Design Principles for Ontario’s New Cap-and-Trade System

The Way Forward for Ontario: Design Principles for Ontario’s New Cap-and-Trade System

Watch the webcast of The Competitiveness Question: Business opportunities and challenges in a cap-and-trade environment which was held June 3rd.
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Executive Summary

Over the next year, Ontario will design and implement a cap-and-trade system for reducing greenhouse gas emissions. Much public discussion has focused on the effectiveness of cap-and-trade as an overall approach to pricing carbon. While it is possible to debate the inherent advantages and challenges of cap-and-trade compared with other carbon-pricing approaches, the fact is, these differences are small. Effective cap-and-trade systems can, and do, exist. But various problems also exist. In Ontario, as in any other jurisdiction, the success of the cap-and-trade system will hinge on the design details.

Drawing on the Ecofiscal Commission’s April 2015 report, The Way Forward, this brief outlines four fundamental principles of good cap-and-trade design. It offers a practical roadmap and specific recommendations to Ontario as the province moves toward developing its policy. The same principles could be used as a guide by any province considering the introduction of a cap-and-trade system.

A common theme runs through these principles and recommendations: transparency. It is not enough to design a policy that is effective, cost-effective, and fair. It must also be clear, predictable, and immune to political interference. The confidence of Ontarians—everyday consumers and big emitters alike—is critical to the success of the province’s new policy. While the principles outlined in this brief do not address every detail of policy the government will need to consider, they offer the basis for a well-designed cap-and-trade system for Ontario.

Principles and Recommendations

  1. Stringency of policy should rise gradually and predictably over time in order to drive meaningful emissions reductions.

 Ontario should

  • introduce a “cap” on emissions that results in meaningful reductions. That cap should steadily and predictably decline over time;
  • manage price volatility to ensure long-term incentives for innovation and deep reductions;
  • enforce strong non-compliance penalties.
  1. Coverage of policy should be as broad as practically possible.

Ontario should

  • use a combination of upstream and downstream points of regulation;
  • avoid exemptions or exclusions to ensure cost-effective, fair, and transparent policy;
  • carefully handle the use of offsets, if used, which can further broaden coverage, but only if they are credible and represent real and verifiable emissions reductions.
  1. Aim to auction all allowances. The scope for free allocations should be narrow, rules-based, and transitional.

Ontario should

  • auction allowances as a rule to enable more cost-effective, simple, and transparent policy;
  • allocate free allowances only as an exception to reduce adverse competitiveness impacts, but provide this support based on clear, transparent rules and for a limited period;
  • avoid free allowances in sectors in which emitters can pass on costs.
  1. Seek out opportunities for linkage.

Ontario should

  • link with Quebec and California, as planned, to improve cost-effectiveness reinforcing an existing template for inter-jurisdictional carbon-pricing;
  • encourage other provinces and jurisdictions to join the linked system, broadening the scope of the cap-and-trade system
  • design its system for harmonization on elements such as price floors/ceilings, reporting, and monitoring, verification, and enforcement.
Download the Full Brief Watch the Webcast of our June 3rd event