Compliance Costs under the Clean Fuel Regulation

ESMIA assessed the impact of Canada’s Clean Fuel Regulations, assessing the potential for credits creation, projecting compliance costs and assessing the impact on gasoline and diesel prices through 2030.

In June 2022, the Government of Canada introduced the Clean Fuel Regulations (CFR), replacing the federal Renewable Fuels Regulations. These new regulations, effective July 1, 2023, require gasoline and diesel producers and importers to reduce the life cycle carbon intensity of fuels supplied in Canada. A variety of compliance options are offered to producers and importers, with price impacts varying based on the specific choices made by both regulated and voluntary participants.

ESMIA was selected to conduct an independent assessment of the regulations for Environment and Climate Change Canada. The main goal was to estimate the incremental costs by quantifying the potential for credit creation, calculating credit costs and market prices for the three compliance categories, and projecting total compliance cost, average cost per credit, as well as gasoline and diesel price impacts on consumers per province.

The credit supply in Canada will be dominated by CC2 (low-CI fuels ), with CC3 (supply of fuels to advanced vehicles technologies) overtaking CC1 (carbon capture and sequestration) by 2025.

Our analysis highlighted that credit supply in Canada will be dominated by the CC2 category (supply of low-CI fuels) over the study period. Initially, credit creation in CC1 (carbon capture and sequestration) will be slightly higher than CC3 (supply of fuels to advanced vehicles technologies), but this trend reverses in 2025 when CC3 sees faster growth. In 2027-2028, it is projected that contributions to a registered emission reduction funding program will begin to be required to meet the obligation amounts due to insufficient credit supply.

ESMIA developed a compliance credit supply curve showing that while credits supply will exceed demand in 2023-2024, shortfalls are expected in 2025 and 2030, with banking of credits from earlier years helping to meet future requirements.

As part of its independent assessment of Clean Fuel Regulations for Environment and Climate Change Canada, ESMIA built a compliance credit supply curve representing the number of credits available each year on the market as a function of the credit price. This supply curve shows the credit requirement (Canada-wide obligation amount) for each year, which is placed at the clearing price used in that year and thereby determines the amount of supply available on the market.

For 2023-2024, the supply exceeds the requirement, however, in 2025 and 2030 the requirement exceeds supply. Banking of credits from earlier years will thus help meet the requirements later in the decade, and increasing the clearing price in earlier years may also provide greater credit supply for banking.

Key findings include:

• Credit supply generally increases over time to meet stricter carbon intensity requirements, except for a dip in 2024-2025 due to retroactive credit creation.
• From 2022 to 2025, most credits will come from CC2 (supply of low-CI fuels) and CC3 (supply of fuels to advanced vehicle technologies), as CC1 (carbon capture and sequestration) requires time-intensive investments.
• As a proxy, the supply curve can broadly be classified into four cost steps, reflecting general trends:
  • CC1 and especially Enhanced Oil Recovery (EOR) and Carbon Capture & Storage (CCS) are actions with revenue streams (i.e., mainly due to the increasing federal carbon price) which constitutes low supply cost;
  • CC2/CC3 credits which fall under other regulations are associated with no-cost (i.e., administrative cost) resulting in a spike of credit creation around 2 (2022)CAD/ credit;
  • Remaining CC3 credits are often low-cost which result in a second spike around the minimum credit price around 38.5 (2022)CAD/credit;
  • Remaining CC2 credits are typically most expensive resulting in price spread from about 110 (2022)CAD/credit for renewable natural gas production to 350 (2022)CAD/credit for renewable diesel production in 2030.

ESMIA’s assessment found that while the CFR will have a minimal impact on fuel prices in 2023-2024, it could increase prices by up to 6.5% by 2030, with regional variations driven by compliance costs and credit prices.

As part of its independent assessment of Clean Fuel Regulations (CFR) for Environment and Climate Change Canada, ESMIA found that the CFR cost component would have a negligible impact on gasoline and diesel retail prices in 2023 and 2024, representing less than 1% of the retail prices. In 2030, the CFR cost component is expected to have a moderate impact on gasoline and diesel price increases in comparison with other price components, representing up to 6.5% of the total price.  

The impact of the CFR cost will differ by jurisdiction, depending on a combination of the following factors:

• The compliance costs for regulated parties in different jurisdictions will drive the increase in revenue requirements to be recovered by gasoline and diesel consumers;
• The interprovincial trade flows of fuels will partly transfer compliance costs from one jurisdiction to the gasoline and diesel consumers in another jurisdiction.

In 2030, the CFR cost component is expected to be highest in provinces that rely more on expensive credits (i.e., CC2 and CC3).  In provinces like Quebec, Ontario, Nova Scotia, and New Brunswick, 90% to 100% of credits will come from these categories. Additionally, these provinces and especially New Brunswick will need more expensive credits from the contributions to registered emission reduction funding programs. This will increase the CFR costs and revenue requirements that must be recovered from sales of gasoline and diesel.

In contrast, a large share of credits will be created in the CC1 category in provinces with significant upstream oil production (30% of all the credits in Alberta and 43% in Saskatchewan), resulting in lower CFR cost impacts in those regions.

Reference: ESMIA (2023). Compliance Costs under the Clean Fuel Regulations: Estimating near-term credit prices, compliance costs, and impacts on fuel prices. Final Report, 117 p.