Go green or go home

Will California’s firm enviro policies shatter our auto and energy sectors?

The sun pours down on the throng of notables seated in the atrium of the MaRS building in downtown Toronto. All eyes are glued to the podium, where the stocky man at centre stage is about to speak. “It’s great to be here,” he says. “Last time I was in Canada was for a bodybuilding championship. I never thought when I said “I’ll be back” that it would be as the governor of the great state of California!”

Arnold Schwarzenegger can’t resist riffing off his most famous line. Shorter than his larger-than-life persona would suggest, the one-time Mr. Olympia and action-hero-turned-political-phenom is so tanned, he’s almost copper. When Schwarzenegger’s face goes into neutral (as it often did during earlier speeches), his mouth forms a tight, determined line. But right now he’s all smiles. An hour earlier, he signed a pact with Ontario Premier Dalton McGuinty to fight greenhouse-gas emissions—to much applause. McGuinty adopted the governor’s low-carbon fuel standard, which will require fuel sold in California to meet tough carbon content restrictions. A day later, British Columbia Premier Gordon Campbell followed suit. It’s a move that could have huge implications for Alberta’s oil exports to all three markets.

But in fact McGuinty did not go as far as California has in fighting emissions. Not even close. Ontario did not sign on to the part of Schwarzenegger’s legislation that called for automakers to reduce tailpipe emissions by 30% by 2016. Asked about that after his MaRS talk, Schwarzenegger dodged smoothly. “This partnership will be extraordinary,” proclaimed the Governator. “It strengthens our countries’ joint commitment to roll back greenhouse-gas emissions.”

Perhaps. But beneath all the bombast and showmanship of the trade mission lies an inconvenient truth.

Schwarzenegger officially visited Canada to celebrate its roaring trade with California—a phenomenally valuable relationship for both sides. According to Bay Area economists Sean Randolph and Niels Erich, who this March published a study called Shared Values, Shared Vision, California’s Economic Ties With Canada, California sold us US$14 billion in goods and services, making Canada its No. 2 market, after Mexico. Our exports to California, though, leave that number in the dust: the relationship represents a US$8.5-billion surplus in Canada’s favour. Crucially, exports of cars, trucks and auto parts to California make up more than the entire surplus—with energy a smaller but rapidly growing piece of the pie.

Numbers like that explain why California’s governor made visiting Canada a top priority for his second term in office. His visit to Toronto in late May garnered the expected crowd of paparazzi shots and headlines. Less talked about, and less recognized, is that Schwarzenegger’s environmental policies will have deep impacts on Canada. Behind the feel-good speeches and handshaking, the Governator’s message to industry is this: Go green—or hasta la vista, baby.

Schwarzenegger is not a traditional Republican. Or so it would seem, considering the lead his government has taken on trying to reduce greenhouse-gas emissions in the most populous state in the union. Last September, Schwarzenegger signed his first policy aimed at reducing greenhouse emissions, California’s AB 32 Global Warming Solutions Act. A sweeping piece of legislation, it classifies carbon dioxide and other greenhouse gases as pollutants, and aims to reduce and cap carbon emissions at 1990 levels by 2020. The policy builds on 2002 legislation calling for a 30% reduction in tailpipe emissions by 2016—a major challenge to any auto industry that exports to the Californian market.

The auto industry struck back. The Alliance of Automobile Manufacturers, which represents GM, Ford, Toyota and others, lobbied the federal Environmental Protection Agency hard, claiming California must demonstrate a link between greenhouse gases and the legislation, and that with this law California had overstepped its jurisdiction under the Clean Air Act. (This is true: in the States, air pollution is regulated by the federal government.)

In a clear win for the Schwarzenegger camp, the U.S. Supreme Court ruled in April that on environmental issues, the EPA should waive restrictions on the state’s jurisidictional rights. (This is because California’s environmental laws predate federal laws.) The issue has been in limbo ever since, with Schwarzenegger recently threatening to sue the EPA unless it grants the waiver.

