Canada: Western Climate Initiative Issues Cap And Trade Design Recommendations

Last Updated: June 29 2008

Article by Perkins Coie and Fasken Martineau

Originally published May 21 2008

The Western Climate Initiative ("WCI") recently issued recommendations for the design of North America's largest greenhouse gas ("GHG") cap and trade program. Before becoming effective, the recommendations must be approved and adopted by each WCI member. Some WCI members plan to require emission reporting before the end of August 2008 and emission caps to be in place as early as 2010.

Our recent update, Regional Climate Initiatives: An Overview, provides background information on WCI and other regional initiatives. This update continues our efforts to inform our clients and friends of WCI's plans to reduce regional greenhouse gas emissions, and their implications for business. WCI's recommendations focus on: (i) Scope; (ii) Point of Regulation; (iii) Allocation of Allowances; (iv) Offsets; (v) Reporting Requirements. Each is discussed in more detail below.

Scope of Coverage: Capped Entities and Gases

Entities:

WCI recommends that its members adopt a "base" program to control a number of GHG source categories (some sources fall into more than one category):

  • Electricity supply

  • Large, fossil fuel, stationary combustion including oil refining, cement manufacture, pulp and paper manufacturing, hydrogen production, and other large combustion sources;

  • Industrial process and waste including stationary sources with "process emissions" from chemical, biological, and other non-combustion processes, such as oil refining, cement manufacture, aluminum smelting, iron and steel; production, adipic acid production, nitric acid production, lime production, pulp and paper manufacture, sawmill kilns, agricultural chemical manufacture, plastics manufacture, natural gas transmission and distribution, magnesium smelters and casters, mineral production, silicon chip manufacture, ammonia production, and wastewater treatment facilities; and

  • Fossil fuel production and processing including facilities and activities associated with oil and gas exploration, production, processing, and coal mining.

WCI's recommended base program covers less than 50% of total WCI area GHG emissions. WCI cannot ensure that its overall regional emissions goal (85% of 2005 by 2020) will be achieved if only the base program is implemented. Therefore, WCI recommends that additional sources such as the transportation sector and residential and commercial fuel usage be phased into the program over time and also recommends members adopt other aggressive policies to control sectors that fall outside the cap and trade program.

Gases

WCI's base program controls all six GHGs regulated under the Kyoto Protocol1. CO2 comprises the overwhelming majority of emissions from these sectors and is the main control target. WCI also recommends an emission threshold to exempt small facilities from regulatory compliance obligations under the cap and trade program. At present, WCI believes that a threshold between 10,000 to 25,000 metric tons of CO2 emission per year per facility would be appropriate to assume necessary, consistent, and adequate coverage of facilities within industries and across jurisdictions.

Point of Regulation

WCI recommends that different controlled emissions be regulated at different stages. Large stationary sources, industrial process, and waste management emissions would be regulated at the facility where combustion or process emissions occur. Emissions associated with fossil fuel production and processing would also be regulated at the facility where emissions occur, but these "facilities" may be larger than traditional "point sources" covering larger areas such as oil and gas fields or coal mines.

In contrast, technology and geography make the point of regulation for the electricity sector complicated. Electricity is difficult to trace as it moves over interconnected high-voltage grids across the WCI region and outside its boundaries.

The simplest way to manage this complexity – and the preferred option identified by the WCI – would be to adopt a "generator-based" approach which would impose compliance obligations on individual electricity generators throughout the western region. However, the generator-based approach is only practical if substantially all Western electric generation is under the jurisdiction of a WCI member. This is not now the case and not likely to be the case in the near future. Some states and provinces in which generation is located are not WCI members.

Therefore, WCI proposes an alternative recommendation, which would place the compliance obligation on the "first jurisdictional deliverer," i.e., the first entity that delivers power to the WCI region grid and is also subject to the jurisdiction of a WCI member. Like the generator-based approach, fossil fuel-fired generators in participating jurisdictions would be covered under the first jurisdictional deliverer model, as would those importing electricity from outside WCI for use within WCI, e.g., independent power producers, retail electricity providers, power brokers and power marketers. However, WCI does not recommend regulating electricity wheeled through the WCI area (i.e., generated outside WCI, but delivered across WCI, to recipients outside WCI).

WCI's recommendations will require accounting for GHG emissions from electricity generated in, imported to, and exported from the WCI area. WCI will also require accounting by utilities that serve load inside and outside WCI based on where electricity is used rather than where it is generated. To avoid problems, WCI recommends its member jurisdictions phase-in these controls. For example, members might first regulate fossil-fuel fired generators before regulating electricity providers that market non-WCI electricity.

The Electricity Subcommittee is considering whether enough generating capacity can be included in the WCI process to make such a generator-based approach feasible. If not, WCI will reconsider how the first jurisdictional deliverer model could be made to work at a practical level.

Allocation and Auction of Allowances

WCI's core purpose is to establish a declining regional cap on emissions. Once WCI calculates the total regional cap, the cap must be allocated amongst WCI's participating jurisdictions. Once each jurisdiction has its allocation, WCI recommends each member allocate its cap amongst emissions sources within its territory as it sees fit. WCI has not yet finally determined how to allocate GHG allowances among participating jurisdictions, but it has described several considerations to ensure fair and effective allocation and avoid unnecessary competitive disruption:

  • Do not over-allocate allowances: Initially, WCI's annual regional cap and its allocation among participating jurisdictions will be set through 2020. Once established, WCI recommends that the initial cap and allowance allocation not change. WCI must have accurate data to avoid capping emissions too high and to determine each jurisdiction's "allowance budget". WCI wants to launch the cap-and-trade program as quickly as possible, and concedes it may be necessary to adjust jurisdictions' allowances if and when it discovers significant data errors. Adjustments may also be necessary if WCI membership changes or the scope of the cap and trade program is expanded.

