September 1, 2015

Why Canadian Oil Producers (and the Parties that Love Them) Should Embrace a Carbon Tax

The fight over climate policy in Canada puts in stark relief the main challenge confronting political leaders in carbon-rich countries. To wit, how does a country whose economy is dependent on fossil fuel production reconcile itself with public demands to address climate change?

Not surprisingly, Canada has been highly conflicted when answering that question. For the past 25 years, Canadian governments committed to carbon emission reduction targets that it had no capacity to meet short of massive economic contraction. Those targets allowed Canada to pose as members-in-good-environmental standing with other western developed economies making similar commitments post-Copenhagen. Yet over the same time period, Canadian governments were actively promoting and facilitating hydrocarbon development, most obviously with respect to oil sands and natural gas development via LNG. National emission reduction targets were functionally aspirational.

While that development has brought economic growth, it has also made it more difficult for Canada to meet its emission reduction targets. Unlike most of the rest of the developed world, Canadian greenhouse gas emissions have not declined over the past decade. If Canada were to realize its growth ambitions for its hydrocarbon sector through 2030 (exceeding 5.0 million bbl/ day of oil production on annual average basis), the country would be a growing emitter in absolute terms.

Unfortunately, there are few (relatively) lost-cost options for reducing greenhouse gas emissions in Canada. Outside of Alberta, Canada does not produce much coal-fired electricity. While an agreement exists to shut those coal-fired facilities down when they reach the end of their economic life (likely over 15+ years), accelerating that timetable would impose further costs on the Alberta economy already battered by declining oil and gas prices and constrained access to global markets. Little scope exists in the foreseeable future to reduce greenhouse gas emissions if oil sands output is to grow to forecasted levels. Short of major technological innovations not presently on the horizon, significant emission reductions can only be secured by cutting back on production.

When one couples the above with the fact that oil sands production is more greenhouse gas intensive than other forms of crude oil production, it is not surprising that Canada’s oil sands have emerged as the bete noire for the North American environmental movement. When environmental opposition failed to convince provincial governments in Alberta to abandon its support for oil sands development, environmentalists turned their assault upon the infrastructure the industry needed to deliver the oil to market. And it worked. The Keystone XL pipeline, a project whose commercial development I spearheaded, was put on death’s door and the Gateway pipeline project, intended to provide access to Pacific ports, is likewise in political jeopardy.

Today, the Canadian oil industry is held hostage by environmentalists. Environmentalists may not be able to halt production—or even (given rail capacity) keep the oil totally out of global markets—but they can increase the costs associated with getting the oil to consumers and block the infrastructural investments necessary to increase present production levels.

The only way out for the Canadian oil sector is to embrace carbon pricing. How else can the industry reconcile its ambition for increased crude oil production with public demands for a credible position on climate change? The simplest answer is to accept the fact that there are, at present, unaccounted for social costs related to oil sands production and argue that, as long as those costs are accounted for in market prices, production can and should go forward. If the tax were $30-40 per ton, Canada could credibly argue that it had dealt with the risks of climate change more aggressively and elegantly than most of its major trading partners, including the United States.

A deal along these lines would likely reduce the political power of the environmentalist assault on oil sands development, especially if the tax was national in scope with a significant portion of the funds applied to carbon mitigation and adaptation. President Obama’s most direct statement to date regarding the criteria he would apply to Keystone XL for its ultimate rejection or approval was an implicit invitation for Canada to embrace carbon pricing to deal with the related emissions from its oil sands production to be shipped via Keystone XL.

If, five years ago, Canada had taken the step to unilaterally impose such a carbon tax on all of that country’s emissions, what might it have gained from it?

  • An actual XL permit;
  • Acceptance from the environmental community that Canada had reasonably accounted for the risk of climate change relating to its hydro-carbon production; and
  • Canadian oil sands production no longer seen as a “pariah” amongst crude oil options internationally.

Canadian champions of oil sands production, however, don’t see it that way. They argue that there is no explicit quid pro quo on this score being offered by either President Obama or any part of the environmental movement. Accordingly, there is little reason to think that acceding to carbon pricing actually “buys” a social license for oil sands production and development. Better, they argue, to persist with disingenuous targets, eroding social license, and frustrated market access.

So, is a carbon tax a license for industry to emit as much greenhouse gases as it wishes, provided that the democratically mandated tax is paid? Or is a carbon tax expected to meet predetermined emission targets and thus simply an alternative pathway to the rapid decarbonization of the Canadian economy?

The newly elected leftist government in Alberta is wrestling with this very question. It wants to be seen in the vanguard of dealing with climate change. Mandated physical reductions is thus the most obvious policy option. But to impose reductions consistent with the targets that Canada intends to offer at the COP 21 talks in Paris this year would mean the loss of any prospect of growth in its oil sands industry and even, perhaps, contracting existing production. And the provincial government could not cope with the loss of revenue that would follow. This explains why there is increasing interest in imposing a provincial carbon tax in lieu of mandated emission reduction targets but with an explicit quid pro quo that pipeline infrastructure projects and subsequent oil sands investment could go forward.

Alas, no national political leader has embraced carbon taxes as means of resolving the conflict between the country’s economic interests and its climate policy ambitions. Prime Minister Stephen Harper has remained steadfastly opposed to carbon taxation, depicting it as “tax grab” with no other purpose. Justin Trudeau (leader of the Liberal Party) and Thomas Mulcair (leader of the New Democratic Party) have both supported the concept of carbon pricing, but neither has advocated a national carbon tax or explained how carbon pricing—however executed—would square with Canada’s ambitions to increase its oil sands production.

This is not a stable political equilibrium. The problems being wrestled with today in Edmonton will soon find their way to Ottawa and demand resolution.