Cap and trade in Ontario: the carbon context and FAQs

February 2016

• In preparing for cap and trade, it is important to recognize the context of carbon as a new commodity when managing energy consumption.
• Although many details of cap and trade in Ontario are still to be worked out, it isn’t too early for large energy users to conduct an assessment of the potential impact of carbon pricing on their operations over the next 3-5 years.
• Aegent has summarized some of the frequently asked questions and corresponding answers we have been addressing recently.

We have often been asked to provide guidance on Ontario’s upcoming cap and trade program. While there are many details still to be worked out, what is clear is that putting a price on carbon through a process of emission allowances and an auction mechanism is causing energy managers some angst. Some of this angst comes from uncertainty around the policy, some from the complexity of it, and some from the perceived cost.

As a very brief background, Ontario will be implementing a cap and trade program beginning in 2017 that will affect most users of energy. The program is being designed to link with the existing cap and trade programs in Quebec and California. The first compliance period is from 2017-2020 and subsequent periods are to be every three years to align with the Quebec and California timelines. Organizations that emit more than 25,000 tonnes of carbon annually - the large emitters - will be subject to program compliance. The government has had a number of stakeholder consultation sessions which have informed the draft cap and trade regulations released February 25, 2016.

Throughout this process and in preparation for the beginning of cap and trade, there is an important context to be kept in mind. Carbon will be a new currency/commodity to consider when managing energy consumption. While it is directly connected to energy, it is a derivative commodity, with varying impacts depending on the source energy from which it comes. For an organization that needs to plan, budget and strategize around managing carbon, it is useful to bear in mind that carbon is a fractional cost of specific energy consumed. When an organization’s entire operating budget is considered, energy is often not a significant portion of that budget. Carbon will be a fraction of that energy budget. As an example, if the auctions that will set the price of carbon under the cap and trade mechanism put a price of $17 per tonne of carbon, that would amount to an additional $0.03/m3 on a natural gas bill. While it’s not insignificant, the spot price of gas has fallen by more than that amount over the last year.

Some of the questions and corresponding answers we’ve recently been addressing are summarized below.

1. If one year my organization is above 25,000 tonnes and the following year it is below, can we opt out of the program?

The opt out criteria are still being developed but the government may consider the option to opt out after a compliance period or after a certain number of years.

2. Should we base the cost of carbon for budgeting purposes on the amount above 25,000 or the whole amount if we are a large emitter?

If you emit more than 25,000 tonnes annually, you are a large emitter and will be subject to a cap, meaning you will be given an allocation of carbon. Allowances for all amounts of carbon emitted will have to be acquired, whether through an allocation by the government or through auction so your total amount of carbon will have to be accounted for in your budget.

3. How much impact will this program have if we buy natural gas from a distributor?

If you are not a large emitter, that is you emit less than 25,000 tonnes per year, you will still pay a specific amount per unit of energy burned. In the case of natural gas combusted on site, a $17 per tonne set by auction works out to an additional $0.03/m3. This amount would be collected by your fuel distributor.

4. If we are a large emitter, will we have to buy allowances at the auction?

If your emissions exceed your allowances, then the normal mechanism for acquiring additional allowances is through the auction. Of course, if you have reduced emissions to below your allowances, then you have allowances to sell. The intention to link Ontario’s emissions trading program with those of Quebec and California is primarily to have access to the larger trading market, which should help make the market more efficient. At this time, however, there is no restriction on organizations pooling their resources to have one individual or organization manage the auction process on behalf of the others in the group. This is now being done in California with some institutional sectors. It is to be expected that third-party service providers will offer to transact in the auction on behalf of emitters, much as agents arrange gas supply for end-users in the gas marketplace.

5. Is there any consideration to changing the threshold of 25,000 tonnes?

In the most recent stakeholder consultations, there was broad consensus on the proposed threshold of 25,000 tonnes.

6. Will the cap decline from one year to the next?

Yes. The proposed rate of decline is on average 4.2% per year for the first compliance period of 2017-2020. This is designed to allow the province to achieve its target for 2020. A central principle of a cap and trade regime is a planned and persistent reduction in caps to ratchet emissions down over time in order to meet the policy goal.

7. If we have a new facility which will become a large emitter, when does its compliance obligation begin?

New facilities will have a compliance obligation starting in their third year of operation.

8. Is the government planning to support participants through this process?

The government is planning outreach, training and even opportunities like practice auctions to help prepare participants – the large emitters.

9. How much of the allowances would be distributed free of charge to large emitters with a direct compliance obligation?

The government intends to distribute many of the allowances free of charge for the first compliance period. Final percentages will be established in the months ahead. In future compliance periods, it is envisioned that fewer allowances would be distributed free of charge.

At this time, significant energy users should conduct an assessment of the impact of carbon pricing in order to better understand its potential effect over the next 3-5 years. While a low gas and carbon price today would indicate low impact, over time this will grow. Users should be considering focused strategies around energy conservation to mitigate future impacts.

What could cap and trade mean for energy costs? Read more »