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9 Mar 2023

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"Green Taxonomy" Aims to End Logjam in Renewables Transition in Canada

Posted with permission from ESG Impact Zone.

A federally appointed council of experts may have broken a three-year logjam to create a Canadian “green taxonomy” for investors by proposing that oil and gas projects be classified as “transition” investments only if they have limited lifespans.

The taxonomy will eventually serve as a guide for companies and investors about what investments are considered “green” or “transition.” And the potential breakthrough comes thanks to a proposal by the Sustainable Finance Action Council (SFAC) contained in the Taxonomy Roadmap Report, released Friday by Finance Canada.

The SFAC compiled the report after it assumed responsibility for creating a green taxonomy after the Canadian Standards Association, a non-profit industry body, failed to reach consensus among fossil-fuel and investment-industry representatives in 2020.

The European Union, China, the United Kingdom and about 20 other countries are developing such taxonomies as a way of discouraging greenwashing and channelling investment to the climate transition. The EU’s taxonomy has been particularly controversial because of its inclusion of natural gas and nuclear as “green investments.” SFAC says the taxonomy is a critical tool in helping Canada to raise $115 billion annually in green and transition financing, the amount it estimates is needed for Canada to meet its climate goals.

The SFAC report includes criteria for a “green” label, which would include renewable energy and cleantech projects with no significant emissions from their own operations (Scopes 1 and 2) or end-use emissions (Scope 3).

For CO2-emitting industries, the report distinguishes sectors that have significant Scope 1 and 2 but not Scope 3 emissions (steel or cement, for example) from sectors that have significant emissions in all three scopes (oil and gas, for example).

To qualify for a “transition” label, projects with Scope 1 and 2 emissions would need to demonstrate significant greenhouse gas reductions in line with Canada’s climate goals for 2030 and 2050.

In addition to reductions from their own operations, oil and gas projects would need to phase out end-use emissions in line with the expected decrease in demand for their products (gasoline, for example, as electric vehicles become more popular). Further, the phase-out would need to be consistent with a science-based approach in line with a global temperature rise of no more than 1.5°C.

“Projects must have well-defined lifespans that are approximately proportionate to the expected decline in global demand,” the report says.

Coal projects and new oil and gas projects would be excluded from the transition label, and companies would not be able to rely on carbon offsets to count against their emissions.

Critics have seized on the fact that the report leaves the door open for oil sands companies to label carbon capture, utilization and storage (CCUS) projects as “transition” investments even though they could potentially contribute significant and open-ended Scope 3 releases, which make up 80 to 95% of fossil fuel industry emissions.

But this is where the “well-defined lifespans” condition comes in. By making the transition label conditional on an established end date for fossil fuel projects, the green taxonomy can provide some assurance to investors that their capital will not be used to finance an indefinite period of carbon emissions.

Projects must have well-defined lifespans that are approximately proportionate to the expected decline in global demand.

For oil sands producers, the prospect of having to achieve significant 2030 Scope 1 and 2 reductions as well as a phase-out date in line with climate science and market demand could render decarbonization projects like CCUS uneconomic. If this is the case, they likely won’t qualify for the transition label (and should not proceed in any case).

But how much assurance will investors really have that these projects will close according to schedule?

On this point, the report is weak, and more work needs to be done. Fossil fuel companies will need to assure investors that they mean what they say about a phase-out date. This might include well-documented plans for mothballing facilities and timelines for staff retirements or reassignments. Or companies could use financial mechanisms such as decommissioning bonds that would be payable if the projects continue past the closure date.

There is another potential loophole in the report. One of the recommendations is that companies publish preliminary net-zero transition plans within 12 months after they issue a transition investment and a comprehensive, science-based plan within 24 months. This would open the possibility that companies could offer transition investments and then only later disclose they don’t meet the standards. Companies should be required to publish a comprehensive plan before issuing a transition investment.

Despite these weaknesses, the proposal deserves to move forward to the next step, which is to establish a joint federal government–financial industry governance council to approve the green taxonomy and to finalize details with independent standard-setting bodies.

The taxonomy itself won’t ensure placement of the vast amount of capital needed to achieve Canada’s climate transition.

But together with other climate tools such as a cap on oil and gas emissions and a rising price on CO2, the green taxonomy holds potential to help the investment community mobilize the billions of dollars necessary for Canada to meet its greenhouse-gas-reduction goals.

Eugene Ellmen is a former executive director of the Canadian Social Investment Organization (now Responsible Investment Association). He writes on sustainable business and finance.

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