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ClearBlue Markets Special Market Report – January 08, 2019Trading and flexibilityThe Credit Trading System will include both FFPS and Voluntary CreditGenerators, who can generate, own and acquire Credits. Although not explicitlystated in the ECCC released documents, this implies that the purchase of Creditscan be used as a Compliance Category.In the case of inter-stream flows, for example, the delivery of biomethane (naturalgas) via pipeline for use a vehicle fuel, Credits will be allocated to the Streamwhere they are used, in this example, it will be the Liquid Stream. Trading betweenStreams will be allowed for up to 10% of a company’s Compliance Obligation.Trading between streams will beallowed for up to 10% of a company'sCompliance ObligationLiquidity of the trading system is a concern, as there may be limited Credits and/orlimited players in the market to support a robust market trading system. Toaccount for the liquidity concerns, ECCC has proposed several attributes tosupport the Credit market, including:---Credits will not expireNo limit to the number of Credits exchanged between parties nor howmany times a Credit can be transferredBanking for future use will be allowed, and in case of an Exceedancedeficit, up to 10% of the deficit can be carried forward into the next period,for a max of 2 years and a 20% penalty.ECCC is also still considering the creation of a market stability mechanism,where FFPS could discharge part of their obligation into a specific fund ata certain price level, which will be used for GHG reduction activities.Early Credit Generation will be allowed for all three Streams before therelease of the final regulation for the Liquid Stream in 2020. Credits fromthe Gaseous and Solid Stream generated in this fashion can be bankablefor future use.Liquidity of the CFS system is aconcern and ECCC has proposedflexibility mechanismsOverlapping regulationsThe CFS has certain interaction with other GHG regulations already in place orunder development. For Category 2 renewable / low-carbon fuels, the CFS willincorporate the volumetric mandate of the existing Renewable Fuels Regulationsfor gasoline (5%) and diesel and heating distillate oil (2%). By 2022, FFPS candemonstrate compliance with the renewable content required through the CFSCredit Trading System. There will be no renewable requirement for natural gasunder the CFS, though, in some provinces like Quebec, there will be separatemandates. Under the CFS, FFPS cannot use Credits from other federal systemsfor compliance (Federal Output Based Pricing System -OBPS). However, the CFSwill allow for the generation of Credits for activities that also generate or complywith the OBPS system. Discussions are also ongoing for the case of existing fuelstandards, as the case of British Columbia’s Renewable & Low Carbon FuelRequirements Regulations. Finally, although the early generation of Credits isproposed in the current document, further clarity is required on the transition forthese activities for when the final regulations are in place.The British Columbia Low CarbonFuel Requirement Regulation, theFederal Backstop OBPS, as well asthe Renewable Fuels Regulationvolumetric mandates will overlapwith the CFS systemOpen Questions and Key Issues for regulated playersThe CFS will be a crucial component of ECCC’s GHG policies targeting climatechange. It brings an ambitious target with several compliance alternatives forFFPS, and by doing this, it does not pick between winners and losers (technologyneutral). There are several open points that ECCC will be developing further thatwill be relevant for potential FFPS or Voluntary Credit Generators, which could leadto increased need for compliance resources and further development of riskmanagement strategies, but also possible optimization and commercialopportunities.On the points that are still under development, ECCC is still considering the validityof providing access to the CFS Credit market to parties that are not FFPS or4

ClearBlue Markets Special Market Report – January 08, 2019Voluntary Credit Generators. This would impact players downstream from thecurrent FFPS who could acquire Credits and for potential aggregators for smallsized FFPS. There is no mention now of the inclusion of brokers in the regulations,although ECCC has indicated that it has no problem with their participation outsideof the regulation. The market stability mechanism could create a price floor/ceilingthat could help obligated parties understand the impacts of non-compliance andavoid tight market situations. In the case of end-use fuel switch to electricity,ECCC is still considering if utilities, network operators and site hosts should useany CFS Credit revenue (or a percentage) to develop zero-emission vehiclesfurther.The risk for Emission Intensive andTrade Exposed industries will beconsidered when developing theGaseous and Solid CFS streamsIn contrast with other fuel standards, CFS aims to bring Solid and GaseousStreams into the regulation. The Liquid Stream regulations, to be implementedfirst, should create a precedent for certain areas for the Solid and GaseousStreams, but also several specific considerations will need to be designed for thesesectors. For example, the risk for Emission Intensive and Trade Exposedindustries (EITE), especially for the Solid and Gaseous Streams is one of thereasons for the delay in these sector’s regulations final documentation compared tothe Liquid Stream. The regulation currently doesn’t consider indirect land use,which may be reconsidered in 2025 and could have a considerable impact ofcertain fuels carbon intensities.Although the final goal for Absolute Carbon Intensity for the Liquid Stream hasbeen indicated at 10gCO2e/MJ, there is still need of clarity on how the goal will besplit over the years between 2022 and 2030 (in case of non-linear distribution) andthe Carbon Intensity targets for the Gaseous and Solid Streams. Finally, in thecase of complex supply chains, for example in natural gas, the situation whereseveral players are involved there is the need for further clarity on who is the FFPSand how would the overlap be managed between players in the same supplychain.Moving forwardAs mentioned above, the CFS has several compliance alternatives, which on theone hand generate interesting options for generating Credits and managingobligations, while on the other hand, it requires complex assessments to optimizethe best path to compliance. In any given year and the short-mid term horizon,FFPS and Voluntary Credit Generators will need to consider at least their owninternal cost for producing fossil fuels and low carbon/alternative fuels, and the costof decreasing production of fossil fuels in addition of any technical issues forblending the renewable/low carbon fuel. They will need to monitor the prices forboth fossil fuel and the alternative/low carbon fuel and to identify and secure areliable supply of alternative/low carbon fuels. They will also need to understandthe price of CFS Credits and the impact of any potential cap price when (and if) themarket stability mechanism is developed. They will need to observe the availability(supply-demand balance) of CFS Credits, from the context of inter-stream tradingbetween Liquid, Solid and Gaseous Streams, CFS Credit bankability and thepossibility of carry forward a deficit for up to two years and the payment of interestfor such a delay.The CFS system will add a new layerof complexity for parties impactedand will require them to be proactivein the coming yearsClearBlue Markets has considerable experience in Environmental andCarbon Markets and will be assisting its clients in understanding further thedevelopments of the CFS, how it will affect them, and in finding the mostoptimal compliance strategy.5

