(Dis)Incentives by Design: Carbon pricing and biofuels in Canada

(Dis)Incentives by Design: Carbon pricing and biofuels in Canada
Climate and Energy

A core plank of carbon pricing is that it provides an incentive to use lower-carbon alternatives. In the case of transportation fuels, carbon pricing should make fossil fuels relatively more expensive compared to things like biofuels or other emerging low-carbon technologies, and make petroleum fuels less attractive. But do the four carbon pricing systems in Canada provide this price signal for low-carbon fuels?

Out with biofuel policies, in with carbon pricing

The Ecofiscal Commission released its latest report this week, focused on the economic and environmental case for biofuel policies in Canada. One of the main conclusions (spoiler alert!) is that biofuels are an expensive way to reduce emissions, especially when compared to carbon pricing. We found that emissions reductions from biofuel policies were at least five times more expensive than the BC carbon tax. We recommend that biofuel policies should end and that carbon pricing should be implemented to achieve emissions reductions at a smaller economic cost.

If designed well, carbon pricing can provide a clear price incentive for low carbon fuels and vehicles. If, for example, someone buys a fuel with 50% of the GHG emissions compared to a fossil fuel, they should pay 50% of the carbon price. In this sense, the treatment of fuels under a carbon price can be a potent price signal for decarbonizing the transportation sector.

All price signals are not created equal

Despite the potential of carbon pricing to generate powerful price incentives, it seems like the four provincial carbon pricing policies in Canada can be improved to better recognize the emissions reductions associated with biofuels. (Information on how biofuels are treated in each province is relatively sparse, so we rely on the work of Advanced Biofuels Canada for this blog, and also some conversations with provincial governments.)

Under the carbon tax systems in B.C. and Alberta, the amount of carbon tax on gasoline and diesel has been reduced (slightly) to reflect the fact that ethanol and biodiesel are already blended with the gasoline and diesel. In other words, whether someone buys straight gasoline or E85 (an 85% ethanol blend of gasoline), the carbon tax will be the same. In fact, due to the lower energy content of ethanol, buyers of E85 might actually pay more in carbon taxes because they need more fuel to drive the same distance. Fuel distributors may be eligible for a rebate equal to the portion of blended lower-carbon fuels; however, how this rebate plays out on the ground, and whether it influences prices, is unclear.

The situation in Ontario and Quebec’s respective cap-and-trade systems is also complicated and unclear. Biomass-based fuels are exempt under each cap-and-trade system, so fuels with more lower-carbon biofuels should technically be priced lower than regular gasoline. In practice, however, research suggests that the price across fuels—no matter the biofuel mix—are the same.

The visibility of prices matter

It’s one thing to have carbon pricing that recognizes the emissions reductions of biofuels, but the visibility of the carbon price is also of critical importance. In order to make smart decisions about fuel choices, consumers need to see the relative difference of fuels based on carbon content. If a certain blend of gasoline and ethanol reduces emissions relative to regular gasoline, consumers should see the price differential at the pump. At the moment, however, the effect of carbon prices on low-carbon fuels relative to petroleum fuels isn’t clearly visible.

Getting prices right

Despite these challenges, the good news is that tweaks can be made to improve each carbon pricing system so they reflect the carbon intensity of each fuel. This would ultimately allow fuels to compete on a level playing field based on their potential to reduce emissions.

Advanced Biofuels Canada suggests a three-part solution. First, fossil fuels would pay the full carbon tax rate and not be automatically adjusted downward to account for biofuel content. Second, low-carbon fuels should pay an amount of the carbon tax that is pro-rated based on their energy densities and full lifecycle carbon intensities relative to fossil fuels. Lastly, governments should use a consistent tool for estimating lifecycle emissions of each fuel type.

Making such changes to carbon pricing in Canada will undoubtedly be a challenge. Most importantly, it will require accurate and reliable data on the lifecycle emissions of each fuel type. Only then can the price of each fuel better reflect the carbon content and therefore the carbon price.

Better design for clearer incentives

Although the carbon pricing systems in Canada attempt to account for the lower carbon intensity of biofuels (lower tax rates for gas and diesel in BC/AB, and exemptions for biofuels in QC and ON), the price incentive for low-carbon fuels (if there is one) is not clear nor visible.

It may be taken for granted that carbon pricing automatically changes the relative price of fuels based on their carbon content. But, in fact, this needs to be baked into its design. As more and more fuel technologies become available to consumers in the future, ensuring that consumers have clear information on the relative prices of each fuel based on its carbon footprint will be vital in the effort to decarbonize the transportation sector.


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