With Canada likely to embark on an emissions-trading scheme this year, Oliver Holtaway looks at the various forms it could take Canada looks set to unveil some form of emissions trading scheme this year. Initial announcements regarding government-mandated emissions cuts are expected in March, before more detailed measures are announced when the Canadian government presents its budget in April.Several Canadian exchanges are now looking to develop markets for carbon credits.The Montreal Climate Exchange (MceX) plans to launch forward products this year, once the government has published its emissions reduction targets, says Leon Bitton, vice-president for research and development at the exchange."Once the targets are officially in place," says Bitton, "companies will start crunching numbers, looking to lock in prices of credits, and generally manage their risk."Bitton expects the Canadian system to develop in a similar way to the European Union's emissions trading scheme (EU ETS), with the government setting targets and building a registry of tradable allowances. The exchange's forward contracts will likely be based on units of one tonne of carbon dioxide (CO2) emitted, as in the EU ETS.MceX is the result of a partnership between the Chicago Climate Exchange (CCX) (which also owns the European Climate Exchange) and the Montreal Exchange, and as such already has trading infrastructure in place.The Toronto Stock Exchange (TSX), meanwhile, is looking to launch a spot market for the trading of carbon credits."Most of the large emitters in Canada are already TSX customers," explains Susan McLean, vice-president, trading at TSX. "We are working closely with them to provide a solution."McLean denies that the TSX will be going head-to-head with the MceX, citing the European experience of spot and forward exchanges existing happily side-by-side.Finally, the Canadian Climate Exchange (CCE), sister company of the Winnipeg Commodity Exchange (WCE), has as-yet-unspecified plans to launch a carbon trading offering. "As with our existing WCE products, we will design what our customers tell us they want to trade," says Steve Teller, project manager at the CCE. "Much will depend on how the Canadian market is shaped by regulation."And Teller is confident that a Canadian emissions trading scheme will quickly attract non-compliance traders. "Many of the speculative trading companies already are conducting this type of trading in other regimes," he says. "Also, there is a sector of buyers who are non-compliance from a regulatory perspective, but have their own internal self-imposed compliance goals to meet."This would include, for example, government departments or companies who choose to have zero-emissions, or conferences that choose to purchase carbon offsets for all attendees at their events.UncertaintiesBut there are still two key uncertainties about the design of the scheme that will affect the potential liquidity and depth of any future Canadian carbon market. The first is whether the scheme will be linked with other emissions trading schemes, including the project-based Clean Development Mechanism (CDM) offset programme. The second is whether the scheme will impose absolute caps on emitters, or take an intensity-based approach that will allow emitters to produce as much carbon dioxide as they like, provided they meet a certain ratio of emissions to output.Key issues: linkagesPolitical signals are mixed on whether any domestic emissions trading scheme would allow for the import of project-based credits from programmes such as the UN-run CDM.Canada's Conservative Party has been a vociferous opponent of international offsets both in opposition and now in office. Environment minister John Baird continues to insist that no taxpayer dollars will be spent on international schemes."We want to make these investments in Canada, not spend $5 billion in carbon credits on the other side of the world," he said at a press conference in January.Political opposition to spending money on 'hot air' was driven initially by objections to the situation with Russia – which has an artificially inflated surplus of intergovernmental carbon credits owing to the collapse of its industry in the years following the collapse of the Soviet Union – but has come to encompass any form of global carbon trading.While the government is refusing to participate in international schemes, however, it is not clear whether it will permit Canadian industry to participate. "Once targets are in place, I think industry will want full flexibility," says Janet Peace, senior fellow at the Pew Center for Climate Change.Indeed, industry figures are calling for such linkages to be permitted. "Regardless of any targets that Canada chooses to meet, it is essential that Canadian business have access to international markets," says Andrei Marcu, chief executive of the International Emissions Trading Association. "It is fundamental that project-based reduction credits from the CDM and Joint Implementation programmes be permitted for compliance."Under pressure from industry, the previous government had made some commitments to link its proposed carbon trading scheme with other schemes. This would provide for a more liquid market, says CCX's Teller – although he does acknowledge some potential downsides in terms of constraining Canadian policymakers."Assuming the linkage will be a two-way street – that is, credits can be imported and exported – then the Canadian domestic regulatory scheme needs to be more or less compliant with the foreign scheme to which it links," he says.TSX's McLean stresses that there is no reason why a Canada-only system could not lead to a liquidly traded market, but acknowledges that a bigger pool of buyers and sellers would promote better price discovery.Even if international linkages are not permitted, it is still possible that Canadian compliance traders will have some flexibility through a domestic project-based offset system. It is not clear at this point whether any such plan is on the table, but if such a system were developed, however, it would not be from scratch: the previous government ran several domestic offset pilot schemes.Key issues: IntensityThe question of whether Canada's emissions trading scheme will be based on absolute caps or intensity ratios is perhaps easier to predict. Intensity-based targets are designed to reduce emissions per unit of output, whereas absolute emissions allows for theoretically unlimited economic growth, which is particularly important to Canada's oil and gas sector, located primarily in the province of Alberta.An absolute cap could shackle Alberta's rapidly growing oil