The Ontario government has signed an agreement with Quebec to create a joint cap-and-trade system to reduce greenhouse gas (GHG) emissions. In its announcement, Ontario has indicated that it will impose a hard ceiling on the amount of GHG emissions that is allowed to be produced by each sector of the economy. By linking Ontario’s system with Quebec’s and tying into the Western Climate Initiative cap-and-trade system already being operated in Quebec and California, Ontario will join North America’s largest carbon market.

Cap-and-trade programs limit the amount of GHGs that enter our atmosphere by setting a limit on emissions. Under this system, businesses will have a GHG emissions quota or emission credits. If a company does not use all of the credits by emitting less than its allotted share, these credits can be sold or traded to other companies that are at risk of surpassing their emissions quota. Therefore, according to the government, the cap-and-trade system will seek to reward innovative companies by incentivizing a reduction in GHG emissions.

It is useful to note that Quebec implemented its cap-and-trade system in 2013. The Quebec system requires facilities in the industrial and electricity sectors, and distributors and importers of fossil fuels whose annual GHG emissions in Quebec are = 25,000 metric tonnes of carbon dioxide equivalent (CO2e) to cover their total reported (and verified) emissions with an equivalent number of compliance instruments or “allowances” in circulation. Compliance units are either allocated freely, auctioned off or sold by mutual agreement by the government or consist of offset credits, credits for early reduction of emissions or emissions allowances issued by California (or any other jurisdiction that may join in the future). The Quebec and California carbon markets became fully linked and harmonized on January 1, 2014. They have been conducting joint auctions for emissions allowances since November 2014.

During the first few years of the cap-and-trade system, Quebec took measure to avoid “carbon leakage”—i.e., the relocation of industry to jurisdictions that do not have a cap-and-trade system—by granting emitters the maximum emissions allowances required to comply with the system free of charge; however, the system provides for a gradual reduction in the number free allowances granted annually.

By adopting a similar system, Ontario would be able to benefit from the carbon market experience of Quebec and California, and it could allow for greater flexibility for emitters and participants in all three jurisdictions as well as have the potential of increasing liquidity in the carbon market.

The Ontario system will take many months to develop and industry-specific targets will need to be established. Ontario will also need to integrate its system with that of Quebec and California. It is anticipated that these caps will not be in place until the fall of 2015 at the earliest. It should be noted that Ontario has adopted Regulation 452/09, which required the reporting of GHG emissions by operators in certain sectors.

While there is a view that carbon taxes, such as those implemented in British Columbia, are a more straightforward approach to discouraging GHG emissions, the Ontario government is taking the position that since the cap-and-trade system is sector-based it is a more flexible means to combat climate change. According to the Ontario government, the revenue collected through the cap-and-trade system will be spent on environmentally-friendly technology and infrastructure.