North American Cap-and-Trade?

In a Vancouver Sun article, Miro Cernetig wonders whether the BC government is slowing down climate change actions because of business push-back. There is no doubt some truth to this, but reading the full article reveals something different entirely. The real issue is the state of the Western Climate Initiative, a cap-and-trade system that focused on the western part of the continent. This is a complex undertaking.

In BC, framework legislation for a cap-and-trade system was recently passed by the Legislature, but it is an empty shell pending the negotiations at the WCI. In the interim, BC companies will be covered by the new carbon tax starting in July, and any subsequent cap-and-trade system would then exempt those sectors from the carbon tax to avoid double coverage. Two major sectors, cement and aluminum, were not covered by the carbon tax proposal when unveiled in February’s budget, although talks are on to bring them inside the tent. This was more to do with budget secrecy, as the 70% of GHG emissions covered could be achieved by taxing fossil fuels, whereas cement and aluminum are emissions created by industrial processes. Fugitive emissions from landfills and pipelines must also be covered somehow.

Unfortunately, Cernetig pegs his hook for the article on backroom BC politics, and does not mention the carbon tax aspect. Hey, this stuff is complicated! Still, musings about the path forward for WCI do raise some interesting issues for how carbon pricing evolves in the North American context:

On Aug. 8, the WCI’s subcommittees working on the C02 reduction targets for various economic sectors will put out recommendations. B.C and nine other states and provinces will consult with their own stakeholders for up to three months. By 2009, they hope to issue yet another memorandum of understanding, or general statement of commitment, on how the carbon-trading system will work. At this rate, targets would only start to be put in place at the end of 2009. I’d bet on 2010.

… The value of a regional carbon market is in doubt, because by 2009, there will be a new U.S president, one who is very likely to spearhead a national cap-and-trade system for the entire United States. Republican presidential nominee John McCain and Democratic hopefuls Barack Obama and Hillary Clinton have all indicated support for the carbon-trading system that President George W. Bush has long resisted.

Where to for cap-and-trade in North America? The WCI has been moving eastward – the article notes that Quebec just signed on, joining Manitoba and BC as full members, with Ontario and Saskatchewan as observers (Alberta? Don’t ask.). There are seven US states as full members, and six more that are observers; plus six Mexican states are also observers. This tent is getting pretty big, and given that they have been actively discussing the devil-in-the-details issues around implementation, this core could well form the basis for a US national cap-and-trade system.

Our federal government has also promised a Canadian cap-and-trade system, though there seems to be almost no work going on to move that idea forward. No one really knows how a Canadian cap-and-trade system in addition to the WCI would work. So a US-wide effort would likely become a North American cap-and-trade system.

But even with a smaller number of participants, the complexity of designing this system is immense. Which is why many carbon pricing advocates favour a carbon tax over cap-and-trade. The redeeming feature of cap-and-trade is that it does deliver emissions reductions on a specified timeline. That is, a carbon tax gives price certainty but is not clear on actual emissions reductions, whereas cap-and-trade gives quantity certainty but lets the market determine the price.

I spent a couple days recently in a room full of carbon price policy wonks and came away leaning more towards the carbon tax as a more elegant and straightforward means of carbon pricing. Certainly, coverage is an issue in the real world of implementation, as cap-and-trade at best only captures large emitters, and would need a carbon tax for the remainder of emissions. Another real-world matter with cap-and-trade is allocation – whether emissions permits will be given away or auctioned. The latter is preferable as the revenue can be used by government to offset regressive impacts and reinforce environmentally-friendly behaviour (like a carbon tax), but political considerations may not lead to an auctioned permit system.

It gets uglier. A cap-and-trade system must make similar choices but in a regional context decide what decisions will apply uniformly to everyone and what will be left to each jurisdication. It must figure out allocations for the whole group, policies on offsets, and what sectors are covered.  See the recent WCI draft design recommendations to get a sense of this.

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