On February 24, 2016 the Ontario government unveiled Bill 172, the Climate Change Mitigation and Low-carbon Economy Act, 2016 [PDF] (the Act). The Act, if passed, will establish the foundation for Ontario’s cap and trade regime. The Ontario Ministry of Environment and Climate Change (MOECC) has also released two draft regulations: the Draft Cap and Trade Regulation [PDF], which outlines the mechanics of the proposed regime, and the Revised Guideline for Greenhouse Gas Emissions Reporting [PDF], which would replace the current Greenhouse Gas Emissions Reporting Regulation (O. Reg. 452/09).

Background

In February 2015 the MOECC released a discussion paper that identified carbon pricing as a critical action necessary to reduce emissions of greenhouse gases (GHG) in Ontario. In April 2015 the Ontario government announced it would be implementing a GHG cap and trade program. While limited details were released at this time, the Province made clear that the program would be implemented through the Western Climate Initiative (WCI), the largest carbon market in North America, which includes Quebec and California.

On November 16, 2015 the MOECC unveiled Cap and Trade Program Design Options [PDF] (the Discussion Paper) which defined the mechanics of the cap and trade regime in more detail, identified proposed design options, and included questions that stakeholders were encouraged to comment on. Stakeholder feedback was reviewed and incorporated into the Act.

Overview of the Act

The key elements of the Act are that it:

  1. Establishes targets for the reduction of GHG emission in Ontario;
  2. Requires the Ontario government to prepare a climate change action plan to achieve these targets;
  3. Requires certain persons to quantify GHG emissions associated with their activities, report these emissions, and have these reports verified;
  4. Establishes a framework for GHG cap and trade in Ontario. More specifically, the Act:
    1. establishes three categories of participants: mandatory participants, voluntary participants, and market participants (i.e. entities with no reporting or verification requirements, but who wish to purchase and sell emissions credits);
    2. authorizes the Minister to create various classes of emission allowances and distribute such allowances to registered participants either for a fee or free of charge. The Regulations establish who may receive emission allowances and the method for allocating free allowances;
    3. authorizes the Minister to create and issue various classes of offset credits to registered participants;
    4. authorizes the creation of regulations to establish market rules and auction protocol, including purchase limits and holding limits;
    5. authorizes the Minister to harmonize the cap and trade system with other jurisdictions, such as Quebec and California;
    6. establishes the Greenhouse Gas Reduction Account, which will receive all proceeds generated by the cap and trade regime. Payments may be made from the Account for initiatives that are reasonably likely to reduce or support the reduction of GHG emissions; and
    7. establishes enforcement mechanisms such as fines for regulated participants whose emissions exceed their allowances or credits and administrative monetary penalties.

Key elements of Ontario’s proposed cap and trade regime

Timing

Mandatory and voluntary participants will be responsible for their emissions starting on January 1, 2017. The first auction of emission allowances will be held in March, 2017; this would be a stand-alone Ontario auction and would not be linked with Quebec and California. Once alignment is complete, auctions with Quebec and California will be held every quarter. The first “true up” period would not be until 2021.

Setting the cap

In order to facilitate a smooth transition into the cap and trade system, the Province proposes to set the 2017 caps at its best estimate of what 2017 emissions will be. More specifically, the Province proposes to set the cap at 142,332,000 allowances which is equal to 142,332,000 tonnes of CO2 “equivalent”. This amount takes into consideration expected growth in the economy as well as new and expanding facilities. This cap will decline each year to support a reduction of Ontario’s GHG emissions to the following levels:

  1. 15% below 1990 levels by the end of 2020;
  2. 37% below 1990 levels by the end of 2030; and
  3. 80% below 1990 levels by the end of 2050.

The Province proposes that all industrial and institutional sectors have an assistance factor of 100% in the first compliance period (i.e. up to 2020). That is, all industrial and institutional mandatory participants will receive 100% of their required GHG emission allowances free of charge until 2020. This assistance factor will be reassessed prior to the beginning of the second compliance period (2021-2023).