Undeterred by the storm of litigation, the man who once played the title role in The Terminator moved swiftly from cars to the stuff they burn. In January, he signed the world’s first-ever low-carbon fuel-standard policy. It puts the oil and gas industry on a low-carb diet, requiring that all fuel consumed in California reduce its carbon content across its life cycle by 10% between now and 2020. As David Crane, the policy brains behind the legislation, explained, the standard evaluates carbon content “from well to wheel,” taking into account the carbon used to make the fuel, as well as that in the final commodity.

Fuels that meet the standard can be traded in the state. Fuels that don’t—such as those extracted in a highly carbon-intensive process from the Alberta oilsands—will have to find markets elsewhere. (In a 2005 study, the Pembina Institute, a Calgary-based environmental research organization, said that crude extracted from the oilsands emits 85.5 kilos of carbon dioxide per barrel of oil, as compared to 28.6 kilos emitted in conventional crude extraction.)

Linda Adams is the secretary of the California Environmental Protection Agency. After Crane, she is Schwarzenegger’s most important environmental adviser, and she accompanied him to Toronto. Asked if oil from the Alberta oilsands would be acceptable in California’s market after 2010, when the low-carbon fuel standard goes into effect, she looked a tad uncomfortable. “No, it wouldn’t,” she said slowly. “It wouldn’t meet the standard.”

Schwarzenegger’s government is targeting cars and crude for a simple reason: cars produce 40% of California’s greenhouse emissions. The state has tinkered with alternatives for decades, yet it remains 96% dependent on fossil fuels for its transportation needs. “What we’ve done,” Crane explains, “is create stable, consistent demand for alternative fuels.”

The policy leaves it up to industry as to how it wants to cash in on this new market. At current rates, California’s transportation fuel market is estimated at $50 billion annually. As Crane puts it, there will be “no extra spending, no subsidies and no tax credits”—just one benchmark on carbon content that industry must figure out the most cost-effective way to meet. A panel of experts at University of California Berkeley is evaluating how best to determine the carbon content of fuels and implement the policies; it will report in midsummer, and the implementing procedures will be rolled out through 2010.

Some oil companies, like Chevron, based in San Ramon, Calif., take an optimistic view of the policy. “Rather than telling us what to do, the government is setting a performance standard,” explains Rick Zalesky, VP of biofuels at Chevron. “They are saying it’s up to the marketplace to figure out the most cost-effective fuel. To us, that sounds cautiously positive.” Further, the policy stands a chance of being effective, because it selects out fuels that are carbon-intensive to produce. “Under this policy, corn ethanol actually doesn’t make the grade,” he notes. That is an incentive for Chevron to find cost-effective ways of producing cellulosic ethanols—derived from cellulose in grasses and starchy feedstocks that, Zalesky says, are 80% to 90% less carbon-intensive to grow than corn. “We’re not there yet,” Zalesky warns. “It requires a certain leap of faith in technology to sign on to something like this. But we’ve always exceeded expectations.”

Over the next two years, Chevron is committing US$2.5 billion to energy-efficient and renewable fuel technology. As to how the policy impacts the 20% stake Chevron holds in the Athabasca oilsands, Zalesky says that source will be evaluated the same way, and refined accordingly: “We’ll be bringing fuels to market in a fashion the market rewards, and we’ll also be using advanced technologies, like converting coal to liquid for transportation, to help streamline the carbon content of those fuels over their entire life cycle. We are convinced we can meet the standards.”

Zalesky’s comments are typical of a business culture that likes to frame problems as opportunities. But if Chevron is preparing for the changes to come, others, including some of the most significant energy producers in Alberta’s oilpatch, have been less assertive in their response to this brave new world.

On an initial call to CAPP, spokeswoman Renee Kelly said the organization had no position on the matter. When pressed, vice-president Greg Stringham came on the line, saying that he hadn’t seen the legislation, but didn’t think it would have much short-term impact, as to his knowledge California doesn’t import oil from Canada. “They may just be putting carbon reductions on vehicles,” he speculated. “The vehicles would burn the same amount of gas.”

