Upcoming Ontario cap and trade auction and proposed regulatory amendments

In June, we prepared a guide to Ontario's new cap and trade program. Since then, the 2016 registration period has closed, and the Ministry of the Environment and Climate Change (the "MOECC") has provided more information regarding the first Ontario cap and trade auction and released two proposals for regulatory amendments to the program. The first proposal clarifies policy, technical and administrative requirements, and the second proposal provides a framework for carbon offset credits.

The First Ontario Cap and Trade Auction

The deadline for Compliance Instrument Tracking System Service ("CITSS") registration was Nov. 30, 2016. Only participants registered under CITTS will be able to participate in the first Ontario cap and trade auction, which will be held in March 2017. The MOECC has not yet released the auction date, but it will post a notice on the MOECC website at least 60 days in advance that will include the following:

• the date and time of the auction;
• a summary of the process and schedule;
• the number of emissions allowances up for auction; and
• a guidance document with detailed instructions on how to participate.

The MOECC has announced that there will be a practice auction in January 2017 to assist participants in preparing for the real auction. The MOECC is also offering two training webinars leading up to the practice auction on Dec. 6 and 8, 2016. There are a number of technical requirements that participants should be aware of leading up to the auction, including: auction platform registration timing; rules surrounding bidding; bid guarantee requirements; purchase limits; a prohibition on sharing information related to auction participation; and allowance holding limits. All of this information is available, or will be available, on the MOECC website.

Regarding auction bidding strategy, it is important to note that the price a participant bids is not the price it will actually pay. Instead, every participant will pay the same price for each allowance: the lowest successful bidding price during that auction for that vintage (year) of allowance, or the "Settlement Price". No bids will be accepted below the "Reserve Price", which is the minimum price set for the sale of one carbon allowance at the auction as set out in the auction notice and calculated using the higher of the most recently published California or Quebec Annual Auction Reserves Prices after applying the auction exchange rate. The Settlement Price will therefore necessarily be the same or higher than the Reserve Price.

Allowances will only be sold at auction in lots of 1000. For the first compliance period, a participant can use 2017 to 2010 vintage allowances to fulfill its compliance obligations. Emission allowances do not expire, so unused allowances from one compliance period can be carried over into any subsequent compliance period. However, a participant cannot use future vintage allowances from the subsequent compliance period to satisfy an obligation from the current compliance period, i.e., a 2021 vintage allowance cannot be used to satisfy an 2017 - 2020 compliance period obligation. Note that in each auction the MOECC will only offer current vintage allowances and allowances from three years in the future, so in 2017 auctions, the MOECC will offer only 2017 and 2020 vintage allowances.

The MOECC has advised that it designed the cap and trade program to avoid some of the problems that have arisen in other jurisdictions. For example, in California, auction participants were coordinating bids, and only about 10% of the available credits were sold in the May 2016 auction (fortunately, the most recent auction in November was much better).

It will be interesting to see whether the Ontario auction Settlement Price changes significantly over the course of a compliance period. One would expect the Settlement Price to start low and then rise at auctions closer to the end of the compliance period as participants find themselves falling short of their required allowances. However, for the first compliance period, most industrial emitters will be given a sufficient number of free allowances to ensure compliance, so we may have to wait until the second compliance period to see accurate market trends.

General Regulatory Amendments

On Nov. 4, 2016, the MOECC released Proposed Amendments to Cap and Trade Program Regulations ("Proposed Amendments") for public comment on the Environmental Registry. The MOECC is accepting comments on the Proposed Amendments until Dec. 4, 2016, and expects to finalize the amendments in early 2017.

The Proposed Amendments are intended to clarify policy, technical and administrative requirements and support the future linking of Ontario's cap and trade market with Québec and California. The Proposed Amendments include changes to The Cap and Trade Regulation (O. Reg. 144/16) and The Quantification, Reporting and Verification of Greenhouse Gas Emissions Regulation (O. Reg. 143/16), as well as to the incorporated Methodology for the Distribution of Ontario Emission Allowances Free of Charge (the "Methodology") and Guideline for Quantification, Reporting and Verification of Greenhouse Gas (the "Guideline"). The Environmental Registry proposal links to revised drafts of the Methodology and Guideline with the proposed changes, but the MOECC has not yet provided the wording of the proposed changes to the regulations.

