Pricing Carbon in the Economy (2011 GHG Report)
| In May, 2011, the ECO his released third Annual Greenhouse Gas Progress Report. Click here for more information on this report, including videos and communications materials. | |||||
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Contents |
Introduction
The ECO believes that Ontario’s transition to a low-carbon economy will only happen if the cost associated with GHG emissions is reflected in the price of goods and services. While Ontario’s CCAP envisions the creation of green jobs and the transition to a low-carbon economy, nowhere is the role that carbon pricing can play in this regard explicitly articulated. A key perceived barrier to the implementation of a carbon price is that increased costs will put Ontario’s industry at a competitive disadvantage and thus have negative economic impacts.
Wanted: Price Discovery
While the Ontario government has made a number of statements and taken steps toward developing a provincial cap-and-trade system (e.g., passing cap-and-trade enabling legislation), important pieces, such as an allowance registry and auction platform are not in place. Furthermore, the government has yet to put forward regulations regarding the generation of offset credits in the province, and has recently announced that it lacks the verified emissions data upon which to base its carbon budget and allocation of allowances. This leaves a considerable degree of uncertainty as to when such a system will be up and running and what the final design will deliver in terms of GHG reductions.
Going It Alone: Implications for Ontario
The Ontario government is sensitive to the potential impacts of cap-and-trade on industrial competitiveness and the challenges this presents to harmonizing climate change policy with the Canadian federal government and with its major trading partners. In the context of a hypothetical national cap-and-trade program with weaker federal government targets, Ontario’s relatively more ambitious emission reductions could compensate for increased emissions in other provinces. This emissions leakage between Canadian provinces could negate some of the climate change benefits of Ontario’s actions.
Under a policy of U.S.-Canada alignment based on harmonized emissions reductions targets, key differences in the emissions profiles of the two countries could result in higher costs for Ontario. This is because, Ontario notwithstanding, Canadian GHG emissions are rising at a faster rate than they are in the U.S. and in sectors with high abatement costs (i.e., oil sands). Thus, while the U.S. should be able to meet its 2020 target through relatively inexpensive abatement in the electricity sector (i.e., fuel switching from coal to natural gas and energy efficiency), reaching Canada’s target will require reductions across a wider range of sectors where abatement technologies are much more expensive (i.e., carbon capture and storage for oil sands upgrading). Thus, a higher carbon price is required to reach the same GHG reduction target in Canada which could increase the compliance costs for Ontario industry relative to competitors in U.S. states.
A policy of alignment based on harmonized carbon prices between Canada and the U.S. would address several interrelated issues, including threats to the competitiveness of trade-exposed industries. Linking systems based on price is a mixed blessing for Ontario. Lower carbon prices weaken the incentive to invest in the carbon-reducing technologies necessary to achieve Ontario’s 2020 target.
It is in this context that the rationale for Ontario to act now to put in place a strong carbon price is compelling. The deployment of low-carbon technologies, facilitated through a strong carbon price signal, will stimulate employment and have minimal impacts on overall economic growth (see Table 1). Furthermore, acting in advance of other provinces and respective federal governments should provide Ontario with more leverage in negotiating the design of a carbon pricing program that acknowledges its early actions.
| Policy Scenario | Forecasted Average Annual GDP Growth, | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Canadian carbon price in 2009 | U.S. carbon price in 2020 | BC | AB | SK | MN | ON | QC | AT | |
| Reference case | $0/tonne | $0/tonne | 2.3% | 2.1% | 2.3% | 2.1% | 2.3% | 1.8% | 1.7% |
| Transitional policy option if U.S. implements Waxman-Markey | $63/tonne | $33/tonne | 2.2% | 1.9% | 2.2% | 2.2% | 2.2% | 1.8% | 1.6% |
| Transitional policy option if U.S. does not implement policy | $30/tonne | $0/tonne | 2.2% | 2.0% | 2.2% | 2.1% | 2.2% | 1.8% | 1.6% |
Managing Carbon Leakage
Industries that produce internationally traded commodities, such as cement, iron and steel, are emissions intensive. As such, their competitiveness can be reduced if a domestic carbon cost is added to their cost of production. Carbon leakage can, therefore, result either through a firm relocating to a jurisdiction with lower effective carbon costs or through substituting product from an unregulated jurisdiction.
There are two basic options for mitigating the risk of carbon leakage within exposed sectors: leveling down carbon prices through the free allocation of permits or investment subsidies, or leveling up carbon costs through a border carbon adjustment (BCA) on imports. While free allocation has been favoured in cap-and-trade programs, it may not effectively deter leakage if a facility can economically reduce output and sell surplus allowances. It may also shift the burden of reductions to other sectors. As a result, it will be important to be selective about which sectors are deserving of free allowances to avoid the scenario where such actions detract from industry’s preparations for a longer-term transition to a low-carbon economy.
Reduced domestic output that results in greater imports from unregulated jurisdictions compromises the environmental effectiveness of a carbon pricing policy. In this situation a facility could generate windfall profits from allowance sales while doing little to reduce the emissions leakage that policymakers were seeking to avoid. A more effective solution from the perspective of economic and environmental efficiency is to level up the carbon costs on imported products through a BCA. Such an approach is particularly suitable for the cement sector where a homogenous product allows for a BCA benchmarked to the best-availabletechnology (e.g., dry kiln technology). With respect to steel, the heterogeneity of product and process along with the significant economic value of internationally traded steel make the establishment of a BCA technically and politically challenging. Thus free allocations, with a gradual transition towards a BCA or preferably a global sectoral agreement, might be preferable.
Conclusions
Industry and the wider public need a clear price signal to guide current economic development in a manner that is less GHG intensive. The province cannot afford to wait until all uncertainty is minimized. The ECO believes that there are greater risks in waiting and that policy options are available to deal with the issues of competitiveness and carbon leakage over the near to medium term.
