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How Cap and Trade Works

Archived Backgrounder

How Cap and Trade Works

A cap and trade program reduces the amount of greenhouse gas pollution going into our atmosphere by setting a limit, or cap, on the amount of greenhouse gases that can be released.

The cap drops each year to lower emissions.

Large emitters must have enough permits (technically known as allowances) to cover their emissions. If they do not, they can purchase additional permits. To that end, the system creates a market for pollution permits. Companies that emit more than they have can buy them through government auctions or companies that have surplus allowances. This ensures the overall cap is maintained. Industries are incented to find new ways to reduce greenhouse gas pollution whether they are buying or selling permits.

The system rewards innovative companies, provides more certainty for industries, and creates more opportunities for investment.

As indicated in the 2016 Budget, cap and trade is expected to generate approximately $478 million in 2016-17, and $1.8-1.9 billion annually for the remainder of the compliance period. The first compliance period runs from January 1, 2017, to December 31, 2020.

As is the case with any market, actual proceeds will vary with changes in carbon prices, supply and demand for credits and efficiencies gained by investments in clean technologies. These estimates are also sensitive to the value of the Canadian dollar relative to the U.S. dollar.

By law, all proceeds from cap and trade must be invested in projects that reduce greenhouse gas emissions. The Climate Change Action Plan outlines how the government intends to spend these proceeds.

As complements to the cap and trade program, initiatives in the Climate Change Action Plan will save households and businesses money, create good jobs in clean tech and construction, and generate opportunities for investment in Ontario. These programs are in addition to other investments currently being made in areas such as energy conservation and public transit.

The action plan, the cap and trade program and other government efforts, such as building code enhancements, will work together to reduce greenhouse gas emissions in Ontario and help reach our 2020 targets of 15 per cent below 1990 levels. They will also set Ontario on a path to achieving its 2030 and 2050 targets.

2016 Legislative Officers' Reports on Climate Change

Within the last week, three officers of the legislature have released detailed reports on Ontario's cap and trade program. These include the Environmental Commissioner, dated November 22, the Financial Accountability Officer, dated November 23, and the Auditor General, released earlier today. 

The government thanks all three legislative officers for their efforts, and is providing the following information in response to key statements raised in these reports.

Statement: The cap and trade system is reasonable and well-designed, balancing the urgent need for GHG reductions with the cost to Ontario citizens and businesses. Linking with California and Quebec will lower compliance costs for Ontario emitters. A linked program may also have less price volatility. Economic theory suggests that linking can be beneficial for smaller jurisdictions like Ontario. (ECO Report)

Response:  Ontario's cap and trade program will be up and running in January 2017 with its first auction being held in March. Ontario intends to link its program under the WCI in 2018, partnering with Quebec and California.

A linked system allows facilities to trade pollution permits across jurisdictions. This provides access to a larger pool of low-cost emissions reductions, making it more affordable for companies to lower their emissions. It is an effective way of lowering greenhouse gas emissions and will give business certainty and maximum flexibility in choosing their compliance path.

Within this linked market, there will be buyers and sellers in each jurisdiction between the two countries. Linking with other cap and trade programs helps companies comply at the lowest possible cost, as well as helping jurisdictions meet their targets for reduced greenhouse gas emissions. Linked markets bring many economic benefits.

A number of countries and regions around the world, including the European Union, South Korea, China and the northeastern United States and California, have adopted cap and trade systems to address climate change. Recently, Nova Scotia has announced its intent to develop a cap and trade system, as it is a cost-effective approach to reducing greenhouse gas emissions.

"A linked system expands the opportunity to find the lowest cost abatement across sectors, firms and regions."

  • Institute for Competitiveness & Prosperity, April 2016 report: Toward a Low-Carbon Economy

Statement: Quebec and California businesses will further reduce emissions to sell allowances, but both jurisdictions have an oversupply of allowances available as of August 2016. (ECO and AG reports)

Response: In Quebec and California's most recent auction as of November 15, 2016, 88 per cent of allowances were sold, up from previous auctions. Variation in demand is expected in market-based programs and the program includes mechanisms to ensure a well-functioning market.

To address the impact of market fluctuations, the WCI program design contains many important measures, including a minimum floor price (unlike the European Union's program), and a Strategic Reserve that can protect against any sudden price increases.

As well, the WCI program is based on declining GHG caps that will ensure greenhouse gas reductions continue over time. The program provides flexibility for participants to choose the compliance path that works for their business. Some may choose to reduce or purchase allowances early in the program that can be used in the future when prices are expected to be higher.

"The government also deserves kudos for its active role in national and international cooperation on climate change mitigation."

  • Dianne Saxe, Environmental Commissioner of Ontario (Nov. 22, 2016)

Statement: Ontario's GHG emissions will be reduced by 3.8MT, with the remaining 80 per cent required to be achieved from other jurisdictions. (AG Report)

Response: Ontario's cap and trade program is intended to provide certainty that the province will meet its emission reduction targets by setting caps and lowering them over time. By working together in a linked system, jurisdictions are able to achieve GHG reductions at the lowest cost. As economic studies show, this reduces costs for business and consumers and is better for the overall economy.