The Proposed Amendments include:

• Clarifying that, when a facility is sold, the new owner or operator bears the obligation to submit compliance instruments for all GHG emissions for the entire compliance period, but permitting the previous owner or operator to ask the MOECC to transfer allowances from its compliance account to the compliance account of the new owner or operator.
• Providing an exception to the prohibition on sharing auction participation information between related persons to facilitate a participant obtaining required approvals from a parent corporation.
• Allowing for the registration of clearing houses as market participants so that they can provide services to other participants.

Carbon Offset Credits

On Nov. 15, 2016, the MOECC released the Compliance Offset Credits Regulatory Proposal (the "Offset Proposal") for public comment on the Environmental Registry. The Offset Proposal sets out the framework for offset protocols and credits in Ontario. It will be implemented through amendments to the Cap and Trade Regulation (O. Reg. 144/16), which are expected by the end of the year. The MOECC is accepting comments on the Offset Proposal until December 30, 2016.

What are carbon offset credits?

Carbon offset credits are actual, measured reductions in greenhouse gas ("GHG") emissions. Each offset credit represents one tonne of carbon dioxide equivalent that is either reduced, avoided or removed from the atmosphere.¹

An Offset Initiative Operator undertakes activities to account for reductions in emissions, and is granted permission to sell an equivalent amount of offset credits to companies or individuals desiring to reduce their overall GHG emissions. The Offset Proposal states that all offset credits are required to be real, additional, enforceable, verifiable and permanent (to a standard of 100 years).²

Offsets may be categorized as sequestration or non-sequestration credits. Sequestration offset credits generally involve capturing GHGs from the atmosphere and storing them for long periods. A simple example involves planting trees that sequester carbon as they grow, and allowing these trees to remain unharvested.

Non-sequestration offset credits typically involve reductions in the production of GHG as opposed to capturing and storing existing GHG. This could involve emissions reduction from livestock, or N₂O reductions from fertilizer management in agricultural activities.

Each offset credit must come from outside a sector subject to a GHG emissions cap. Interestingly, the Offset Proposal states that the province will consider offset initiatives undertaken anywhere in Canada.³ However, any Offset Initiative Sponsor must be either a resident or an entity with a presence in Ontario.⁴

Why do carbon offset credits matter?

For companies that produce more than their emissions allowances under the cap and trade program, offset credits provide an alternative method of complying with requirements under the legislation and regulations. Greenhouse gas emitters may use offset credits to account for up to 8% of their obligations under the cap-and-trade program, granting them an extra level of flexibility and choice in how they meet their reductions targets.⁵

What types of projects are eligible for carbon offset credits?

As outlined in the Offset Proposal, the MOECC may only award offset credits to a narrow range of initiatives that fit within the scope of offset protocols. Only initiatives that began on or after Jan. 1, 2007 will be eligible to create offset credits.

The MOECC is in the process of developing protocols to guide certain classes of carbon offset initiatives. The 2015 Cap and Trade Design Options paper suggests that the initial three protocols will involve:

• Mine methane capture and destruction;
• Landfill gas capture and destruction; and
• Ozone depleting substances capture and destruction.

These first three proposed protocols are based on existing protocols in Québec, and are expected to be fast-tracked for operation by early 2017.⁶

The remaining ten suggested protocols are largely directed at the agriculture and forestry industries, and they are expected to be in place by 2018:⁷

• N2O Reductions from Fertilizer Management in Agriculture
• Emission Reductions from Livestock
• Organic Waste Digestion
• Organic Waste Management
• Forest Project
• Afforestation
• Urban Forest Project
• Grassland
• Conservation Cropping
• Refrigeration Systems

The MOECC has advised that these thirteen Ontario offset protocols will be developed for use in both Ontario and Québec.⁸

The proposed protocols are currently quite narrow in scope. Future protocols may be developed either by the Minister, or submitted by another entity for consideration.⁹ It remains to be seen what other types of protocols will be developed in the future, and whether they will be available for novel technologies.

