By Cheryl Slusarchuk

The phrase "cap and trade" is largely unfamiliar to most North Americans, but it will soon be well-known at both boardroom tables and kitchen tables. Canadian and U.S. legislators have been contemplating carbon trading, mostly in the form of "cap and trade" regimes, and three regional regimes are in the works, at varying stages of development: the Regional Greenhouse Gas Initiative (RGGI), the Western Climate Initiative (WCI), and the Midwestern Greenhouse Gas Reduction Accord (MGGRA).

Although there are differences between cap and trade regimes, they all share the same goal, and their implementation will influence business costs and present significant economic opportunities.

What is cap and trade?
In a "cap and trade" regime, a central authority sets an annual emissions "cap" that limits the amount of total greenhouse gases (GHGs) that can be emitted by regulated entities. The emissions that make up this cap are converted into permits that are distributed to regulated entities. To reduce overall emissions, the regulating authority reduces the size of the cap, and companies that need to emit more greenhouse gases than they have permits for must buy additional permits from other companies. In theory, this free-market system encourages emissions reductions at the lowest possible overall cost.

The RGGI (a.k.a. "Reggie") ― first cap and trade system in North America
The RGGI is the first mandatory compliance cap and trade system in North America, and applies only to power plants over 25MW, which account for about 95 per cent of the region’s total power sector CO2 emissions. The RGGI’s member states - Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont - have agreed to cap their CO2 emissions from the power sector at 188 million tonnes annually, beginning in January 2009.

Emissions allowances were distributed through an auction system, with proceeds dedicated to carbon reduction mechanisms. So far two auctions have been held, generating over $145 million in revenue for about 44 million allowances. The RGGI is not expected to substantially affect the region’s energy bills; according to New York state officials, monthly household power bills will only raise by about 78 cents on average.

The WCI ― most comprehensive North American cap and trade system yet
In contrast to the RGGI, the WCI includes both Canadian and U.S. jurisdictions. WCI partners include four Canadian provinces (British Columbia, Manitoba, Ontario and Quebec) and seven U.S. states (Arizona, California, Montana, New Mexico, Oregon, Utah and Washington). Together, they represent over 70 per cent of the Canadian economy and 20 per cent of the U.S. economy.

The WCI scheme is the most comprehensive GHG reduction plan to date, and is targeted to cut greenhouse gas emissions to 15 per cent below 2005 levels by 2020. Where the RGGI applies to power generation only, the WCI will include emissions from electricity, industry, transportation and residential and commercial fuel use - nearly 90 per cent of all emissions produced by WCI partners. Also, the WCI will focus on more than just CO2 emissions, regulating another five significant GHGs — methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride.

The WCI’s draft design was released a few months ago, and the first compliance period will begin on January 1, 2012. WCI partners are drafting their respective legislative and administrative regimes that correspond to the draft design. Expect this draft legislation to be debated in WCI member jurisdictions throughout 2009.

The MGGRA ― a comprehensive multi-sector cap and trade system
The MGGRA also includes both Canadian and U.S. jurisdictions. In 2007, six Midwestern states - Minnesota, Wisconsin, Illinois, Iowa, Michigan and Kansas ― together with the province of Manitoba, established the Midwestern Greenhouse Gas Reduction Accord (MGGRA). Their aim is to reduce emissions by 60-80 per cent below 2005 levels by 2050, partly through the implementation of a multi-sector cap and trade regime they are developing and expect to have implemented by about April 2010.

What about the Feds?
With the Obama administration taking power in the U.S., an American federal cap and trade system is all but guaranteed. The big questions are how and when it will be implemented. President Obama has pledged to implement an economy-wide cap and trade program that will reduce greenhouse gas emissions to 1990 levels by 2020 and by an additional 80 per cent by 2050. Cap and trade remains a critical pillar of his commitment to create five million green-collar jobs, increase energy security and shift that nation towards a clean energy future.

To the extent that the Canadian federal government is participating in this area, it is expected to align with either a federal or North American approach to carbon trading. A continental cap and trade system would benefit industry and government by minimizing compliance costs and enhancing market opportunities. As a result, the Canadian government may engage the Obama administration on the creation of an integrated North American cap and trade regime.

Different cap and trade regimes, same central issues
No matter what form cap and trade eventually takes in North America, the development and implementation of any new regime will be complex and contentious. Hotly debated issues will include:

ï    cap level;
ï    cap application - upstream, at the mine mouth or refinery, or further downstream, at utilities or industrial concerns;
ï    cap extent - economy-wide or specific-sector-focused;
ï    auctions extent ―for emission permits, compared to handouts based on prior emissions; and
ï    management of reductions from "early action" and other domestic or offshore projects that reduce emissions.

If cap and trade is inevitable, start considering your liabilities and opportunities
With cap and trade appearing inevitable in North America, carbon trading will have a significant influence on North American businesses. The costs of various inputs - including electricity, fuels and goods - are likely to change as cap and trade regimes take shape. As cost mitigation will take time to research and implement, many businesses are working towards determining their exposure to liabilities associated with any incoming cap and trade regimes.

New cap and trade systems will also present substantial economic opportunities. Despite the credit crisis and broadening recession, clean tech investment only from the venture capital funds reached $8.4 billion in 2008, a 38 per cent increase over 2007, the Cleantech Group recently reported. Expect this figure to jump significantly once carbon trading becomes established.

Similarly, cap and trade regimes will promote the development of both new and existing businesses. With New Carbon Finance economists estimating that carbon trading in the U.S. will be worth $1 trillion by 2020, expect cap and trade to become one of North America’s largest industries. Expect not only the clean tech sector to benefit from this new market, but slumping industries such as agriculture and forestry, which are likely to see their markets revitalized by cap and trade regimes that use offsets and other flexibility mechanisms.

Although the implementation of cap and trade regimes will provide uncertainty over the next few years, Canadian businesses will be well positioned to take advantage of these expanding market opportunities. In the meantime, businesses should keep track of developing carbon trading systems to maximize future revenues and minimize negative cost adjustments when the inevitable occurs.
 
Cheryl Slusarchuk is a partner in the Vancouver office of McCarthy Tetrault LLP practicing in the business law and technology groups. She is the president of the B.C. Premier’s Technology Council and serves as Chair of the B.C. Climate Action Team.

 

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