Emission trading system canada

Emission trading system canada

Author: Roobox Date: 25.05.2017

Carbon markets and emissions trading: In March the Harper government announced the final details of its regulatory framework for reducing industrial greenhouse gas GHG emissions. The government has indicated its intention to move from emission intensity targets to fixed emission caps in the period. Intensity targets are relative targets that specify GHG emissions per unit of production of a good relative to a base year, as opposed to absolute targets that specify reductions in total GHG emissions.

Regulated companies will have several options to meet their intensity targets. One alternative is domestic emissions trading, where companies whose emissions are below their target will receive credits that can be sold to other companies.

The European Union Emissions Trading System

In particular, firms would need to pay attention to this market when making investment decisions. This article begins with an overview of the global carbon market and the role of emissions trading. Emissions trading can be important for encouraging the reduction of emissions in a cost-effective manner.

The article summarizes some of the lessons from the European Union Emission Trading Scheme EU ETS , which has been running since This market consists of two types of assets: An emissions allowance represents a permit to emit one tonne of CO2 or its equivalent in other greenhouse gases. Emissions allowances are created under national cap-and-trade schemes, where the supply of carbon allowances for a given period is set by a national regulator to achieve a targeted reduction in overall GHG emissions over a given time horizon.

Individual firms then decide how best to meet their individual targets " either by improving their production processes or by purchasing allowances from other firms known as emissions trading. Emissions trading has taken off since , with trading in this new asset class representing 78 percent of the carbon market by value traded in , with almost all the volume in the EU ETS.

Emissions trading is seen as a costeffective and flexible way to reduce carbon emissions. By creating an allowance that can be traded, emissions trading transforms a constraint the obligation to cut emissions into an asset a new commodity to be traded alongside other commodities such as oil, natural gas and electricity.

This approach provides flexibility for firms that can choose the most cost-effective strategy to meet their individual emissions targets. Firms with low-cost opportunities to reduce emissions can invest to reduce their emissions and finance part of this investment by selling their surplus allowances to firms that have uneconomic abatement opportunities.

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An important benefit is that emissions trading becomes a source of information for firms on the costs involved in reducing CO2 emissions, and for policy-makers on the appropriate level and the pace to achieve national targets. The most active cap-and-trade market for carbon is the European Union Emission Trading Scheme EU ETS , launched in Table 1 shows that the allowances created under the EU-ETS represented 78 percent of the global carbon market by value traded in Emissions trading in CO2 under the EU ETS has followed the practices pioneered by the United States Acid Rain Program, where a cap-and-trade system in emissions of sulphur dioxide SO2 and nitrogen oxides NO2 developed following the passage of the US Clean Air Act.

The US and European experiences suggest five steps in the creation of a cap-and-trade scheme.

Regulation of air pollution in Canada

The first step is to pass regulation that sets mandatory limits or caps on CO2 emissions over a specific time period. The national cap determines the supply of allowances over a given period, which will affect the price signal.

The cap is set to achieve a reduction in emissions to a desired level over the target horizon. The second step is to pass national regulations that specify which individual firms are covered by the cap " whether private companies, public sector installations or both.

Each firm is given its own cap consistent with an aggregate reduction in CO2 emissions. The firms are then allocated the appropriate number of carbon allowances. At the end of the period covered by the regulations, each firm must either reduce its CO2 emissions to a level at or below its individual cap, or deliver allowances equal to the excess amount of emissions. Firms that fail to meet their targets are fined. Once allowances are allocated, the third step is for trading to begin. Each firm must determine the most cost-effective means to reduce or abate its carbon emissions.

The firm may invest to improve its production processes. Or it may judge that it is cheaper to buy allowances in the carbon market sufficient to cover its excess emissions. Physical trading in carbon instruments takes place either on an organized exchange or over the counter, similarly to the trading of other commodities.

A number of carbon exchanges have emerged in Europe and North America that trade spot, forward and option contracts in carbon. In Canada, for example, the Montreal Exchange launched the Montreal Climate Exchange in to provide a location for Canadian firms to trade in CO2 allowances. The fourth step is to put in place the necessary infrastructure.

Experience suggests that a successful cap-and-trade system relies on the following elements:. These components are critical for promoting both public and business confidence in the system, allowing the market to function properly and minimizing uncertainty.

