Québec’s cap-and-trade system: Emitters cautiously testing the waters

Vol. 45 No. 5

Charles Kazaz is a partner practicing environmental law with Blake, Cassels & Graydon LLP in Montreal and Toronto. Anne-Catherine Boucher is an associate practicing environmental law with Blake, Cassels & Graydon LLP in Montreal.

Québec’s GHG reduction efforts

The province of Québec has been at the forefront of policy and legislative efforts to control greenhouse gas (GHG) emissions. Québec has adhered to the principles of the United Nations Framework Convention on Climate Change since 1992 and has consistently implemented policies and action plans aimed at reducing GHG emissions in the province. Following its adoption of the Kyoto Protocol, the Québec government has confirmed on several occasions by way of parliamentary motions and government decrees that Québec would adhere to the Kyoto Protocol’s principles and objectives. In 2009, the government adopted Decree 1187-2009 setting its GHG emission reduction target for 2020 at 20 percent below 1990 levels and when Canada, as a nation, formally withdrew from the Kyoto Protocol in 2011, the Québec legislative assembly unanimously adopted a motion reaffirming Québec’s commitment to the Kyoto Protocol target. According to the latest annual inventory of GHG emissions (Québec Inventory of Greenhouse Gas Emissions in 2010 and Their Evolution Since 1990, Government of Québec, 2013), published by Québec’s Ministry of Sustainable Development, Environment, Wildlife and Parks, the province’s GHG emissions in 2010 totaled 82.5 million metric tons of carbon dioxide equivalents (Mt CO2e). This marked the second consecutive year GHG emissions were below 1990 levels. Moreover, Québec’s per capita GHG emissions were 10.4 t CO2e in 2010, compared to the Canadian average of 20.3 t CO2e.

In 2008, Québec joined the Western Climate Initiative (WCI), which at the time was composed of seven U.S. states and four Canadian provinces working collectively to develop a North American carbon market. That same year, Québec’s legislature amended its Environmental Quality Act to provide the government with regulatory authority to implement a cap-and-trade system, including the ability to establish reduction targets, set emission caps, implement a mechanism for the sale and auction of emission credits, and require the reporting of emissions. At the time, Québec’s Minister of Sustainable Development, Environment, Wildlife and Parks stated that the main purpose of the amendments was to allow for the implementation of a cap-and-trade system together with other WCI members and to provide access to a broad carbon market.

Québec subsequently adopted two regulations to implement a cap-and-trade system and an emissions reporting mechanism to support it. The “Regulation Respecting Mandatory Reporting of Certain Emissions or Contaminants Into the Atmosphere” came into force first on December 30, 2010, and the “Regulation Respecting a Cap-and-Trade System for Greenhouse Gas Emission Allowances (the “Cap-and-Trade Regulation”) came into force on January 1, 2012. As a result, Québec became the first Canadian province to adopt a cap-and-trade system and the second partner, with California, in the WCI carbon market. Although all of the U.S. states that were WCI members, except for California, withdrew from the WCI and although no other Canadian province moved forward to establish a cap-and-trade system, the Québec government did not swerve from its objective of implementing a cap-and-trade system. In the fall of 2013, Québec and California signed an agreement to harmonize and fully link their respective carbon markets effective January 1, 2014. When the government of Québec announced it would move ahead with the cap-and-trade system with just California, industry raised concerns about the effectiveness and liquidity of a carbon market comprising only two participating jurisdictions and the potential competitive disadvantage for Québec businesses compared to businesses located nearby in Ontario and the northeastern United States, which were choosing not to implement a cap-and-trade system.

The implementation of the cap-and-trade system within the broader North American carbon market is a key component of Québec’s current Climate Change Action Plan (2013–2020 Climate Change Action Plan: Québec in Action—Greener by 2020, Government of Québec, 2012), which covers the period between 2013 and 2020. The government will use funds that it raises through the cap-and-trade system to fund the Action Plan’s initiatives, such as promoting public transit and alternative transportation (including the use of electric means of transportation), enhancing energy efficiency in the private sector, promoting the transition to renewable energies and greater energy efficiency in buildings, and supporting municipal and community initiatives to reduce GHG emissions, adapt to climate change, and engage in sustainable land-use planning.

Overview of the cap-and-trade system

The Cap-and-Trade Regulation seeks to harmonize and link the Québec cap-and-trade system with the California system.

Regulated Emitters

On January 1, 2013, facilities in the industrial and electricity sectors whose GHG emissions were equal to or greater than 25,000 t CO2e per year became subject to Québec’s cap-and-trade system. As of January 1, 2015, distributors and importers of fossil fuels whose annual GHG emissions met or exceeded the annual threshold of 25,000 t CO2e will also be subject to the system. It is estimated that approximately 80 facilities from the industrial and power generation sectors became subject to the cap-and-trade system on January 1, 2013. In 2015, the system should cover about 85 percent of Québec’s total GHG emissions.

For a given compliance period, the Cap-and-Trade Regulation requires regulated emitters to cover their total reported (and verified) GHG emissions with an equivalent number of compliance instruments or “emission allowances” in circulation on an annual basis. The government may freely allocate allowances, auction them off, or sell them to a party by mutual agreement. The regulation provides for other sources of compliance instruments, including offset credits issued in connection with reductions in GHG emissions in sectors not subject to the cap-and-trade system, credits for early reduction of emissions between 2007 and 2011, and emission allowances issued by California.

