Cap-and-trade is one step closer, with the recent release of draft design recommendations by the Western Climate Initiative (WCI).

The WCI is a partnership of seven US states and four Canadian provinces — including British Columbia, Manitoba, Québec and Ontario — with the goal of reducing greenhouse gas (GHG) emissions by 15 per cent below 2005 levels by 2020. The WCI’s draft design was produced through 18 months of negotiation and consultations, and is expected to come into effect on January 1, 2012. In the meantime, each WCI partner will use the draft design as a framework for drafting its own corresponding legislative and administrative regimes.

Businesses need to concern themselves with how the WCI system will influence their operations. The WCI scheme is the most comprehensive carbon reduction plan introduced so far. It will include nearly 90 per cent of the emissions produced by WCI partners, including those from electricity, industry, transportation, and residential and commercial fuel use. Furthermore, this system will require strict reporting but allow for the use of flexible mechanisms such as allowance banking and the use of offsets.

Each WCI partner will receive a set number of emissions allowances based on its own emissions goal for 2020, which will then be distributed to regulated emitters. Although most allowances can be distributed in any way the WCI partner sees fit, a small percentage must be distributed via auction — 10 per cent initially, increasing to 25 per cent in 2020.

Regulated entities — those that emit 25,000 or more tonnes of CO2 equivalents annually — will be required to abide by strict reporting requirements. These entities will need to budget their allowances effectively, as financial penalties will result from any allowance shortfalls. Reporting will begin in 2011, based on emissions from the previous year. The first compliance period will begin in 2012, and in 2015 the program will expand to include transportation, residential, commercial and industrial fuels.

To increase flexibility and reduce economic impacts, the WCI draft design includes the use of offsets and the banking of allowances. Offsets are credits given to regulated emitters for their contributions to the reduction of GHG emissions by sectors not governed by the cap-and-trade scheme, such as forestry, agriculture and waste management. The WCI scheme will even allow offset credits to be traded among regulated entities. However, the use of offset credits will be limited, as they can only be used to achieve 49 per cent of the total emissions reductions from 2012 to 2020. This restriction helps ensure that the majority of emission reductions are achieved within the emissions sources actually regulated by the cap-and-trade program.

Currently, the greatest uncertainty regarding the WCI scheme is how (or if) it will merge with any emissions reductions schemes introduced by Canadian or US federal governments. Given the change in government in the United States, an American cap-and-trade system may be ahead. Similarly, a national emissions regulation scheme has been debated in Canada for some time. But regardless of political uncertainty, WCI partners are forging ahead with their own emissions reduction scheme. As a result, businesses that maintain any connection with WCI partner jurisdictions should beware that provincial and state regulatory frameworks are likely to change in the near future.