By John McCloy for Canadian Clean Energy Conferences

In the run-up to the 2nd Annual Ontario Cap and Trade Forum on April 18-19 at the Beanfield Centre in Toronto, Canadian Clean Energy Conferences is producing a series of articles featuring the key topics concerning regulated entities under Ontario’s program.

At first glance, the benefits of Western Climate Initiative (WCI) linkage to Ontario industries are clear. Access to the more extensive WCI market, with its more significant pool of liquidity, increases the chances of compliance entities finding opportunities to reduce carbon emission at the lowest cost. Ultimately a larger market is one that is more effective at creating low-cost solutions.

“The linkage is a backstop on compliance,” comments David Sawyer, Founder of EnviroEconomics. “It keeps compliance costs down and adds compliance flexibility to Ontario emitters. It’s really a cost containment mechanism.”

The linkage, however, is not without its difficulties and potential drawbacks. Policy harmonisation across the jurisdictions continues to be a difficulty, especially in the areas dealing with the production and procurement of carbon offsets, calling into question their unilateral fungibility.

“Going forward, the question is whether measures outside, but connected, to the program will harmonise over time and fall in behind the cap and trade program,” notes Jean-Philippe Brisson, Partner at Latham & Watkins. “By measures, I refer to the complementary measures which are command and control policies that the states adopt to mandate specific reductions of greenhouse gases in the specific sectors which are covered by the cap and trade program.”

The Importance of the First Auction

With the first WCI auction with Ontario included now a couple of weeks away, market experts and industrial emitters are looking to its results as an indicator of how Ontario’s inclusion will affect the price of allowances.

“It’s going to be the first time that we have a large pool participants in this first auction, so you should have a more efficient outcome and something that is reflective of the broader set of consensus in the market,” contends Stephen McComb, Director of US Environmental and Coal Markets for Intercontinental Exchange. “That is something you didn’t necessarily see in the last Ontario auction where they didn’t have full participation and prices were not in line with the broader market. It is a long time from here to the compliance deadline so that may have increased the appetite to consume the allowances.”

There is, however, some contention that this first auction may not be as significant as is being suggested. While its outcome will be indicative of how Ontario’s entry into the WCI will affect carbon allowances prices, some experts expect the addition of a new jurisdiction to have little effect on the buying strategies of large industrial emitters.

“I see no significant change in compliance behavior,” reports EnviroEconomics’ Sawyer. “The auction has been heavily subscribed, and it’s the large upstream fuel distributors, companies who are supplying natural gas or liquid fuel, who are wading into the market on a quarterly basis, buying what they need for compliance and moving on. We don’t expect much change when the auction comes along, and, in fact, we suspect that an expectation of the WCI linkage had already been built into compliance behavior.”

Elements of Policy Harmonisation Still to be Decided

As it stands, the cap and trade programs of the WCI jurisdiction are largely harmonised as a condition of linkage. This harmonisation allows the unilateral use of allowances between jurisdictions and Ontario industries will be able to buy at the lowest possible cost.

“As far as I am aware the registry barrier that separated the markets is no longer in place,” notes McComb.” “So, in that sense, holdings will be equivalent across the jurisdictions. Our futures contract, as a market operator on the exchange, allows for delivery of anything that is deemed to be eligible per the program rules. Our view is that allowances are fungible and that’s how the contract works. There are larger issues to deal with on offsets, but it seems as if each jurisdiction is making their own eligibility requirements for that.”

Beyond the cap and trade programs, there is an expectation that the WCI will work towards greater harmonisation across a number of carbon emission regulations.

“One example of this would be the power sector and the use of the Renewable Portfolio Standard,” comments Latham & Watkins’ Brisson. “The RPS is a measure that requires utilities to purchase a certain quantity of renewable power every year.”