That’s wishful thinking on Stringham’s part, as California’s rules are very clear. In Schwarzenegger’s state, both cars and the gas that burns in them are going on a low-carb diet.

When contacted by Canadian Business, EnCana spokesman Alan Boras said that this was the first he had heard of the policy, and that the Calgary-based company, which produces and refines oil and natural gas from the oilsands and elsewhere, had no response as yet to the legislation or its impact. “We do expect to export a lot to the U.S., but whether it’s affected by this legislation in California, it’s too early to tell,” he said.

Suncor spokesman Brad Bellows also said his company’s approach would be wait-and-see. “Suncor is invested in alternative fuels where we look at the carbon content of the fuel throughout its life cycle. But effectively enforcing a policy of that kind will be fiendishly difficult,” he said. “Anyway, there are lots of these kinds of initiatives. Until they become law in a market more important to us for export than California, we won’t be doing anything.”

Recall, however, that Ontario and B.C. have also signed on to the policy, and Ontario is a significant market for heavy crude, accounting for nearly 30% of domestic consumption last year. And though California is not currently a big energy market for Canadian oil, that is changing. Exports from Canada to California are rising steadily, from negligible in 2002 to 4.9 million barrels of crude last year, or 0.8% of the total to the United States. Economists Randolph and Erich attribute the increase to Canada “picking up the slack” after a fall-off in Middle East supply following the Iraq invasion in 2003. What's more, a National Energy Board report from 2006, titled Canada's Oil Sands: Opportunities and Challenges to 2015, identifies California as an “excellent” potential market for crude from the oilsands. Enbridge is working on developing its Gateway crude pipeline from Alberta to Kitimat, B.C., and a third of the pipeline's 400,000 barrels-per-day capacity is expected to ship to California.

Meanwhile, the Schwarzenegger diet is catching on in other states and overseas. The European Commission signed their own version of the low-carbon fuel policy into law in January. U.S. Republican presidential candidate John McCain and Democratic candidate Barack Obama have both endorsed it. Several states are considering similar standards, and in May Obama and Senator Tom Harkin of Iowa introduced federal legislation proposing the low-carbon fuel standard be enacted nationwide.

But if such low-carb standards are trouble for the oilpatch, its misery will have company. California's tailpipe-emissions law could hit Ontario's automakers and auto-parts manufacturers hard. According to Gerry Fedchun, president of the Canadian Auto Parts Manufacturers Association, Schwarzenegger's green policies, as they are currently worded, have the potential to shut down Canadian trade in automobiles and auto parts completely?all US$9.7 billion worth of it. “Reducing emissions to that extent?well, not even Toyota makes cars that would qualify for most of what they're asking,” he said.

A source in the Canadian consulate general in San Francisco confirmd the low-carbon policy's emphasis on reducing emissions “from well to wheel” means Canada's oilpatch and auto sector will have a big problem on their hands?particularly in light of the policy's popularity with American legislators outside the state. “Ottawa is intensely focused on finding a solution to this,” he said. “Currently, it's top priority.”

Back on the trade mission, Schwarzenegger is giving a speech to the Economic Club of Toronto. He's explaining how not everyone is in love with his emissions policies: “There's a billboard in Michigan right now that is accusing me of costing the car industry $85 billion because of our new emission standards. The billboard says, “Arnold to Michigan: Drop dead.” But the fact is that what I am saying is, “Arnold to Michigan: Get off your butt.'” The audience explodes in applause.

His speech over, Schwarzenegger wades into the crowd. The flashbulbs pop, children swoon, politicians jostle for photo ops, but he's not taking questions?certainly not on topics as crude as the oilsands. And then he's gone, leaving a roomful of star-struck fans, basking in the afterglow of celebrity. Thoughts of why Michigan might put up that sign are far from anyone's mind.

But guess what, Canada: We're next.