Canada: Western Climate Initiative Finalizes Cap-And-Trade Program Recommendations

04 November 2008

Article written by Barbara Hendrickson with assistance from Marty Venalainen, Student-at-Law.

The Western Climate Initiative (the “WCI“) released the Draft Design of the Regional Cap-and-Trade Program (the “Draft Design“) in July 2008 and, in August, we published a bulletin highlighting the key features of the Draft Design.¹ Having received public input on the Draft Design, the WCI released, on 23 September 2008, its “Design Recommendations for the WCI Regional Cap-and-Trade Program”² (the “Recommendations“).

The WCI is a multijurisdictional voluntary collaboration launched in February 2007 to develop regional strategies to address climate change. WCI goals include setting regional emissions reduction goals, developing a registry to track and manage emission reductions and offset credits, and designing a multi-jurisdictional market-based cap-and-trade system. The goal of the WCI is to reduce greenhouse gas emissions by 15 percent below 2005 levels by 2020.WCI partners include Arizona, California, Montana, Oregon, Utah, New Mexico, Washington, with Manitoba, British Columbia, Quebec and Ontario (the “Partner(s)“). Together, the seven states and four provinces represent over 70 percent of the Canadian economy and 20 percent of the U.S. economy.³ Saskatchewan, Alaska, Colorado, Idaho, Kansas, Nevada, Wyoming, Baja California, Chihuahua, Coahuila, Nuevo Leon, Sonora, and Tamaulipas are observers.

The following bulletin summarizes the main features of the cap-and-trade program (the “Program“).

Cap-and-Trade Design Features

1. Scope

The scope of Program includes electricity generation (including imports); combustion at industrial and commercial facilities; and industrial process emission sources. Emissions from residential, commercial, industrial, and transportation fuel combustion below the WCI thresholds will begin in the second compliance period. The combustion of biofuels and carbon neutral biomass will not be included in the Program. The Program delegates the treatment of upstream emissions from biofuels to the Partners.

2. Point of Regulation

The point of regulation for industrial sources will continue to be the point of emission. For electricity, the point of regulation is the First Jurisdictional Deliverer (the “FJD“). The FJD is the generator when the generator is located inside a Partner jurisdiction. The FJD is the deliverer of the electricity where the generator is located outside a Partner jurisdiction. The WCI trumpets such an approach as superior to that of the Regional Greenhouse Gas Initiative, which is purely generator-based.⁴ For residential, commercial, industrial, and transportation fuel combustion, the point of regulation will be the point where the fuel enters commerce in the Partner’s jurisdiction.

3. Thresholds for Coverage Under the Cap-and-Trade Program

Generally, those entities or facilities⁵ emitting at least 25,000 metric tons of carbon dioxide equivalent will be subject to the Program. The threshold was set with the objective of “covering a large portion of emissions with as few facilities and entities as possible.”⁶ The 25,000 ton threshold ensures that more than 90 percent of emissions are covered.⁷

However, the threshold is somewhat malleable. The Recommendations state “additional analyses will be performed to determine if adjustments to the threshold are need to ensure sufficient coverage or to address competitiveness issues within individual sectors.”⁸ Presumably such flexibility is meant to address situations where competitors in an industry straddle the threshold.

Also, the WCI intends to develop anti-avoidance measures to prevent an entity from devolving into smaller entities.

4. Role of Other Policies

While it is clear that there is no conflict between the Program and policies that complement the achievement of emissions reductions (e.g., energy efficiency standards), the role of alternative policies in the Program has yet to be determined. For example, it may be 2012 before the WCI determines a mechanism by which to integrate BC’s carbon tax.⁹

5. Setting the Regional Cap

The regional cap will be the sum of the Partners’ allowance budgets. A cap will be set for each year from 2012 to 2020, with the cap declining annually, while compliance periods will be three years long. Adjustments, including those to address the inclusion of new sectors in future compliance periods, will only be made before the compliance period commences. As stated in the Draft Design, caps will be set such that the regional goal is met by the Program through the combination of the Program and policies for uncapped sectors.

6. Apportionment

The determination of Partners’ allowance budgets, and the ensuing allocation of the burden of meeting the regional goal, will undoubtedly be a complex process. For example, the Recommendations note that two Partners will have to “agree to an equitable solution” where electricity is generated in one Partner’s jurisdiction and consumed in another.¹⁰ For the time being, the WCI can only offer that estimates will be based on “population growth, economic growth, voluntary and mandatory emissions reductions, and other factors.”¹¹ The allowance budgets will decline using the straight-line method, factoring in the addition of new sectors in 2015. Partners are required to treat each others’ allowances equally.

7. Distribution of Allowances

Partners are responsible for allocating their allowances among the entities and facilities in their jurisdictions. Partners have agreed that a portion of the value of each allowance budget will be set aside for public purposes such as renewable energy incentives. WCI Partners are to give each other advance notice of how they intend to distribute allowances, and are to discuss amongst themselves the uniform treatment of allowances to sectors with “competitiveness issues.”¹²

The Draft Design had suggested the auctioning of a minimum of 25% to 75% of allowances. However, the Recommendations now call for the auction of a minimum of 10% of allowances in the first compliance period and 25% by 2020. The WCI will design a regional auction process by the end of 2009. New to the Recommendations, the first 5% of auctioned allowances will have a minimum price to reduce the risk of an inaccurately set cap.

