Ontario Releases Draft Cap-and-Trade Regulations

During its budget announcement this afternoon, February 25, 2016, the Ontario Ministry of the Environment and Climate Change (MOECC) released draft regulations for the province’s much-anticipated cap-and-trade program for greenhouse gas (GHG) emissions. The draft regulations build on the MOECC’s public consultation in late 2015 and report back to stakeholders in January 2016 (for more detail, see our bulletins here and here). The draft regulations are open for public comment until April 10, 2016 and would be issued under the proposed Bill 172, the Climate Change Mitigation and Low-carbon Economy Act, 2016. This bill passed first reading in the legislature on February 24 and will be open for public comment until March 25, 2016.

What You Need To Know

• The program would cover upwards of 150 emitters (covered emitters) in the following categories: (i) approximately 102 large industrial emitters; (ii) certain natural gas distributors; (iii) certain petroleum product suppliers; and (iv) certain importers of electricity into the province.
• The program would take effect on January 1, 2017, with the first compliance period running until December 31, 2020, and with successive three year compliance periods after that date.
• At the end of each compliance period, covered emitters would be responsible for retiring emissions credits in an amount equal to their actual emissions during that period.
• Large industrial emitters would receive free emissions allowances during the first compliance period based on the calculations described below, whereas natural gas distributors and petroleum product suppliers would need to purchase all of their necessary credits, whether from quarterly auctions, other covered emitters or qualifying emissions offset projects.
• The program would have design features to facilitate future linkage with the existing cap-and-trade systems in California and Québec, allowing credits to be traded between these jurisdictions.
• Comments on the draft regulations can be submitted to the MOECC until April 10, 2016. Comments on Bill 172 can be submitted until March 25, 2016.

Highlights of the Draft Regulations

Coverage and Timing

The draft regulations would require emissions reductions from covered emitters in each of the following categories: (i) large industrial facilities with emissions of 25,000 tonnes or more of CO2_e per year; (ii) natural gas distributors with attributed emissions of 25,000 tonnes or more of CO2_e per year; (iii) petroleum product suppliers that supply 200 litres or more of petroleum products in the province per year; and (iv) importers of more than zero megawatt hours of electricity into the province per year. The large industrial emitters would include facilities in the following sectors: iron and steel; petroleum refining; cement; hydrogen; beer; ammonia; nitric acid; lime; glass; institutions; mining; base metal smelting; brick-making; carbon black; ethylene; magnesium production; mineral wool insulation; lubricants manufacturing; and styrene.

Under the draft regulations, emitters would be required to cover their actual emissions in each compliance period with an equivalent amount of emissions credits, such as emissions allowances or offset credits. Emissions allowances could be purchased from quarterly auctions or on the secondary market from other covered emitters or market participants. Some emitters would also receive free allowances from the province (as discussed further below). Emissions offsets could be purchased from qualifying offset projects or on the secondary market.

The first compliance period for covered emitters would run from January 1, 2017 until December 31, 2020, with successive three year compliance periods after that date. In 2017, the number of allowances released into the system, whether through auction or free allocation, would be roughly equal to expected emissions for that year, which is meant as a “soft start” to compliance obligations. The cap would then decline between approximately 4 and 5% each year during the first compliance period. New facilities would have a grace period until their third year of operations before being covered by the program.

Linkage and Price Containment

Ontario has been developing its cap-and-trade regulations under the framework of the Western Climate Initiative, a regional program for GHG emissions reductions that currently counts California, Québec, B.C and Ontario as its core members. In January 2013, California and Québec each launched their own cap-and-trade systems and linked those systems a year later. The two jurisdictions now hold joint auctions of emissions allowances that can be used for compliance in either jurisdiction. Ontario plans to link its proposed cap-and-trade system with the California-Québec system as early as 2018. By linking to other systems with a common price on carbon, Ontario expects to reduce the cost of compliance for covered emitters relative to an unlinked system.

To ensure compatibility with the California-Québec system, the draft regulations would adopt common rules regarding, among other things, the format and process for auctioning emissions allowances and, importantly, the price of those allowances. The price of allowances sold at auction would be subject to a floor price of nearly C$14/tonne in 2017 and rise by 5% plus CPI in each subsequent year. This would generally correspond with the escalating floor price used in the joint California-Québec auctions. As mentioned above, the settlement price for credits at the February 2016 joint California-Québec auction was just over C$17.50/tonne.

