Canada Carbon Market: The search for carbon harmony

As the federal government of Canada prepares its own legislation for offsetting greenhouse gases, the wind industry is wondering how the US government's plans for a more straightforward cap-and-trade system will affect North American carbon markets - and crucially, whether the more populous neighbour will be looking to import wind power from outside its borders in order to meet new renewables targets.

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Signs that the climate change policy in Canada and the US will lead to greater integration of North American carbon markets has left Canadian wind developers wondering exactly where and how they will fit in.

Canada's federal government released draft rules in June for its proposed greenhouse gas offset trading system. The good news for wind power developers is that it will allow them to sell the emissions reductions they generate to companies that need them because they are producing emissions over and above those that the government allows. The bad news is that nobody is quite sure whether Canada's system can survive the changes south of the border that are planned by President Barack Obama's Democratic administration.

The US government plans a cap-and-trade system for greenhouse gas emitters, where those who don't reach their capped limit can sell their allowance on to those who wish to exceed their limit. With the Canadian government having stated publicly that it favours continental harmonisation, few doubt that Canada will follow suit.

"I think cap-and-trade is here in Canada. It may not be here next year or in 2011 or 2012, but we are going to be facing cap-and-trade in the next several years," says Nathan Maycher, senior manager of sustainable development for TransAlta Corporation, an independent power producer based in Calgary.

Currently, Canada's approach is based on reductions in emissions intensity, which is the amount of greenhouse gas released per unit of production. It establishes a baseline for each emitter from which it must make improvements, and buying emissions credits, or offsets, from wind producers is one way to do that.

The US strategy is fundamentally different. It sets an absolute cap on total emissions within a specific sector. The consensus is that it will not allow offsets from wind because of the danger that this will lead to a double counting of reductions. "When you get a pure cap-and-trade system, which the US approach is, offsets don't tend to work well," says Maycher.

The question now facing Canadian wind developers is what will work if the federal government follows the US lead on carbon policy. Under a cap-and-trade system, companies are either allocated allowances to emit a specified amount of greenhouse gases or are required to purchase them through an auction process. The number of allowances that are available is determined by the level of the cap. Strictly speaking, because wind facilities have zero emissions they would qualify for zero allowances. But the system could be set up to recognise the value of the clean energy they produce. A share of the available allowances could be set aside for wind producers, who could then sell them to emitters who need them.

Alternatively, some of the revenue from an auction process could be channelled into programs that support development of renewable energy sources.

The Canadian Wind Energy Association (CanWEA) has commissioned a study to assess which option is more desirable, but Maycher advises going after the ready cash. Wind energy's share of allowances would decrease over time as the emissions cap is lowered and fewer are available, whereas the revenue from auctions is likely to increase as carbon prices rise.

"If we get a chunk of that, I think we can get some predictability in the industry," says Maycher.

Creating the incentive

One complication is that finding a way to directly encourage development of renewable energy sources is not likely to be a priority in a US cap-and-trade system. While US legislation currently pending, known as the Waxman-Markey climate bill, earmarks a small allocation of emissions allowances to renewable energy projects, the US is looking at a separate mechanism to help bring new wind projects online.

There are proposals before both the US House of Representatives and the Senate to create a national renewable energy standard (RES), which would demand that a minimum amount of wind and other clean power sources are included in the country's electricity supply mix. It also sets up a market for renewable energy certificates (RECs) through which the target is met. RECs are tradeable credits and each certificate proves that 1 MW/h of power has been generated from a renewable source.

Elizabeth Salerno, industry data analysit for the American Wind Energy Association (AWEA), says that when the US wind industry was examining the options for the planned US legislation its conclusion was that not only would it be a relatively minor player at the table in the negotiations for creating a cap-and-trade system, but also that even if the system was designed perfectly for wind, it would be years before the legislation would deliver the kind of carbon prices that are needed to drive development.