The Climate Change Action Plan will also help people and businesses save more money in their everyday lives. The plan will make Ontario one of the easiest and most affordable jurisdictions in North America for homeowners and businesses to install or retrofit clean-energy systems, increasing the availability of zero-emission vehicles, switching inefficient fuels with cleaner alternatives, and supporting a carbon market that drives the lowest-cost greenhouse gas emission reductions.

By investing in new technologies and processes that can help businesses and homeowners reduce GHGs, it is expected that more emissions reductions will occur in Ontario. As part of the program, the province will also be putting in place a system of offsets that will allow for the creation of emissions reduction credits for sale in the carbon market.

"The ability of a jurisdiction to calculate important compliance instruments against its reduction targets is a fundamental principle at the core of the rationale for linking."

  • Matt Rodriquez, Secretary for Environmental Protection for California, and David Heurtel, Minister of Sustainable Development, Environment and the Fight Against Climate Change (Nov. 23, 2016)

Statement: A linked market has the potential for double counting, where more reductions may be claimed than actually achieved (AG Report).

Response: There will be no double counting. Ontario, California and Quebec have agreed to strict, clear and consistent rules and infrastructure that ensure no double counting occurs in compliance with the cap and trade program. Ontario and our WCI partners are committed to a sound accounting approach that accurately attributes greenhouse gas reductions towards targets. At the 22nd Conference of the Parties (COP22) in Marrakesh, the three jurisdictions agreed to reaffirm this commitment and develop methods for reporting against targets to enhance the transparency of inter-jurisdictional flow of compliance instruments. Quebec and Ontario will also be working with the federal government to reflect the WCI accounting approach in the national reporting framework.

"Transparency as well as market and environmental integrity are the cornerstones of the WCI regional carbon market and are necessary to ensure its effectiveness and robustness."

  • Matt Rodriquez, Secretary for Environmental Protection for California, and David Heurtel, Minister of Sustainable Development, Environment and the Fight Against Climate Change (Nov. 23, 2016)

Statement: Cap and trade will result in a total of about $8 billion more in costs to businesses and consumers over four years; households to see average increased costs of $156 in 2017 and $210 in 2019 for Ontario to meet its 2020 GHG-reduction target. (AG Report)

Response:  As the Financial Accountability Officer noted, it is too soon to determine the costs and the exact amount of proceeds. These will be determined by market results and based on an assessment of initiatives and auction proceeds. According to ministry estimates, it could be up to $1.8 billion to $1.9 billion a year.

All revenue generated through cap and trade will be deposited into a dedicated account and reinvested in green projects that reduce greenhouse gases and fight climate change. These investments will help make the shift to a low-carbon economy easier for families and businesses.

In the Climate Change Action Plan, the Greenhouse Gas Reduction Account (GGRA) funding is estimated to range from $5.96 billion to $8.3 billion. We intend to use this funding to invest in initiatives such as retrofit programs that reduce greenhouse gas emissions like solar energy systems, battery storage, building insulation, heat pumps and switching fuels with cleaner alternatives to help homeowners use less energy and save more money. Current natural gas conservation programs, such as the Ontario Home Energy Conservation Incentive Program, can help save households $7 to $11 per month.

"The Province is required to record the proceeds of allowance auctions in the GGRA. Amounts in this account can only be spent on initiatives reasonably likely to reduce, or support the reduction of, greenhouse gas emissions."

  • Financial Accountability Office of Ontario (Nov. 23, 2016)

"With every leading jurisdiction we compete with studying cap and trade models, it is important that this Province continues to be a leader in the formulation and implementation of global best practices. We look forward to being part of that policy initiative and partnering in a responsible future."

  • Flavio Volpe, President of the Automotive Parts Manufacturers Association (April 13, 2015)

Statement: Will cap and trade impact electricity rates? (AG Report)

Response: As committed to in Budget 2016, there will be no net increase to electricity prices because of cap and trade.

In addition, the government is taking action to reduce electricity costs through a series of measures. The Ontario Rebate for Electricity Consumers Act, 2016 that recently received Royal Assent is scheduled to come into force on January 1, 2017. This legislation will provide an eight per cent rebate, equivalent to the provincial portion of HST, for approximately five million eligible electricity consumers including residences, small businesses and farms.

The government is also increasing the amount of rate protection available to approximately 330,000 eligible rural customers living in low-density areas by updating the Rural or Remote Rate Protection (RRRP) program.

Finally, a portion of cap and trade auction proceeds will be invested to reduce greenhouse gas emissions and keep rates affordable for industrial and commercial consumers.

These steps build on significant action taken by Ontario to reduce greenhouse gas emissions from the electricity sector through the elimination of coal-fired electricity generation and associated investments in emissions-free generation. The elimination of coal-fired generation has resulted in a 30 Mt reduction in greenhouse gas emissions annually since 2003. Ontario's electricity sector was 90 per cent emissions-free last year. As noted by the Environmental Commissioner, Ontario's residential electrical rates are also average relative to the rest of North America.

