Pricing Carbon: Can a Cap-and-Trade System Deliver the Tonnes?
There is a clear causal connection between rising global temperatures and the release of greenhouse gases (GHG) during the combustion of fossil fuels. With each passing day, it becomes more urgent that we reduce GHGs before we reach an environmentally catastrophic tipping point. Governments are looking for ways to use market mechanisms as one way to put a price on carbon emissions and encourage industrial emitters to reduce their GHG emissions. One of these mechanisms is a cap-and-trade system.
In December 2009, Bill 185, the Environmental Protection Amendment Act (Greenhouse Gas Emissions Trading), 2009 (EPAA) was passed by the Ontario Legislature and received Royal Assent. The EPAA amends the Environmental Protection Act (EPA) to allow Cabinet to make regulations establishing measures for the use of economic and financial instruments and market-based approaches. The purpose of these instruments and approaches is to maintain or improve environmental standards, protect the environment and achieve environmental quality goals in a cost-effective manner. The EPAA specifies that such market-based approaches could include – but are not limited to – emissions trading. This caveat is significant as it keeps the government’s options open to consider other ways to price carbon, such as a carbon tax or levy.
The EPAA is designed to set a firm foundation for the development of a cap-and-trade system in Ontario. It is supported by a new O. Reg. 452/09 - Greenhouse Gas Emissions Reporting Regulation, under the EPA, and an accompanying technical guideline (see Mandatory GHG Reporting: What gets Measured gets Managed ). Although the Ontario government has had the authority since 2001 (under the EPA) to regulate a cap-and-trade system for nitrogen and sulphur dioxide emissions, the EPAA expands the government’s ability to make market-based regulations involving GHGs. The EPAA gives the government the power to make regulations prescribing: those persons and facilities to which a cap- and-trade system will apply; how the emission allowances (or “permits”) will be created, distributed or allocated; and how these instruments can be used, traded, reported, verified and/or retired.
Once the relevant provisions of the EPAA are proclaimed, a separate account in the Consolidated Revenue Fund – the Greenhouse Gas Reduction Fund (GGRF) – will be created to hold money collected from the distribution of financial instruments related to GHG reductions. Money in this fund may be used to cover the costs of administering the economic or financial incentives or to support GHG reduction initiatives.
A cap-and-trade system in isolation cannot reduce overall emissions unless the cap is periodically ratcheted down. However, cap-and-trade can establish an incentive for industry to reduce emissions well below the regulated cap – to over-comply – in exchange for the right to sell excess permits to others who may need them for compliance purposes. Proponents of tradable permit systems stress that greater emission reductions occur under a cap-and-trade system than under conventional command-and-control regulations because, under the latter, no one is overtly rewarded for over- compliance. However, tradable permit systems do not replace regulation: they work best when they are supported by strong regulatory frameworks.
A cap-and-trade regime is being positioned by the province as a key element in its Climate Change Action Plan, designed to help Ontario meet its 2020 target to reduce GHG emissions by 15 per cent below 1990 levels. In recognition of the economic linkages between Ontario and the rest of North America, the amendment also sets the administrative foundation for the trading of allowances across jurisdictions. This reflects the province’s desire to ensure that the eventual design of its cap-and-trade system can be harmonized with other North American systems currently under development. To ensure the province is on the same page and working in tandem with cap-and-trade developments elsewhere in North America, in July 2008 Ontario joined the Western Climate Initiative (WCI), a collaboration of U.S. states and Canadian provinces working towards a common framework for the design and implementation of a tradable permit system.
The Ontario government has yet to confirm the specific design elements of its cap-and-trade system. Although details are proposed in the Ministry of the Environment’s (MOE’s) discussion paper “Moving Forward: A Greenhouse Gas Cap-and-Trade System for Ontario,” a decision on this policy proposal is not expected until the fall of 2010, at the earliest.
Public Participation & EBR Process
In addition to an Environmental Registry proposal notice, the government held a day of public hearings on Bill 185 before the Standing Committee on General Government.
The majority of commenters stressed the need to ensure that the design, operation and administration of any cap-and-trade system consider that the Ontario economy is closely linked with the North American and global economies. Commenters disagreed on how emission permits/allowances should be distributed and one energy company expressed concern about the potential impact of market speculation on carbon price volatility.
