In our latest blog piece covering Ontario’s planned adoption of a cap-and-trade system that will be linked with the existing systems in Quebec and California, we described some of the major recent developments in Ontario and the United States to help put the province’s cap-and-trade efforts in context. These developments include: the successful implementation of legislation and market mechanisms to curb sulfur dioxide and nitrogen oxide emissions in the 1990s and early 2000s, the development of the Western Climate Initiative, the signing of a Memorandum of Understanding with respect to a provincial and territorial cap-and-trade initiative between Ontario and Quebec, and the introduction of enabling cap-and-trade legislation in Ontario. In this piece, we illustrate the key elements of Quebec and California’s linked cap-and-trade regime with a view towards anticipating how Ontario may choose to design its system over the coming months.

While the content, scope and design of Ontario’s cap-and-trade system has yet to be determined, there is already a significant congruence between the California and Quebec regimes. For example, both systems cover the same greenhouse gases and sectors, set the same emissions thresholds and have virtually identical allocation methods. Several other similarities are also evident when comparing Quebec’s relative population size and gross regional product to those of California (21% and 16%, respectively). For example, Quebec’s Allowance Budget, Maximum Emissions Covered, Emissions Target and Offset Use Limit (as illustrated in the table below) are all between 15% and 16% of California’s, closely mirroring their differences in population size and economic activity. On this basis, with a population of 13.6 million (35% of California) and a gross regional product of US $570 billion (30% of California), Ontario’s cap-and-trade system may well yield similar relative results. Naturally, however, other factors will come into play as Ontario implements cap-and-trade, and we will follow these developments closely.

The significant parallels between Quebec and California’s cap-and-trade systems have enabled both markets to integrate quickly and seamlessly. Despite only officially linking carbon markets in 2014, Quebec and California have already successfully held two joint auctions of greenhouse gas allowances in December, 2014 and March, 2015, respectively. The third joint auction of greenhouse gas allowances between the two jurisdictions was recently held on May 21, 2015.

Given Ontario’s desire to link with the cap-and-trade markets in Quebec and California, their systems will likely play a significant role in dictating the approach Ontario takes. Below is a chart that summarizes the main features of California and Quebec’s cap-and-trade systems as it relates to several key criteria the Ontario government will have to consider in the coming months.

Click here to view table.

The significant similarities between Quebec and California’s systems are largely dictated by detailed policy architecture prepared over a period of several years by the Western Climate Initiative (WCI) and their partner jurisdictions. The WCI, launched in 2007, consists of a voluntary coalition of US states and Canadian provinces that have developed guidelines to facilitate mutual cooperation in order to reduce greenhouse gas emissions, in particular by developing and implementing a North American system for cap-and-trade. Since its inception, WCI partners, including Quebec and California, have been working together to create a linked cap-and-trade system that covers each member jurisdiction. In September of 2008, the WCI released Design Recommendations for the WCI Regional Cap-and-Trade Program, laying out the vision and basic program parameters of a cap-and-trade system. The report directly contemplated linkages with cap-and-trade programs in other jurisdictions. At section 13.5, the report states: “The WCI Partner jurisdictions will seek bilateral and multilateral linkages with other government-approved cap-and-trade systems so that those allowances and allowances issued by WCI Partner jurisdictions would be fully fungible.”

Two years later, the WCI released the Design for the WCI Regional Program, which provides a comprehensive roadmap for WCI partners as they implement cap-and-trade in their jurisdictions. Like its predecessor in 2008, the document places a great deal of emphasis on congruent regulatory schemes and linkages with other jurisdictions. While noting that not all WCI partner jurisdictions will implement the cap-and-trade program, the report recognizes that all WCI partners participated in creating the program design, and that it is structured so that additional partners can join in the future. The report outlines several benefits of linking cap-and-trade systems with other jurisdictions, such as:

  • Incorporating more opportunities to reduce greenhouse gas emissions can improve cost-effectiveness while also achieving greater emissions reductions;
  • Expanding the geographic coverage of the price of greenhouse gas emissions can reduce the risk of emissions leakage and maintain competitiveness;
  • Enlarging the market for emission allowances and offsets can improve market liquidity, reduce volatility, and reduce the likelihood of manipulation; and
  • Collaborating among jurisdictions can provide an opportunity to share administrative functions, reducing the costs of program operation and enhancing consistency across jurisdictions.

Ontario has also consistently emphasized the importance of linking cap-and-trade systems with other jurisdictions. In 2008, for example, Ontario Premier Dalton McGuinty and Quebec Premier Jean Charest signed a Memorandum of Understanding (MOU) with respect to a provincial and territorial cap-and-trade initiative. The MOU heavily contemplates and encourages linkages to other greenhouse gas cap-and-trade systems, noting that such linkages can reduce greenhouse gases at lower costs, allow for larger trading volumes, improve liquidity and speed the pace of innovation, among other benefits. Shortly after entering into the MOU, the government of Ontario demonstrated its further commitment to a cap-and-trade system by introducing enabling legislation in 2009 - Bill 185, or the Environmental Protection Amendment Act (Greenhouse Gas Emissions Trade). The Bill provided the government with broad authority to implement emissions trading systems and establish rules relating to the scope, trading, distribution and administration of such a system. Like the WCI and MOU, Bill 185 explicitly contemplates integration with other regional cap-and-trade systems.

Given the significant progress made by the WCI and its partner jurisdictions as it relates to the architecture of cap-and-trade, the emergence of the linked Quebec and California systems, and Ontario’s desire for linkage, it is unlikely that Ontario’s approach to cap-and-trade will differ materially from the Quebec or California regimes. Caution should be exercised before any deviations in our structure or design from the regimes in Quebec or California are developed. We expect Ontario’s system, once unveiled, to largely mirror the characteristics illustrated in the chart above. Further, California’s Senate Bill No. 1018 at Section 12894(f) sets out four requirements for linking market-based mechanisms with other jurisdictions, as follows:

  1. The jurisdiction with which the state agency proposes to link has adopted program requirements for greenhouse gas reductions, including, but not limited to, requirements for offsets, that are equivalent to or stricter than those required by Division 25.5 (commencing with Section 38500) of the Health and Safety Code.
  2. Under the proposed linkage, the State of California is able to enforce Division 25.5 (commencing with Section 38500) of the Health and Safety Code and related statutes, against any entity subject to regulation under those statutes, and against any entity located within the linking jurisdiction to the maximum extent permitted under the United States and California Constitutions.
  3. The proposed linkage provides for enforcement of applicable laws by the state agency or by the linking jurisdiction of program requirements that are equivalent to or stricter than those required by Division 25.5 (commencing with Section 38500) of the Health and Safety Code.
  4. The proposed linkage and any related participation of the State of California in Western Climate Initiative, Incorporated, shall not impose any significant liability on the state or any state agency for any failure associated with the linkage.

Evidently, these requirements essentially mandate policy congruence with California, which will further shape Ontario’s cap-and-trade system to resemble those in Quebec and California.

As with any program designed to achieve policy aims through capital markets and commercial means, the devil will be in the details. We will be sure to update this blog and the chart above as new developments are announced in Ontario in the coming months.