Author:Carmody, Chios
Position:Proceedings of the 42nd Canada-United States Law Institute Annual Conference: Back to the Future: The Canada-United States Relationship at a Crossroads

ABSTRACT: This Guide presents an overview of the cap-and-trade system of carbon emission trading created and adhered to under the Western Climate Initiative (WCI). The Guide is divided into five chapters. Chapter I provides an overview of a cap-and-trade system of emission permits. Chapter 2 explains the constitutional background to cap-and-trade schemes in the United States and Canada. Chapter 3 provides an overview of the linked system and a summary of its principal features in each WCI cap-and-trade partner jurisdiction (California, Quebec, Ontario). Chapter 4 explains how emission allowances are traded under the WCI and includes the results of a survey undertaken of emissions trading market participants. Chapter 5 provides some concluding observations with respect to WCI cap-and-trade.

TABLE OF CONTENTS Table of Contents Chapter 1: Introduction 1.1 Purpose 1.2 Executive Summary 1.3 How this Guide Works. 1.4 Addressing Climate Change 1.4.1 Background 1.4.2 Cap-and-Trade Basics 1.4.3 Cap-and-Trade versus Carbon Tax 1.4.4 Criticisms of Cap-and-Trade 1.5 A Brief History of Cap-and-Trade 1.5.1 The EPA Acid Rain Program 1.5.2 The Regional Greenhouse Gas Initiative 1.6 Comparative Experience 1.6.1 The European Union Emissions Trading System (EU ETS) 1.6.2 China Chapter 2: North America and the Western Climate Initiative 2.1 The Background to Cap-and-Trade in North America 2.1.1 The United States 2.1.2 Canada 2.2 State and Provinces 2.2.1 California 2.2.2 Quebec 2.2.3 Ontario 2.3 The WCI Cap-and-Trade System 2.3.1 The Western Climate Initiative 2.3.2 The Western Climate Initiative, Inc. (WCI, Inc.) 2.4 Harmonization 2.4.1 Program Design 2.4.2 Linkage California-Quebec Linkage (2014) California-Quebec-Ontario Linkage (2018) Chapter 3: WCI Cap-and-Trade: Overview and Cap 3.1 System Overview. 3.2 Legislation California Quebec Ontario 3.3 The Cap California Quebec Ontario 3.4 Compliance Periods California Quebec Ontario 3.5 Coverage California Quebec Ontario 3.5.1 Determining Emissions Attribution California Quebec Ontario 3.6 Emissions Allocation California Quebec Ontario 3.6.1 Initiation of Activity California Quebec Ontario 3.6.2 Permanent Cessation of Activity 3.7 Flexibility 3.7.1 Banking and Borrowing of Allowances 3.7.2 Offsets and Credits. California . Quebec Ontario 3.7.3 Price Management Price Containment Reserves Price Floors and Price Ceilings California Quebec Ontario 3.8 Registration California Quebec Ontario 3.9 Reporting California Quebec Ontario 3.10 Verification California Quebec Ontario 3.11 Monitoring 3.12 Enforcement California Quebec Ontario Cap-and-Trade Litigation Chapter 4: WCI Cap-and-Trade: Trading 4.1 Nature of the WCI Markets 4.2 Account Types California Quebec Ontario 4.3 The Transfer Process 4.4 Auctions 4.4.1 Format 4.4.2 Administration and Participant Application 4.4.3 Auction Results 4.5 Reserve Sales California Quebec Ontario 4.6 Secondary Markets California Quebec Ontario 4.7 Taxation 4.7.1 United States 4.7.2 Canada Legislative Scheme Value of Emissions Allowances GST/HST Collection Tax Deductions Disposal of Emissions Allowances 4.8 Survey 4.8.1 Survey Questions 4.8.2 Summary of Survey Responses Chapter 5: Conclusion . CHAPTER 1: INTRODUCTION

1.1 Purpose

This is a Guide to the legal framework for carbon emissions trading under the cap-and-trade system created and adhered to under the Western Climate Initiative (WCI). This Guide has three aims. First, provide an overview of the WCI cap-and-trade system for emissions trading by users of the system, potential industry participants, state, provincial, and municipal governments, academic institutions and members of civil society. Second, to foster learning among domestic and international actors interested in North America's collective response to climate change and highlight one attempt to combat climate change through a subnational cap-and-trade system on the continent. During the course of research for this Guide, in 2018, the province of Ontario linked its WCI-inspired cap-and-trade system with that of California and Quebec and six months later delinked its system, eventually terminating its participation altogether and announcing its intention to withdraw from the WCI. Accordingly, a third purpose of this Guide is to serve as an account of Ontario's short-lived cap-and-trade system and its brief experience with linkage.

