Ontario's Cap and Trade Agreement with Québec and California

Ontario plans to join the Québec-California carbon market as of January 1, 2018, under a harmonization and integration agreement (linkage agreement) announced on September 22.¹ The Ontario Ministry of the Environment and Climate Change (MOECC) has also proposed changes to its cap and trade regulations, which are open for public comment until November 6, 2017.

What You Need To Know

• The linkage agreement will facilitate joint auctions of Ontario, Québec and California greenhouse gas (GHG) emissions allowances; harmonization of each party's cap and trade and GHG reporting regulations; mutual recognition and trading of compliance instruments; and a common accounting mechanism to determine each party's share of GHG emission reductions.
• The proposed amendments to the Cap and Trade Program Regulation (O. Reg. 144/16) and the Methodology for Distribution of Ontario Emission Allowances Free of Charge (Free Allowance Methodology) would lay the groundwork for linkage with Québec and California; modify the rules for free allowance allocation; and establish the methodology for determining 2021-2030 GHG emissions caps.
• The MOECC also proposed a new regulation regarding administrative monetary penalties for certain offenses under the Climate Change Mitigation and Low-carbon Economy Act, 2016 (CCMLEA), and proposed changes to the Quantification, Reporting and Verification of Greenhouse Gas Emissions Regulation (O. Reg. 143/16) and the Guideline for the Quantification, Reporting and Verification of Greenhouse Gas Emissions (Reporting Guideline).

Linkage with the Québec-California Carbon Market

Ontario’s cap and trade system for GHG emissions was developed under the Western Climate Initiative (WCI), a regional framework under which both California and Québec have implemented their own cap and trade systems. In 2014, the California and Québec systems were linked, allowing them to host joint auctions of carbon allowances. Throughout the development of its cap and trade system, the Ontario government stated its goal of participating in this joint market.

The anticipated benefits of linkage include increased liquidity of carbon allowances realized through access to a larger market, administrative efficiencies achieved through sharing in the administration of joint auctions, and lower overall costs of emissions reductions.

Summary of the Linkage Agreement

The linkage agreement is a high-level framework for achieving integrated carbon markets. Ontario, California and Québec will follow this framework as they complete the steps necessary to implement linkage as of January 1, 2018.

Under the linkage agreement, the three jurisdictions will hold joint auctions of emissions allowances, similar to those currently held by California and Québec. Allowances generated in each system, including those sold at joint auctions, may be used by capped participants in any of the three jurisdictions toward their compliance obligations.

Table 1 illustrates the recent activity at Ontario and Québec-California auctions of carbon allowances, prior to Ontario linkage.

Table 1: Qualified Bid Summary Statistics Comparison²

As of linkage, all three jurisdictions will have common auction reserve and settlement prices; the auction reserve price is expected to be the highest reserve price in any of the three jurisdictions.

Integration of regional cap and trade programs will require harmonization of the respective parties' regulations and reporting requirements. Under the linkage agreement, the parties will examine their respective regulations, determine whether any differing elements require alignment and consult each other regarding a harmonized approach. The linkage agreement also contemplates the development and implementation of an accounting mechanism to attribute to each party its portion of the total GHG emission reductions achieved by the linked cap and trade programs. The intent is to provide transparent and data-driven calculations for how GHG reductions from the cap and trade programs are counted toward each party's emission reduction target.

As the integration process unfolds, Ontario may require additional amendments to its cap and trade program. For example, California enacted legislation (AB 398) in July 2017 to extend its cap and trade program—which was set to expire at the end of 2020—until the end of 2030, and to adjust certain program requirements in a way that departs from the standard WCI model. Changes included reducing the limit for offset credits usage (from 8% of a regulated entity's compliance obligations to 4% for 2021-2025 and 6% for 2026-2030), and requiring the establishment of a price ceiling and price containment points to control allowance prices.

Proposed Amendments to the Cap and Trade Program

Changes to O. Reg. 144/16 and Free Allowance Methodology

The MOECC is proposing certain amendments to O. Reg. 144/16 and the Free Allowance Methodology, as follows:

• To support the linkage agreement, the amendments would recognize compliance instruments from California and Québec, facilitate joint auctions of emissions allowances, adjust holding and purchase limits for allowances to account for the emissions cap of all three jurisdictions, require related persons in Ontario to share their holding and purchase limits with related persons in California and Québec, and allow registration in multiple jurisdictions for capped participants and offsets sponsors.
• The MOECC also proposes to develop an approach to provide allowances free of charge to voluntary participants on account of GHG emissions that do not result from combustion (e.g., process emissions that result from chemical reactions). These emissions are not eligible for free allowances under the energy use-based allocation method currently applicable to voluntary participants.
• The amendments would also establish a methodology for determining emissions caps for the years 2021 to 2030. The plan is to set the 2030 cap using a method similar to that used for the first compliance period. More specifically, the 2030 cap will be set at a level to support Ontario's 2030 GHG reduction target under the CCMLEA (37% below 1990 levels) once emissions not covered by cap and trade and emissions from electricity import have been taken into account.³ The final regulatory amendments will set declining annual caps to 2030 based on the 2020 cap, amounting to approximately a 26% reduction in the 10 year period.

Changes to O. Reg. 143/16 and Reporting Guideline

The MOECC is proposing certain amendments to O. Reg. 143/16 and the Reporting Guideline, which will require reporters to submit verification reports. This amendment is intended to improve program efficiency by reducing the administrative burden for the MOECC in reviewing emissions reports.

Proposed Administrative Penalties Regulation

The MOECC also proposes a new regulation under the CCMLEA to provide a framework for issuing administrative penalties for contraventions of the CCMLEA. The proposed regulation includes: (1) a framework and process for issuing administrative penalties under the CCMLEA; (2) ranges and maximum amounts of penalties; (3) considerations taken into account in determining penalty values; and (4) potential reductions for actions taken to prevent and mitigate a contravention.

Comments on the proposed amendments and new regulations can be submitted online to the MOECC through the Environmental Registry by November 6, 2017.⁴

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¹ See: https://news.ontario.ca/opo/en/2017/09/quebec-ontario-and-california-join-forces-to-fight-climate-change.html

² See: http://files.ontario.ca/summary_results_report_english_2017-09-13.pdf; and http://www.mddelcc.gouv.qc.ca/changements/carbone/ventes-encheres/2017-08-22/Vente_22-08-en.pdf

³ Emissions from generation of imported electricity (which are covered under Ontario's cap-and-trade program) are not included for the purposes of Ontario's emission reduction targets.

⁴ See: http://www.ebr.gov.on.ca/ERS-WEB-External/displaynoticecontent.do?noticeId=MTMzNTQx&statusId=MjAzMDcx

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