"To achieve Ontario's legislated emission reduction targets, a linked cap and trade program has a carbon price of $18 per tonne and a monthly impact to households of $13. Comparatively to reach those same targets through an unlinked cap and trade program, the carbon price would be $157 per tonne and a monthly household impact of $107. Under a revenue neutral carbon tax, the carbon price would be $72 and a monthly household impact of $50."

  • EnviroEconomics' Impact Modelling and Analysis of Ontario's Cap and Trade Program (May 17, 2016)

Statement: Under a linked system, Ontario businesses will pay up to $466M for Quebec and California allowances (to 2020). This amount could rise to $2.2B by 2030. (AG Report)

Response: The Ministry officials do not expect this figure to rise to $2.2 billion. Through the Climate Change Action Plans and complementary measures, the plan can help to ensure that more reduction opportunities and capital investments stay in Ontario. The Ministry's expert modelling showed investments in households and businesses would grow Ontario's economy while emissions targets are met.

"We are pleased to see that Ontario continues to provide responsible leadership in the area of climate change with the release of Ontario's Climate Change Action Plan. The Action Plan enables and encourages consumers and citizens to focus on the critical goal of reducing greenhouse gas pollution while supporting and developing Ontario businesses in the transition to a low carbon economy."

  • John Coyne, Vice President, Legal and External Affairs, Unilever Canada (June 8, 2016)

Statement: The Ministry of the Environment and Climate Change forecasts less greenhouse gas reductions than its own Climate Change Action Plan communicates. (AG Report)

Response: The reductions forecasted in the Climate Change Action Plan (9.8 Mt) reflected the best available estimates at the time and are subject to detailed program design. More detailed program design will yield further analysis on projected GHG reductions. Decisions will be reported on in a transparent manner as part of the approval process for resources from the Greenhouse Gas Reduction Account. Successful programs under the action plan will help ensure that more reductions are achieved in Ontario and that the carbon price continues to be the lowest at achieving Ontario's targets.

"Putting a price on carbon, by itself, whether through a carbon tax or through a cap and trade program, would not be enough to achieve Ontario's reduction targets, unless the price were very high. As in other jurisdictions, Ontario needs complementary emission reduction measures."

  • Dianne Saxe, Environmental Commissioner of Ontario (Nov. 22, 2016)

Statement: The Climate Change Action Plan commits about $1 billion to previously approved initiatives, like electric vehicles and regional express rail. (ECO, FAO and AG reports)

Response: The Climate Change Mitigation and Low-carbon Economy Act allows for the use of proceeds to fund any initiatives that are reasonably likely to reduce greenhouse gases. The Climate Change Action Plan will build on existing initiatives and fund new initiatives to reduce GHGs.

"Ontario has matched a price on carbon pollution with a comprehensive package of measures to invest the money in programs proven to further reduce greenhouse gas emissions. This approach will benefit Ontario residents and businesses, and has been shown to be the best way to address climate change and build a cleaner economy around the world."

  • Tim Gray, Executive Director, Environmental Defence (June 8, 2016)

"GM Canada sees tackling climate change as both a necessity and an economic opportunity. As Ontario moves to place a value on carbon, we will work together and support the development of market mechanisms that are effective, protect our manufacturing competiveness and support consumers interested in adopting new technologies, like our Chevrolet electric vehicles."

  • David Paterson the Vice President of Corporate & Environmental Affairs from General Motors Canada (Nov. 24, 2015)

Statement: Many of the 37 recommended actions in Ontario's 2011 Adaptation Plan have not been acted upon. (AG Report)

Response: As of June 2016, 36 of 37 actions are fully or partially complete, with significant progress across many of the actions. Ontario will be updating the 2011 adaptation plan early in 2017. 

Statement: By joining a linked market, Ontario will not drive new reductions globally. (AG Reports)

Response: Greenhouse gases are global pollutants, which means reductions in one area have effects on total global concentrations of carbon dioxides. A linked market means that emissions reductions will take place at the lowest cost.

Cap and trade will provide greater certainty that the province will meet its targets and drive significant emission reductions moving forward. The main purpose of cap and trade is to fight climate change by focusing on reductions in greenhouse gas pollution. Achieving these reductions responsibly while maintaining Ontario's competitiveness requires a plan that is both affordable for households and businesses and effective at reducing greenhouse gas pollution.

"The key purpose of linking is to reduce compliance costs for Ontario emitters. Linking reduces compliance costs in two main ways: 1. Creating a bigger, more liquid market for allowances; and 2. Giving Ontario emitters access to lower cost allowances from other jurisdictions"

  • Dianne Saxe, Environmental Commissioner of Ontario (Nov. 22, 2016)

Statement: Ontario could be assessed as not meeting its target as Ontario's emissions reporting will not follow federal rules. (AG Report)

Response: Canada's National Inventory Report (NIR) accounts for greenhouse gases generated in Canada. To provide a complete understanding of how Ontario is contributing to global greenhouse gas reductions, we intend, working with our partner Quebec and the federal government, to report both on the NIR and achievements through cap and trade.

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