Alberta must address the looming risk of an unstable carbon market

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Originally published by The Globe and Mail


Grant Bishop is the Calgary-based founder of KnightFork, which builds data-driven tools for carbon pricing and the energy transition. Michael Bernstein is the executive director of Clean Prosperity, a non-profit focused on practical climate solutions to reduce emissions and grow the economy.

Alberta faces a make-or-break moment for its industrial carbon pricing system.

The Technology, Innovation and Emission Reduction Regulation, or TIER – the province’s output-based pricing regime – is a critical component of Canada’s decarbonization efforts, given that so many of Canada’s industrial emissions are regulated under the system. Alberta represents more than half of the total emissions reductions required from industry to achieve Canada’s climate target of a 40-per-cent reduction in emissions below 2005 levels by 2030.

However, because of its current structure and stringency, TIER faces the risk that its market for emission credits and offsets would be oversupplied in coming years.

In order to accelerate emission reductions, large emitters and project developers must have confidence that investments in decarbonization will pay off. So fears of future credit oversupply make investments in big decarbonization projects less likely today.

The clock is ticking to resolve this uncertainty. After its review of TIER over the summer, Alberta must now decide the degree to which it will tighten the stringency of industrial facilities’ compliance obligations. At the same time, the federal government is preparing to approve provincial industrial carbon pricing systems for the next five years.

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Without tightening Alberta’s industrial carbon pricing system, the province could miss opportunities to benefit from growth in jobs and investment in the emerging low-carbon economy – and Canada could miss its emission reduction targets.

As we elaborate in our recent report, the stringency of obligations under TIER must be significantly tightened to maintain demand for credits and offsets and to reach equivalence with the federal backstop and consistency with the federal 2030 Emissions Reduction Plan.

The risk of oversupply is inherent in the “output-based” design of Alberta’s TIER regime, in which an industrial facility’s compliance obligations are determined by its emission intensity – that is, its greenhouse gases relative to the amount of a given product it produces.

Specifically, TIER assigns each facility a benchmark emission intensity above which an industrial facility faces obligations to pay the carbon price and below which it generates credits. The Alberta government’s proceeds from payments of the carbon price financially support decarbonization projects. Certain decarbonization projects – like renewable electricity generation or carbon capture and storage – also create offsets that emitters can purchase to satisfy their obligations.

The aim of this output-based design is to provide continuing incentive for emission reductions while buffering the impact on industrial facilities’ competitiveness. In a world where many countries do not price carbon, imposing the full costs from carbon pricing on Canadian producers could result in so-called “carbon leakage” to foreign producers who don’t face a similar burden.

But, there’s a flip side: If TIER’s benchmarks are too generous, overall obligations will be insufficient to absorb the available credits and offsets. This creates a “chicken and egg” problem for those considering investments in decarbonization. If project developers fear an oversupplied market for TIER credits and offsets, they won’t go ahead. The simple reality is that someone must pay for decarbonization.

In our recent report, we consider the implications for the TIER market if Alberta’s industrial facilities achieve the goal of a roughly 40-per-cent reduction in emissions by 2030 in the federal Emissions Reduction Plan. We show that, even with the accelerated tightening of TIER benchmarks proposed by Alberta’s government, emission credits would substantially exceed obligations in coming years.

Alberta’s government has proposed tightening most benchmarks by 2 per cent a year. However, our modelling indicates that benchmarks must be tightened by 5 per cent a year to avoid an oversupplied market for TIER credits while reducing emissions as targeted in the federal plan.

A plan for reducing emissions by 40 per cent does not mean Alberta’s industrial facilities will actually achieve the target. Indeed, certain voices from industry have raised concerns over the speed and scale of the federal climate target. The pending decisions about the future stringency of Alberta’s TIER therefore represent a test of whether governments are truly serious about using carbon pricing as the linchpin of Canada’s decarbonization goals.

Given uncertainties facing Alberta’s decarbonization pathway, we believe Alberta should pursue an “adaptive” approach for tightening TIER stringency to ensure that demand for credits and offsets will consistently exceed supply.

This could take the form of a rule to increase the stringency every year to the degree necessary to keep demand for credits consistently higher than supply. This would give industry the confidence to invest now in long-term decarbonization, knowing that they can count on the future value of the credits they earn.

Finally, present tensions around Alberta’s TIER highlight wider questions about industrial competitiveness as carbon costs become more and more significant.

Canada accepts a province-by-province patchwork of different carbon pricing systems, equivalent to the federal system though adapted to each province’s industrial needs.

But, as stringency tightens and carbon pricing rises, provincial governments will need to work with Ottawa to find more durable solutions – such as border carbon adjustments that impose tariffs on the carbon content of imports and could also rebate the carbon price to exporters.

Carbon pricing should remain the backbone of Canada’s emission reduction plans. And yet, without strengthening output-based pricing systems in Alberta and beyond, the potential for carbon pricing to drive deep industrial decarbonization could turn out to be a pipe dream.

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