The fifth step is to ensure compliance. The firm must either deliver the equivalent number of allowances for its excess emissions or pay some predetermined fine if it is short. This fine effectively sets an upper limit on prices for emissions. In the case of the US Acid Rain Program, compliance has been very high, with over 99 percent of firms meeting their targets, thanks to rigorous monitoring, reporting requirements and stringent penalties.

By , the Environmental Protection Agency reported that sulphur dioxide emissions were 41 percent below their levels, while emissions of nitrogen oxides were 57 percent below their levels. Since , a number of countries have experimented with voluntary cap-and-trade schemes, but only New South Wales in Australia and the European Union have passed regulations establishing legal caps on CO2 emissions.

The EU ETS, launched in , sets mandatory caps on CO2 emissions for the 27 member countries of the European Union. The EU-ETS has consecutive trading phases, with the first phase running from to and a second phase from to A review of the third trading phase of the ETS, starting in , is in preparation.

The number of allowances given to installations covered by the scheme is based on national emissions caps set by EU member states in their National Allocation Plans NAPs. Uncertainty over supply and demand in the EU-ETS has led to very volatile prices for EU allowances see figure 1 , which is a typical feature of any new trading system where market players have insufficient information about supply and demand dynamics.

Prices dropped sharply in April , after the release of the EU verified-emissions report that showed emissions were around 7 percent lower than expected. Prices fell again in September following the collapse of spot natural gas prices.

Member states did not allow installations to bank excess allowances from phase I for use in phase II, so by mid there was no longer any demand for phase I allowances, since companies had purchased all the necessary allowances. As a result, the price of spot allowances fell close to zero and remained there as the first phase expired at the end of Forward allowances have exhibited lower volatility than spot EU allowances as market participants anticipate improvements in the allocation and design features of the EU ETS.

There are a number of lessons to be learned from the operation of phase I of the EU-ETS. These lessons point to design features and operational issues that other countries should consider when developing their own emissions trading systems. A difficult issue in a cap-and-trade system is setting the level of the overall cap on CO2 emissions. The cap effectively sets the number of allowances that will be created under the scheme and thereby affects the price at which they trade.

Setting the right cap requires, foremost, reliable data about historic emissions for each installation. The lack of reliable data is seen as the main cause of the collapse in the allowance price in the EU ETS.

To ensure that trading takes place, a cap-and-trade system must include a diversity of players with different abatement costs. If all firms covered by the scheme face similar costs to reduce emissions, there is no incentive to trade.

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From the perspective of diversity, the entry of financial actors that trade for speculative rather than compliance purposes is a welcome development in the carbon markets. Brokers, dealers and investors such as hedge funds have the potential to increase market efficiency by providing liquidity and facilitating price discovery. The design flaw with this initiative is that there were insufficient limits on the number of credits that could be imported.

The EU experience with emissions trading suggests that rules for a capand-trade scheme should be clear and easily enforced. Markets function better and transaction costs are lower when rules are simple and easily understood by all participants. A key complaint about phase I has been that the allocation of national allowances was too complex and not transparent enough. Complexity contributes to uncertainty. A lack of transparency also makes it difficult for firms to understand and form a view on investment plans.

On March 10, , the federal government released T urning the Corner: Regulatory Framework for Industrial Greenhouse Gas Emissions. This document elaborates and strengthens the April Regulatory Framework for Air Emissions that laid out the broad design of regulations for industrial emissions of both GHGs and air pollutants.

These targets are seen as realistic and achievable through a combination of federal and provincial policies. Turning the Corner suggests that linkages to North American emissions trading systems " such as the Western Regional Climate Action Initiative and the Regional Greenhouse Gas Initiative " will be actively pursued.

Industrial sectors include, among others, electricity produced by combustion, oil and gas, base metal smelters, iron and steel, some mining sectors, cement, pulp and paper, aluminum and chemical production. Firms in these sectors will be required to reduce their emissions intensity from levels by 18 percent by , with 2 percent continuous improvement every year after that, for a cumulative reduction of 26 percent by The Canadian proposal targets relative intensities of GHG emissions, with credits issued with reference to a base year known as a baseline-and-credit system.

Intensity targeting is seen as more compatible with economic growth. Whether it produces more or less reductions than absolute caps depends on the stringency of the intensity targets.

Operationally, an emissions intensity target would be set for a given product with reference to a base year. Facilities that reduce emissions below their target would be allocated tradable credits that they could either bank for a future compliance obligation or sell to another facility.

Facilities that emit above their target would have to buy credits from other facilities or use their own banked credits to meet their regulatory obligation. For example, suppose the emissions intensity target is 5. Suppose Facility A has an emissions intensity of 4. It would then receive tradable credits from the government equal to the difference between the target 5.

