Making Sense of Industrial Carbon Pricing in Ontario

Jonathan Brun


Una Jefferson: So Ontario just released a proposal which put some meat on the bones of the environmental plan that it released at the end of last year. And this included some emissions performance standards for large industrial emitters. There’s been a lot of commentary pointing at the similarity of the standards to the federal output based pricing system, which currently applies in Ontario. How similar are we talking and what are the major differences?

Chris Ragan: Very similar, I suppose would be my high level answer. So first of all, we’re talking about a particular part of a carbon pricing or climate policy. And this is the part that deals with the large industrial emitters. They are called emissions intensive and they also tend to be trade exposed. So emissions intensive means that they’ve got a fair chunk of emissions that come with each unit of output. But trade exposed means they’re selling into markets and possibly competing against firms that come from jurisdictions that don’t have climate policy or carbon pricing. What you’re trying to do here is two things with a well designed policy. You’re trying to put a carbon price in place that actually gives firms an incentive to reduce their emissions and to come up with ways to produce their output that are less emitting. So that’s the incentive part. But the second thing you’re trying to do is you’re trying to protect their business competitiveness against their rivals. So what you don’t want them to do is to shrink and reduce their emissions because they get smaller or reduce their emissions because they go out of business or reduce their emissions in your jurisdiction because they leave the jurisdiction and go elsewhere. What you’re really trying to do is give them the incentive to reduce emissions, but also give them the incentive to keep on producing and keep on employing people in your jurisdiction.

Una Jefferson: Just to give an example of what trade exposed means, so power generation for example would not be able to leave to the jurisdiction.

Chris Ragan: So power generation is a good example of an industry. So if it’s coal fired power, it may be carbon intensive, but it’s not very trade exposed because they’re all selling within the domestic market. If you are producing cement or lime or fertilizer or steel, then you’re fairly carbon intensive but you’re also trade exposed because you’re selling into markets outside of your jurisdiction, maybe even outside the country and competing against firms from other jurisdictions. The federal system does these two things, they put a carbon price in place, they give you an incentive to reduce emissions, but they also are basically giving you a subsidy based on the amount of output you produce. So the carbon price gives you an incentive to reduce emissions. The output subsidy gives you an incentive to increase your output or your employment or your activity. If you squish those two things together, you get what is basically an output based pricing system. That’s what the federal planned backstop is going to do. The Ontario plan in fact, is going to do a very similar thing. They’re just not calling it carbon pricing.

Una Jefferson: Okay, so more of a branding decision?

Chris Ragan: I think that’s a branding decision.

Una Jefferson: So the mechanism is very similar to the existing system. What about the types of industries covered? Are they also the same?

Chris Ragan: Yes, they are. A lot of these details for the Ontario system are not yet final. And in fact a few of these details for the federal system are not yet final, but the coverage appears to be roughly the same. What I like to call the usual suspects in terms of the emissions intensity and trade exposed; cement chemicals, electricity, petroleum, lime, natural gas, pulp and paper, oil extraction, this kind of stuff. The Ontario system starts with the same set of sectors that the federal system has. They may add more to it, but they’re kind of starting with the usual suspects. And if you look at the Ecofiscal work in the report that we did on business competitiveness, we identified these emissions intensive and trade exposed sectors in different provinces. The chemicals and cement and lime and fertilizers show up province after province because they are kind of structurally, fundamentally the same sort of industry. So same sort of coverage by industry and also the same sort of coverage for firms size within the industry. These systems typically identify a threshold. So firms that emit more than 50,000 tons per year of emissions or firms that emit more than 25,000 tons. They may end up using different thresholds, but both systems are offering smaller firms the option to opt into this output based pricing system if they so choose. So in fact, the threshold isn’t going to matter that much because anybody that’s below that threshold can choose to be part of the system if they desire.

Una Jefferson: A firm might do that voluntarily if it was doing very well in terms of emissions reductions and wanted to trade away it’s allowances for example.

Chris Ragan: Correct.

Una Jefferson: How does this scheme compare to the federal scheme in terms of the discretion given to the government to exempt certain industries or facilities from it?

Chris Ragan: Two comments on this. There’s another parameter that we haven’t discussed yet, which is the threshold of intensity. How these systems are typically designed, and this is true for the federal system and it’s true for the Ontario system, is that within each sector you set a threshold for emissions intensity, that’s emissions per unit of output so emissions per cement block or emissions per ton of steel, that kind of thing. You set a threshold and if your emissions intensity is above that, then you pay for any emissions above that threshold. If your emissions intensity is below that, then you get credits. A very important parameter when you’re setting the system is what is that industry threshold? Is it set at the current emissions intensity for the industry, which is what the Ontario plan is, or are you setting it below that emissions intensity that currently exists for the sector, in which case you’re effectively putting on a little more pressure to get better, to get cleaner. The federal system has a tighter threshold if you like. But you can also turn that around and say another way to see that the Ontario system is protecting the competitiveness more, which flip side means they’re kind of asking the firms to do less. Whereas the federal system is protecting the competitiveness less and asking the firms to do a little bit more in terms of emissions reductions. But that’s a really important parameter that it has to get set by the system.

