removal activities that reduce lifecycle carbon intensity of fuels, by purchasing credits created by others, and/or paying into a compliance fund. The intent of this credit creation and trading system is to incentivize low carbon fuel production, electrification of the transportation sector, and investment in new technologies.

While past Clean Fuel Standard consultations suggested that it would cover gaseous and solid fuels as well as liquids, ECCC has indicated that there are no plans to expand the scope of the mandated carbon intensity reduction beyond liquid fuels. Primary suppliers may partially meet their obligations by obtaining credits related to carbon intensity reduction of gaseous or solid fuels, but only up to 10 per cent of the required credits.

Carbon intensity reductions

The baseline carbon intensity for liquid fuels is calculated at 90.4 gCO2e/MJ. The mandatory reductions to this carbon intensity are proposed to commence in December 2022, with a 2.4 gCO2e/MJ reduction from the baseline. These reductions would then increase year over year until 2030, when the maximum carbon intensity for liquid fuels would be reduced by 12 gCO2e/MJ from the baseline. From 2030 to 2040, the maximum carbon intensity would remain steady at 12 gCO2e/MJ less than the baseline, subject to further regulatory review. Exemptions apply to fuels that are used for non-combustion purposes, research, by remote communities, and in international marine transportation and aviation.

The Proposed Regulatory Approach released in 2019 had originally proposed an initial reduction of 3.6 gCO2e/MJ commencing in June 2022, ramping up to 10 gCO2e/MJ in 2030. In response to concerns raised by industry stakeholders about their ability to meet those targets on time, particularly in light of the COVID-19 pandemic, ECCC revised that plan. The proposed Regulations are drafted so that the reduction requirements start with a smaller initial reduction from baseline, but ramp up to a higher total reduction, in order to give primary suppliers relief in the initial years while still achieving the same overall carbon intensity reduction. The proposed commencement date of the mandatory reductions was also moved back by six months, from June 2022 to December 2022.

Primary suppliers have several ways to meet their obligations:

  • Create compliance credits themselves;
  • Purchase compliance credits from others;
  • Pay into a compliance fund at an equivalent rate of $350 per credit (up to a maximum of 10 per cent of the firm’s compliance obligation); and
  • If insufficient total credits are available, primary suppliers may also carry forward up to 10 per cent of their annual reduction requirement for a maximum of two years.

ECCC has stated that it expects the greatest number of credits (and the largest greenhouse gas emission reductions) will come from the supply of low-carbon fuels over the life of the regulations, although in the earlier years of the reduction schedule, more credits will come from actions along the lifecycle of high-carbon fuels that reduce their carbon intensity.

Compliance Category 1: Lifecycle improvements in fuel carbon intensity

Lifecycle improvements can be taken by primary suppliers or their service providers, and may include projects such as:

  • Carbon capture (and utilization) and storage (CCS);
  • Low-carbon intensity electricity integration;
  • Enhanced oil recovery; and
  • Co-processing of biocrudes in refineries and upgraders.

The number of credits created by each project will depend on the quantification methods set by ECCC, and developed outside of the proposed Regulations.

As discussed in our article from November 4, 2020, the key considerations to credit creation for lifecycle improvements are demonstrating that a project is “additional” to changes a facility would otherwise undertake due to other regulatory and business reasons, and the details of applicable quantification methods.

ECCC is currently developing a generic quantification method, which could include projects such as energy efficiency, cogeneration, electrification and methane reductions.

The development of specific quantification methods will follow. These methods will have to demonstrate additionality, which could be met by showing that the specific technology has a penetration rate of 5 per cent or less, or no more than five facilities, adding crediting flexibility for improvements in industries with fewer facilities.

Following industry feedback regarding the crediting period, the draft Regulations set out a 10-year credit period with a five-year renewal for credits created from most projects, and 20-year credit period with one five-year renewal for CCS projects.

