After more than a decade of debate and political positioning regarding the Canadian regulation of greenhouse gas emissions (GHG), the Canadian domestic carbon trading market is beginning to show signs of life. This is despite the fact that a single Canadian regulatory structure for GHG has yet to emerge and may not be developed any time soon. On May 30, 2008 the Montreal Climate Exchange (MCeX) commenced the trading of Canada’s first exchange-traded contract for the delivery of CO2 equivalent compliance units under the current federal government’s proposed GHG regulations. These regulations are anticipated to regulate large industrial sources and electricity generators starting in the year 2010.

Carbon trading on the MCeX opened at a price of C$9.50 per tonne. Since its launch, volume and liquidity on the contract have been relatively moderate. This is not surprising, given the uncertainty regarding the federal government’s proposals. However, prices recently crept upwards into the C$13 per tonne range.

Federal Regulatory Framework

The MCeX is a joint venture of the TMX Group Inc.’s Montreal Exchange and the Chicago Climate Exchange® – the United State’s first organized exchange for the trading of voluntary GHG reductions. The contract sponsored by the MCeX relies on the current federal government’s Turning the Corner regulatory framework for industrial GHG. That framework was first released in April 2007 and further clarified in March 2008. In contrast to a traditional cap-and-trade regulatory scheme whereby regulated emitters are subject to hard caps (the basis on which emissions markets are typically structured), the current federal regulatory framework is based on an “intensity-based” emissions target. Under this framework, regulated entities are subject to a prescribed amount of GHG per unit of economic output.

The federal government has indicated that specifics relating to emissions trading under the plan would be contained in draft regulations which have not yet been published. The timing, substance and ultimate destiny of the current federal plan, as well as associated trading rules, appear particularly uncertain at present, given that a Canadian federal election is scheduled for October 14, 2008 and the current minority Liberal Party platform focuses on a GHG-based tax program that does not involve emissions trading per se. The federal GHG trading proposal ultimately is intended to settle via physical transfer of actual regulatory compliance units. However, in the event that the federal regulatory framework and associated carbon credit registry are not available at the expiry of the contract, the MCeX carbon contract provides for cash settlement (whereby the seller delivers cash at a settlement price specified by the exchange which is based on final trade prices of the contract prior to its expiry).

Western Climate Initiative

In addition to the current federal GHG trading proposal and the associated trading taking place on the MCeX, there are several regional, provincial and state GHG regulatory frameworks at various stages of development across North America. Each of these frameworks includes some role for emissions trading and/or the creation and use of carbon offsets or other alternative compliance mechanisms. The Western Climate Initiative (WCI), for instance, is a collaboration to develop regional strategies to address climate change that was originally launched in February 2007 by several western U.S. states. The Canadian provinces of British Columbia, Manitoba, Ontario and Québec have subsequently joined the WCI, and the province of Saskatchewan is registered as a WCI observer. In July 2008, the WCI issued a draft design paper for its regional cap and trade program, and anticipates having final program design recommendations in place by mid-September.

Regional Greenhouse Gas Initiative

The Regional Greenhouse Gas Initiative (RGGI) is a similar cooperative effort covering power plants in ten North-eastern and Mid-Atlantic U.S. states. RGGI has developed a CO2 Budget Trading Program for its participating states. The first compliance period for this program begins on January 1, 2009. Trading in futures contracts and options on futures contracts for compliance units under the RGGI has recently been launched on the Green Exchange™ – a newly developed, regulated commodity futures exchange for environmental products powered by the New York Mercantile Exchange.

Canadian companies and financial market participants, who are no strangers to over-the-counter and exchange-based commodities trading, appear quite eager to develop and support GHG trading in Canada. Nonetheless, the struggle continues at the political and legislative level to define the underlying Canadian GHG commodity and to avoid the pitfalls of fragmented and potentially overlapping GHG markets.