Understanding the Extent of Output-Based Pricing: Direct and Indirect Emissions
Output-based pricing is a cornerstone of many carbon pricing programs, including federal and provincial systems within Canada. It is often seen in jurisdictions aiming to control greenhouse gas (GHG) emissions from large industrial producers without creating undue hardship on trade-exposed sectors. At its core, output-based pricing sets a benchmark of emissions intensity per unit of product (or output). Facilities that emit below this benchmark may earn credits, while those that exceed it typically must submit compliance units or pay a levy for their excess.
A common question is whether output-based pricing covers only direct emissions (often referred to as Scope 1) or also addresses indirect emissions from purchased power or other sources (Scopes 2 and 3). Understanding this distinction is crucial, because many facilities across industries grapple with both direct sources (fuel combustion or industrial processes) and indirect sources (electricity use, supply chain-related emissions, and more). Below, we will delve into how these systems typically account for emissions and clarify where indirect emissions may or may not be included.
What Is Output-Based Pricing?
Output-based pricing is one tool that governments use to regulate emissions-intensive industries. Unlike a straightforward carbon tax that charges a set amount per tonne of emitted carbon dioxide equivalent (CO₂e), an output-based system takes into account the economic output of a facility. For instance, if a power plant produces electricity or a factory manufactures cement, they are assigned an emissions-intensity benchmark, such as “X tonnes of CO₂e per unit of product.” If their actual emissions intensity is lower, they can earn credits that they can bank, sell, or trade. If it is higher, they must procure credits or pay additional fees.
By tying emission costs directly to production levels, policymakers seek to reduce the risk of carbon leakage (where production might shift to regions with weaker climate regulations). This means in the grand scheme, output-based pricing is primarily focused on the direct emissions a facility generates in producing its goods or services. However, various jurisdictions may tweak the scope of coverage to include at least some portion of what are generally called indirect emissions, particularly through electricity purchases or other embedded emissions in raw materials.
Distinguishing Between Direct and Indirect Emissions
To better understand whether output-based pricing addresses indirect emissions, it helps to define the difference between direct and indirect sources:
- Direct Emissions (Scope 1): These are emissions released on-site from sources owned or controlled by the facility. They mostly include combustion of fossil fuels, process emissions from chemical reactions (e.g., in cement production), and use of on-site equipment. Direct emissions are the primary target of output-based pricing systems because they are the most straightforward to measure and assign accountability for.
- Indirect Emissions (Scopes 2 & 3): Scope 2 covers emissions associated with purchased electricity, heat, or steam. Scope 3 usually refers to a broader range of “value chain” emissions such as transportation and distribution, use of sold products, disposed waste, and more. Indirect emissions can constitute a significant part of an organization’s total GHG footprint, especially in sectors that rely heavily on power purchases or have complex supply chains. Yet, policy frameworks do not always include them. Coverage varies by regulation, especially for large industrial emitters under output-based systems.
Scope of Coverage in Typical OBPS Frameworks
Generally, an output-based pricing system (OBPS) imposes its obligations on facilities whose direct emissions exceed a specified annual threshold. In Canada, for example, certain federal or provincial OBPS programs might set a minimum threshold of 50,000 tonnes of CO₂e per year, although the exact figures vary by jurisdiction. Once a facility is enrolled, it must calculate its direct (Scope 1) emissions intensity per unit of output, comparing it against a regulatory benchmark.
Historically, OBPS frameworks tend to focus on direct, on-site emissions. This is because:
- Direct emissions can be measured and verified with greater accuracy under standardized protocols such as ISO 14064-3.
- Policy aims to hold industrial emitters accountable where they have operational control, i.e., on site.
- Indirect emissions can be more complex to quantify in a single facility-based system. For example, one facility’s indirect emissions might be another facility’s direct emissions, leading to double counting if both are covered under separate frameworks without careful design.
Even so, certain programs might incorporate partial coverage for indirect emissions if electricity generation is subject to a companion regulatory mechanism. In that scenario, the electricity supplier’s direct emissions are still regulated, but the facility using that power might not face a direct carbon cost for Scope 2 under the same output-based system.
Provincial vs. Federal Variation
Within Canada, the federal government sets overarching guidelines for carbon pricing, including the Output-Based Pricing System for provinces or territories without their own compliant carbon pricing approach. Some provinces have developed their own programs, like Alberta’s TIER (Technology Innovation and Emissions Reduction) or Ontario’s Emissions Performance Standards (EPS). These frameworks share a similar idea but can have differences in:
- The specific benchmark levels or calculation methods.
- The volume threshold triggering regulation.
- Inclusion or exclusion of certain industrial activities or operational processes.
- Potential coverage of indirect emissions, especially in energy-intensive sectors.
In most of these programs, the focus remains on capturing the largest sources of on-site emissions. However, each system’s overlapping policies may indirectly address some portion of Scope 2 or Scope 3 emissions via broader provincial or federal measures on electricity generation, fuel suppliers, or transportation. In that sense, while the regulated facility itself might not directly submit compliance units for its indirect emissions, those emissions might still be priced elsewhere within the overall carbon policy framework.
