Federal government launches greenhouse gas offset credit system

The Government of Canada has published the Greenhouse Gas Offset Credit System Regulations, which establish an offset system under the Greenhouse Gas Pollution Pricing Act (GGPPA). The system allows registered participants to carry out projects based on federal offset protocols to generate tradeable offset credits (each credit representing one tonne in GHG emissions reduced or removed). The government also published its first protocol, for Landfill Methane Recovery and Destruction.

What you need to know

• Offset credits are one type of compliance units that covered facilities can use to compensate for excess emissions (i.e., above annual emission limits) under the Output-Based Pricing System. These credits can also be used for other purposes, such as meeting corporate net-zero commitments.
• The offset system is intended to incentivize voluntary GHG emissions reductions or removals from eligible activities that are not otherwise legally required or covered by existing carbon pricing systems.
• To generate federal offset credits, proponents must, among other things: have an account in the offset credit system; implement a project to generate GHG reductions that are real, additional, quantified, verified, unique and permanent; and meet applicable reporting and verification requirements.
• The Regulations incorporate by reference the protocols published in the Compendium of Federal Offset Protocols (Compendium). ECCC is developing protocols for quantifying GHG reductions for various project types. The only published protocol to date is for Landfill Methane Recovery and Destruction, with a protocol for refrigeration systems scheduled for finalization in late summer or early fall.
• The market for federal offset credits is already developing, with proponents and purchasers developing innovative agreements for future credit streams.
• The publication of the Regulations concludes a multi-year design and consultation process led by Environment and Climate Change Canada (ECCC) (see prior Torys bulletins here and here).

What do the regulations say?

Application

The Regulations apply to proponents of projects to which a federal offset protocol applies. To be eligible, a project must have started on or after January 1, 2017 and be shown to generate GHG reductions that are real, additional, quantified, verified, unique and permanent. Reductions are quantified against baseline emissions (i.e., “additional” to a business-as-usual scenario), must not result from an existing legal requirement, and must arise from sources, sinks and reservoirs that are not already covered by a carbon pricing system.

The system applies in each province or territory that does not have an active, published offset protocol for a given project type. In other words, the federal protocols cannot be used in provinces or territories that have methodologies covering the same project type. For example, Alberta and Québec currently have protocols for landfill gas recovery and destruction projects.

Conditions of registration and project aggregation

In addition to prescribed information requirements for registration on the Credit and Tracking System (CATS), project eligibility will be linked to a proponent’s contractual right to, or ownership of, offset credits generated. Proponents receiving a financial incentive from a funding program would still be eligible for registration provided that the exclusive entitlement to credits resulting from the project remains with the proponent. A proponent may group multiple projects (i.e., register them as one aggregated project) if it is the proponent for all the projects. Aggregated projects must be in the same province and use the same version of the same protocol.

Crediting period

The Regulations specify the crediting periods in which offset projects may generate credits and the number of times and maximum duration for renewal. Unless otherwise provided in a protocol, the crediting period is 30 years for forestry sequestration projects, 20 years for other sequestration projects, and 10 years for all other project types¹. Forestry sequestration projects may be renewed for up to a total of 100 years, while other projects may be renewed no more than two times.

Tonne-year accounting

The Regulations allow proponents of sequestration-based protocols, once they are finalized, to use tonne-year accounting.

Under this approach, the number of credits issued to a sequestration project each year is based on an estimate of the total GHG removals that will occur over a 100-year project lifespan, after making deductions for leakage and uncertainty, divided by a tonne-year conversion ratio. In that way, it allows proponents to quantify the benefits of projects that last less than the full 100-year period. The Québec offset program is slated to use a similar approach for its forestry offset protocol.

Registration application deadline

If the start date of a project predates the publication of the applicable protocol in the Compendium, the registration deadline is 18 months after the publication date, and no more than 10 years after the project start date (but not earlier than January 1, 2017). If the project start date is on or after the applicable protocol’s publication, the deadline is 18 months after the start date.

