Canada’s carbon offset market starts to take shape, with a lot of pitfalls still to be avoided

Open this photo in gallery:

The federal government is finally beginning to implement a controversial and long-delayed piece of its national carbon pricing strategy.

On Wednesday, Environment Minister Steven Guilbeault announced that he is ready to launch a domestic carbon offset market. It will allow certain sectors not covered by industrial carbon pricing to generate credits by reducing their greenhouse gas emissions, then sell those credits to heavy emitters that need to meet carbon-pricing obligations.

Ottawa is conducting the rollout rather slowly and cautiously. It’s starting with rules for how offsets can be created by landfill operators who recover methane and other gases emitted from their sites, which is one of the easier forms of offset creation to regulate. Protocols for other credit-generating sectors – including forestry, agriculture and direct air capture of carbon dioxide – are to follow gradually in the months ahead.

But that’s done little to ease concerns from environmental groups that the new system will undermine Canada’s pursuit of its national emissions-reduction targets. They worry about flooding the market with cheap offsets that give heavy polluters an easy way to avoid reducing their own emissions.

Canada’s first carbon offset market coming to help big industry cut emissions at a lower cost

Indeed, the government still has a lot of work to do in order to land on the sweet spot it’s aiming for: an offset system sufficiently inviting to entice investment in emissions-reducing activity that wouldn’t happen otherwise, but not so loose as to undermine the integrity of the entire carbon-pricing system.

In part, Ottawa is grappling with challenges that surround any offset system, including those in three Canadian provinces (British Columbia, Alberta and Quebec) that have already set up their own systems and from which Mr. Guilbeault said he has been drawing lessons.

One is known as additionality: ensuring that emissions reductions being rewarded with credits are happening because of the offset market’s existence – that they wouldn’t be taking place regardless. That’s tricky when, for instance, the government will be looking to reward agricultural processes such as cover cropping that are increasingly common because they’re good for farmers’ bottom line. And it’s made more challenging across the board by the growing suite of other regulations and incentives for sustainable practices with which offsets ideally shouldn’t overlap.

Another is permanence: avoiding credits for emissions reductions that prove temporary. That’s part of the reason environmentalists are especially concerned about offsets involving nature protection such as forest management; it’s hard to guarantee those protections will last many decades.

And there are more basic imperatives, such as confirming that emissions reductions being rewarded with credits are actually happening, for which the government is promising third-party verification.

While the devil will be in the details for each sector, Mr. Guilbeault also tacitly recognized Wednesday that it won’t be entirely possible to know how the rules will work until the market has started taking shape – and that the government will have to be highly attentive and nimble to adjust where needed.

“We always have the ability to course correct,” he said.

But the success of the new market will depend on more than just the rules for how offsets are generated. As Mr. Guilbeault acknowledged, it will be equally contingent on strengthening the existing industrial carbon pricing system in which offsets will be available for purchase.

The basic idea for how the offsets will interact with that system is simple enough. Rather than paying the national carbon price ($50 a tonne and rising), large emitters will be able to negotiate offset purchases at a somewhat lower rate.

The complication is that, unlike the carbon price paid by most fossil-fuel consumers in Canada, the one for large industry prices only a share of a company’s emissions, as a way of protecting international competitiveness. And Ottawa has allowed most provinces to set up their own industrial pricing systems, with varying degrees of stringency on the threshold at which the price kicks in.

In some parts of the country – Ontario, with a rather lax industrial system, is the biggest example – the burden on heavy emitters is currently too low for the offsets to be helpful.

Companies’ low emissions-reduction requirements could allow them to almost entirely meet them through offset purchases, alleviating them of any burden to cut their own pollution. Conversely, they might be able to achieve their obligations so easily, through modest efficiency improvements, that they don’t need to use any offsets at all – sabotaging the market’s development.

The stringency discrepancies are a problem for meeting Canada’s climate targets already, and Mr. Guilbeault is in the midst of negotiating stricter equivalency agreements with the provinces. But taking a tough line on that front will be all the more critical as offsets enter the equation.

Yet another obstacle to the offset market’s development is political uncertainty around the carbon price’s upward trajectory. Credit-generating emissions reductions may only be worthwhile if the price steadily rises to $170 a tonne as planned – far from a sure thing if a different federal government takes office.

So there is extra incentive for Mr. Guilbeault to make good on introducing contracts for differences, a mechanism that would help protect investors in emissions reductions from that sort of uncertainty.

If all this seems extraordinarily complicated – well, it probably is. And that’s without even getting into the government’s plans to also make the offsets available outside the industrial carbon-pricing system, to companies wanting to voluntarily purchase them to help meet their net-zero emissions commitments, which involves competing with other offset markets currently available to them.

The complexity is an argument for forgoing the creation of a new offset market altogether.

Seeing enough upside to proceed anyway – the chance to achieve emissions reductions that its carbon pricing system won’t achieve otherwise – Mr. Guilbeault and his colleagues have their work cut out for them to avoid compromising national climate goals if any aspect of this plan goes wrong.

Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.