Scope

The following discussion, organized by sector, explains which facilities and persons will be mandatory participants under the cap and trade regime.

1. Electricity, including imported electricity for consumption in Ontario

For domestic electricity generation, mandatory participants will be the fuel distributors providing fossil fuel to such electricity generation facilities. The exception to this general rule is where generation facilities receive fuel directly from inter-provincial or international natural gas pipelines, i.e. not via a gas distribution utility. In this case, the generation facilities themselves will be mandatory participants. For electricity imports, the mandatory participant will be the “first jurisdictional deliverer” (i.e. the entity who first imports the electricity into the province).

2. Industrial and large commercial operators (such as manufacturing, base metal processing, steel, pulp and paper, and food processing)

Mandatory participants would be facilities with annual GHG emissions equal or greater than 25,000 tonnes. Industrial and large commercial operators include facilities that produce copper, nickel, iron, steel, hydrogen, lead, pulp and paper as well as other facilities listed in Table 2 of O. Reg. 452/09.

3. Institutions

Similar to the industrial sector, mandatory participants will be facilities with annual GHG emissions equal or greater than 25,000 tonnes. It is worth noting that when considering what constitutes a facility (either an institutional facility or industrial/commercial facility), the Province has indicated it will follow the guidelines in the applicable GHG emissions reporting regulation. O. Reg. 452/09 defines a facility as all buildings, equipment, structures and stationary items that are owned or operated by the same person and  are located on either a single site or adjacent sites that function as a single site. A facility also includes sites that are not adjacent if they are connected by natural gas pipelines.

4. Transportation fuel, including propane and fuel oil

The mandatory participants in this sector will be distributors who (i) distribute to an Ontario consumer, (ii) deal with volumes of 200 litres or more, and (iii) first place the transportation fuel into the market.

5. Natural gas distribution

Mandatory participants will be those that, in aggregate, are associated with annual GHG emissions of 25,000 tonnes or greater, and operate the point the gas is transferred from pipeline into the distribution network for local customers.

In addition to the mandatory participants identified above, the Act allows certain persons to opt in the regime as “voluntary participants.” Persons with annual GHG emissions of 10,000 – 25,000 tonnes, who are required to submit emissions reports but are not required to have them verified, can choose to opt in as voluntary participants. A person who is not an employee of a mandatory or voluntary participant may apply to act as a market participant. Note that the cap and trade system as currently proposed does not include regulating GHG’s at the individual or retail consumer level (e.g. home or vehicle owners).

Market design

The Act allows the Ontario government to develop regulations that clarify the market design features of the cap and trade regime. Market design features will largely be based on those developed by the WCI. Consistent with WCI market design, the Ontario regime will allow market participants to participate in auctions and purchase credits. Key components of market design include registration requirements, auction rules, trading rules, settlement or reconciliation rules, and strategic reserve sales. Auctions will be conducted by sealed bid in a single round with lot sizes of 1,000 allowances with a uniform minimum price. With respect to market rules, there will be a purchase limit and a holding limit. The purchase limit will prevent mandatory and voluntary participants from purchasing more than 25% of allowances sold at an auction; market participants will be limited to 4% of allowances available at auction. The holding limit refers to the total amount of emissions allowances and credits a participant may own. The limit will be set annually and will depend on the number of Ontario emission allowances created for the year. It is worth noting that section 31(6) of the Act prohibits a person from disclosing whether or not they are participating in an auction, except to the extent they may be exempt from this prohibition by regulation.

Market stability

Price stability will be accomplished by two main mechanisms: (i) the auction reserve price and (ii) a strategic reserve. The auction reserve price sets a minimum price level for emission permits sold at auction. In 2016, Quebec and California set this price at $12.82 CAD; Ontario plans to align its auction reserve price with that of Quebec and California for 2017. The strategic reserve sets aside 5% of all allowances from 2017 to 2020 and divides these allowances into three price tiers. This strategic reserve will only be available to Ontario emitters, and strategic reserve allowances can only be used for compliance. Ontario plans to align its strategic reserve price tiers with that of Quebec and California for 2017. Quebec and California set their price tiers at $40, $45, and $50 per allowance in 2013, escalating annually at 5% plus inflation and converted to Canadian currency.

