The week of October 3, 2016 was an eventful one for Canadian climate change policy as the federal government introduced a pan-Canadian carbon price and ratified the Paris Agreement. Following the federal election in October 2015, indications were that all provinces and territories would be expected to price carbon. This was confirmed on October 3, 2016 when Prime Minister Justin Trudeau announced that the federal government will set a minimum price on carbon starting at $10 per tonne of carbon dioxide equivalent (CO2e) in 2018, which will increase by $10 per year until it reaches $50 per tonne of CO2e by 2022. This approach will be reviewed in 2022 to confirm the path forward, including continued increases in stringency.
Under the federal plan, each province and territory will be required to implement carbon pricing in its jurisdiction within two years, whether in the form of a carbon tax or a cap-and-trade system. If the carbon price in a jurisdiction does not meet the federal minimum price, the federal government will step in and impose a carbon price that makes up the difference and return the revenue to the province or territory. In addition, provincial and territorial goals for reducing emissions must be at least as stringent as federal targets. Canada has pledged to reduce its greenhouse gas (GHG) emissions by 30% from 2005 levels (approximately 523 Mt) by 2030. Currently, Canada’s four biggest provinces representing more than 80% of Canada’s population (Ontario, Quebec, Alberta and British Columbia) either have carbon pricing in place or will introduce it in 2017. For more information on climate change policies in each province and territory, please refer to our Climate Change Essentials Guide. Prime Minister Trudeau has indicated he will convene a first ministers’ meeting on December 8 with the aim of concluding a pan-Canadian climate plan, which will likely include more detail on carbon pricing and other measures.
Canada’s Approach to Carbon Pricing
While the details are still pending, Canada’s pan-Canadian approach to carbon pricing is premised on the following principles, which are drawn from principles proposed by the Working Group on Carbon Pricing Mechanisms that was established during the First Ministers’ Meeting in March 2016:
- Carbon pricing should be a central component of the Pan-Canadian Framework on Clean Growth and Climate Change.
- The approach should be flexible and recognize carbon pricing policies already implemented or in development by provinces and territories.
- Carbon pricing should be applied to a broad set of emission sources across the economy.
- Carbon pricing policies should be introduced in a timely manner to minimize investment into assets that could become stranded and maximize cumulative emission reductions.
- Carbon price increases should occur in a predictable and gradual way to limit economic impacts.
- Reporting on carbon pricing policies should be consistent, regular, transparent and verifiable.
- Carbon pricing policies should minimize competitiveness impacts and carbon leakage, particularly for trade-exposed sectors.
- Carbon pricing policies should include revenue recycling to avoid a disproportionate burden on vulnerable groups and Indigenous peoples.
The federal government’s goal is to ensure that carbon pricing applies to a broad set of emission sources throughout Canada with increasing stringency over time to reduce GHG emissions at lowest cost to business and consumers and to support innovation and clean growth.
The federal government’s carbon pricing benchmark includes the following elements:
- Provinces and territories will have flexibility in deciding how they implement carbon pricing: they can put a direct price on carbon pollution or they can adopt a cap-and-trade system.
- Pricing will be based on GHG emissions and applied to a common and broad set of sources to ensure effectiveness and minimize interprovincial competitiveness impacts. At a minimum, carbon pricing should apply to substantively the same sources as British Columbia’s carbon tax.
- The price on carbon should start at a minimum of $10 per tonne of CO2e in 2018 and rise by $10 a year to reach $50 per tonne of CO2e in 2022.
- Provinces with cap-and-trade need: (i) a 2030 emissions reduction target equal to or greater than Canada’s 30% reduction target; (ii) declining annual caps to at least 2022 that correspond, at a minimum, to the projected emissions reductions resulting from the carbon price that year in price-based systems.
- The federal government will provide a pricing system for provinces and territories that do not adopt one of the two systems by 2018.
- Revenues from carbon pricing will remain with provinces and territories of origin.
- Provinces and territories will use the revenues from this system as they see fit, whether it is to give it back to consumers, to support their workers and their families, to help vulnerable groups and communities in the North, or to support businesses that innovate and create good jobs for the future.
- The federal government will work with the territories to address their specific challenges.
- The overall approach will be reviewed in 2022 to ensure that it is effective and to confirm future price increases. The review will account for progress and for the actions of other countries in response to carbon pricing, as well as recognition of permits or credits imported from other countries.
- Legislated increases in stringency, based on modeling, to contribute to Canada’s national target and provide market certainty.
- Jurisdictions should provide regular, transparent and verifiable reports on the outcomes and impacts of carbon pricing policies.
