This is the third article dealing with Canada’s legislation on climate change.
As previously discussed, Canada’s GHG Act contains two mechanisms for pricing carbon. The first involves straight taxation. The second mechanism uses cap and trade.
In a cap and trade system, the government sets carbon emission caps on the regulated sectors. The government then issues certain emission allowances by an auction process. Those businesses purchase the allowances to allow for a certain amount of carbon emissions. If the business exceeds those levels of allowances, then it has to pay a charge on the excess. However, if it is able to reduce its level of emissions to below the level of allowances, it can trade those allowances to other businesses requiring them. The government in charge of the cap and trade system then simply reduces the amount of allowances issued for each time period. The economy then reduces its overall carbon emissions.
The difficulty with a national cap and trade system would be the federal government’s potential lack of jurisdiction to issue such a system. The government’s solution involved creating the first mechanism, the carbon charge, which clearly falls into its ability to legislate. The cap and trade system becomes merely an add-on. This flexibility for the carbon charge then would justify this second mechanism.
The GHG Act allows the provinces to implement their own tax system or cap and trade system. The provincial systems must plan to achieve a certain level of emission reductions in order to be comparable to the same results that would have been achieved by the federal system. If the planning objectives are comparable, then the federal system does not apply. This achieves the ‘backstop’ type of legislation where the provinces retain sufficient authority to develop their own homegrown process for emission reductions.
A cap and trade system possesses numerous pros and cons. For example, this system shows historical success. The sulphur dioxide trading system reduced emissions to alleviate acid rain impacts. The system produced actual and substantial reductions in sulphur dioxide over a short period of time.
The European Union Emissions Trading System for carbon initially appeared to be substantially less successful. The government issued far too many emission allowances which substantially reduced their value. Businesses did not have to modify their operations in order to meet their emission caps. Presently, the EU’s $38 billion annual carbon market now seems to be operating the way intended and carbon prices have more than doubled in the past year.
A cap and trade system can result in real reductions of carbon emissions. Meanwhile, a carbon tax can simply be paid by a business as a cost of doing business instead of it trying to reduce its emissions. However, the B.C. carbon tax systems does appear to have resulted in an overall reduction of emissions from 2008 to today’s date. Ontario’s recently introduced cap and trade system required time to prove itself.
Ontario’s first 2017-2020 compliance period allowed some eligible capped emitters to receive emission allowances free of charge. This was to make the transition easier and make the system manageable for companies with competitors in jurisdictions without a carbon price. Allowances were not to be given free of charge to fuel suppliers/distributors, electricity importers and electricity generators. The rate of allowances was to be decreased over time at a rate of 4.75% per year for combustion emissions starting in 2018.
Partnering with other cap and trade systems can result in even greater savings. Ontario signed on with the Western Climate Initiative. This Initiative includes California and Quebec. Other governments had joined in, but dropped out of the Initiative. Nova Scotia recently indicted its intent to join.
The theory of comparative advantage shows that where a country has a lower opportunity cost, it can produce less expensive emission credits and this can result in a greater economic return for all countries involved. This allows countries to specialize in emission credits where they have comparative advantage.
Being involved with international trading provides organizations with the ability to source the least expensive emission credits. This somewhat resembles a free trade agreement where funds leave one jurisdiction and emission credits come back. Some politicians criticize such an arrangement which drives investment out of the country. However, business have the ability to source the least expensive emission credit to reduce its expenses and meet its overall emission cap.
Ontario recently indicated its intent to withdraw from the Initiative. Its agreement states that it has to provide one year’s notice. The Initiative then blocked Ontario businesses from any future auctions of emission credits. This prevented these business from dumping all of their credits and negatively impacting the value of credits.
In the next article, we shall examine the Ontario situation.