Last week, Ontario unveiled some of its thinking on the upcoming cap-and-trade program, a key component of the province’s climate change strategy. And on Tuesday, the province released the rest of its strategy.

In this two-part blog, I’ll discuss some key details of the strategy. I’ll start with the cap-and-trade program, reviewing its good points and what could be better. I’ll also explain what leakage is and the concerns around it.

The details of Ontario’s cap and trade program have not yet been finalized. Last week the province released a document, which was intended for consultation by industry, environmental groups and the general public, and it poses a number of questions. The consultation period is a key window of opportunity during which stakeholders can weigh in and help secure a fair and effective system.

In a nutshell, the design options Ontario is proposing for the cap-and-trade system hit the mark – with one major exception.

First, the good news:

• The system will cover the vast majority, about 85 per cent, of carbon emissions in Ontario. The broader the coverage, the more effective the system, economically and environmentally. Greater coverage allows for greater emission reductions. Broader coverage also means more options for reducing pollution, which should help to ensure the most cost effective solutions are done first.
• The document says the province will implement the cap-and-trade system in 2017, which is the soonest it could reasonably be expected to get the system in place. Ontario’s 2020 emissions target is fast approaching, and the province can’t afford to delay any longer if it hopes to hit those targets.
• Ontario has chosen to include fuels such as natural gas and gasoline in 2017, the first years of the system. This is very good news. California and Quebec brought fuels into their systems in the third year, but as Ontario is late to the game, it couldn’t afford to delay including fuels if it wants to hit its 2020 carbon reduction targets (15 per cent below 1990 levels). Thankfully, it appears the province appreciates this.
• The design document also says that Ontario’s cap will come down at a rate that will allow the province to hit its 2020, 2030 and 2050 targets. This too is good news and an indication that Ontario is serious about meeting those targets.

The one big drawback of the proposal is that it appears that Ontario may give most industries in the province a huge break for the first four years of the program, and perhaps even shelter them from paying anything for the carbon pollution they emit. Cap-and-trade is one of the ways jurisdictions can put a price on carbon emissions, but for the system to be effective, polluters actually need to pay that price. The point of a cap-and-trade system is for polluters to pay to pollute, providing an incentive for them to pollute less. Without this, a key piece is missing to the system.

Under a cap-and-trade program, polluters need to obtain permits to emit carbon, and those permits are either auctioned by government or given away freely. Free permits are the most common way to deal with leakage, the concern that a company could relocate their operations to another jurisdiction to avoid paying the carbon price.

Leakage is problematic because the jurisdiction that is doing the good thing, putting a price on carbon, can lose jobs and economic activity to a jurisdiction that isn’t addressing climate change. Meanwhile, the carbon price, cap-and-trade in this case, doesn’t have the intended effect because the company is free to pollute in its new location, instead of reducing its emissions at home.

Both California and Quebec, Ontario’s partners in cap-and-trade, gave out some free permits to avoid leakage, and it was expected that Ontario would also give out some free credits. But it looks as though Ontario may be even more generous than either of its partner jurisdictions.

Following California’s lead, Ontario sorted companies into three leakage categories: high risk, medium risk and low risk. But it looks as though the province is proposing to treat each of these three categories equally and give them all or almost all of their permits for free.

Arguably, it’s the cap, —the limit on carbon pollution —and not the price that’s most important in a cap-and-trade system. But, as the government states in its paper, “the most efficient means of distributing allowances is by selling them all at auction.”  The fewer permits auctioned (because more are handed out for free), the less revenue the program will raise,  and the less money the province will have to reinvest into other climate actions, such as renewable energy or energy efficient, that will help Ontario meet its emissions reduction targets.

With our allies in the Clean Economy Alliance, we agreed that free permits should only be given to a very small set of industries, where there is compelling evidence that there will be competitiveness challenges and potential leakage. We urge Ontario to follow this recommendation and consider revising its approach to providing free permits to nearly all industry. For cap-and-trade to be effective and durable we need to ensure that polluters pay to pollute, and that includes industry.