sands industry. At present, it is pumping out roughly one million barrels a day, according to the Canadian Association of Petroleum Producers - but by 2020, that figure will be up to 4 million barrels a day.Much of the governing Conservative Party's support comes from the province of Alberta, home to most of Canada's oil and gas sector."It doesn't seem likely that they will move away from intensity based targets," says Peace. "The emphasis on intensity was pioneered by regulators in Alberta and now an Alberta Conservative is at the helm of the Federal system!"Indeed, the introduction of the Clean Air bill last October involved a "notice of intent to regulate" that mentioned intensity-based targets. The environmental objections to intensity-based targets are obvious: they don't necessarily reduce overall emissions. But there are also concerns that intensity-based targets will not be conducive to the creation of a liquidly-traded market."Intensity-based systems give very little certainty about how many credits an installation ends up with, as companies don't know their exact emissions in advance," says Claire Demerse of the Pembina Institute, an environmental issues think-tank. "This makes it much harder to have a tradable unit."On a theoretical level, there are concerns that a system that allows for unlimited emissions growth will not be able to create the scarcity of credits required for a functioning market. And there are also practical concerns that an intensity-based system such as this will be very difficult to measure, benchmark and administer.Despite these concerns, however, market participants say that a market based on intensity targets could function. CCX's Teller, for example, argues that a strict intensity target could add far more liquidity to the market than a lax absolute target."From a purely market-based perspective, I don't think intensity targets are as problematic as some people have made them out to be," he says. "Ultimately, there is still an obligation to reduce emissions. Assuming all other aspects of the regulatory program are the same, it is possible that an intensity-based system could result in very vibrant market."Mcex's Bitton agrees: "From a market perspective, it's the same."Not that anyone should bet the house on intensity targets. "It is not certain that any trading scheme will be intensity based," says Lisa DeMarco, partner at law firm McLeod Dixon. "A number of provinces are moving in a different direction."These two market design uncertainties are underpinned by a high degree of political uncertainty. Canada's direction on climate change policy was thrown into confusion last January when the pro-Kyoto Liberal Party was voted out of office and replaced by a Conservative government that had run on an anti-Kyoto platform.PoliticsThe outgoing government's climate change plan, which was based on Canada's Kyoto commitments and included the development of both an emissions trading scheme and a domestic project-based offset programme, was scrapped.The new government claims that Canada's Kyoto target cannot be met. Prime Minister Stephen Harper once described the Kyoto Protocol as a "socialist scheme to suck money out of wealthy nations" - and is instead pursuing a "made in Canada" approach to emissions reduction (hence the mistrust of international linkages).So far, this has taken the form of the Clean Air bill, introduced in October last year. The initial draft contained no binding targets prior to 2011, and no absolute reduction targets before 2050. The bill looked unlikely to pass Canada's legislature in its original form, and is currently being redrafted in a parliamentary committee in which opposition parties hold a majority.The committee's work is scheduled to wrap up by the end of March, but it is difficult to predict what the outcome of its deliberations will be.To muddy the waters further, Canada's opposition parties have co-operated to pass a private member's bill that puts pressure on the government to re-commit to Canada's Kyoto obligations. And finally, the presentation of the budget in April will serve as a confidence motion in the minority government that many believe could trigger an election, and potentially a new government – which could dramatically alter the course of Canada's climate change policy.ProvincesCanada's constitutional set-up adds a further layer of uncertainty for companies trying to navigate the climate change policy landscape. Responsibility for environmental matters is shared between Canada's federal government and the provinces. The provinces also control the fuel mix for power generation, an important determinant of carbon emissions. Some provinces are developing their own climate change policies independently of the federal government.Quebec's government, for instance, has continued to recognise the province's Kyoto target and is following its own plan to meet it, focusing primarily on promoting hydropower and introducing carbon taxes on upstream oil production. In Ontario, the Liberal provincial government has promised to phase out the use of coal-fired power plants. And British Columbia announced emissions reduction targets in February, which it plans to achieve through a variety of measures, including forcing all new coal-fired plants to sequester 100% of their carbon emissions (there are no coal-fired plants in British Columbia at present, but at least two are scheduled to be built).There is also some speculation that, in the absence of a federal emissions trading scheme, the provinces may take the initiative in developing their own schemes, as is the case in the US. These could even be linked to US regional or federal schemes."There is a scenario in which the provinces take the lead," says Veronique Bugnion, analyst at research provider Point Carbon. "The provinces have shown a greater willingness to tackle the climate change problem."Observers say, however, that Canadian companies would regard such an outcome as sub-optimal. "I would think that it is in industry's interest to have a national system, as companies often operate across different provinces," says Demerse.While there is still much uncertainty about what precise form Canada's climate change policy will take, any clear leadership on the subject will be welcome to Canada's energy and heavy industry sectors, who, like their counterparts south of the border, are struggling to make long-term decisions that take into account an imminent but as-yet-undefined climate change policy."It has been a nightmare for the energy sector to navigate long-term investment decisions," says DeMarco....
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