Whereas the Draft Design had called for Early Reduction Allowances to be drawn from each Partner’s budget in 2012, the Recommendations call for such allowances to be in addition to each Partner’s 2012 allowance budget. The WCI will develop criteria for Early Reduction Allowances by the end of 2009.

As with the Draft Design, banking of allowances will be permitted, though the borrowing of allowances from future compliance periods will not.

8. Offsets, and Allowances from Other Systems

While the Draft Design had suggested that entities would only be permitted to rely upon offsets for 10% of their compliance obligations, the Recommendations have drastically increased the limit to 49% of each Partner’s obligations. This increase will make it all the more important for the WCI to develop rigorous criteria for the offsets system. Further, the change from limiting entities to limiting jurisdictions now requires that jurisdiction create mechanisms for allocating the rights to offsets among entities.

While encouraging the purchase of offsets from the jurisdictions of fellow Partners, the Recommendations also permit Partners to buy offsets issued under the Kyoto Protocol’s Clean Development Mechanism. Offsets from developed countries are permitted provided that they do not stem from emissions reduction projects in sectors that are subject to the Program. The restriction is intended to prevent double-counting and to encourage other developed country jurisdictions to enact emissions reduction policies.¹³

9. Reporting

Entities and facilities emitting at least 10,000 metric tons of carbon dioxide equivalents must report their 2010 emissions in early 2011. A key reason for the lower reporting threshold is to collection information so that the cap-and-trade threshold can be adjusted if many emitters are approaching the cap-and-trade threshold. While the Draft Design had used permissive language regarding third party verification, the Recommendations make third party verification mandatory. On 30 September 2008, the WCI released its second draft of reporting guidelines.¹⁴

10. Compliance and Enforcement

Compliance and enforcement are aspects of the Program that the Partners themselves must ultimately design. Other than setting a treble penalty for each ton emitted without an allowance, the Recommendations merely call for each Partner to “retain and/or enhance its regulatory and enforcement authority,” for there to be some degree of transparency, and for Partners to develop accounting mechanisms.¹⁵ To ensure some degree of consistency in enforcement standards, the WCI might consider developing a Model Rule similar to that developed by the Regional Greenhouse Gas Initiative (RGGI).¹⁶

11. Administration, New Entrants, and Linkage

The Recommendations call for the creation of a “regional administrative organization.” The Recommendations also set certain criteria for permitting new entrants as Partners. Admission will be permitted only at designated times (e.g., the start of a new compliance period) and new entrants must have an emissions reduction goal at least as stringent as the WCI goal. The WCI also endeavours to seek linkages with the cap-and-trade programs of other jurisdictions and to influence the design of prospective federal programs.

Conclusion

The Recommendations provide a welcome foundation on which businesses can begin to plan their affairs. As an initial step, businesses in WCI jurisdictions should begin monitoring their emissions. Provided that effective offset protocols are designed, the raised ceiling on the use of offsets will lower compliance costs while still allowing the regional greenhouse gas reduction goal to be met. As many details are yet to be decided by the WCI and by the Partners, there will undoubtedly be more opportunities for businesses to provide input into the Program design.¹⁷ Reporting obligations begin in 2010 and the cap-and-trade program commences on January 1, 2012.

Footnotes

^{1. Barbara Hendrickson, “Western Climate Initiative” (August 2008) McMillan Bulletin. Online: http://www.mcmillan.ca/Upload/Publication/WesternClimateInitiative_0808.pdf .}

^{2. Western Climate Initiative, Design Recommendations for the WCI Regional Cap-and-Trade Program, online: http://www.westernclimateinitiative.org/ewebeditpro/items/O104F19865.PDF [the “Recommendations”].}

^{3. Western Climate Initiative, U.S. States, Canadian Provinces Announce Regional Cap-and-Trade Program to Reduce Greenhouse Gases (September 23, 2008). Online: http://www.westernclimateinitiative.org/ewebeditpro/items/O104F19871.PDF .}

^{4. Supra, note 2, at 23.}

^{5. The term entity is generally used when the point of regulation is upstream of the point of emissions to describe a company that has an obligation to surrender allowances to cover the carbon content of the fuel the company is moving through commerce. When the point of regulation is at the point where the emissions occur, the term facility is generally used.}

^{6. Op. cit. at 24.}

^{7. Ibid.}

^{8. Ibid., at 3.}

^{9. Ibid., at 4.}

^{10. Ibid., at 5.}

^{11. Ibid., at 5.}

^{12. Ibid., at 7.}

^{13. Ibid., at 41.}

^{14. Western Climate Initiative, Essential Requirements of Mandatory Reporting for the Western Climate Initiative, Second Draft (September 30, 2008), online: http://www.westernclimateinitiative.org/ewebeditpro/items/O104F19958.pdf .}

^{15. Recommendations, supra note 2, at 12-13.}

^{16. Regional Greenhouse Gas Initiative, Model Rule. Online: http://rggi.org/docs/model_rule_corrected_1_5_07.pdf .}

^{17. Note that California, a WCI member, has recently released its Proposed Scoping Plan, which includes a cap-and-trade program. For more details, please refer to our October 2008 bulletin on the topic. Online: http://www.mcmillan.ca/EmissionsTradingandClimateChange.html .}

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2008 McMillan LLP