Equivalency of Carbon Pricing Systems Under the Pan-Canadian Framework
Guest Blog By Joanna Kyriazis, Policy Director at Zizzo Strategy
On December 9th, Prime Minister Trudeau and the First Ministers released a national climate plan. The Pan-Canadian Framework on Clean Growth and Climate Change (the Framework) outlines a coordinated approach for significant emissions reductions across the country. A key part of the Framework is a benchmark for pricing carbon pollution that all provinces and territories need to adopt by 2018 to help Canada meet its greenhouse gas (GHG) reduction targets and provide predictability to Canadian businesses. Under the recent Paris Agreement, Canada committed to 30 percent reduction target below 2005 emission levels by 2030.
Carbon pricing sounds straight-forward; however, it is not as simple as it appears. To be clear, the Canadian federal government is not taking a top-down approach by setting a national carbon tax applicable across the country. Rather, the federal government has granted provinces and territories flexibility in determining which carbon pricing system they wish to use—so long as they meet the 2018 deadline and certain federal minimum standards. To this point, the provinces have taken leadership on climate change in Canada, something which the Framework seeks to build upon.
For provinces adopting an explicit price-based system such as a carbon tax, the Framework provides that the carbon price is to start at a minimum of $10 per tonne in 2018 and rise by $10 per year to $50 per tonne in 2022. Cap and trade systems, on the other hand, need: (i) a 2030 emissions-reduction target equal to or greater than Canada’s 30 percent reduction target, and (ii) a declining annual cap through at least until 2022 that corresponds, at a minimum, to the projected emissions reductions resulting from the carbon price that year in price-based systems. If a province or territory fails to adopt a carbon tax, cap and trade system, or a hybrid approach by 2018, the federal government will implement a carbon price directly.
In the late hours of the Pan-Canadian Framework negotiations, British Columbia Premier Christy Clark raised concerns related to fairness between different types of carbon pricing systems under the Framework. For instance, BC has taxed carbon emissions since 2008 and she was concerned that the measures some other provinces are adopting would not amount to the same thing.
These concerns appear valid on their face. BC’s carbon tax is currently priced at $30 per tonne. Meanwhile, in Quebec, which implemented a cap and trade system in 2013, carbon allowances at its most recent joint auction with California in February 2017 sold for $18 CDN (note that for this particular auction, however, the number of allowances sold was said to be quite low, which many observers attribute to continued legal uncertainty of the California cap and trade system).
Premier Clark’s concerns raise an interesting question: how will we ensure equivalency between carbon pricing systems? If BC continues to raise its carbon tax to $50 per tonne, as required under the Pan-Canadian Framework, and Quebec and Ontario’s cap and trade systems are subject to potentially significantly lower allowance prices, can we really say that the systems are equivalent?
First, the evaluation of equivalency is not as simple as comparing the price of a carbon tax to the price at which allowances are bought and sold under a cap and trade system. Several other factors must be considered, including how a province or territory chooses to spend the revenues generated from carbon pricing. Carbon tax jurisdictions that are “revenue neutral”, returning money through household dividends or corporate tax breaks, could help to offset the impact of a price of a $30 or $50/tonne tax. Meanwhile, a cap and trade system might trade carbon allowances at $18/tonne but then reinvest revenues in ways that do not result in economic benefits for the majority of the population. In this case, the carbon price could be felt more potently by business and consumers despite appearing lower on its face. Moreover, most provincial governments will use a variety of revenue recycling approaches that balance the individual circumstances of the province in question.* A carbon price to allowance price comparison will thus not provide an accurate picture of how two pricing systems compare.
Second, an equally if not more important point of comparison is the carbon pricing system’s effect on carbon emissions. But such a focus also presents challenges, as carbon tax and cap and trade systems are unpredictable in different ways. For instance, while a carbon tax provides price certainty, it does not guarantee emissions reductions. Take BC for example. Despite having had the highest carbon price in Canada at $30 per tCO2e (tonne CO2 equivalent), the total amount of emissions in BC have actually flatlined since the carbon tax was introduced in 2008 and have lately begun to increase. Its carbon price is not high enough to drive meaningful emission reductions. As such, the province will miss its 2020 emission reduction target and has unfortunately declined to set one for 2030. In fact, a recent study by Navius has indicated that, even if BC implements a $50/tonne carbon price and the provisions of BC’s recent Climate Leadership Plan, the province would still miss its 2020 and 2050 emission reduction targets. Emissions have increased significantly in BC in recent years due to the rise of shale gas exploitation.
In contrast, a cap and trade system (if implemented properly) provides predictable GHG reductions but uncertainty around the market price of allowances. In the Quebec-California example, the price of Quebec’s allowances is currently subject to the uncertainty created by legal challenges impacting confidence in California’s carbon market. Also important is how differences in the cost of reducing emissions between California (relatively low) and Quebec (relatively high) affects the price of carbon in the linked carbon market between them. By purchasing allowances from California where emissions are cheaper to reduce, Quebec can achieve considerable emissions reductions in a relatively cost-effective way. Therefore, while the cost of allowances is lower in Quebec ($18) than in BC ($30), this does not translate to fewer emissions being reduced under Quebec’s cap and trade system. Economic models suggest that total emissions across both Quebec and California will decrease.
It will be interesting to watch whether the federal government recognizes emission reductions achieved outside of provincial boundaries for those jurisdictions with linked cap and trade systems as counting towards Canadian provincial and federal emission reduction targets. Canada has indicated that it may use international mechanisms to achieve its 2030 target, if those international mechanisms come from robust systems that deliver real and verified emissions reductions.
Thinking about the equivalency between carbon taxes and cap and trade continues to evolve. To accommodate this, the Pan-Canadian Framework incorporates a formal review in 2022, at which time equivalency will be assessed and the effects of new and existing carbon pricing regimes in other countries will be considered. At this point we will need to wait and see how things play out among various carbon pricing systems—both in Canada and across the world.
* It worth noting that in the situation where the federal government is obliged to implement a carbon price in a province, under the Framework it will return any revenues to the province in spirit of being “revenue neutral”.