  • Consistency in issuance of allowances: WCI recommends that each participating jurisdiction retain discretion to allocate allowances within its respective territory. WCI recommends greater emphasis on free allocation in the early years of the program and that each jurisdiction auction not less than 25% and not more than 75% of its allowances through a coordinated regional auction. WCI recommends that the minimum percentage of allowances to be auctioned should increase with time, potentially to 100%. As a result, allocation of allowances may differ among sectors, and different participating jurisdictions may auction or distribute allowances differently. These differences could create cost differentials among competing businesses within and outside the WCI. To avoid unintended competitive effects, WCI recommends that participating jurisdictions "harmonize" their allocation procedures for specific business sectors – in particular for carbon-intensive industries. WCI has not yet recommended how to achieve "harmonization," but has indicated that the participating jurisdictions will engage in a sector-specific analysis for these industries to determine if a harmonized approach is needed.

  • Authorize allowance banking: A participating jurisdiction need not allocate all of its allowances, and may hold allowances in reserve. However, it must allocate or retire all of its allowances by the end of the applicable compliance period. Businesses may transfer allowances from one compliance period to the next ("Banking"), but will not be allowed to "borrow" allowances from future compliance periods to meet earlier compliance obligations.

  • Credits for early action: WCI recommends that participating jurisdictions retain discretion to give credit for early action, but that any such credit must come from the allowances allocated to that jurisdiction.

  • Compliance period: WCI recommends 3 year compliance periods, with the exception of the first compliance period which may be 2 years and have other specific rules attached to it to facilitate the transition to a cap and trade system.

WCI's allocation recommendations will likely create controversy as each jurisdiction seeks to maintain competitive positions for its industry and economy.

Offsets

WCI's recommended cap and trade program allows GHG offsets. Offsets are tradable credits created by projects that avoid, reduce, or sequester uncapped GHG emissions that are not otherwise controlled by law. These offset credits can be certified and sold to emitters subject to emissions caps, and be used by the emitter in the same way as allowances to meet compliance requirements.

WCI proposes using GHG offsets for three reasons:
(i) to reduce initial cap and trade compliance costs;
(ii) to support initial aggressive reduction caps; and
(iii) to encourage innovation and co-benefits.

Key Offset Program Recommendations

  • Eligible Offset Projects: Prior to the launch of the cap and trade program, WCI will develop a list of eligible projects and establish a process to review and approve additional project types

  • Offset Protocols: WCI will develop an initial set of methodologies to measure offsets, using standardized, existing programs where possible, and will establish a process to review and approve additional protocols

  • Offsets and Allowances from non-WCI Jurisdictions: WCI will approve offsets and allowances from non-WCI jurisdictions subject to similarly rigorous regulation; WCI recommends priority for offset projects located within WCI

  • Limits for Offsets and non-WCI Tradable Units: WCI will limit the amount of non-WCI offsets and allowances that a capped emitter may use for compliance – a specific recommendation on the limit is still being drafted

  • Administrative Structure: To the extent possible (keeping in mind the paramount jurisdiction of WCI participants over certain issues), WCI proposes to use a central administrative structure to coordinate the review and adoption of protocols and the issuance of offsets and provide accreditation for service providers

  • Offset Registry: WCI intends to select or develop a centralized offset registry with links to its emissions reporting and allowance tracking systems

Reporting Requirements

To the extent possible, WCI's reporting system will rely on The Climate Registry ("TCR"). Reliance on TCR should reduce implementation costs, ease reporting burdens, and ensure consistency among regions. In addition to TCR, WCI will develop its own reporting specifications consistent with the sources and gases it regulates.

Key Reporting Requirement Recommendations

  • Who is affected: Reporting will be required for all sectors and sources in the cap and trade program, plus emissions from similar sources that are under the cap and trade thresholds, but which may be phased in over time.

  • Initiation: Mandatory reporting in some jurisdictions will begin as early as 2008, before the cap and trade program commences.

  • Coordination: Essential reporting requirements will be uniform and consistent among participating jurisdictions, taking into account existing reporting rules, minimizing disruption to existing programs where possible, and potentially allowing members to impose additional requirements beyond WCI "base" requirements.

  • Data Management: Each participating jurisdiction will have the option to require sources to report to it, and then upload data to TCR, or permit reporting directly to TCR.

  • Verification: WCI will establish data quality assurance programs consistent among the participating jurisdictions, with each member retaining oversight authority to ensure compliance with its reporting requirements.

  • Consistency with Federal Program: WCI seeks dialogue with the U.S. Environmental Protection Agency as EPA develops the federal GHG reporting program. To the extent possible, WCI seeks to minimize differences with the existing Canadian GHG reporting program.

Conclusion

There are two important reasons to follow the development of WCI's cap and trade program. First, the program will require major reductions in GHG emissions across multiple sectors of the economy. It will have significant economic effect beyond the sectors subject to its emission caps. Every business that purchases products and services from capped sectors may incur additional costs. Second, WCI's program hopes to influence the design of larger scale Canadian, U.S. or North American cap and trade programs. As WCI members and stakeholders work to design and implement their own cap and trade program, they may also be setting the guideposts for future comprehensive national or continent-wide programs.

In the near future, most large industrial businesses will be required to inventory and report their GHG emissions. Thereafter, they will be required to reduce their GHG emissions either directly at their facility or by acquiring allowances or offsets. The implications are great. Businesses subject to future regulation need to follow the rules that will govern them as they develop. They can also consider early action to ensure that coming regulations do not find them unprepared or impose unnecessary or unequal burdens on their activities relative to competitors.

Footnote

1. CO2, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons, and sulfur hexafluoride

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