Action on climate change is heating up in Ontario as the government is poised to make important changes to its environmental framework. The province of Ontario is proposing to implement a greenhouse gas (“GHG”) cap-and-trade program as part of the government’s efforts to help mitigate climate change and its effects. According to its April 13, 2015 news release, such a program “effectively reduces the amount of GHG pollution going into our atmosphere by setting a limit on emissions, rewarding innovative companies, providing certainty for industries, and creating more opportunities for investment”. These changes are in line with the recent high profile climate change talks on the world stage.

Details of the program have now been unveiled. On February 24, 2016, the Ontario Ministry of the Environment and Climate Change (“MOECC”) released the Climate Change Mitigation and Low-Carbon Economy Act, 2016 (the “Bill”). The next day it released the Cap and Trade Regulatory Proposal and Revised Guideline for Greenhouse Gas Emissions Reporting (the “Draft Regulations”), which would be promulgated under a new act. This article briefly outlines the key features and implications of the cap-and-trade program under the Bill and the Draft Regulations. The implications will be relevant to regulated emitters and other entities wishing to participate in Ontario’s carbon market, all of whom have until April 10, 2016 to provide their feedback on the proposed program.

Ontario’s cap-and-trade in the past year

On April 13, 2015, Premier Kathleen Wynne announced that Ontario would be participating in a cap-and-trade program to reduce the province’s GHG. In July 2015, 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 Québec. MOECC was tasked with setting up the province’s carbon market.

On November 24, 2015, days before the United Nations Climate Conference in Paris, MOECC produced a discussion paper entitled “Cap-and-Trade Program Design Options”. The discussion paper offered an initial look at the province’s options for how its cap-and-trade market will achieve its goals to reduce short-term emissions. We provide a review of the proposed design options in our previous bulletin.

Following the release of its discussion paper, MOECC solicited comments from the public on the several options it had proposed. The province has also been meeting about cap-and-trade with over 700 stakeholders, including industries, associations, environmental organizations, and labour groups.

The recent release of the Bill and Draft Regulations builds on this momentum by revealing the details of the proposed cap-and-trade program. The Bill codifies the province’s carbon reduction commitment of 15 per cent below 1990 levels by 2020, 37 per cent below 1990 levels by 2030 and 80 per cent below 1990 levels by 2050. The proposed program is broad ranging in scope, includes features to encourage an economically efficient and competitive transition to carbon caps, and is designed to interconnect with the broader carbon market in California and Québec.

What is being proposed

The proposed Bill, which is currently in its second reading, aims to establish a framework for climate change-countering action in Ontario. In addition to codifying Ontario’s GHG reduction commitments, it would act as the enabling legislation for, among other initiatives, the regulatory regime behind Ontario’s cap-and-trade program.

Scope of cap-and-trade obligations

The Draft Regulations require reduced emissions from over 150 emitters (“Capped Emitters”) in four categories:

  1. large industrial players with emissions of 25,000 tonnes or more of CO2 per year;
  2. natural gas distributors with emissions of 25,000 tonnes or more of CO2 per year;
  3. petroleum product suppliers that supply 200 litres or more of petroleum products during the year; and
  4. electricity importers if the quantity of electricity imported during the year is greater than zero megawatt hours.

The sectors in which large industrials operate include iron and steel; petroleum refining; cement; hydrogen; beer; ammonia; nitric acid; lime; glass; ceramics; institutions such as universities and colleges; mining; base metal smelting; brick-making; carbon black; ethylene; propylene; magnesium production; mineral wool insulation; lubricants manufacturing; and styrene.

Caps and options to achieve compliance

The proposed program commences on January 1, 2017 and would function in three-year compliance periods, the first of which would end on December 31, 2020. The 2017 GHG emissions limit for Capped Emitters would be roughly equivalent to the projected emissions for that year. Following this, this cap would decline between four and five per cent each year during the first compliance period.

Capped Emitters would be required to retire emissions credits in an amount equivalent to their actual emissions for each compliance period. To achieve compliance, Capped Emitters may therefore:

  • mitigate their actual emissions by investing in clean technologies to become more efficient or otherwise by burning less fossil fuels;
  • acquire emissions allowances from the government, by way of free allocations for some sectors or otherwise through quarterly auctions;
  • purchase additional emission allowances from other Capped Emitters on the secondary market; or
  • purchase offsets from qualifying offset projects.

Under the Draft Regulations, if a Capped Emitter fails to submit all required emissions allowances and credits before the applicable deadline, it will be prohibited from transferring emissions allowances or credits from its holding accounts into any other account other than its compliance account. In addition, the Bill provides that in the event of a shortfall, Capped Emitters will be required to submit additional emissions allowances in an amount equal to three times the shortfall, failing which they may be required to pay an amount equal to any emissions allowances it failed to submit, multiplied by the lowest bid price accepted at the most recent auction.

