Ontario has taken another step forward with its cap and trade program to limit greenhouse gas emissions in the province. On Nov. 16, 2015 it released its Cap and Trade Program Design Options paper1, setting out both its program design proposal and the options under consideration for a provincial cap and trade program linked to the existing programs of Quebec and California. The next step is proposed regulations to make it happen.

The context is important: Ontario is currently one of the largest per capita greenhouse gas (GHG) emitters in the world. The provincial government is determined to aggressively reduce those emission levels.  It has set GHG emissions targets of 15% below 1990 levels in 2020, 80% by 2050, and intends to achieve carbon neutrality by the end of the century. These targets are aligned with the recommendations made by the Intergovernmental Panel on Climate Change.2

Ontario has determined that a carbon pricing scheme is critical to Ontario’s ability to meet its objectives. While there are other methods of carbon pricing, such as a carbon tax or performance standards, Ontario has decided to pursue a cap and trade program.3 It is an approach Ontario has been exploring for some time. In 2008, Ontario joined Quebec, California, and others to develop the Western Climate Initiative (WCI) program, a model cap and trade program.

Generally speaking, a cap and trade program places an overall limit, or cap, on emissions from regulated sectors. The cap is then allocated and distributed to emitters in those sectors. The means by which the allowances may be distributed is discussed below. Annual step-downs, or declines, in the cap reduces the allowances available to the regulated sectors, resulting in a progressive reduction in overall emission levels.

Those emitters who reduce their GHG emissions to levels within their allowed levels may sell their unused allowances to those emitters who need additional allowances because their emissions exceed their distributed allowances. This dynamic is intended to result in a market price for carbon emissions. To emit GHGs at levels greater than permitted by the allowances one holds will be an offence.

Unlike direct command and control regulation, which simply prohibits and penalizes undesirable behaviour, the cap and trade system creates a market-based incentive to act in the desired way— to reduce greenhouse gas emissions. The market rewards those whose performance exceeds their compliance obligations, and creates a market price penalty for those who do not do so. And to ensure participation in the market, there is the traditional approach to ensuring compliance — non-compliance is an offence which may lead to prosecution and conviction and an array of penalty consequences.

When is the program going to start?

It is proposed that the program would begin on Jan. 1, 2017, with the first emissions allowance auction to be held in March 2017. The initial compliance period, if the start date is Jan. 1, 2017, would be four years. After the initial four-year period, Ontario would move to a three year period, bringing Ontario onto the same compliance schedule as Quebec and California.4

What is the proposed cap?

The 2017 cap is proposed to be set at the forecasted total emissions for that year, taking into account the expected growth in the economy. The cap would decline by 3.7% per year to enable Ontario to achieve its 2020 target.5

What sectors will be covered?

The following sections are proposed to be covered:

  • Electricity, including imported electricity consumed in Ontario;
  • Industrial and large commercial operations (such as manufacturing, food processing, and pulp and paper), with annual GHG emissions equal to or greater than 25,000 tonnes;
  • Institutions;
  • Transportation fuel (imports or domestics at volumes of 200 litres or more that are delivered to an Ontario customer);
  • Distribution of natural gas (distributors of natural gas with aggregate annual GHG emissions equal to or greater than 25,000 tonnes);

Energy from waste facilities are being considered for inclusion.

It is proposed that both combustion emissions and fixed process emissions be covered, but reported separately.6

New and expanding facilities are subject to different compliance obligations. New facilities beginning operations after Jan. 1, 2016, with annual emissions equal to or greater than 25,000 tonnes would be subject to the regime in their third year of operation. Expanding facilities that exceed the compliance threshold would be obligated to comply starting in the first year the threshold is reached.7

What is the point of regulation (or point of regulatory attachment) of the compliance obligation?

It is proposed that the compliance obligations would attach upstream: in the case of fuel, electricity, or natural gas, at the distributor in Ontario level. For electricity imports, the “first jurisdictional deliverer”, or the point at which the electricity enters Ontario, would be the point of regulation. The point of regulation for natural gas would be the moment when the gas is transferred from the pipeline into the local distribution network. Similarly, for transportation fuel, the point of regulation would be when the fuel is first placed into the Ontario market.

