Features, May 2001 Emissions trading Canadian province of Ontario has issued a discussion paper proposing a hybrid emissions trading scheme covering nitrogen oxides and sulphur dioxide. Elisabeth DeMarco examines the plans for a scheme that could form the basis for a wider emissions trading system Ontario sets out emissions trading plans In late March, the Ontario Ministry of the Environment (MoE) released a policy option paper, Emissions Reduction Trading System for Ontario, outlining its intended design for a "cap, credit and trade" scheme to facilitate and accelerate reductions of nitrogen oxides (NOx) and sulphur dioxide (SO2) in the Canadian province. The paper provides details on what is to be the first emissions trading system for NOx and SO2 in Canada - and a scheme which analysts expect to provide a model for other provinces and for any future greenhouse gas trading scheme in Canada. The proposed trading system is part of the broader process of electricity deregulation in Ontario. Under the scheme, which the MoE anticipates will be up and running by the end of the year, emissions limits will initially only be applied to the six fossil-fuel generation facilities in Ontario that are currently owned by Ontario Power Generation Inc. (OPG - formerly Ontario Hydro). But other sectors of the economy will also be able to participate in generating and trade credits by reducing their own emissions. The MoE is therefore proposing a hybrid system of closed emissions trading (such as the SO2 allowance trading scheme under the US Acid Rain Program) and open emissions trading (which allows for emission reduction credits to be created relative to a project base-line). This hybrid system is likely being pursued to increase the number of participants in the resulting Ontario emissions trading market and thereby increase market liquidity. In the US, hundreds of companies were subject to emissions caps when the Acid Rain Program was rolled out in 1994. In Ontario these initial caps will apply only to six, albeit large, fossil-fuel electricity generating stations all owned by the same entity. It is unclear, however, as to whether or not the emissions trading policy as currently proposed will draw additional participants into an emissions trading market. If the proposed emission caps do not provide for sufficient emissions allowances to be allocated to new electricity market entrants as the market deregulates, and cogeneration facilities are limited in the emissions credits that they can potentially create by offsetting coal-fired generation, it is possible that the end goal of increased liquidity will be frustrated and the proposed hybrid system will merely increase regulatory and administrative costs. As with most policy proposals, the devil will lie in the details - many of which have yet to be determined and are set out as options in the discussion paper. The main features of the proposed hybrid emissions trading system are outlined below. All elements of the proposed system are subject to change following the MoE's consultation process, which is due to end on 24 June. At this stage, the proposed elements of the hybrid system are likely quite malleable. Ontario has a new Minister of Environment, Elizabeth Witmer, who is aware of the need for a political win on air quality initiatives. In addition, the Ontario government has been keeping a close eye on electricity reform in California and Alberta. To the extent that the California energy crisis has been blamed, in part, on air emission restrictions, the Ontario government is likely to be very cautious to address air quality issues in a manner that does not unduly restrict new generation. The Proposed Ontario Cap, Credit and Trading System. Caps Annual 2001 NOx and SO2 caps of 36 kilotonnes (kT) and 157.5kT, respectively, will be ratcheted down to 28kT NOx and 131kT SO2 by the year 2007. The Lakeview Generating Station, one of OPG's coal-fired electricity stations located in a heavily populated area outside of Toronto, will be required to convert from coal to natural gas by the 2005. It has individually specified NOx caps to reflect that requirement. New and existing non-OPG electricity generation sources will not be afforded an allocation of the province-wide emissions caps until 2004. At that time, they will be allocated approximately one quarter of the NOx cap. It is anticipated that caps will be extended to other commercial and industrial sectors in the future. Allocation of allowances Until 2004, all allowances will be allocated to OPG which will then have the discretion to distribute these allowances among its fossil-fuel burning stations (with the exception of the stipulated NOx cap on Lakeview). In 2004, the MoE proposes to allocate allowances to individual generators in proportion to the relative amount of electricity that they produce in each year. Credit creation All emitters of NOx and SO2 that can create emissions reductions from a pre-defined baseline will potentially be able to create emission reduction credits. Baselines are to be determined in the year prior to the reduction activity. Credits created from a reduction action may be generated for a period of five years or until the facility or sector becomes capped. Credit creators may nonetheless request that the credit period be extended for high-cost reduction activities. The MoE is considering some form of baseline protection to ensure that facilities that undertook early emissions reductions will not be penalised for doing so. However, nothing specific has been proposed. Most significant is the strict limitation on the creation of credits from new energy sources, demand side management or conservation efforts and the displacement of fossil-fuel generation by cogeneration facilities. In these instances, direct facility-based emissions reductions of NOx and SO2 will be awarded with emissions credits but indirect emissions reductions created by displacing fossil-fuel generation in Ontario will not. The MoE went with this policy choice to avoid double counting issues in a manner that is simple to administer. However, there are other solutions to the double counting issue that the MoE may be prudent to explore if it wants to create a robust market and encourage alternate forms of electricity generation. If the MoE chooses to disallow indirect emissions reduction credits, the ramifications on green energy marketing will need to be addressed. Equally, the discussion paper does not deal with past credits created through the PERT and GERT voluntary emissions trading pilots. The requirements for valid credit creation will be defined by regulation and include acceptable technologies, reduction activities and quantification methods. Codes will be developed to define the requirements for credit creation protocols and quantification and verification reports. Third party verification will be required by the party that wishes to use the emission credit and confirmed by the MoE prior to certification of the credit for use in Ontario. A private sector registry may be used to review credit documentation for completeness and validity, and post and track credits from creation through to use. But, even if credits are determined to be valid by the registry, the MoE may still refuse to certify credits for use. Elisabeth (Lisa) DeMarco is a Toronto-based environment, energy and emissions trading lawyer, with law firm Donahue Ernst & Young, part of the global Ernst & Young Law Network. E-mail: lisa.demarco@ca.eyi.com. FOR THE FULL STORY EVERY MONTH, SUBSCRIBE TO ENVIRONMENTAL FINANCE, OR CONTACT info@environmental-finance.com FOR OUR BACK ISSUES SERVICE