Una Jefferson: So you’re saying that the emissions reductions required under the new proposed Ontario scheme are less than those under the existing Federal Scheme?

Chris Ragan: That’s correct. The second comment I wanted to make was about the word exemptions. So some people view these systems as exemptions because you only have to pay the carbon price on your emissions above a threshold. So you’re being “exempted” for the ones below that. But that’s not right because even if you are below that, then you still have an incentive, you can sell your allowances and keep having an economic incentive to get cleaner because then you can sell more allowances to the high emissions intensity firms. A true exemption is where you just exempt the industry all together and you say you’re just not covered by this policy at all. So for example, it’s pretty typical in the carbon pricing systems that we have across the country to exempt agriculture. No, I don’t think there’s a great economic reason for exempting agriculture. Certainly you could get the emissions that come from the gasoline or the diesel that is used in farm trucks and farm tractors, you could absolutely include that, other types of emissions would be tougher to cover. But I think this has been mostly a political decision on the part of the provinces putting these policies in place. Farming in this country tends to be favored in many ways when it comes to policies like this but I don’t think there’s a real serious economic reason for exempting. And the problem with exempting any particular industry is from an economic point of view, when you exempt any industry, you’re saying, okay, well you don’t have to do anything and that puts more pressure on the other industries to do more. So that’s a problem. And I think politically it becomes a bit of an us versus them problem. The best way to think about reducing greenhouse gas emissions is that we are all emitters. All of us as households or small businesses or large businesses and across all sectors of the economy. We all emit greenhouse gases. So from a political point of view, I would argue that it’s best to get everybody involved in the common project. And so exemptions I think are bad idea economically. They’re also a bad idea politically, but you should not view the output based pricing system either in Ontario or federally as really an exemption.

Una Jefferson: And how much does this set of industrial emissions performance standards interact with the other piece of the federal carbon pricing system which is this Carbon Levy, which is supposed come into effect in April of 2019. How would they interact if they were to apply together?

Chris Ragan: If the Ontario emissions performance standard co-existed with the federal output based pricing system I think you’d have a mess. It’s difficult to think through how those two systems might interact as you might have slightly different coverage of firms and industries, you might have different thresholds you might indeed even have different prices which would make the analysis of how they interact very complicated. Our sense, when we looked at the output, the emissions performance standards as planned in Ontario, they looked so similar to the federal system that it surprised us that the federal government had actually rejected that part of the Ontario plan. But remember there’s an other part of the federal plan that the Ontario government doesn’t have in its plan, which is the more economy wide carbon levy applied to fuels. And that’s the part that would impact on household and impact on small businesses. And that is a really important part of a good and well-designed carbon pricing plan. That’s the part that really is missing in the Ontario plan, but it’s front and center in the federal plan. Perhaps it’s the case that the federal government just rejected Ontario’s plan as a whole rather than accepting or rejecting bits and pieces of it. But it is true that the Ontario emissions performance standard is output based pricing. They just have chosen not to use those terms.

Una Jefferson: And what does this proposal from Ontario mean for Ontario’s ability to meet its emissions reduction targets and Canada ‘s? What does this mean for Canada’s ability to meet its Paris targets for example?

Chris Ragan: Well, what does it do for Ontario’s targets, almost certainly it is a less stringent plan and will be less effective at reducing emissions than the plan that it replaced. When you look at Ecofiscals work on this, our assessment was that it is going to do less emissions reductions and probably do it at a higher cost than the previous cap and trade plan, the one that was repealed. So it’s a less stringent plan. It’s a less aggressive plan and it’s probably more costly per unit of reduction. What that means for Canada’s overall target is, if Ontario is going to do less and if Canada is to achieve its target, then more of the emissions reductions have to come from outside of Ontario. So that’s putting more onus on the rest of the country.

Una Jefferson: The EcoFiscal Commission is in his last year. This project is set to end at the end of 2019. What do you guys have in the works for your last few months?

Chris Ragan: We have a nice snappy little report coming out in the next month about myths that are permeating the carbon pricing debate in this country, and we slay those myths. So we identify 10 things that you commonly hear discussed in this, overall policy debate and we go through the analysis and the evidence for why those things are not true. So that’s coming out soon. And then you’ll see toward the end of the year, what will be our final report, that is really doing a kind of a horse race between different approaches. A very realistic carbon pricing approach versus two very realistic, non-carbon pricing approaches and doing an overall assessment of which ones reduced the most emissions, which ones cost the most in terms of economic growth, which ones are most politically feasible, which ones are most administratively achievable or complicated. Basically do an overall assessment of carbon pricing versus two other approaches. We’ll also have some discussion about what Canada should be doing looking forward, but that’ll will be our last report and that will come out sometime in the fall.