Several commenters voiced a preference for a carbon tax instead of a cap-and-trade regime, noting concerns about the administrative costs and complexities of designing, operating, adjudicating and enforcing a tradable permit system. They noted that a carbon tax provides a “stable, predictable cost of carbon” and that “having predictable emission prices makes it easier for emitters to make decisions about… investments to reduce emissions.”
ECO Comment
The challenge for the Ontario government is to ensure sufficient harmonization between its domestic GHG trading regime and the respective regulations of other WCI members. As is permitted under the broad design parameters of the WCI, Ontario plans to seek the middle ground on the allocation of allowances and the use of offsets. Still-to-be-proclaimed provisions in the EPAA would give the province discretion to decide the percentage of allowances to be auctioned and the role of offsets as a compliance mechanism to address competitiveness issues. The ECO will carefully monitor how the province exercises this discretion once MOE has posted its decision on the design of its proposed cap-and-trade system.
The ECO notes that a provision in the WCI’s design recommendations provides for the WCI to intervene to “address… competitiveness issues” between WCI partner jurisdictions regarding the distribution of allowances if it is determined that a member jurisdiction is favourably considering local industry. It remains to be seen if Ontario will actually cede sovereignty over such a crucial provincial policy issue. This reluctance to cede sovereignty may apply equally to other WCI partners and calls into question the ultimate viability of the WCI as a suitable platform for trading.
The ECO is sensitive to commenters’ concerns about the potential for Ontario industry to be placed at a competitive disadvantage. These concerns relate primarily to the regulation’s treatment of the cost of carbon and how this will affect the province’s trade position in North America and the rest of the world. Addressing this issue is not an easy task, given the lack of climate change policy direction at the Canadian federal level and the uncertainty surrounding the climate change agenda in the U.S. Congress.
The ECO notes that one of the key objectives of Ontario’s Climate Change Action Plan, in addition to reducing GHG emissions, is to “support the transition to a low-carbon economy.” The ECO describes in Powering the Future: The Green Energy and Green Economy Act, 2009 the important role that the Green Energy and Green Economy Act, 2009 (GEGEA) will have in accelerating this transition. If implemented wisely, the GEGEA may be the game-changer Ontario needs to achieve more aggressive GHG reduction targets, either through a tradable permit system or by other means.
The province expects a cap-and-trade system to play a key role in helping to achieve its GHG reduction target by the year 2020. In our 2008/2009 Annual Greenhouse Gas Progress Report, the ECO noted considerable risk in the medium-term (to 2020) associated with the government’s positioning on the potential GHG reductions “that may be delivered by a cap-and-trade system.” While the province has been reluctant to even suggest a range of potential GHG reductions that could be delivered by a tradable permit system, the ECO is pleased that the Climate Change Secretariat has developed a range of GHG reductions that could be delivered by a cap-and-trade system by the year 2020. The ECO looks forward to reviewing these projections to assess their likely contribution to the province achieving its 2020 GHG reduction target.
The ECO will pay close attention to how still-to-be proclaimed provisions of the EPAA are implemented. In particular, we are concerned about the rules and regulations that may apply to how funds from the proposed GGRF are disbursed. Because the Ministry of Finance (MOF) will play a key role in the oversight of this fund, and because the oversight and disposition of funds from the GGRF may result in significant environmental effects, the ECO reiterates our request that MOF be re-instated as a prescribed ministry under the EBR (see pages 200-202 of the Supplement to the ECO’s 2003/2004 Annual Report).
The foundation of any trading system is the monitoring and reporting protocols employed to validate and verify the reductions claimed. The ECO strongly supports the enactment of O. Reg. 452/09 and the approval of its accompanying guideline. These will be indispensible in both setting historical benchmarks and in establishing fair but meaningful emission caps for sectors of the economy.
Finally, the ECO welcomes anticipated synergies between initiatives to reduce GHG emissions and measures that support the transition to a low-carbon economy. These synergies are particularly well demonstrated in the relationship noted between the EPAA and the GEGEA. As noted in the ECO’s 2008/2009 Annual GHG Progress Report, there is a strong ecological imperative to pursue more aggressive GHG emission reductions in the face of mounting evidence that we are fast approaching an environmental tipping point.
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| This is an article from the 2009/10 Annual Report to the Legislature from the Environmental Commissioner of Ontario. |
Citing This Article:
Environmental Commissioner of Ontario. 2010. "Pricing Carbon: Can a Cap-and-Trade System Deliver the Tonnes?." Redefining Conservation, ECO Annual Report, 2009/10. Toronto, ON : Environmental Commissioner of Ontario. 27-30.
