What to Expect from Ontario’s New Cap and Trade System

Matt Thompson

Premier Kathleen Wynne has announced that Ontario would adopt a cap and trade plan to curb greenhouse gas emissions and help battle climate change. The province will eventually join the cap and trade system jointly maintained by Quebec and California under the Western Climate Initiative.  This is a major policy development with potentially far reaching implications for Ontarians, so it is worth considering what the new system will ultimately look like.

What is Cap and Trade?

By way of background, in a cap and trade system, the government sets a maximum, province-wide cap on the amount of greenhouse gas pollution that may be emitted during a reporting period. It then allocates portions of the cap to individual companies in the form of emissions allowances (or permits). Companies which emit less than their allowance can sell their unused portion to companies which emit more than their allowances. Higher emitting companies may also purchase additional emissions credits from the government through annual auctions, or offset credits from companies in sectors not covered by the cap and trade system. Governments tend to progressively reduce the emissions cap over time to induce greater energy efficiency, thus driving up the price of emissions allowances and progressively increasing the price of carbon.

It is important to note that a cap and trade system generally applies to businesses which emit high levels of greenhouse gasses. In Quebec, for example, only businesses emitting 25,000 metric tons of carbon dioxide per year are subject to emissions caps. This includes aluminum smelters, cement factories, electricity producers and fossil fuel distributors that must cover greenhouse gas emissions associated with all of the products that they distribute in the province (including, gasoline, natural gas, heating oil and diesel, among others). We should expect similar limits in Ontario.

What will this mean for Ontario businesses?

Certainly, companies in sectors covered by the system (particularly the energy sector) will be affected financially. For instance, imports of power from coal fired generators in the US could well become more expensive since US plants would not be part of the cap and trade market. Moreover, some of the companies’ added costs will likely be passed on to consumers of carbon-based products. Gasoline prices rose two-to-3.5 cents per litre in Quebec, for example, after it adopted a cap and trade system.

We will have a greater sense of the price impact once the government reveals further details about the program. And in a cap and trade system, the devil is always in the details. Unlike the other major, market-based policy mechanism for pricing carbon emissions (carbon taxes) cap and trade requires the enacting government to design a complex and completely new set of regulations and administrative procedures to manage the system. When designing it, governments must answer a number of questions, like: ‘what will the total emissions cap level be, and how will it change over time?’; ‘what will the process be for allocating emissions credits?’; ‘how will it track annual emissions?’; and, ‘will it give out some allowances for free in order to mitigate price impacts and maintain a level playing field for entities that compete with out of province emitters?’

Implementation will take time

Based on the experiences of Quebec and California, we may not see Ontario’s cap and trade system become operational for at least a year, perhaps longer. Given its intention to partner with Quebec and California, those systems will probably serve as models for the Ontario government and we are likely to see many features of those systems adopted here. In any event, Ontarians will have the opportunity to influence the design of the new system in the coming months, as the government will be holding public consultations before releasing a final plan in the fall.

It is also important to note that the program will not be revenue neutral. Unlike some recent carbon tax proposals, the government has made it clear that the revenues obtained through the sale of emissions allowances will not be returned to Ontarians in lower taxes or otherwise. Rather, the proceeds will be re-invested in projects that aim to reduce greenhouse gas emissions or promote energy efficiency. Notable among the government’s listed examples of the types of projects that might be eligible for cap and trade-generated funds are public transit projects. Cap and trade could thus help finance the Wynne government’s ambitious, and currently underfunded, $30 billion transit expansion plan.

We will learn a great deal more about what the cap and trade system will look like in the weeks to come, but it is safe to assume at this stage that it will impact all Ontarians in one form or another. Stay tuned.