The numbers bear that conclusion out. An analysis of the Waxman-Markey bill by the US Congressional Budget Office estimates that the price of an allowance in 2012 will be US$16 a ton, rising to US$25 by 2020. That translates into an electricity price increase of US$8/MWh.

"Would $8 really change the game?" asks Salerno. "Would it really change choices in new energy resources? In terms of changes in general behaviour, would $8 really trigger that? If the answer is no, you probably need to do something else in addition to the planned climate bill to really push renewables into the system in the next few years."

AWEA, and now US policy makers, are looking to the RES as a way to accomplish that goal. The trouble is that it is a mechanism Canada may not be able to match.

"It's a very open question as to whether Canada can even develop a national electricity standard - with the default answer probably being no," says CanWEA president Robert Hornung. "Electricity is an area of provincial jurisdiction. Provinces will scream like mad if the federal government tries to do this. When we are looking at the scenario where, at the end of the day, you might have a national renewable electricity standard in the US and no equivalent in Canada, what does that mean for investors? What does that make Canada look like as an investment destination and opportunity? It does have implications for Canada and Canadian competitiveness."

It is this prospect of reduced Canadian competitiveness, Hornung believes, that will ultimately drive the provinces to accept, and possibly even demand, a federal renewable energy framework that makes investment in Canada competitive with that in the US. "The US will have a renewable energy standard, and once that happens I think there will be a lot of pressure on Canada to match it," he says. "Not only so it can be synchronised with our main trading partner, but also to provide an equal playing field to wind so that most Canadian developers don't just move to the US. If you can make a 20% rate of return in the US and only 10% or 8% in Canada, you are likely to spend more money and more capital and more time in the States."

The effect on wind exports

Another uncertainty for the Canadian wind industry is the question of how the planned US legislation will affect wind power exports from Canada to its main trading partner. The answer could have a major impact on the ability of developers to find markets for their product.

"There are finite chances to actually sell in Canada. In order to sell anything, you may end up selling to the US," says Liz Cussans, lead business development manager for wind with Canadian-based TransAlta. The situation has Canadian wind developers looking south for export opportunities, where there is a much bigger demand and a more varied customer base.

Although it is not explicitly spelled out, says AWEA's Salerno, she understands that the intent of US RES legislation is to exclude wind power imports from being used to meet the target. "It goes back to the jobs," she says. "Part of the desire for a national RES is to get those green jobs."

Politics plays a role as well. Much of the opposition in the US to a national RES comes from state or regional jurisdictions with fewer indigenous renewable energy resources. They complain that it will act like a tax on their states by forcing them to buy RECs and renewable energy from states that do have the resources. "So the concept of importing renewables from another country causes an outcry," says Salerno.

The story may be different, Salerno says, if the proposed US target was more demanding. The House bill, which has advanced the furthest along the legislative path, sets a target of 20% renewable electricity by 2020 and allows for 8% to be met through energy efficiency improvements. "Basically our projections tell us that we are going to meet this bill," says Salerno. "Now if the target was made more robust, and as such created a bigger market for renewables, I think there'd be more willingness for us in the US to open up to suppliers from other markets, such as Canada, because we want to meet our target, and we'd want to do so at the least cost."

However, even as things stand, there are markets in the US that already have more demanding targets for wind where Canadian wind could have an opportunity to participate. California is a case in point. The state has an RES of 20% by 2010, and Governor Arnold Schwarzenegger has signed an executive order that increases that target to 33% by 2020.

The resulting demand for green power is huge, says Nicole Finerty, renewable energy director at Evolution Markets, an REC broker based in the state: "What is going on in California is really going to drive everything that will happen in western Canada and the western US. That's where the juiciest pricing is going to be by far."

Precisely what California will do in order to meet its target, however, remains unclear. Currently, the requisite proportion of green power must actually be delivered into the state in order for California to meet its RES requirements. But assessments say that California is already three years behind in meeting its 2010 target and, with Schwarzenegger's even more demanding target looming, policy makers in the state are looking at allowing utilities the flexibility of trading in RECs as a way to meet their renewables obligations.