Industrial and institutional sources are proposed to be regulated at the point of emissions, i.e., at the facility itself.8

How are allowances to be distributed?

It is intended that Ontario allowances be sold at auction, with a reserve price aligned with the joint California- Quebec market. In August 2015 the reserve price was $15.84/t CAD.

This feature is fundamental. The need to acquire allowances to emit puts a price on those emissions; it is the auctioning of the allowances that creates the initial market price. The more one emits, the more one has to pay. Hence a price on carbon.

However, it is recognized that certain emission-intensive sectors are more susceptible to pressure from international markets. They are considered trade exposed (referred to as “emissions intensive trade exposed, or “EITE”, sectors).  A price on GHG allowances makes them particularly vulnerable to competitors in other jurisdictions who do not face this cost of production.

Ontario is sensitive to the risk that its cap and trade system may result in “carbon leakage”— production in the EITE sectors relocating to jurisdictions without carbon pricing or with less stringent carbon emission standards. Carbon leakage means that not only is the GHG reduction opportunity lost, but also some of Ontario’s valuable productive capacity.

In order to help mitigate carbon leakage and the impacts of the cap and trade system on EITE sectors, Ontario proposes the initial distribution of a portion of allowances free of charge to large EITE emitters. The number of allowances given free of charge would then progressively decline over time.

The assessment of which entities would receive free of charge allowances would be based on California’s approach.9 Facility allocations would be calculated according to an equation of A (assistance factor) x B (base amount for facility) x C (cap adjustment factor, which reflects the annual cap reduction). An assistance factor is the percentage of free allowances provided to an emitter based on the carbon leakage risk of that sector. For the first compliance period, Ontario has proposed that all industrial and institutional sectors have an assistance factor of 100%.10

Under consideration are certain system flexibility mechanisms harmonized with Quebec and California, such as such as allowing purchasers to bank allowances for use in future compliance periods. However, the borrowing of allowances from future compliance periods will likely not be allowed.11

Will Ontario allow the use of offset credits?

Offset credits may be created from projects that result from GHG emission reductions outside the regulated sectors. Ontario proposes to allow the use of offset credits for compliance purposes if created pursuant to an Ontario approved compliance protocol.12

However, Ontario does not intend to allow full utilization of offset credits for compliance purposes, but rather to limit the use of offsets to up to 8% of one’s total compliance obligation.

Ontario approved off-set protocols would require that reductions be real, additional, verifiable, validated, enforceable and permanent.13 Ontario proposes to evaluate for adaptation on a fast-track basis three protocols already adopted in Quebec and California: those for mine methane capture and destruction; landfill gas capture and destruction; and ozone depleting substances capture and destruction.14 Protocols for ten other project types are in the development process.15

What are the general compliance obligations?

At the end of a compliance period (initially four years, thereafter in three year cycles), all entities which are obligated must surrender the number of compliance units (including allowances or offsets) equal to their emissions during the period. This is known as a “true-up”.

This true up would be due by Nov. 1 of the year following the end of the compliance period. Ontario is considering have a partial true-up, for one time only, during the first compliance period to help prepare entities for the final true-up at the end of the first compliance period.

Compliance units are then placed into a retirement account for the entity and retired.16

What are the potential penalties for non-compliance?

Ontario is considering several penalty options. One option is a three-to-one compliance penalty, consistent with the WCI design, and Quebec’s and California’s programs. This would require an entity with excess emissions to submit three additional allowances for each allowance it is short at the true-up, plus the allowance originally owed.

Other options including suspending an emitter’s holding account, revocation of registration, and administrative monetary penalties.17

Conclusions

The Ontario Cap and Trade Program Design Options paper is a discussion paper. It sets out Ontario’s proposed design for the cap and trade program, and it also sets out issue specific alternative approaches that have been considered and are being considered. There remains an opportunity to provide the government with one’s comments and suggestions on the design features of the system.

Ontario is clearly moving forward with a cap and trade system. Draft regulations are imminent. Those in the intended regulated sectors should be assessing the potential impacts of compliance, carbon market costs and carbon market opportunities.

As Canada goes into the Paris Climate Summit on November 30, we will be watching to see if Ontario, Quebec and California’s adoption of the WCI model is one to be followed by other sub-national jurisdictions. This might just be the beginning of a growing North American carbon market.