Canada must soon decide whether to ratify the Kyoto Protocol and join an international attempt to arrest the man-made or ”œanthropogenic” causes of global warming. To ease its economic burden under Kyoto, Canada is supporting a ”œCleaner Energy Exports” (CEE) amendment to the treaty. This amendment would give carbon credits to countries that export energy sources, such as natural gas and hydroelectricity, that are environ- mentally ”œcleaner” than traditional fossil fuels. An exami- nation of the environmental justification for the CEE pro- posal suggests, however, that there is little reason to believe it would strengthen the agreement. On the con- trary, it appears to be a politically motivated attempt to avoid this country’s international commitments to the global environment.

Canada argues that without a CEE amendment Kyoto could inadvertently cause increased greenhouse gas (GHG) emissions. Unlike their counterparts in the United States, which has already announced it is not going to ratify Kyoto, Canadian natural gas producers will have to account for the GHG emissions they cause, whether in exploring for, processing or transporting natural gas. Kyoto effectively creates a charge for emissions, which will increase the price of Canadian natural gas. Since 15 per cent of the natural gas consumed in the U.S. is Canadian, this price increase could cause American consumers of Canadian gas to switch to more polluting fuels produced in the U.S., such as coal, an outcome the authors of the Kyoto Protocol presumably would prefer to avoid. Giving Canadian producers carbon credits so that they can keep their prices where they are would enable U.S. utilities not to substitute more heavily polluting fuels. In principle, at least, the benefit from preventing this substitution could be less than the admitted environmental cost of granting the credits.

The CEE proposal is both economically and politically important for Canada. Economically, it would represent a grant of carbon credits worth hundreds of millions of dollars annually during the Kyoto period of 2008- 2012. Politically, it would ease Canada’s burden under the Protocol and thus reduce frictions between Ottawa and the provinces, especially Alberta. International acceptance of the CEE principle might even be the final step toward Canadian ratification of the Kyoto Protocol.

Publicly, Environment Minister David Anderson argues for up to 70 mega-tonnes (million metric tons, or Mt) of CEE credits. Privately, the federal government must know that the case for such a large credit is unlikely to be convincing at the international negotiating table. In effect, Canada is requesting credit for entirely unintended environmental benefits of its current economic activities. And the request is enormous: 70 Mt at an estimated $US10 per ton is worth $US700 million annually and rep- resents roughly 35 per cent of the expected reduction in Canadian emissions under Kyoto! Abroad, the 70 Mt request is seen, quite justifi- ably, as an attempt to weasel out of Canada’s commitments. The Globe and Mail reports that the European Union has ”œflatly rejected” any proposal on these grounds, and ”œwill not accept that Canada now comes back saying ”˜We want even more.’”

Even if the exact amount of the credit is open to negotiation, the case for a CEE credit of some size is, on its face, quite plausible. Without a CEE allowance, the Kyoto Protocol may well cause a net increase in GHG emissions due to the higher price of Canadian clean energy. As Minister Anderson has put it: ”œClearly we don’t want to have a system of rules and mechanisms which restrict an opportunity for reducing greenhouse gases.” Replying to severe objec- tions from the European Union, he has suggest- ed that the Europeans are not looking yet at what this CEE proposal can do to improve the environment by reducing greenhouse gases.

Its opening offer notwithstanding, when the negotiations get serious the federal govern- ment is likely to pursue a more modest request of 30 Mt, which is probably sufficient to offset the GHG emissions associated with the explo- ration, production and transmission of its natu- ral gas exports. But is even a 30 Mt credit justi- fied? Let’s go through the arithmetic.

Industry experts estimate the total upstream GHG emissions of natural gas production at 8.5 Mt per trillion cubic feet. Convert this to a dol- lar value using the mid-range economic esti- mate for the value of carbon dioxide under a ratified Kyoto agreement, namely, $10 per metric ton. This yields an expected increase in the pro- duction cost of a marginal unit of natural gas of roughly nine cents (U.S.) per thousand cubic feet.