1.2 Executive Summary

Cap-and-trade systems have been written about extensively, often from the perspective of public participants in the system, that is, the governments involved. By contrast the focus in this Guide is on private behavior, that is, the private actors --cap-and-trade market experts, cap-and-trade participant entities, and cap-and-trade offset project developers and advisors--that are directly engaged in emissions trading, that advise such actors, or that develop cap-and-trade offset projects. The research focuses on this topic because it is less studied and because it appears to be pivotal in debate about the pros and cons of emissions trading.

At the outset we were interested in determining whether private actors believe that emissions trading under the WCI is an efficient, market-based response to climate change. Our general conclusions based on a very limited survey of private actors is that they do concur in this belief. The two-step approach to regulatory harmonization of emissions allowance markets pursued under the WCI--involving separate phases of 1) program design and 2) linkage--is useful in allowing jurisdictions to accommodate certain necessary political realities in establishing emission trading markets. At the same time, the research reveals that linkage under the WCI does not involve "plug-and-play" (i.e. unthinking transposition of cap-and-trade regulation from one jurisdiction to another). Instead, the introduction of a cap-and-trade scheme in a jurisdiction requires indigenous commitment and an authentic investment of administrative resources as well as difficult political choices. Later, in the linkage phase, a common platform and continuing dialogue between jurisdiction partners is necessary. Dialogue evidences how harmonization and linkage are not static but rather dynamic and adaptive processes. The market(s) created out of this process are also dynamic and require continuing intervention to regulate and discipline.

Our specific findings with respect to private behavior are that:

  1. Participants agree that WCI cap-and-trade is cost-effective and efficient. WCI cap-and-trade allows entities to achieve environmental goals more efficiently.

  2. Currently, the market for carbon allowances under the WCI is small and highly technical. It is dominated by a few major players, with the market for carbon allowances being little understood beyond them. The technicality of the market demands specialization, yet specialization limits participation to those who can afford to do so.

  3. The acquisition by Ontario market participants of some CAD $2.8 billion worth of allowances in 2017-2018 at a time of free allowance distribution in the province suggests that eligible participants were using the emissions trading market under the WCI to hedge (i.e. to limit their exposure to future emission price increases).

  4. The possibility of excessive banking of emission credits and the threat of market domination and manipulation in future cannot be discounted. Both of these potential developments raise serious issues about the equity of the emissions trading system and could make the public in WCI jurisdictions skeptical about the use of market-based mechanisms to combat climate change in years to come. In response to these concerns, regulators may consider developing a Code of Conduct for WCI market participants and others going forward.

  5. the survey conducted as part of this research involved only a very small set of market participants. We contacted 61 participants. Only four agreed to respond. The survey questions and results are contained in Chapter 4.8. We surmise that events during the course of the research may have depressed sample size. Consequently, the conclusions put forward here merit confirmation in a wider sampling of market participants and others.

    These findings lead us to conclude that the vital thread running through the successful emission trading system is trust and fairness. There must be trust and fairness if emission trading schemes are to continue to function as intended. However, those values can only be instilled if allowances are equitably allotted, if ethical standards are adhered to in all phases of market operation, if continuing efforts are made a transparency, and if public can be made to see tangible evidence of fair and efficient markets contributing to climate change goals.

    1.3 How this Guide Works

    This Guide is divided into five chapters. This Introduction (Chapter 1) provides readers with an overview of a cap-and-trade system of emission permits, including how cap-and-trade systems work, a comparison of cap-and-trade systems versus a carbon tax, and comparative experience with cap-and-trade systems in the European Union (EU) and China.

    Chapter 2 explains the constitutional background to cap-and-trade schemes in the United States and Canada. It also provides a factual background to cap-and-trade legislation in three North American subnational jurisdictions (California, Quebec, Ontario), a description of the effort to harmonize cap-and-trade legislation in each jurisdiction, and an overview of the framework for doing so under the Western Climate Initiative and its corporate form, the Western Climate Initiative, Inc. The chapter then examines the linkage of cap-and-trade systems in California and Quebec in 2014 and the addition (and subsequent withdrawal) of Ontario to/from the link in 2018.

    Chapter 3 provides an overview of the linked system and a summary of its principal features in each WCI cap-and-trade partner...

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