Posted by: Matthew Hoffmann | April 13, 2015

Preliminary Thoughts on Cap and Trade in Ontario

It’s official—Ontario is now pledging to join California and Quebec in a joint cap and trade carbon market. For those historically inclined, this is a long time coming and Ontario has been discussing various carbon market options for years. This is different. The province is set to join an already functioning system which will now cover over 60 million people and encompass the 8th largest economy in the world (California) and the majority of Canada’s economy too.

What does this mean? What’s next?

1. It means that carbon tax proponents lost the argument. Ontario was always going to either go with a BC style carbon tax or join up with Quebec in a cap and trade system. Lots of ink and tweets were spilled pulling for one or the other, but the loudest calls tended to be for a carbon tax. Tax proponents aren’t necessarily going to go quietly as the carbon tax/cap and trade debate sometimes reaches religious levels of fervor. This needs to be dialed back. Functionally, both carbon taxes and cap and trade systems do the same thing—put a price on greenhouse gas emissions (note that the cap and trade system that Ontario is joining covers all 7 anthropogenic greenhouse gases, not just carbon dioxide). They have different strengths and weaknesses. If it is going to work in Ontario, the key now is for all proponents of carbon pricing to get behind the cap and trade system and work to ensure that its design details are done well. To some extent the parameters of the design are set because Ontario is joining a working cap and trade system, but figuring out how to make it work in Ontario will be a crucial task. No carbon pricing system is magic and there are multiple ways to design either taxes or cap and trade systems that can achieve both economic and environmental goals. The key will be reconciling and translating those economic and environmental goals into the design of the cap and trade system.

2. It bears repeating then that design matters. From what we know about cap and trade systems, the evolution of the system that Ontario will now be joining has followed a pretty conventional path. The California/Quebec system started with lots of free allocation of emissions permits in order to build political support to get the system up and running. The goal is to ratchet down the cap and, over time, increase the percentage of permits that are auctioned rather than given away. The designers of the California system had the benefit of seeing what worked and didn’t in earlier carbon markets like the EU and the Regional Greenhouse Gas Initiative among northeast states in the US. The system seems to be working relatively smoothly and has yet to experience serious price volatility or collapses. The announcement about initiating cap and trade will get the most press, but the most important work comes in the design of the system. There will be two key pieces to the design:
a. Nuts and bolts. There’s lots to put in place to get the trading system to work             (allocations, trading rules, floor prices, verification, compliance, etc). Again, it is an         advantage that Ontario will be joining an already functioning market system where many of these questions have been explored and answered.
b. Allocation and Resources. The more challenging design decisions are around allocating permits and deciding what to do with auction resources. These are the directly political aspects of design and this is where economic and environmental goals (where they overlap and where they diverge) will be debated most vociferously. It is enormously important to get the cap right. Finding a balance between free allocation and auctioning is a matter of what’s economically optimal (most say that full auctioning is the best economically) and politically possible (many find it reasonable to protect industries that face significant competition by providing free allocations) is a delicate dance. Figuring out how to avoid industries taking windfall profits from free allocations is imperative. It is estimated that the auctions in Ontario could produce over $1billion so deciding what to do with auction resources and hopefully using them to create further momentum for decarbonization will take imagination and political fortitude.

3. Carbon pricing is one piece of the decarbonization puzzle, it’s not the only piece. This is another reason to dampen down the tax/cap and trade debate. Cap and trade must, must, must be seen and developed as a catalyst for moving on decarbonization, not an end in itself. The political and economic ripples of cap and trade are likely more important than the cap and trade system/price itself. Systems like this create both immediate economic benefits and delayed or indirect economic benefits and these tend to produce coalitions that want to see the continuance of the cap and trade system and/or other kinds of policy action on decarbonization. Immediate and direct bumps will come to the “Cap and Trade” industry—those with the skills and capacity to measure companies’ greenhouse gas outputs,  consultants and organizations that verify compliance, organizations and companies that can help with accounting. Perhaps the largest immediate beneficiary is the financial sector—developing and participating in trading in permits and secondary markets (e.g. futures for permits). This is a source of both hope (getting big finance on board potentially makes cap and trade a political winner) and concern (the financial sector is less likely to see cap and trade as a means to a climate goal, rather than an end in itself and complex financial instruments are not exactly popular in the wake of the financial crisis). Of course, there will also be indirect or delayed economic benefits as well. Resources from the auctions of permits and from companies seeking to reduce their own greenhouse gas emissions will create opportunities for such diverse sectors as renewable energy, building trades (efficiency measures), public transportation, and research and development. Cap and trade is important because it helps to normalize the move to a green economy and because it helps build coalitions and capacities to make the green economy a reality. It is a tool and this is why design is so important—in order to be effective as a catalyst it needs to have the right design.

4. Companies that started accounting for greenhouse gas emissions already have a leg up. It’s important to remember that a number of companies across the province had begun to work on accounting for and reducing their greenhouse gas emissions before the province decided to move on cap and trade. Organizations like Sustainable Waterloo Region and Sustainability Co-Lab and the companies and communities that are members of them have already gotten to work on accounting for and reducing greenhouse gas emissions. The province is providing a big source of motivation and momentum for these bottom-up processes.

The announcement is the first step. It is a crucial one and one worth celebrating. The work of design and implementation will take place with less fanfare but more importance. Those interested in moving Ontario towards a green economy and acting on the urgent problem of climate change should work together to ensure that that work is done well and helps to catalyze further pathways to decarbonization.

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Responses

  1. […] Preliminary Thoughts on Cap and Trade in Ontario […]

  2. […] insights from my own research and the political science literature to the public discourse through blogging, the occasional op-ed, public lectures, and the like. I am by no means a pioneer and in the last […]


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