At current prices, nine cents represents an increase of 3.4 per cent of the sale price of natu- ral gas, which is small relative to the ordinary volatility of natural gas prices. Indeed, one U.S. official memorably described it as ”œstatistical noise.” Even so, it does constitute a sustained, long-term cost increase. Policy-makers will therefore wish to consider the following ques- tion. How much U.S. fuel substitution must occur in response to the price increase to cause the 30 Mt increase in GHG emissions implied by Canada’s claim for credits?

To give the CEE proposal a fighting chance of being environmentally justified, let’s make some extreme assumptions. First, assume that Canadian producers pass on the entire nine- cent cost increase to their consumers without absorbing any of it in lower profits. Second, assume Kyoto has no effect on the total energy demand in the U.S."i.e., no one decides to reduce their consumption of energy. Finally, assume that coal is the substitute fuel that replaces Canadian natural gas. In reality of course, the ”œmissing” natural gas would be replaced by a mix of substitutes, including oil, coal, hydroelectricity, nuclear power and renew- able sources.

Exactly how much Canadian natural gas would have to be replaced by U.S. coal to justi- fy a 30Mt carbon credit to Canada? Coal pro- duces almost twice as much GHG as natural gas: 1.016 mega-tonnes per terawatt-hour (TWh) of electricity generated, compared to 0.558 Mt/TWh for natural gas generation. So each TWh produced with coal generates 0.458 Mt more GHG than if it were produced with gas. How many TWh would have to be pro- duced with coal rather than gas in order to pro- duce the 30 Mt of extra emissions that would justify a Canadian credit of 30 Mt? The answer is 30Mt divided by 0.458Mt/TWh, or 65.5 TWh of electricity. How much Canadian natural gas would be displaced if American producers did switch over to coal to produce those 65.5 ter- awatt-hours of electricity? A billion cubic feet of natural gas produces just 0.0957 TWh, so to produce 65.5 TWh would require 685 billion cubic feet (= 65.5/0.0957), an amount that rep- resents 20 per cent of Canada’s yearly exports to the U.S.

Could a 3.4 per cent increase in the price of Canadian natural gas cause a 20 per cent drop in natural gas exports to the United States? This implies an elasticity of 6.0 or greater. Despite a large body of academic literature on this ques- tion, no study produces an elasticity even close to this range. Most academic studies agree that the best estimate for the elasticity of supply for natural gas in North America is approximately 1.0; no study puts the value higher than 2.45. Thus an elasticity of 6.0 seems completely implausible. It is therefore highly unlikely that U.S. consumers would engage in the kind of fuel substitution necessary to provide the environ- mental justification for the CEE proposal.

Europeans would therefore seem to be jus- tified in suspecting that ”œCleaner Energy Exports” credits, rather than strengthening Kyoto, are a political manoeuvre to enable Canada to avoid its international commitments to the environment. Unfortunately, even with- out any environmental justification, it is not impossible that Canada will succeed in its pro- posal. History shows that countries can receive carbon credits for actions that create no addi- tional environmental benefit. For instance, Russia’s GHG emissions have dropped dramatically since 1991 but the reduction is an unin- tended result of Russia’s economic decline, not its environmental policies. Even so, Kyoto will allocate an enormous number of carbon credits to Russia, which it can then sell to other coun- tries. In the end, however, it is hard to believe that Canada will receive even its relatively modest 30 Mt request for Cleaner Energy Exports. Canada does not have the negotiating clout of countries like Russia and Japan. Moreover, it is proposing the CEE amendment at a time when the negotiations are nearly com- plete and ratification looms.

But on balance this is not a bad-news story. Kyoto’s impact on the Canadian natural gas industry’s competitiveness in the U.S. is very minor. Moreover, an increase in domestic demand for natural gas is likely to more than compensate for any production cost increase. As a consequence, ratifying the Kyoto Protocol will not appreciably damage the Canadian natural gas industry, and may even help it.