Canada: Québec Lays The Foundation For An Emerging Carbon Market

Last Updated: July 27 2009

In May 2009, the Minister of Sustainable Development, Environment and Parks, Line Beauchamp, introduced Bill 42 which, if passed into law, would create government regulatory powers that would deepen its control over greenhouse gas (GHG) emissions through market mechanisms.

This measure was adopted in connection with Québec's involvement in the Western Climate Initiative (WCI), which is a grouping of Canadian provinces, including Québec, Ontario, Manitoba and British Columbia, and American States, including Arizona, California, Montana, New Mexico, Oregon, Utah and Washington, known as the WCI partners. The WCI partners are planning on establishing an integrated carbon market by 2012 by instituting cap-and-trade systems in participating jurisdictions.

Regional Carbon Market

Essentially, Bill 42 will allow for the creation of a provincial cap-and-trade system, the details of which will be established by government regulation following the enactment of the law. The entities and installations, to be identified by future regulation, will be required to obtain sufficient emission allowances to cover their actual annual GHG emissions, each allowance being equal to one metric ton of CO2-equivalent (see below for a description of different types of emission allowances). Failure to comply with this requirement will result in penalties which have yet to be determined.

Entities subject to the regulation will also have an incentive to reduce emissions below required levels in that any allowance surpluses generated by such reductions may be sold on the carbon market to other facilities and firms which, due to technical, economical or strategic considerations will choose to buy allowances as an alternative to reducing their own emissions. Accumulation and banking of emission allowances for subsequent compliance periods or future transactions will also be permitted.

Each WCI partner jurisdiction is expected to pass legislation in order to create compatible cap-and-trade systems, with each jurisdiction recognizing allowances issued in other jurisdictions, thus creating an integrated and regionalized carbon market. The Montréal Climate Exchange (MCeX) will potentially be involved in this carbon market.

Caps on emissions will not be established by the WCI on a regional basis, but rather, each partner jurisdiction will have the discretion to set its own GHG emissions reduction targets and decide how it will distribute the budgeted emission allowances to regulated firms and facilities.

Bill 42 will allow the government to ensure harmonization of its cap-and-trade system with those of other jurisdictions, whether it be Ontario, other WCI partners, and eventually Canada and the United States, or even Europe.

Entities subject to the law

Although Bill 42 does not identify the categories of firms and facilities that will eventually be subject to the cap-and-trade regulation, the government intends to first target the electricity generation industry and large industries, emitting 25,000 tons or more of GHG. These are the sectors that the WCI proposes to regulate during the first compliance period, i.e. 2012 to 2015. During the second phase, the residential, commercial and transportation sectors will also be subject to an emissions cap, thereby covering nearly 90% of GHG emissions in WCI partner states and provinces.

Types of emission allowances

At least three types of emission allowances will be issued: emission units, offset credits and early reduction credits, each allowance being equal to one metric ton of GHG in CO2-equivalent.

1. Emission units

Firstly, the government will issue emission units to entities subject to the cap-and-trade system by either allocating them without charge, by selling them at auction, or by agreement, in accordance with their mandatory reduction targets.

According to the model recommended by the WCI, a minimum of 10% of the total emission allowances for the first compliance period should be sold at auction, although each partner jurisdiction is free to auction off a greater proportion. This proportion will increase in time until it reaches 25% by 2020, eventually reaching 100%. Auctions will be coordinated amongst the WCI partners by means of a regional process to ensure that the emission allowances issued by one jurisdiction may be bought by firms operating in any other partner jurisdiction. This process should be elaborated by the WCI before the end of 2009.

2. Offset credits

In addition to these emission units, offset credits will also be awarded to businesses and municipalities not subject to the mandatory reductions imposed under the cap-and-trade system, but who will carry out projects that will capture, store, eliminate or avoid causing GHG emissions. Such offset credits may then be sold on the carbon market to entities which require additional allowances to meet their emission targets under the regulation.

For example, constructing an energy efficient building that reduces emissions would entitle the entity to offset credits that could then be sold or traded to firms subject to the regulation to use towards their compliance obligations.

Awarding offset credits for projects that meet specific criteria allows firms to reduce compliance costs, while reaching the global system reduction targets, and promoting innovation and technological development related to carbon sources and carbon sinks not subject to mandatory reduction targets.

Cap-and-trade systems typically limit the amount of offset credits which can be used towards compliance obligations so that the regulated firms and facilities fulfill the majority of their reduction obligations themselves. The participating jurisdictions of the WCI have agreed to limit the use of offset credits to 49% of the amount of emission reductions for the 2012-2020 period.

3. Early reduction credits

Finally, the third type of emission allowances will be early reduction credits. Voluntary measures reducing GHG emissions before the system is enforced, will be recognized with early reduction credits. While Bill 42 does not specify the admissibility period related to these voluntary measures, the WCI partners have agreed to recognize reductions that will have taken place between January 1, 2008 and January 1, 2012, i.e. within the four-year period preceding the projected enforcement of the cap-and-trade system. Specific criteria governing the eligibility of such voluntary measures will be established by the partner jurisdictions before the end of 2009. This being said, typically, in order to be recognized, emissions reductions must be voluntary, additional, real, verifiable and permanent.

For the time being, the specifics regarding the reductions imposed, and the allocation of the allowances amongst the regulated firms, remain undefined. The details relating to the awarding of all three types of emission allowances will be defined by government order and regulation following Bill 42's enactment.

GHG public register and mandatory declaration

Bill 42 also provides for the creation of a public register of emissions of the following GHGs: carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride, being the six GHGs targeted by the Kyoto Protocol at the international level.

Next fall, the government intends to adopt a regulation to require certain GHG emitters to report their annual emissions starting in 2010. The WCI proposes that emitters producing more than 10,000 tons of GHG in CO2-equivalent emissions be required to declare their emissions.

Based on the data collected in this register, the government will elaborate the rules with respect to the allocation of emission allowances among the regulated firms and facilities.

Trends in other jurisdictions

Ontario recently introduced a Bill proposing a cap-and-trade system which could be harmonized with Québec's Bill 42. Last year, British Columbia also adopted a similar law, although its cap-and-trade system is not yet operational.

The Federal Government has recently released a series of draft guides relating to the proposed Canadian offset credits system, intended to form part of the future regulatory scheme on the reduction of industrial GHG emissions. However, the Federal Government has also expressed its intention to delay the implementation of its own program, initially planned for 2010, in order to revise and harmonize it with a future cap-and-trade system south of the border. The American Congress is presently studying a legislative proposal for such a program (the American Clean Energy and Security Act of 2009), which aims to come into force in 2012.

The harmonization of the various cap-and-trade systems in North America would surely contribute to the efficiency of an emission allowances market, and reduce the costs linked with GHG reductions. In Canada, the legislation proposed by Québec and Ontario creating the framework for the regulation of GHG emissions, is, in this respect, an important milestone in the establishment of an efficient carbon market in North America.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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