Market leakage

The Province has recognized “carbon leakage” as a risk of implementing the cap and trade regime. The Discussion Paper explains that carbon leakage “occurs when production shifts to a jurisdiction with a less stringent carbon pricing policy.” In order to address this risk, the Act authorizes payment from the Greenhouse Gas Reduction Account to assist sectors at risk for market leakage. Additionally, the Act gives the Director the discretion to distribute emission allowances free of charge, which can be used to assist emissions intensive and trade exposed entities. Emissions from electricity generation, however, will not be eligible to receive allowances free of charge. The Province has indicated that distribution of free allowances will decline over time, and such distribution would be reviewed at the end of the first compliance period as part of the program review.

Offset credits

The Province proposes to develop an Offset Credit Registry and issue credits for emissions reductions generated by non-regulated entities. According to the Discussion Paper, mandatory and voluntary participants would be able to use offset credits to satisfy up to 8% of the total compliance obligation. The government has not yet developed an offset protocol, meaning that what constitutes an “offset credit” has not yet been determined. Current proposed offset project types include the capture and destruction of mine methane, landfill gas, and ozone depleting substances.

True up and penalties

At the end of a compliance period all mandatory and voluntary participants must surrender a number of credits equal to their emissions. Participants have 11 months to complete this true up (e.g. for the compliance period ended December 31, 2020 participants would have to true up by November 1, 2021). Participants with excess emissions will be subject to a three-to-one compliance penalty. That is, for each allowance an entity is short at true up they must surrender (i) the allowance originally owed, and (ii) an additional three allowances. An emitter’s holding account can be suspended if it fails to surrender the required amount of allowances and/or offset credits and the emitter may be subject to fines.

Much of the Act is dedicated to establishing investigation, enforcement and administration mechanisms. For example, section 38 gives a provincial officer the ability to inspect certain documents. Section 47 states that every person who contravenes or fails to comply with the Act is guilty of an offence. Section 47(4) specifically states that directors and officers of a corporation who directed or acquiesced an offence under the Act may be held personally liable for such an offence. Further, section 48 of the Act establishes fines that are applicable to a range of offences. For instance, on a first conviction for failing to submit emission allowances and credits a corporation is liable for at least $25,000 for each day the offence is committed, up to a total of $6 million. For the same offence, an individual is liable for at least $5,000 for each day the offence is committed, up to a total of $4 million and imprisonment for up to five years. Finally, section 54 allows the Director to make an order requiring a person to pay an administrative monetary penalty. These penalties can be used to ensure compliance with the Act or to prevent a person or entity from deriving an economic benefit as a result of contravening the Act or its regulations. Unlike a fine under the Act, an administrative monetary penalty cannot be levied for a failure to submit emission allowances and credits. The cap for administrative monetary penalties is $1 million.

Discussion

The Ontario government anticipates that 82% of Ontario’s GHG emissions will be captured by its cap and trade system, with the remaining 18% coming from small emitters not covered by the regime.[1] The Province also expects the cap and trade regime to generate $1.9 billion annually, with all of these proceeds being reinvested in initiatives that will reduce Ontario’s GHG emissions and support the transition to a low carbon economy.[2]Further, the Ontario government has noted that after California introduced its cap and trade regime, the state’s economy and total number of jobs grew at a rate that outpaced the rest of the U.S. economy.[3] Whether Ontario will realize such benefits and whether its proposed GHG cap and trade system will have sufficient liquidity and pricing to stimulate excess GHG reductions by those with lower marginal costs of reduction, or rather operate in substance as a tax, remains to be seen.