Allowance Allocation

Large industrial emitters covered by the draft regulations would receive a free allocation of emissions credits during the first compliance period. This free allocation is meant as transition assistance, particularly for carbon-intensive, trade-exposed industrial facilities (i.e., facilities whose operations generate significant GHG emissions and whose competitors may incur lower operating costs in jurisdictions that do not have a price on carbon).

The amount of the free allocation for large industrial emitters would be determined primarily by three factors: (i) an assistance factor (with certain emissions-intensive and trade-exposed industries receiving a higher assistance factor, and therefore a higher percentage of free allowances); (ii) a base emissions amount (determined based on a facility’s benchmark production, energy use, historical emissions or direct allocation); and (iii) a cap adjustment factor (which reflects an annual reduction in the province’s overall emissions cap). The first two factors are of particular importance. Under the draft regulations, the MOECC is proposing an assistance factor of 100% for all of the sectors that will receive free allowances in the first compliance period. It is also proposing to calculate the base emissions amount at the facility level using one of four approaches depending on the facility sector (as outlined in the table below):

Allowance Allocation Method	Examples of Sectors/Facilities Eligible for Allocation Method Under Current Proposal
Product-Output Benchmarks (based on allowances per unit of output)	Iron and steel; petroleum refining; grey cement; hydrogen; and beer.
Energy-Used Benchmarks (based on allowances per GJ of energy used)	Eligibility requirements are exclusions-based. At a high level, facilities that are subject to one of the other three allocation methods are generally ineligible for allocation under this method.
Historical Emissions	White cement; glass; ammonia, nitric acid; carbon black; ethylene; lubricants; styrene; magnesium; lime; mining, base metal smelting, and refining; brick making; and mineral wool insulation.
Direct Allocation	Carmeuse Lime Canada; Terra International (Canada) Inc.; University of Toronto; University of Western Ontario; University of Guelph; York University; London Health Sciences Centre; Hamilton Health Sciences Corporation; Queen’s University; Emerald Energy From Waste Inc.; and Clean Harbors Canada, Inc.

By way of example, given the proposal to use a 100% assistance factor, a facility in the iron and steel sector would receive free allowances covering 100% of the emissions associated with its benchmark product output, less a percentage reduction in any given year based on the corresponding reduction in the province’s overall emissions cap.

Use of Auction Revenue

The province expects to generate approximately $1.3 billion in revenue from the cap-and-trade program in 2017, with that amount rising as covered emitters are allocated fewer credits for free. Under Bill 172, the Climate Change Mitigation and Low-carbon Economy Act, 2016, all auction revenue would be paid into a Greenhouse Gas Reduction Account. This fund would be used for GHG reduction initiatives, such as initiatives relating to renewable and alternative energy sources, land use changes, building retrofits and improvements, transportation infrastructure and low-emission technologies. Further details regarding these funding initiatives are expected to be included in the MOECC’s 2016 Climate Change Strategy and Action Plan. This plan will likely specify measures, in addition to the cap-and-trade program, that the province intends to carry out over the next five years to reduce Ontario’s GHG emissions, in part using auction revenue paid into the Greenhouse Gas Reduction Account.

Emissions Offset Program and Early Reduction Credits

Under the cap-and-trade program, covered emitters will likely be able to use credits generated by qualifying offset projects to meet up to 8% of their compliance obligations. This is consistent with the approach taken in California and Québec. Generally, a qualifying offset project must involve a voluntary emission reduction project outside of the capped sectors that results in emissions reductions that would not have occurred in the normal course, and that is implemented in accordance with an approved methodology. The MOECC is proposing to issue a separate regulation for the offset program later this year. Building again on the California and Québec systems, that regulation is expected to initially include protocols for the following three offset project types: mine methane capture and destruction, landfill gas capture and destruction and ozone-depleting substance capture and destruction.

The draft regulations also contain provisions that would allow certain covered emitters to apply for early action credits – effectively credits for eligible emissions reductions that occurred between January 1, 2012 and December 31, 2015.