Compliance Category 2: Supplying low-carbon fuels

The Category 2 credit creation is how Canada will seek to incentivize investment in alternative fuels production.

A low-carbon fuel is eligible for credit if its carbon intensity is 90 per cent or less than the reference carbon intensity value for the fuel type. The credit reference value for liquid class fuels is based on an average carbon intensity of all liquid fuels supplied in Canada in 2016, and decreases every year until 2030, in accordance with the reduction requirement set by the Regulations.

The use of alternative fuels will therefore be eligible for credits to the extent the low-carbon fuel is shown to have a lower lifecycle carbon intensity than the reference. Facilities seeking to create credits can either rely on a default carbon intensity set in Schedule 5 of the draft Regulations, or, if the facility has been operating for longer than two years, it may undertake a specific Life Cycle Assessment based on a model tool that is currently under development by the ECCC.

As previously alluded to in our November 20, 2020, article on the treatment of alternative fuels, under the 2019 Proposed Regulatory Approach, the new clean fuel Regulations are notable for including both biofuels (such as ethanol) and synthetic renewable fuels (such as syngas from biomass) under the creditable low-carbon fuels.

One of the changes to the proposed Regulations as compared to previous proposals is a streamlining of the land-use and biodiversity (LUB) criteria that must be followed by creditable feedstocks. The intent of the LUB criteria is to prevent negative impacts from increased harvesting of feedstocks for biofuel production. Several changes were made to the LUB criteria under the proposed Regulations, including:

  • Feedstock that meets similar national or sub-national requirements will be deemed to meet the LUB criteria; and
  • Agricultural biomass feedstock that results in significant crop expansion into high-carbon stock (forests, wetlands, etc.) will not be creditable, and the baseline for determining crop expansion was amended from 2008 to 2020.

Compliance Category 3: Specified end-use fuel switching in transportation

Credit creation under Category 3 will incentivize the shift from gasoline and diesel in transportation towards vehicles and equipment that uses fuels or energies with lower carbon intensity (hydrogen, electric vehicles (EVs), as well as natural gas, renewable natural gas or propane). Credits for end-user fuel switching are not contemplated in sectors beyond transportation.

As described in more detail in a previous analysis on credit opportunities under the clean fuel standard, the credit generation possibilities will likely spur investments throughout the EV and hydrogen-powered vehicles in Canada’s transportation sector. One notable difference between past proposals and the draft Regulations is that the charging network operators that generate revenue from the sale of credits from residential and public EV charging stations will be required to reinvest 100 per cent of that revenue in further financial incentives for EV owners and expanding infrastructure in residential or public locations.

ECCC estimates that the majority of end-use fuel switching credits will be created by EVs and related infrastructure.

Implications of the proposed clean fuel regulations

As we noted in a previous post, following the 2019 Proposed Regulatory Approach, primary suppliers raised concerns about a present lack of available low-carbon biofuel supply to meet the demand for fuel blending that the Clean Fuel Standard will create, given that this is expected to be the primary credit creation mechanism overall. In its commentary accompanying the new draft regulations, ECCC acknowledged this concern, but stated that it expects there to be sufficient low-carbon supply to enable compliance with the proposed regulations in 2030. This expected supply will highly depend upon the rate of development of biofuel technologies over the next decade, in response to the newly created demand.

Overall, ECCC estimates that incremental compliance costs under the proposed regulations will total $26.9 billion, and that there will be a net cost to society of $20.6 billion. The regulations would result in an expected greenhouse gas emission reduction of 221 megatonnes of CO2e, amounting to a net cost of $94 per tonne of CO2e reduced. Under the government’s cost-benefit analysis, this figure is lower than the estimated current ‘social cost of carbon,’ which ranges from $135-$440 per tonne, yielding an expected net benefit overall.

Following the 75 day public comment period that ends on March 3, 2021, the final regulation is expected at the end of 2021, with compliance beginning in December 2022.

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