Another bill rejects imports

Yet the concessions on the table in this regard are trifling. California's Assembly Bill 64, says Finerty, allows the state's utilities to meet only 10% of their obligation with imported RECs. "That's a drop in the bucket," she says. Moreover, its Senate Bill 14 allows no imported RECs and, she argues, actually takes a step backward when it comes to imported wind energy.

As things stand, out-of-state wind energy within the jurisdiction of the Western Electricity Coordinating Council, which includes the Canadian provinces of British Columbia and Alberta, get a temporary reprieve from the current energy delivery rules. Wind energy producers in the western provinces and states can deliver on their certificates by generating their renewable energy units outside Californian state lines, provided they pump the commensurate amount of electricity into the state within one calendar year. Under Senate Bill 14, however, they'd have to deliver that green electricity into the state at the moment it is generated. "That's completely ludicrous," says Finerty.

The details of the legislation can make or break the viability of exporting Canadian wind energy. That also applies to emerging regional greenhouse gas markets, like the one being contemplated under the Western Climate Initiative (WCI). The US states of Arizona, California, Montana, New Mexico, Oregon, Utah and Washington, and the Canadian provinces of British Columbia, Manitoba, Ontario and Quebec are signed up to the initiative.

Policy makers at the WCI are in the process of designing a cap-and-trade program to help meet its goal of a 15% reduction in emissions from 2005 levels by 2020. Although many details remain to be worked out, says Greg Baden, president of the Calgary consulting firm BECL and Associates, it appears that wind developers in provinces that are not in the partnership will have some challenges if they want to export to those areas that are.

WCI will apply a uniform emission rate - that is a specified amount of carbon emitted per KW/h of power - to exports based on the mix of power sources in the area they are coming from, explains Baden. The first company or organisation within the WCI boundary to take control of that exported electricity will have to surrender the necessary emissions allowances. For wind producers in a province such as Alberta, which is not a part of the WCI and where the grid is heavily weighted to coal and gas, that presents a problem. It interconnects to other markets through British Columbia, which is part of the initiative. "As soon as you cross the border you are going to be subject to this default emission rate," says Baden.

WCI, says Baden, is likely to act as a test bed for many of the details of both the US and Canadian cap-and-trade systems. But it is only one of a growing patchwork of carbon-related regulations, action plans and initiatives that the wind industry is trying to cope with.

"It is sort of like having a puzzle with a lot of pieces," says Chris Joy, regulatory specialist of Enmax, a Calgary electricity retailer and independent power producer. "You're missing some of the pieces, and you don't know what the picture looks like at the end of it. But you've got millions of dollars on the line so you want to figure it out as fast as you can."

But Graeme Martin, environment products business development manager for Shell Energy North America, says having a variety of carbon markets "is actually a nice situation to be in," explaining that it allows participants to experiment with what works and what doesn't. But from a market perspective, it will need to coalesce into something that allows trading across the various jurisdictions within North America. "Really what you're after is a more homogenous market where you get that liquidity and you can actually rely on those prices in your investment and economic decisions. Having fragmented markets just doesn't do that," says Martin.

A broader, transcontinental market for carbon ought to be of benefit to Canadian wind, especially considering that almost 75% of the electricity produced in Canada is already emissions-free hydro and nuclear. "Our grids are connected north and south," says CanWEA's Hornung. "As we have a lot of electricity trade across the border, if we have a North American system and if the US also puts a price on carbon, that will help wind energy in all parts of Canada."

TransAlta's Cussans agrees: "If North American carbon prices kick in, the race is going to be based around the speed to build, the cost to build and the volume of production, the same as it is when you are picking a wind farm location within a market. You pick the easiest place, the cheapest place and the windiest place - and that is going to be the best place. If that happens to be in Canada and your market is in the US, so be it."

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