In December 2012, Quebec adopted a decree (Order in Council 1185-2012, Government of Québec, December 12, 2012), which sets a cap on the number of emission allowances that the government will put into circulation each year starting in 2013. The cap set for each year will gradually drop starting in 2015, resulting in absolute reductions in GHG emissions.

Free allowances

The Quebec government annually allocates a number of free emission allowances to regulated emitters in certain source categories, including some agri-food establishments, thermal power producers, and a number of industries, namely the aluminum, lime, cement, chemical and petrochemical, metallurgy, mining and pelletizing, pulp and paper, petroleum refining, glass container manufacturing, electrode manufacturing, and gypsum products industries. In 2013, the government freely allocated 75 percent of the emission allowances to 44 emitters within certain industrial sectors.

Essentially, the Québec government considers these industrial sectors to be facing foreign competition and as a result decided to award free emission allowances to them in order to avoid “carbon leakage”—the relocation of industry (and the associated GHG emissions) to jurisdictions that do not have a cap-and-trade system. The government intends for the number of free allowances that it awards to drop gradually each year, beginning in 2015. Companies whose GHG emissions for a given year are above the number of units allocated to it by the government need to purchase emission allowances at government auctions or on the carbon market. Companies may choose to reduce emissions by adopting cleaner technologies and possibly sell surplus allowances on the carbon market.

Auctions

The Cap-and-Trade Regulation provides that the government may hold up to four auctions per year for carbon allowances. Auctions are announced at least 60 days before they are held. Participants in the auction must register at least 30 days in advance, deposit a financial guarantee to cover the cost of its purchases of allowances, respect a bidding limit based on this financial guarantee provided, and respect the holding limit for allowances and the purchase limit at the auction. The regulation establishes a minimum auction price annually, starting at CAD$10 per allowance in 2012 and increasing annually by 5 percent plus inflation until 2020. The minimum prices for 2013 and 2014 are set (in Canadian dollars) at $10.75 and $11.39, respectively.

The government held its first auction on December 3, 2013, and it was limited to Québec participants only. This auction was for the sale of emissions units for the then present vintage (2013) and for a future vintage (2016) and had limited success—only 19 participants submitted bids during the auction, and only one-third of emission allowances for 2013 and one-fourth of the emission allowances for 2016 found bidders. In both cases the allowances were purchased at the minimum auction price of $10.75. The reasons for this initial limited participation and interest in purchasing allowances was not clear; however, it was thought that the level of participation was not necessarily indicative of future participation in auctions considering that all of the emission allowances available for auction in 2013 were made available at once and some emitters may be waiting for later auctions to purchase allowances. The subsequent auction, held on March 4, 2014, was also limited to Québec participants and participation increased significantly. That auction was for the sale of emission units for the present vintage (2014) and for the 2017 vintage. Sixteen participants submitted bids, and 98.65 percent of the emission allowances for 2014 and 84.15 percent of those for 2017 were auctioned off. Once again, the allowances were purchased at the minimum auction price of $11.39. The second auction of 2014, scheduled for May 27, 2013, and subsequent auctions are to be held jointly with California.

Offset credits

Québec may issue “offset credits” to emitters or participants domiciled in Québec who avoid causing emissions or who capture, store, or eliminate GHGs in the course of their activities. In accordance with WCI recommendations and the agreement entered into between the Québec government and the California Air Resources Board (described below), Québec may issue offset credits only if the emission reductions are real, verifiable, additional, permanent, and enforceable. In order to be admissible for offset credits, an offset project must be carried out in accordance with one of the three protocols recognized by the Cap-and-Trade Regulation and the offsets must be validated and verified by properly accredited third-party verifiers in accordance with the requirements of the regulation.

The Québec regulation recognizes three protocols to offset GHG emissions: (i) Covered Manure Storage Facilities—CH4 Destruction, (ii) Landfill Site—CH4 Destruction, and (iii) Destruction of Ozone Depleting Substances Contained in Insulating Foam Recovered from Appliances. These protocols are similar to the protocols adopted by the California Air Resources Board. The Québec regulation limits an emitter’s use of offset credits to 8 percent of the number of compliance instruments that the regulated entity must submit.

Linking the Québec and California markets

In September 2013, the California Air Resources Board and the Québec government entered into an agreement for the harmonization and integration of their respective cap-and-trade programs. The relevant branches of each government subsequently ratified the agreement, and the Québec and California carbon markets became linked effective January 1, 2014. The main thrust of the agreement is to achieve harmonization and integration of the parties’ cap-and-trade programs, which includes mutual recognition of the other party’s compliance instruments; the trading of compliance instruments among registered participants in each party’s program; joint auctions; and the use of a common platform for the reporting, tracking, and trading of emission allowances. The linkage of the two systems is expected to improve liquidity in both markets.

Trading of allowances

Emission allowances allocated freely by the government, emission allowances purchased at a government auction, offset credits, early reduction credits, and emission allowances issued by a partner entity may all be traded through the Compliance Instrument Tracking System Service (CITSS), a common registry developed and shared by Québec and California. As of January 1, 2014, users of CITSS registered either in Québec or in California will be able to sell and purchase carbon allowances originating from either one of these territories and the origin of these allowances will not be identified in the system. Québec and California have adopted common holding limits for allowances to minimize the risk of market manipulation through the exercise of market power.

It will be interesting to see the level of participation in the upcoming joint auctions now that the Québec and the California carbon markets are linked.

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