Ontario outlines key aspects of incoming cap-and-trade market

Environmental Alert

On November 24, 2015, just prior to the United Nations Climate Conference in Paris, the Ontario Ministry of the Environment and Climate Change (MOECC) released two important documents on how the province intends to achieve its greenhouse gas (GHG) emissions reduction targets.  By 2050, Ontario hopes to be 80% below 1990 levels and has set a new mid-term target of 37% below 1990 levels by 2030. 

First, MOECC put out a new ‘Climate Change Strategy’ that lays out various pathways and high-level approaches it intends to make in meeting this target.  Much of the new strategy will be fleshed out in new climate change legislation and a new five-year action plan will be introduced in early 2016. 

Perhaps more importantly, MOECC also released a discussion paper entitled “Cap-and-Trade Program Design Options” (the “Discussion Paper”) which provides some key insights into the role of the province’s cap-and-trade market “as the primary tool” for achieving its short-term emissions reductions goal.  This bulletin reviews the cap-and-trade design options being proposed in the Discussion Paper, which is expected to be reflected in a draft regulatory proposal to be tabled in early 2016.

Overview of cap-and-trade in Ontario

On April 13, 2015, Premier Wynne announced that Ontario would be participating in a cap-and-trade program to reduce the province’s GHG emissions.  In July, Premier Wynne furthered this commitment by announcing that Ontario would be an active participant in the Western Climate Initiative (WCI), a carbon trading market with California and Quebec. MOECC is now tasked with setting up the province’s carbon market rules and is currently targeting a January 1, 2017 start date for the cap-and-trade regime with the first auction expected in March 2017.  To achieve the province’s 2020 targets, the cap on allowable emissions is expected to decline by approximately 3.7% per year, though certain sector and types of emissions could face different rates of decline.

One of the key revelations in the Discussion Paper is that MOECC intends to take a very broad sectoral approach to covering as much of the province’s GHG emissions as possible.  To achieve this goal, the Discussion Paper proposes two approaches: ‘upstream’ for three industries and  ‘downstream’ for one industry to regulate and cap GHG emissions.

First, large industrial or institutional sources of annual GHG emissions equal or greater than 25,000 tonnes would be covered downstream at the point of emissions (i.e., at the facility).  Over 140 facilities in Ontario would be covered under this proposed threshold.  However, for electricity generation (including imports), transportation fuels and natural gas, all regulation will be applied ‘upstream’ at the distributor level if certain thresholds are met.  It is further proposed that any new industrial or distributor facilities that begin operations after January 1, 2016 will be given a two-year grace period before they are required to comply with the cap-and-trade program.

Key market design features

In addition to laying out the high-level aspects of the cap-and-trade market, the Discussion Paper proposed a number of more detailed market design features that will be crucial to any future participants in the market.  Below are some of the most important proposed features:

  1. Free allowances -To help mitigate against the possibility of ‘carbon leakage’, whereby emissions intensive and trade exposed (EITE) industries shift production to less regulated jurisdictions, MOECC proposes free allowances for all industrial and institutional emitters during the first compliance period (until 2020) The free allowances would begin to be withdrawn after 2020, though the highest EITE industries would be provided with most protection from new compliance costs. However, the EITE concern only applies to the industrial sector, so electricity, transportation fuel and natural gas distributors would still have to purchase their allowances beginning in 2017.
  2. Minimum price - For those entities who will have to purchase emissions allowances, MOECC proposes aligning with Quebec and California’s ‘price floor’ in 2013 of USD $10/tonne plus five per cent and inflation per year.  At the most recent Quebec and California auction, this price was $15.84/tonne in Canadian dollars.
  3. Banking allowances - To further mitigate potential compliance costs of the new regime, MOECC proposes that covered entities will be permitted to bank allowances over time so unused allowances in one compliance period may be used or traded in subsequent periods. 
  4. Offsets - MOECC plans to allow the use of offset credits using Ontario-approved offset protocols, which are still under development.  The Discussion Paper indicates that three protocols already in use in Quebec and/or California may be adopted on an expedited basis: mine methane capture and destruction; landfill gas capture; and capture of ozone-depleting substances.  MOECC proposes a further ten project types will be subject to a more intensive protocol review process.  While there may soon be opportunities for offset developers in Ontario, their market will be partially constrained by MOECC’s desire to limit the use of offsets to no more than 8% of the total compliance obligation (meaning the total cap of allowable emissions in any given year).
  5. Penalties -  Finally, entities that are not able to provide sufficient allowances and/or offset credits for their emissions cap in any given compliance period will be assessed a ‘three-to-one’ penalty whereby they will be forced to purchase an additional three allowances for each allowance they were short plus the allowance originally owed in the next compliance period.

Comment period on Discussion Paper now open

As mentioned above, early 2016 promises to be a busy time for MOECC with the stated intention to introduce new provincial climate change legislation, a five-year action plan and a regulatory proposal based on feedback from the Discussion Paper.  In the short-term, MOECC is accepting comments on the Discussion Paper until December 16, 2015.

More broadly, 2016 could result in a significant shift in Canadian climate change policy following the outcomes of the Paris conference and the First Ministers’ Meeting on climate, planned for early 2016.  Currently, Canada has a patch-work of climate regulations with Ontario and Quebec participating in their own carbon market with California and BC and, recently, Alberta, preferring the carbon tax route to achieving their emissions reductions targets.  While a pan-Canadian federal carbon tax seems unlikely, Prime Minister Trudeau’s stated intention of putting a price on carbon may result in greater harmonization of schemes across the country and, potentially, more provinces participating in the Quebec and Ontario carbon market.

One other area to watch out for is the possibility of border adjustments whereby the federal government could introduce new tariffs or taxes on imports from countries without carbon pricing schemes to help level the playing-field from EITE industries.  How such tariffs could work with current and proposed free trade agreements will likely be a key policy debate in 2016.