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Greater Niagara Chamber of Commerce

Cap and Trade – the future’s green, but is it bright?

The Ontario government has joined California and Quebec in implementing a carbon cap-and-trade system, beginning in January 2017. How will it actually work, what will it cost, and how does it affect your business?

What it is

The Government of Ontario’s cap and trade program is an effort to fight climate change by offering a financial incentive to businesses that control and reduce greenhouse gas (GHG) emissions, and a disincentive to businesses that pollute heavily. The idea is to use market mechanisms and incentives for emissions control rather than flat taxes or hard emissions caps.

As we all know, climate change is a serious threat to our way of life, and its consequences are already being felt in rising food prices, droughts, and extreme weather phenomena. Governments in Canada and the world have the difficult job of finding solutions to mitigate climate change without causing economic disruption or hardship. The cap and trade program is an attempt at that.

The government anticipates that 82% of Ontario’s GHG emissions will be captured in the system, with the remaining 18% coming from small emitters not covered. If it works as expected, it should enable Ontario to hit its emissions targets by 2020.

How it works

The system establishes a limit on the amount of GHG that an organization can emit. This is the “cap”. Each participating organization receives allowances for emissions up to the cap. A business that emits less than they have permits for can sell the excess permits or bank them for future use, and businesses that emit more can buy these permits – this is the “trade” part. Over time, the cap is gradually moved downwards to achieve lower emissions, starting with 142 megatonnes per year and moving down on an annual basis, reaching 125 in 2020.

The idea is that polluters who can reduce their emissions for the lowest cost will do so the most and the fastest, and selling their excess allowances gives them a financial incentive. This (theoretically) means that emissions will be reduced in not only the fastest but also the cheapest way possible, and rather than having the government figure everything out, markets will determine who reduces and by how much.

The system will create a trading market for emissions permits with financial instruments and trading strategies. This new market could provide a boost for businesses in the financial services industry. However, lawyers from the University of Toronto’s Environmental Finance Advisory committee warned that it was unclear whether allowances and credits would be property, in the legal sense, which creates a disincentive to trade them. Registration requirements for market participants were also alleged to be onerous. These issues might have to be fixed before the market becomes as effective as it could be.

The Government of Ontario commissioned EnviroEconomics to develop an impact model and analysis. That analysis uses long-term energy prices from the U.S. Energy Information Administration, current and forecast trends for Ontario’s economic growth, historical GHG emissions trends, and the Ontario Long-Term Energy Plan.

Who is affected

Any organization that generates more than 25,000 tonnes of GHG emissions per year is required to participate in the program, as is any natural gas distributor, fuel supplier, or electricity importer. Businesses emitting between 10,000 and 25,000 tonnes a year can volunteer to participate, but they aren’t required to. Obviously it only makes sense to volunteer if a business generates less emissions than its cap, and can turn the sale of permits into an extra revenue stream.

Heavy emitters and/or those who can’t easily reduce emissions may flee to more permissive parts of the country or the world. This is called “carbon leakage,” and to offset it, the Province has authorized payment from the Greenhouse Gas Reduction Account to assist sectors at risk. The Director also has discretion to distribute emission allowances free of charge, which can be used to help here.

Businesses in certain key sectors with competitors in jurisdictions with no carbon pricing system will be given a four-year exemption or free allowances. These exemptions will cover 14% of heavy polluters. This is to try and make sure those Ontario businesses don’t get driven out of the market by competitors that don’t have to pay for emissions, or don’t just up and leave for more permissive jurisdictions, taking Ontario jobs with them.

At the end of a given “compliance period,” all participants have 11 months to “true up,” i.e. to surrender a number of credits equal to their emissions. It’s like income taxes – at the end of the calendar year, you have a number of months to file your tax return and pay any outstanding taxes you owe. And as with income taxes, there’s a penalty for noncompliance. If any credits are missing at true up time, the participant must then surrender the credits originally owed plus a penalty of three times the outstanding credits.

