Canada: Designing The Western Carbon Frontier: WCI Announces Proposed Framework For Regional Cap-And-Trade Program

Copyright 2008, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Environmental Law, October 2008

On September 23, 2008, the Western Climate Initiative (WCI) released its detailed draft design recommendations for its Regional Cap-and-Trade Program (the Program). The WCI, which was launched in February 2007, is a collaboration of seven U.S. states and four Canadian provinces including British Columbia (BC), Manitoba, Ontario and Quebec participating as partners, along with Saskatchewan as an observer. The draft design of the Program represents the culmination of 18 months of stakeholder consultation, analysis and deliberation among WCI members. The Program, which is anticipated to start trading on January 1, 2012, is a key component of the WCI's collective effort to achieve its emissions reduction target of 15% below 2005 levels by 2020. Each WCI member is now responsible for further developing the draft design and taking the next steps, including establishing the necessary legislation, to implement the Program in its jurisdiction.

Overview of the Draft Design

Under the draft design, WCI members recommend the implementation of a multi-sector cap-and-trade program with the following key parameters:

• a limit on emissions from all major sources of greenhouse gas (GHG) emissions;

• the cap will include all electricity-related emissions, including those from electricity imported from outside WCI member jurisdictions;

• use of a consistent reporting methodology among regulated entities; and

• a flexible system to mitigate economic impacts on consumers and regulated entities by allowing the use of offsets and banking of allowances.

The Program will cover the largest emitters in each state and province, including energy (electricity generation, natural gas and heating fuels), industrial emissions and transportation emissions. Carbon dioxide emissions from the combustion of biomass and bio-fuel in a blended fuel will not be included in the Program (except for purposes of reporting).

Reporting Requirements

The integrity of the Program is rooted in the implementation of a rigorous emissions reporting regime. Entities with annual emissions of 10,000 metric tons of carbon dioxide equivalent (CO2e) or more will be subject to mandatory reporting. To ensure data is reported accurately and thoroughly, each WCI member will require third party verification of reported emissions.

The timeline for reporting by WCI members has been agreed as follows:

• 2011 – WCI members will begin reporting emissions that occurred in 2010;

• January 1, 2012 – the first phase of the Program will begin with a three-year compliance period; and

• 2015 – the second phase of the Program will begin, when it is expanded to include transportation fuels and residential, commercial and industrial fuels.

At the end of each compliance period, regulated entities must submit the same number of emissions allowances to the government as the emissions they had during the compliance period. If the entity does not have a sufficient number of allowances to cover its emissions, a penalty of three allowances will be assessed for each one it is short.

Allocation of Emissions Allowances

Each WCI member jurisdiction will be given an annual emissions allowance budget within the declining regional cap from 2012 to 2020. Emissions allowances represent a limited authorization to emit and are not considered property rights. The annual allowance budget will be established prior to the start of the Program in 2012 and each WCI member will have the flexibility to decide on the best method to allocate its allowance budget within its jurisdiction. For example, a WCI member could give away allowances to large emitters operating within its jurisdiction or auction the allowances to willing buyers.

The draft design calls for a minimum auction level of 10% at the start of the Program, rising to at least 25% by 2020. WCI members have agreed to use a portion of the allowance value for energy efficiency initiatives and the development of low-carbon technologies.

There is concern that by allowing up to 90% of emissions allowances to be given away to emitters, there could be an adverse impact on the competitiveness of certain types of industries within the WCI. By giving away emissions allowances, a WCI member could enable some companies to profit at the expense of others, particularly those requiring a significant number of allowances. For example, if allowances are allocated to two companies – one of which is a coal-fired power plant and the other a manufacturer – it is likely that the power plant will require a greater number of allowances than the manufacturer. If the manufacturer does not use up its allocation of allowances, it can sell the allowances to the power plant, thus profiting from the system and putting the power plant at a cost disadvantage. The low minimum for auctioning allowances may also decrease the effectiveness of the Program by removing the cost incentive for companies to reduce emissions (in contrast, 95% of emissions allowances in the Regional Greenhouse Gas Initiative, North America's first mandatory cap-and-trade program covering power plants in the northeastern U.S., will be auctioned, rather than given away for free). This generous system for the distribution of emissions allowances resulted from the failure of WCI members to reach a consensus on how allowances should be distributed. With the low minimum auctioning requirement, the WCI estimates the initial price of carbon allowances will be close to zero, rising to between $6 and $19 per tonne by 2015. By 2020, the WCI anticipates that the price will rise to between $18 and $71 per tonne of CO2e, depending on energy prices.