Addressing Scope 2 Emissions Under Output-Based Pricing
Scope 2 emissions result from the purchase of electricity, heat, or steam generated by another entity. The question is whether a facility must account for them in its output-based pricing calculations. Typically, direct coverage of Scope 2 under OBPS is uncommon. The reason is that the facility generating emissions to supply electricity — for example, a power plant — will itself be regulated if its emissions surpass the threshold. Thus, the power plant is responsible for meeting or exceeding its own emissions-intensity bar.
Consequently, the consumer of that electricity is not always penalized a second time for the same carbon output. From a policy perspective, this method prevents double counting in regulated markets. Some programs might provide partial credits or adjustments for facilities that use low-carbon or zero-emission electricity, but only if they can credibly demonstrate that their consumption has lowered the total carbon intensity of regional generation.
Indirect Emissions Beyond Electricity (Scope 3)
When we talk about “indirect” emissions in a comprehensive sense, we typically refer to Scope 3. These can include upstream raw materials, product distribution, employee commute, or waste disposal. Usually, output-based pricing does not address this category directly. Instead, other elements of the broader carbon policy environment may incentivize improved supply chain practices, vehicle fleet upgrades, or material efficiency. This might be done through offset programs, low-carbon incentives, or mandates like the federal Clean Fuel Regulations. But strictly speaking, under a classic OBPS, a facility’s compliance obligation is set around direct emissions. Its indirect (Scope 3) footprint is not typically priced in the same way.
Nevertheless, many organizations are beginning to address Scope 3 voluntarily through internal sustainability goals or to meet stakeholder expectations for transparent climate risk disclosure. Even if the policy does not strictly obligate companies to pay for Scope 3, many forward-thinking businesses see a strategic value in factoring supply chain emissions into their reduction strategies. Doing so improves their overall climate readiness, fosters operational resilience, and responds to investor concerns about long-term performance and carbon risk.
Potential Implications for Companies
Though indirect emissions rarely fall within the direct compliance requirements of an OBPS, they can still carry significant reputational and operational impacts. Companies might:
- Experience cost pass-through from electricity providers if the provider’s own OBPS obligations raise overall energy prices.
- Find new market opportunities to purchase low-carbon electricity or other resources, potentially earning incentives or rebates.
- Face pressure from investors, customers, or end-users to address Scope 2 or Scope 3 emissions even if these are not mandated in the output-based system.
- Benefit from calculating their full emissions profile — direct and indirect — to gain a holistic view of their risk exposure and potential efficiency gains.
Key Considerations for Compliance
Though much of the attention under output-based pricing is on direct emissions, regulated facilities that closely track both direct and indirect emissions are often better positioned to make strategic decisions. Some key steps include:
- Comprehensive Emissions Quantification: While not mandated for compliance in all cases, measuring your Scope 2 and Scope 3 emissions can reveal hidden efficiency opportunities or cost savings, reinforcing your long-term sustainability strategy.
- Regulatory Guidance: Because provincial and federal policies can change, especially regarding how to treat electricity generation and certain industrial processes, staying updated is critical. Consulting expert insights or services such as GHG Emissions & Carbon Pricing guidance ensures your facility meets evolving compliance requirements.
- Benchmark Analysis: Understand how your operations compare to the official benchmark. This helps in projecting potential compliance costs or credit opportunities, especially if you plan expansions or modifications.
- Adaptation Planning: While output-based pricing deals primarily with emissions, it can also interact with broader climate legislation. Assessing how your facility might be impacted by future carbon policies ensures you maintain an efficient and forward-looking approach.
Looking Ahead: The Evolving Policy Landscape
As governments seek deeper GHG reductions and respond to global climate mandates, some frameworks could expand coverage to include specific categories of indirect emissions. Though changes are not guaranteed, it is worth noting that policy shifts may be more likely to impact major industrial emitters first, given their higher profile. Additionally, as carbon pricing strategies evolve — for instance under the introduction of new federal or provincial regulations — the indirect emission categories could be factored into new compliance instruments or offset protocols.
For many organizations, the prudent approach is to maintain reliable, audit-ready data on both direct and indirect emissions, even if indirect emissions are not currently regulated under OBPS. This positions them to adapt more easily to future policy changes and stakeholder expectations, while also identifying potential cost savings and reputational benefits in the process.
In sum, output-based pricing overwhelmingly focuses on direct emissions from facilities. Indirect emissions are generally tackled either by the regulating authorities (such as power plants or industrial suppliers) or addressed through complementary climate policies. Nonetheless, organizations that track and manage their indirect emissions often gain a strategic advantage, building stronger credibility and resilience within an evolving low-carbon economy.
If you have further questions or want to navigate the complexities of carbon pricing, from compliance requirements to advanced risk assessments, you may benefit from a more detailed consultation. For example, reviewing your operational boundaries and emissions inventory in the context of current regulations can reveal how output-based pricing applies to your facility. Understanding what is covered or not — and how that might change — can also help you stay ahead of shifting standards and reduce operational uncertainties.