Largest Carbon Market in North America Will Expand Further

Jonathan Brun

The carbon market is making an impressive entrance in North America. Ontario announced this week that the province will join the Quebec and California carbon market. Quebec and California aligned their emissions regulations in 2014 to create a joint carbon market, the largest in North America and the only one in the world operated at the subnational level. The current Quebec and California harmonized provincial and state regulations apply to more than 80 large companies and concern over 400 million metric tonnes of carbon emissions (source available here) and this will grow with the addition of Ontario. The next couple of years will see Ontario bring its emissions regulations into mutual alignment in order to join this developing market, while other states and provinces consider following suit.

California’s and Quebec’s cap-and-trade system can be summed up as a market where participants buy and sell permits to emit carbon, called “emissions allowances.” One emissions allowance equals one metric tonne (kt) of carbon (CO2) released into the atmosphere. Every company producing more than 25,000 kt CO2 must possess enough allowances to match its emissions. Most companies are issued emissions allowances free of charge by the government, but only up to a certain emissions amount – called the emissions limit or “cap.” If a company wants to emit CO2 beyond the cap, the company must purchase the necessary emissions allowances at auction. Conversely, companies who have reduced their emissions to a level below the cap may sell their excess allowances at auction. Every year the cap lowers between 1% and 2%, thus reducing the supply of free allowances and possibly increasing the auction price.

One of the most appealing aspects of the California-Quebec joint cap-and-trade system is its potential to add other government jurisdictions, thus expanding the carbon market. Developed as part of the Western Climate Initiative, the system was envisioned as connecting multiple states and provinces. Emission allowance interchangeability is the link between jurisdictions. Although California and Quebec have very different economies and distinct carbon reduction goals, emissions allowances at auction are fully interchangeable. An emission allowance from Quebec equals one from California, and vice versa. Quebec and California hope that, in this way, businesses and governments will benefit from an emissions framework tailored to their region but part of a larger, more competitive carbon market.

This expansion and cohesion is made possible through harmonized regulatory systems. California’s cap-and-trade system was implemented under the aegis of Assembly Bill 32: Global Warming Solutions Act, passed in 2006 (Act available here). The Quebec National Assembly passed a similar bill in 2009 with Bill 42: An Act to Amend the Environment Quality Act and Other Legislative Provisions in Relation to Climate Change (Act available here). Regulations allowing linkage with other jurisdictions followed in 2011 with the California Cap on Greenhouse Gas Emissions and Market-Based Compliance Mechanisms Regulation and the Quebec Regulation respecting a cap-and-trade system for greenhouse gas emission allowances, and were finalized in 2012 with Quebec’s Regulation respecting the delegation of management of certain parts of a cap-and-trade system for greenhouse gas emission allowances.

In the coming years, Ontario is expected to pass similar legislation. Environmentalists and businesses alike will have their eye on this developing regulatory framework. The results of continuing joint auction will also affect Ontario’s regulatory choices. At present, the carbon market is bearish but respectable. The second joint auction in February 2015 resulted in all emissions allowances being sold, yet only a mere dime above the price floor. How the entry of Ontario affects the auctions will likely influence whether or not other jurisdictions join. If Ontario smoothly joins the established market, cap-and-trade may have the potential to expand across North America.

A recent report by the Ecofiscal Commission, available here, lauded the joint cap-and-trade model. The report argued that the model is a flexible market mechanism that can be successfully adopted by other governments. The report has academic and political clout – the Ecofiscal Commission’s advisory board features one former Prime Minister and three former provincial Premiers. So, it is unsurprising that the report has already had a political impact. Glen Murray, Ontario Minister of the Environment and Climate Change, tweeted here that “Quebec’s leadership on climate change is recognized & celebrated.” This comment came just days before Ontario signed on to cap-and-trade.

The hoped-for result of the cap-and-trade system is a price on carbon that encourages environmental innovation, does not overly penalize heavy emitters, creates new business opportunities and brings in revenue for the government. Whether cap-and-trade can accomplish all this remains to be seen. Nevertheless, the debut of the carbon market has been impressive. Less than two years old, it already encompasses California, one of the largest economies in the world. California and Quebec have been able to overcome differences of language, legal systems, economic profiles, and geography to form a promising level of regulatory cohesion. For the rest, the market will be the test.