The draft design also allows for early reduction allowances, which are aimed at encouraging entities included under the cap to reduce GHG emissions after January 1, 2008 and before the start of the first compliance period in 2012. It is anticipated that the criteria for determining which early reductions are eligible for early credit will be established by the end of 2009. These allowances will be issued in 2012 by each jurisdiction and will be issued in addition to each member's 2012 allowance budgets. The draft design also allows each member jurisdiction to "set-aside" allowances for specific purposes. For example, a WCI member with hydro power may wish to set aside allowances for use during low water years. Alternatively, a WCI member may wish to recognize early reduction activities that would not qualify for early reduction allowances under the WCI regime. Any set-aside allowances created by a WCI member will come from that member's own allowance budget.

The Role of Offsets

The Program allows for the limited use of offsets as a compliance mechanism. Offsets, defined as reductions in GHG emissions from activities outside of regulated sectors, may be traded or used for compliance purposes. The use of offsets for compliance has been limited to 49% of total emission reductions from 2012 to 2020 to ensure the majority of emission reductions is achieved at facilities covered by the Program.

WCI members have identified a series of project types as a priority for development in the offset system:

• agriculture – soil sequestration and manure management;

• forestry – afforestation, reforestation, forest management, forest preservation and conservation, and forest products; and

• waste management – landfill gas and wastewater management.

The development and approval of protocols for these priority projects will begin in 2009. The WCI will also establish a process in 2009 to facilitate the review and approval of other projects and protocols put forward by project developers.

Provincial Initiatives

By joining the WCI as full members, BC, Manitoba, Ontario and Quebec have committed to taking certain actions to reduce their emissions. Each WCI member is responsible for adopting an economy-wide GHG reduction goal for 2020 that is at least as stringent as the WCI regional target. To that end, the Canadian WCI members have committed to the following:

• BC will reduce its GHG emissions to 33% below 2007 levels by 2020 and to 80% below 2007 levels by 2050;

• Manitoba will reduce its GHG emissions to 6% below 1990 levels by 2012;

• Ontario will reduce its GHG emissions to 6% below 1990 levels by 2014, 15% below 1990 levels by 2020, and 80% below 1990 levels by 2050; and

• Quebec will reduce its GHG emissions to 6% below 1990 by 2012.

With such diverse economies, each province is focusing its efforts on different sectors to meet its emissions reduction obligations. For example, Ontario has committed to phasing out its coal-fired power plants by 2014 while increasing its energy efficiency initiatives and implementing clean technologies. Manitoba and Quebec, both blessed with abundant hydro-energy resources, will focus their reduction efforts on the transportation and agricultural sectors, and improving energy efficiency. Similarly in BC, the focus is on transportation and energy efficiency as well as energy production and forestry.

BC however, is faced with a unique challenge within the context of the WCI. Businesses and individuals in the province are concerned about how BC's carbon tax (which came into effect on July 1, 2008) will be integrated into the Program. The carbon tax currently covers transportation, residential, commercial, and small industrial fuel users. The WCI has said that by 2012, member jurisdictions will determine the mechanism for integrating the Program with BC's carbon tax. As the Program will not cover emissions from transportation, residential, commercial and smaller industrial sources until 2015, BC's carbon tax will have been in place for seven years at that point and, assuming that the current legislation remains in effect, the carbon tax will have grown to C$30 a tonne. To satisfy a disgruntled public and to ensure that BC does not get short-changed, the BC government will need to ensure the province gets full credit for its innovative use of fiscal measures (for example, through the mechanism for early reduction allowances) as a tool to reduce its GHG emissions.

Uncertainty Remains

A number of variables will affect the evolution of the WCI cap-and-trade program. Perhaps the biggest variable is the possibility of a national cap-and-trade program in the U.S. once a new federal administration assumes power after the U.S. presidential election. The development of a Canadian emissions trading system under the federal climate change framework may also have an impact, but to a lesser extent. However, as long as a leadership vacuum exists at the U.S. and Canadian federal levels, state and provincial governments will likely continue to move forward with their own climate change plans. With regard to offsets from jurisdictions outside the WCI, the draft design allows WCI members to approve and certify offset projects located throughout North America as long as such projects are subject to comparably rigorous verification standards as those established in WCI member jurisdictions. This will open up opportunities for project developers to generate eligible offsets with projects located in non-WCI member jurisdictions. Finally, it remains to be seen how the WCI will link to other emissions trading systems. All of this uncertainty warrants paying close attention to the WCI as it continues to advance its agenda.

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.