What it will cost

One permit or emissions allowance covers one metric tonne of CO2 equivalent (CO2e), so the holder of one permit may emit one tonne of CO2e into the atmosphere. The government will set the auction reserve price for a permit at $12.82 CAD. This is the minimum price level for emissions permits sold at auction.

If Ontario’s accession to the WCI program does not affect pricing, the EnviroEconomics model projects that permit sale prices should be $17.74 in 2017, $17.40 in 2018, $17.73 in 2019 and $18.33 in 2020 (in 2016 Canadian dollars). The Ontario government anticipates the cost of permits in 2017 at somewhere between $14 and $18, rising to $95 by 2030, which will equate to an annual expenditure of at least $2 million per covered participant in that year.

Ontario has joined with California and Quebec under the Western Climate Initiative (WCI). This not only synchronises the programs, but allows organizations in each jurisdiction to trade carbon permits with those in the others. The Globe and Mail reported that this could result in up to $250 million USD being sent by Ontario companies to California to purchase emissions credits. However, the impact study calculated that an Ontario-alone approach, without participation in WCI, would increase the effective CO2e price from $14-18 CAD a tonne to almost $160.

Revenues from the program are estimated at $1.9 billion per year, which will be reinvested in initiatives to reduce GHG emissions and support a transition to a low carbon economy, plus other investments, such as revitalizing social housing.

However, this estimate was made before California and Quebec reported that they had only sold 11% of their emissions permits in May 2016, and so the $1.9 billion figure might be overly optimistic. All permits on offer were sold at the first five auctions, and 95% were sold in February’s, so the poor showing in May is unusual. The downturn in the carbon market is probably due to deliberate oversupply of allowances in California, done to avoid skyrocketing prices and unexpected costs for industry, and uncertainty about the future of the regime leading to businesses becoming wary of stockpiling allowances for the future. The next joint California-Quebec auction is set for August 2016. How it plays out will have significant implications for Ontario’s plan.

What it means for the economy

Modelling shows that the program should have virtually no effect on the provincial economy as a whole. With an average growth rate of 2% per year, the program is expected to slow economic growth by less than 0.01%. Conceptually, it will take the economy 1.5 days longer every year to achieve the same level of growth it would have achieved without it.

The economic impact study predicts reduced exports by 0.24% in 2017, but by only 0.1% in 2020. Imports will be reduced by 0.003% in 2017, and 0.004% in 2020.

The impact on the economy is far less under the proposed plan than in other scenarios. Proposed alternative scenarios in which Ontario does not participate in the WCI result in economic losses of between 0.2% and 0.4% of GDP, and trade impact between 2.5% and 8.5%. In terms of economic impact, the adopted cap and trade program has the lowest impact on business of all.

After the introduction of California’s cap and trade regime, that state’s economy and total jobs grew faster than the U.S. economy as a whole.

What it means for households and prices

Average food and beverage prices will rise by an average of 0.02% as emissions costs are passed on to consumers. Very slight reductions in household income will result in reduced consumption by about 0.04% in 2020. If auction proceeds are directed towards households, the negative impact could be reduced by about 0.01% per year. Conceptually – again – it would take the average household one day more to reach the consumption level it would have reached in a year without the cap and trade program. The average household will pay an additional $13 a month for energy (including heating and automobile fuel); under alternative schemes, the increase would range from $50 to over $100.

What it means for energy prices

Energy prices have been rising far in excess of inflation in Ontario due to other factors. The average Ontario household will spend an extra $5 a month on home heating and $8 a month on gasoline after the program is introduced. Natural gas prices are projected to go up around 3.3 cents per cubic metre, propane by 4 cents per cubic metre, gasoline by 4.3 cents per litre, and diesel by 5 cents per litre.

Further reading

Review the EnviroEconomics Impact Study: http://www.enviroeconomics.org/#!Impact-Modelling-and-Analysis-of-Ontario%E2%80%99s-Proposed-Cap-and-Trade-Program/c1uze/573a64620cf23f57cc66dd05

Read the Ontario Government’s summary of the program: https://www.ontario.ca/page/how-cap-and-trade-works

Read the Cap and Trade Program laws: https://www.ontario.ca/laws/regulation/r16144