Canada ratifies Paris Agreement; Paris Agreement to come into force on November 4, 2016
Following the federal government’s announcement, parliament ratified the Paris Agreement by a vote of 207 to 81 on October 5, 2016. The Paris Agreement, which was opened for signature on April 22, 2016, sets a goal of holding the increase in global average temperature to well below 2°C above pre-industrial levels, while countries pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels. With Canada’s ratification and ratification earlier in the week by the European Union and India, the implementation threshold for the Paris Agreement was reached on October 5, 2016. This means that the Paris Agreement will enter into force on November 4, 2016, which is thirty days after the date on which at least 55 parties to the United Nations Framework Convention on Climate Change accounting in total for at least an estimated 55% of the total global GHG emissions have deposited their instruments of ratification, acceptance, approval or accession with the United Nations depositary.
Overview of Carbon Pricing Mechanisms
Canada’s move to put a price carbon follows a global trend where carbon pricing is being increasingly seen as the key mechanism by which meaningful GHG emission reductions can be achieved. A price on carbon looks to capture what are referred to as the external costs of carbon emissions, i.e. costs that the public pays for indirectly, such as damage to property as a result of flooding. By placing a monetary value on carbon, the rationale is that governments, businesses and individuals will have an incentive to change their behaviour to less carbon intensive alternatives. Market instruments are perceived as providing more cost efficient and flexible compliance mechanisms to drive emission reductions, so governments are now looking to the market for solutions. There are two main types of carbon pricing mechanisms available to policymakers:
- An Emissions Trading System (ETS) is a market-based approach designed to provide economic incentives for reducing emissions. While emissions trading systems tend to be complex, the economic concept behind it is straightforward – since climate change is a shared global burden and the environmental impacts of reducing emissions is the same wherever the reductions take place, it makes economic sense to reduce emissions where the cost is lowest. Under an ETS, an annual limit or cap is set on the amount of GHG emissions that can be emitted by certain industries. Regulated entities are then required to hold a number of emissions allowances equivalent to their emissions. Regulated entities that reduce their GHG emissions below their target will require fewer allowances and can sell any surplus allowances to generate revenue. Regulated entities that are unable to reduce their emissions can purchase allowances to comply with their target. By creating demand and supply for emissions allowances, an ETS establishes a market price for GHG emissions. In order to achieve absolute reductions in GHG emissions, the limit or cap is gradually lowered over time.
- A carbon tax puts a price on each tonne of GHG emissions generated from the combustion of fossil fuels. The idea is that over time, the carbon price will elicit a market response from all sectors of the economy, thus resulting in reduced emissions. The design and implementation of carbon taxes varies widely and will depend on the jurisdiction’s energy mix, composition of its economy, existing tax burdens, existence of complementary environmental policies, and political considerations. In terms of scope, some jurisdictions have focused on a narrow category of energy users and large emitters, while others such as British Columbia (BC) have adopted a broader scope where the carbon tax covers GHG emissions from the combustion of all fossil fuels.
The key differences between the mechanisms are that with an ETS, the quantity of emission reductions is known, but the price is uncertain. With a carbon tax, the price is known, however the quantity of emissions reductions is uncertain. Both carbon pricing mechanisms can generate revenue that can be used to lower other taxes or invest in “green” initiatives. Both mechanisms also have related monitoring, reporting, verification and compliance obligations, and both need special provisions to minimize the effects on certain energy intensive, trade exposed industries.
Industry Leads the Way
In recent years, companies have been working hard to reduce their carbon footprints by setting emission reduction targets and taking action to address climate change impacts in both their own operations and their supply chain. Given the range of climate policies across jurisdictions, companies are often faced with having to consider multiple carbon compliance costs in their business decisions. As a result, there have been increasing calls from the private sector on governments to establish clear pricing and regulatory certainty to support climate-related investments and climate risk assessment efforts. In the meantime, companies have been assessing risk and developing business plans based on a real or internal carbon price that is incorporated into their planning and investment decisions. This means that companies worldwide are already advanced in their use of carbon pricing and in planning for climate change risks, costs and opportunities. According to the CDP, internal carbon pricing has become standard operating practice in business planning and the prices used range from US $6 to 89 per tonne of CO2e. On April 22, 2016, the United Nations Global Compact (UNGC) called for a minimum internal carbon price level of US$100 per tonne of CO2e by 2020, which UNGC believes is the minimum price needed to shift market signals in line with the 1.5 – 2°C pathway set out in the Paris Agreement.
As countries and businesses look for innovative approaches to reduce their carbon footprint, carbon pricing will become an increasingly prominent policy and business planning tool for governments and industry alike.