Initial allocation of emissions allowances

During the initial compliance period, most large industrial emitters would benefit from a free allocation of emissions credits. This is intended to assist industry members of trade-exposed industrial facilities with high carbon emissions transition into the new model, which the MOECC recognized are more susceptible to competition from international markets. Electricity generators, transmitters and distributors, natural gas distributors, petroleum product suppliers and certain other emitters cannot qualify for free allocations.

To calculate the free allocation, three factors would be taken into consideration:

  1. the assistance factor of up to 100%, which may be set to provide a proportionally greater allocation to trade-exposed industries;
  2. the base emissions amount, which is specific to each facility and would be determined using sector specific methodologies included in the Draft Regulations; and
  3. the cap adjustment factor, which would be used to ratchet down the cap in successive years of a compliance period.

The MOECC indicated in its November 2015 discussion paper that it intends to set the initial assistance factor for all sectors at 100%, meaning that all eligible sectors will have the opportunity to obtain a full allocation of free emissions allowances.

Those who do not receive free allowances will have the opportunity to purchase them in auctions run by the MOECC. Each auction would be subject to a floor price, starting around $14/tonne and escalating by 5% plus the CPI.

Under the Bill, Ontario proposes to pay all revenue from auctions into a “Greenhouse Gas Reduction Account”. This account would be segregated from general revenue and would be used to reimburse the government’s costs of administering the legislation and regulations and to fund initiatives that are reasonably likely to reduce, or support the reduction of, GHGs. The types of initiatives that may become eligible for funding are listed in Schedule 1 of the Bill could include those that reduce GHGs through the use of:

  • renewable, low-carbon or carbon free energy,
  • land use and building changes,
  • transportation innovation,
  • industrial improvements,
  • agricultural and forestry practices,
  • waste disposal, and
  • financial models and services.

This funding will complement the recently announced Green Investment Fund.

Offsets

The new program would include a mechanism under which certain qualifying projects would generate credits, which could be used to offset emissions in a given year, up to a maximum of eight per cent of a Capped Emitter’s compliance obligations. These projects would be undertaken in sectors that are not subject to the cap and would require proponents to demonstrate that the GHG reductions are real, additional, verified, unique, permanent, and enforceable.

Details of the offset program will be set out in a separate regulation, which is expected to be modelled after offset programs in place in Québec and California and would list specific types of qualifying offset projects. Once created, emissions offsets will could also be tradable in the secondary market.

The Western Climate Initiative

California and Québec, which have both launched cap-and-trade systems, are linked under the WCI. Ontario is also a party to the WCI and has indicated its intention to link its own cap-and-trade and offset programs with those of California and Québec. Once implemented, this regional market will allow member states to hold joint auctions of emissions allowances and will permit cross-border trading of emissions allowances and offsets. By joining a larger carbon market with fungible allowances and offsets, Ontario hopes to give Ontario’s Capped Emitters more options for complying with the applicable cap and to increase the economic efficiency of the cap-and-trade system.

Implications for businesses

A cap-and-trade system would create significant implications for businesses throughout the province, including the following:

  • Capped Emitters will face significant compliance obligations and costs. They will have to develop strategies for mitigating emissions, obtaining and trading emissions allowances and credits, and hedging against compliance costs.
  • Customers of Capped Emitters could expect increased prices that reflect the new prices of carbon.
  • Innovators may be able to bring to market new emissions reduction technologies and offset projects that were previously uneconomical.
  • Financial stakeholders will need to understand the implications of the cap-and-trade system for credit and offset trading and carbon finance. New players will likely emerge to facilitate and implement from such transactions.
  • Cross-border carbon mitigation and trading opportunities may open up, particularly with California and Québec.

These implications will have to be considered in the context of an evolving national conversation about climate change. On March 3, 2016, Prime Minister Justin Trudeau and the provincial premiers agreed to the Vancouver Declaration On Clean Growth And Climate Change. As part of the Vancouver Declaration, they committed to transitioning to a low carbon economy by adopting a broad range of domestic measures, including carbon pricing mechanisms adapted to each province’s and territory’s specific circumstances.

What to expect

Starting February 25, 2016, the Draft Regulations are available for a 45 day public review and comment period. All comments received prior to April 10, 2016 will be considered in the course of the decision-making process by MOECC, if they are submitted in writing or electronically using the form provided in the MOECC notice and reference Environmental Bill of Rights (“EBR”) Registry number 012-6837.

Stakeholders should stay alert for the release of the offset regulations, which are expected in the near future.