ClearBlue Markets Special Market Report – January 08, 2019Appendix - Obligation and Credit generation calculationsBased on the documentation released by ECCC, this section presents a simplified example of how Credits and Deficits arecalculated in the proposed CFS system. Since ECCC is still developing the Fuel Life Cycle Assessment Modelling tool,calculations should be considered preliminary. Other fuel standards like California’s Low Carbon Fuel Standard, BritishColumbia’s Renewable & Low Carbon Fuel Requirements Regulations and the European Union’s Fuel Quality Directive,have been used as a reference. Canada fuel data was sourced from E3MC.Obligation and Credit calculation (gasoline as an example)1. Exceedances calculationa. Baseline CI (gCO2/MJ) calculated based on the weighted average of the carbon intensities of all fossil andrenewable fuels covered in the Liquid Stream in 2016 85.7 gCO2e/MJ. This will be the starting point for allthe fuels in the Liquid Stream.b. Absolute CIy (gCO2e/MJ) is the yearly decrease in carbon intensity from the Baseline. 1.1 gCO2e/MJ peryear up to 10 gCO2e/MJ in 2030. The Absolute CI is the Carbon Intensity reduction target per year, asshown in Figure 1.c. Standard CIy (gCO2e/MJ) Baseline CI – Absolute CIy. It is the maximum carbon intensity for a given yearfor the Liquid Stream (acts as a limit of GHG emissions). The Standard becomes the limit Carbon Intensityin a given year, as shown in Figure 1.d. Exceedance generatedy (tCO2e) Quantity of fossil fuel in a given year (MJ y) * Absolute City (gCO2e/MJ).The Obligation is calculated for each fossil fuel under the Liquid Stream.e. Compliance Obligationy (tCO2e) Exceedance generatedy (tCO2e) Exceedance carried overy (tCO2e)f. FFPS need to retire a number of Credits equal to their Obligation on a given year2. Credit calculationa. Difference CIy (gCO2e/MJ) Standard CIy (gCO2e/MJ)– Alternative / low carbon fuel CI (gCO2e/MJ). Itcorresponds to the Carbon Intensity for which Credits can be generated in a given year. Its based on thealternative/low carbon fuel carbon intensity and the Standard CIy of a given year, as shown in Figure 2.b. Credits Generatedy (tCO2e) Quantity of Alternative / low carbon fuel in a given year (MJ y) * Difference CIy(gCO2e/MJ). The Credits generated can be used to offset or cancel out FFPS’s Obligations.Simplified example of compliance calculation gasoline 2025ObligationCompliance1000 liters of gasoline in 2025 generate 154tCO2e as an Obligationo 1000 lgasoline 34.7 MJo 34.7 MJ * 4.44 gCO2e/MJ (Absolute CI2025) 154 tCO2eAssuming 100% with Ethanol, 154tCO2e Obligation Credit need requires 202 litres of ethanolo 202 lethanol 154tCO 2e / 32.22 gCO2e/MJ (Ethanol Difference CI2025)o Please notice that such blending is not feasible ( 10% ethanol blend) or it will require aspecific engine typeo FFPS will need to consider other compliance categories or purchasing Credits from otherFFPS or Voluntary Credit Generators6

ClearBlue Markets Special Market Report – January 08, 2019ClearBlue MarketsClearBlue is an award-winning carbon advisory firm at the forefront of North America’s carbon markets, providing expertiseand guidance in Cap & Trade and other carbon pricing systems. We actively advise entities and organizations across NorthAmerica, which includes providing market and regulatory analysis through our Weekly Updates and Reports on Supply andDemand. With a carbon market focus, ClearBlue delivers integrated and cutting-edge solutions to manage carbon value,including supporting entities in minimizing compliance costs while maximizing opportunities.DisclaimerThis report has been prepared by ClearBlue Ltd. (ClearBlue) solely for information purposes based on information providedby ClearBlue and publicly available information, and should not be construed as advice. ClearBlue considers the informationused to generate this report reliable, but we do not represent that it is accurate or complete, and it should not be relied on assuch. Past results are not necessarily indicative of future results. The appropriateness of a particular transaction willdepend on an entity’s or an investor’s individual circumstances and objectives. Entities and investors should, without relyingsolely on this report, make their own independent decisions and, if necessary, seek tailored professional advice. This reportmay not be reproduced or redistributed, in whole or in part, by any person for any purpose without the prior writtenpermission of ClearBlue, and ClearBlue accepts no liability whatsoever for the actions in this respect. Neither ClearBlue, norany of its employees, officers, and directors have interests in carbon compliance instruments referred to in this report, or anyrelated futures, derivatives or options, including incentives for performance of investment services.7

The purpose of this Special Report is to update clients on the current regulatory . tCO 2 that is equivalent to the Compliance Obligation. In the case of FFPS active in . In the case of inter-stream flows, for example, the delivery of biomethane (natural gas) via pipeline for use a vehicle fuel, Cre