How are offset credits issued and tracked?

As part of the offset credit verification process, the MOECC will require in-depth information on the initiative. In order to be eligible for offset credits, each initiative must fit the requirements of an established protocol. The Offset Initiative Sponsor is a person designated to register an initiative and provide annual reports to the MOECC to ensure consistency and relevance of the particular project and any credits issued.

The Offset Initiative Sponsor will be responsible for providing specific and detailed information on the initiative, including the nature and estimated duration of the initiative, and the expected amount of GHG equivalent emissions reductions over the lifetime of the initiative. Once registered, the Offset Initiative Sponsor may apply for offset credits.

The quality of the offset credits will be continually monitored by requiring each Offset Initiative Sponsor to submit annual Initiative Data Reports to the MOECC. These reports will include information on all facets of the specific initiative, and will be independently verified by an accredited organization.

To add a further layer of accountability, the MOECC plans to create a publicly accessible Offsets Registry.¹⁰ The Offsets Registry will also allow those who purchase offset credits to make informed decisions about the source of their purchases.

Accounting for Greenhouse Gas "Leakage" and "Reversal"

Two interesting concepts addressed in the Offset Proposal are "leakage" and "reversal."

"Leakage" is described as a reduction in emissions by an offset initiative in one jurisdiction resulting in an equivalent increase in emissions in another jurisdiction. For example, the conservation or protection of forests as carbon sinks in one area may result in additional deforestation in another area. Any potential leakage must be measured or estimated quantitatively where possible in order to provide an accurate representation of offset emissions.¹¹

The Offset Proposal also addresses the risk of "reversal", in which the effects of carbon offsets are reversed, either intentionally or unintentionally. For example, if an offset initiative is based around the preservation of tracts of forest, with carbon sequestered in living trees, a forest fire might result in a significant amount of this sequestered carbon being released back into the atmosphere.

The risk of reversals for initiatives are accounted for by creating a Buffer Account.¹² If an Ontario Offset Protocol identifies a risk of reversal associated with a particular form of carbon offset, the regulation and protocol will require a corresponding amount of credits to be placed into the Buffer Account as a form of insurance policy against this reversal. The Buffer Account will also include 3% of all non-sequestration credits in order to address the risk of intentionally reversed credits, or credits created fraudulently or in error.¹³

Looking Ahead: Key Cap and Trade Program Dates

Key Date	Description
Dec. 6 & 8, 2016	MOECC hosting cap and trade auction training webinars
Jan. 1, 2017	First compliance period begins
January 2017	Practice cap and trade auction
Early 2017	Finalization of general regulatory and offset credit amendments
Early 2017	Proposal for administrative penalties regulation
March 2017	First Ontario cap and trade auction (there will be 4 auctions per year and up to 4 sales per year)
Dec. 31, 2020	First compliance period ends
Nov. 1, 2021	Deadline for submitting allowances equal to attributed emissions for compliance period Obligation to submit 3 allowances for every allowance not submitted on time

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¹ See Ontario's Compliance Offset Credits Regulatory Proposal at p.4.

² Ibid at p.8.

³ Ibid at p.4.

⁴ Ibid at p.6.

⁵ Ibid at p.4.

⁶ Ibid.

⁷ See Ontario's Cap and Trade Program Design Options paper at p.31.

⁸ Ontario Ministry of the Environment and Climate Change, Cap and trade: offset credits and protocols, available online.

⁹ Ibid at p.25.

¹⁰ See Ontario's Compliance Offset Credits Regulatory Proposal at p.7.

¹¹ Ibid at p.11.

¹² Ibid at p.20.

¹³ Ibid.