“Beyond the market rules we would expect that there would be a move towards greater harmonisation of GHG accounting,” agrees Sawyer. “California has a preexisting framework for this that others can adopt. We’re in the early days of offset development in the Ontario and Quebec market, and we’re also in a state of flux in California with new offset rules under AB398 to be rolled out.”

AB-398 and the Question of Offset Fungibility

While carbon allowances are universally acknowledged to be fungible across the WCI jurisdiction, the use of carbon offsets is a more complicated issue. At the heart of this complication is the nascent stage of the Ontario and Quebec offset programs and the potential impact of California regulation AB-398.

The bill specifies that, of the offsets used to meet compliance by Californian entities, “no more than one-half may be sourced from projects that do not provide direct environmental benefits in-state.” While there is still a robust discussion on the exact meaning of AB-398, and the Californian Air and Resources Board (CARB) has yet to come to a decision, it could potentially disallow the use of millions of non-Californian offsets.

While in the short term this would result in more offsets being made available to compliance entities in Ontario it would eventually restrict sales of carbon offsets from Canadian offset creation projects.

“Protocols are still being developed in Ontario, and the rules around offsets are changing in California,” comments Sawyer. “I think there needs to be a settled policy framework for offsets in each jurisdiction before they start to look at alignment or linking by degrees. Each jurisdiction has to agree that the use of offsets leads to real and verifiable emission reductions.”

While the lack of policy harmonisation on carbon offsets has the potential to affect Ontario industries in the future negatively, some experts suggest that this very lack of coordination could create opportunities for offset creation projects in the province.

“Quebec and Ontario are now working very closely to develop their own offset programs, and I believe that this offset program will provide more opportunities to include project types that, until now, have not been eligible in California, but could be eligible in Canada,” notes Brisson. “So this new partnership between Ontario and Quebec is very promising.”

Potential Linkage to International Carbon Markets

Questions continue to be raised about the possible linkage of the WCI with international carbon markets, with Mexico being the most obvious candidate. The concept of a potential pan-American carbon market was further strengthened by the signing of the Cali agreement in 2017. This agreement saw the heads of state of the Pacific Alliance countries of Mexico, Colombia, Chile, and Peru agreeing to strengthen monitoring, reporting, and verification frameworks for greenhouse gas emissions in the region.

While there are significant benefits associated with international linkages, such as greater liquidity and lower offset pricing, the impediments, both logistical and political are substantial.

“There is a possibility of Mexico joining in, these things are always possible, but they do come with their own challenges,” comments McComb “It’s hard enough for Ontario and Quebec to get linked and they, generally speaking, have all of the same international trade policies. To bring in another entity with a third set of national laws would be significantly more difficult. I think it is more likely that we will see other states joining before international partners.”

“This notion of shipping money outside of our domestic borders does not play politically for all kinds of reasons,” agrees Sawyer. “In fact, the biggest criticism of the Ontario cap and trade program is the shipping of money off to California to purchase offsets.With that kind of mindset, linking to international carbon markets would be very challenging.”

A possible alternative to international linkage would be for the WCI to link with the Regional Greenhouse Gas Initiative (RGGI), connecting the carbon markets of Ontario, Quebec, and California with those of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, and Vermont.

“The only obstacle to a potential link with RGGI is that, currently, RGGI prices are trading below the floor price of the WCI jurisdiction,” notes Brisson. “In order for such a link to be work, there would need to be put in place some kind of discounting mechanism that would account for the differential in the floor price. That would be a very interesting market because it would have scale, liquidity and a lot of participants, but its potential issues would not be easy issues to resolve.”

The Ontario Cap and Trade Forum takes place at Toronto’s Beanfield Centre on April 18-19.

Take advantage of this high-calibre networking opportunity with mandatory participants in Ontario’s cap and trade and key government decision-makers, and gain useful updates on compliance and trading strategies from international carbon market experts.

Visit the event website for more details on the Ontario Cap and Trade Forum, which will bring together regulated entities from Ontario, Quebec and California with key government decision-makers and carbon market experts.