Suppose Facility B has an emissions intensity of 5. It would be required to remit to the government credits equal to the difference between its actual emissions intensity 5. It could buy these credits from another facility or use credits that it has banked from a previous compliance period.

There will also be some credit available for firms that take early action to reduce their emissions. First, intensity targeting introduces greater uncertainty as firms and other market participants may find it difficult to forecast the supply and demand in this market, leading to price swings similar to those that occured in the EU ETS.

Unlike a carbon tax or levy that sets a price for carbon directly, intensity targeting will set the price indirectly, leading to greater volatility in the price. While volatility is a feature of many asset prices that are subject to market forces, the World Resources Institute suggests that the uncertainty and, by implication, the volatility in carbon allowances may be greater under a baseline-and-credit system than under an absolute cap-andtrade system.

Participants in existing asset markets where supply and demand are uncertain " such as the foreign exchange markets " have found ways to manage this uncertainty. Fluctuations in the Canadian dollar, for example, can be hedged due to the availability of derivative instruments such as currency forwards, futures and options. These financial instruments develop when markets are deep and liquid, and feature a diversity of players with different risk preferences.

In the case of the EU ETS, forwards on EU allowances have been available for some time, although the World Bank reports that these hedging instruments became liquid and widely available only in Hedging instruments are therefore crucial tools in a new and volatile market.

By providing a cheap alternative to in-house reductions or emissions trading, CCTF credits will effectively place a price cap on carbon credits. The price of CCTF credits is set to rise slowly over subsequent years, while the maximum allowable contribution will decline to 10 percent by Trading volumes may be limited if there is an insufficient surplus from regulated firms.

In the EUETS, companies are allocated allowances equal to their total cap, not just the surplus to their cap.

emission trading system canada

While the EU ETS features over 11, regulated entities, estimates suggest that only Canadian firms will be covered by industrial caps. Without a large diversity of players, it is not clear which companies will provide liquidity by selling surplus allowances.

It remains to be seen whether firms in unregulated industries will have an incentive to supply domestic offsets to regulated firms. If the carbon price is too low, the incentives will not be great. The concern about supply and illiquidity may limit the availability of hedging instruments. Limited turnover in the underlying carbon credits will make hedging difficult, limiting the development of derivatives.

In this situation, the ability of the market to discover the fundamental price becomes impaired, and transaction costs will likely be higher. Fourth, Canada needs to put in place an emissions registry and a system for verifying emissions from regulated companies. A UN compliance committee recently noted that Canada had not yet established a national registry to keep track of its GHG emissions, putting it in violation of the Kyoto Protocol and jeopardizing access to CDM offsets.

What Countries Are Doing To Tackle Climate Change : NPR

A registry is crucial for ensuring the success of emissions trading, as it provides credibility for counterparties on ownership. The World Resources Institute argues that intensity targeting systems require a higher level of public assurance regarding data quality in order to be credible and effective. The federal government therefore needs to collect and publish data on energy intensity and output, as intensity targets are a function of both inputs.

While emissions for relatively homogeneous products such as cement, steel, aluminum or electricity are easier to monitor, more complex products with multiple energy inputs such as chemicals or pulp and paper are more problematic. The EU has addressed this issue by providing third-party verification, which ensures compliance and avoids the risk of firms gaming the system.

Canadian policy-makers should consider this option carefully. The American system is expected to emerge around A related issue is that the different supply and demand dynamics and greater complexity of the Canadian system will likely lead to price differences between markets. As a result, a carbon allowance in Canada will have a different cost than an allowance in the United States.

Linking trading systems with the US and the EU would facilitate arbitrage, increase liquidity, reduce transaction costs and allow Canadian firms to face a global price for carbon emissions, maintaining Canadian competitiveness.

In summary, the carbon market is here to stay. Emissions trading is a cost-effective and flexible mechanism to reduce carbon emissions. An effective system has these features: The Canadian intensity targeting framework meets some of these criteria, but falls short on others. In particular, the greater complexity, potential illiquidity and existence of cheap alternatives may hamper development, increase volatility, raise transactions costs, limit the availability of hedging instruments and restrict the ability to link with the US and EU systems.

Canadian policy-makers should consider whether it is better to proceed with a system that may be illiquid in its early years, or whether it is worth amending it to address these issues. Whatever choices are made, simplicity and transparency will ensure the most effective outcome.

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