Reporting requirements and credits issuance

The Regulations set out requirements for reporting, monitoring, verification, and record-keeping. Notably, proponents must submit an initial project report (together with a verification report) for the first year in the first crediting period no more than six months after the one-year period ends. Subsequent project reports are required no later than six months after the end of the reporting period.

Each project report must be verified by an accredited third party and quantify the GHG reductions and removals for each year in the reporting period based on the applicable protocol. Moreover, sequestration projects that use certain quantification methodologies (i.e., tonne-tonne and hybrid tonne-year) must prepare a reversal risk management plan and submit monitoring reports to document and confirm the measures implemented to mitigate credit reversal risk.

The credits issued into a proponent’s Offset Credit System Account for a given year will correspond to such quantified reductions and removals, minus: (i) any credits the proponent may have agreed to forgo under a funding agreement, (ii) credits required to be deducted and deposited into the environmental integrity account², and (iii) credits corresponding to any net increase in GHG carried over from a previous year.

Protocol development and Indigenous participation in offset system

The first published protocol (Landfill Methane Recovery and Destruction) allows the quantification of GHG reductions from landfill sites, due to the installation and operation of equipment to capture and destroy methane.

ECCC is currently developing protocols for: refrigeration systems³, improved forest management, enhanced soil organic carbon, and livestock feed management. According to ECCC, the refrigeration protocol is expected to be finalized in late summer or early fall. In addition, in summer 2022, ECCC will begin to develop protocols for direct air carbon capture and sequestration. Subsequent project types under consideration for federal offset protocol development include: bioenergy carbon capture and sequestration, improved forestry management on public lands, livestock manure management and anaerobic digestion.

In addition, to facilitate opportunities for Indigenous participation in the federal offset system, ECCC has released a discussion paper outlining existing and proposed initiatives, with a focus on forestry projects. About 88% of Canada’s forests are located on provincial Crown land and public land in the territories. According to ECCC, it is important to consider how forestry offset projects can be enabled on Crown land, while respecting Indigenous rights. Given that the Regulations require proponents to have exclusive entitlements to the offset credits from their projects, ECCC is therefore considering the following:

• In land tenure contexts where Indigenous peoples hold title to the land or have the right of exclusive use and occupation of the land, Indigenous peoples could undertake an offset project or assign entitlement to a project proponent⁴.
• For forest-based offset projects on Crown land where entitlement is not clear (i.e., in contexts other than the above scenarios), a project proponent would need to enter into an agreement with a provincial or territorial government managing Crown land in order to meet requirements to demonstrate entitlement under the federal GHG offset system.

Comments may be submitted on this discussion paper to ECCC (at [email protected]) by June 30, 2022.

Market development

Demand for federal offset credits is expected to come from several sources.

Under the GGPPA, facilities covered by the Output-Based Pricing System can use these credits to compensate for any excess emissions (i.e., emissions above their annual emission limits). Those facilities may also comply by lowering their GHG emissions or purchasing recognized units (currently, from certain approved protocols under Alberta’s offset program). However, if the federal backstop carbon price rises to $170 per tonne of carbon dioxide equivalent by 2030, as the federal government has proposed, these facilities will increasingly explore lower cost abatement options in the offset sector.

ECCC has also suggested that demand for federal credits could arise in the voluntary markets. Increasingly, companies are voluntarily committing to achieve net-zero GHG emissions and setting interim GHG reduction targets. To the extent these emissions reductions cannot be achieved internally, organizations may seek to balance their emissions using high-quality carbon credits. The development of a robust federal offset program, with a high degree of environmental integrity, may therefore be an attractive option for companies voluntarily seeking to purchase credits for retirement towards their corporate targets, while helping minimize some of the integrity concerns in the offset markets.

The market for these credits is already being developed, with proponents of projects that may be eligible for federal offset credits already entering into agreements for the sale of future credit streams. As part of our climate change counsel to clients, we are working with many of the country's largest investors and resource companies as they pursue carbon purchase and streaming agreements, and are helping them manage the delivery risks associated with early entry into the market for federal offsets. Reach out to our team for more information on this emerging opportunity.