New Brunswick’s draft carbon pricing plan for big emitters came out last week, and it raises some interesting and important questions. As Ecofiscal has noted before, well-designed “output-based carbon pricing systems” are a good way to reduce emissions and protect businesses’ competitiveness. We’ve argued that providing targeted support for “emissions-intensive and trade-exposed” industries is a good idea. As a rule, output-based support doesn’t undermine the incentive created by carbon pricing for firms to improve their emissions performance. But here’s the thing: New Brunswick’s plan has a potentially serious design problem. It provides too much support to industry. It might be the exception to that rule. And that exception should not become the norm for Canadian provinces.

Why output-based pricing doesn’t let big emitters off the hook

OK a quick reminder: the system for large emitters in New Brunswick is an output-based carbon pricing system, just like the federal backstop, the Alberta system implemented under the Notley government as well as the replacement system proposed by Jason Kenney, Saskatchewan’s system, and the system proposed by the Ford government in Ontario. Quebec’s cap-and-trade system similarly provides some permits to vulnerable sectors for free. In terms of the kind of policy we should use for big emitters, Canada seems to have an emerging consensus.

Those systems work by charging only for emissions above a certain benchmark defined based on emissions intensity (emissions per unit of output). Firms have incentive to produce more output but fewer emissions. Further—if systems are designed well—firms always have incentive to improve their emissions performance, because if they go beyond their benchmark, they can generate credits that they can sell to other firms.

That’s why it’s inaccurate to think of an output-based system as an exemption for big emitters. That targeted support for emissions-intensive and trade-exposed industry is a feature, not a bug. Under these systems, big emitters still face incentive to reduce their emissions by improving their performance. But they don’t have incentive to shift investment, production, jobs (and GHG emissions) to other jurisdictions with weaker policy: reduce emissions in Canada, avoid leakage and competitiveness problems. Win-win. If the system is designed well.

Why New Brunswick’s approach is the exception to the rule

As always, the details of policy matter too. I want to highlight two details for New Brunswick’s system.

First, the New Brunswick plans to define those emissions intensity benchmarks we discussed above based on individual facilities. Normally, it makes much more sense to define benchmarks based on sector averages to avoid giving more support to dirtier facilities (the federal system and the Alberta system put in place in 2018, for example, do exactly this). New Brunswick has several sectors with only one facility (e.g., the Irving oil refinery in Saint John) so it doesn’t really have a choice, though it could consider using a national average.

Second, the New Brunswick plan appears to set those emissions-intensity benchmarks at a very high threshold, which provide very substantial benefits to industry. According to a briefing deck from the New Brunswick government, it looks like big emitters will only pay the carbon price on 0.84% of their emissions to start. In other words, the policy will set emissions-intensity benchmarks for output-based allocations roughly equal to current emissions for each emitter. Compare that to the federal system, which sets benchmarks at 80% to 90% of sector averages.

Together, the implications are troubling. These choices suggest that firms can very easily achieve their emissions intensity benchmark, because it will be essentially set to current levels. With firms facing small or non-existent compliance gaps, demand for additional compliance credits is likely to be low. As a result, the market price of these credits will also be low, and so will be the incentive for firms to improve their emissions performance beyond the benchmark. It won’t matter that government will supply additional credits at $50 per tonne in 2022 if no firms require those credits.

All this suggests that the true market price of carbon will not necessarily match the price of carbon in the rest of Canada, and that the system will be less effective in reducing emissions.

Why support for industry can be too much of a good thing

There’s a certain irony that opponents of the federal carbon pricing backstop criticize the system as providing “big breaks for industry.” Yet in provinces such as New Brunswick (and Ontario and Saskatchewan), opponents of the federal system are proposing systems that increase the support to industry.

The reality is in the middle. Output-based pricing does lower the costs of carbon pricing for big emitters. It does so to ensure that those big emitters reduce emissions by improving their performance, not by shifting investment, production, jobs (and emissions) to other jurisdictions. But providing too much support can mean that emitters might not reduce emissions (much) at all. As Ecofiscal recommended four years ago, output-based carbon pricing works best when support for industry is targeted, temporary, and transparent. 

Details matter. New Brunswick is proposing the right policy instrument, but should revisit its proposed emissions intensity benchmarks. Otherwise, it risks undermining the very objective that the policy seeks to achieve, reducing provincial greenhouse gas emissions. Furthermore, if other provinces follow the same approach, Canada will lag even further behind its climate objectives, requiring more ambitious (and more expensive) policy in other sectors or later in time.

Well-designed output-based carbon pricing makes sense for Canada. So let’s make sure we design those systems right.