Complex alternative to carbon tax questioned

Ontario takes revenue projections, but no large industrial bidders to the allowance market
Tuesday, May 31, 2016
By Barbara Carss

Ontario’s pending cap-and-trade system will initially function as an elaborate structure for applying a carbon tax on fossil fuels, while creating an avenue for proceeds to flow to California. The legislation, which passed into law earlier this month, was designed to oblige large industrial emitters producing more than 25,000 tonnes of carbon dioxide equivalent (CO2e) annually to purchase carbon emission allowances, but, in practice, the Ontario government will disburse free allowances to the sector until at least 2020.

“The first auction is going to be dominated by two natural gas utilities and about half-a-dozen transport fuel providers that need to buy tens of millions of allowances,” explains Duncan Rotherham, Canadian vice president with the environment and energy management consulting firm, ICF International. “Then all those costs will be passed through to small energy end-users on the natural gas bill or at the pump.”

As such, commercial and multi-residential real estate owners will catch a significant share of the fallout. Even so, a projected natural gas price increase in the range of $0.84 to $1.05 per gigajoule (GJ) is lower than carbon tax rates in British Columbia or Alberta and is expected to cause Ontario landlords and residential customers less pain than spiking electricity rates.

“It’s symbolically important and the revenue may be put to good use, but it’s too low to affect behaviour,” submits Mark Winfield, a professor with York University’s Faculty of Environmental Studies and co-chair of its Sustainable Energy Initiative.

Details about the mechanisms for collecting pass-through costs are still coming in regulations and directives from the Ontario Energy Board, but the select group of designated traders is now preparing for an initial exclusive-to-Ontario carbon auction early next year prior to planned entry into the broader pool of the Western Climate Initiative (WCI) with California and Quebec. The Ontario government foresees earning up to $1.9 billion annually in the 2017-2020 period from the sale of emission allowances, and has pledged to invest the money in programs that will promote low-carbon technology, products and practices.

Price and revenue projections

Based on the three current WCI partners, analysts project the market price of carbon allowances will remain low for at least another decade, largely due to what’s seen as California’s disproportionately generous allocation of allowances at the launch of its trading in 2012. This has created plenty of space for bidders, keeping the price around the regulated minimum, known as the floor price.

The jump in Quebec’s market price from $10.75 per tonne in 2010 to $17.46 in November 2015 reflects the mandated incremental increase with each auction and the declining value of the Canadian dollar against U.S. currency. Soon, the Ontario government will be bringing another 150 million emission allowances to the marketplace.

“It’s a good thing if the primary focus is on minimizing the price of carbon, and, definitely, most of the economy is focused on that, but joining a system that’s very long on allowances, like WCI, isn’t the best idea if you’re a government that’s looking to maximize revenue through the sale of your allowances,” Rotherham says. “Ontario is going to be a net buyer of California allowances so proceeds are leaving that could otherwise be poured back into Ontario’s economy.”

Projections from California Carbon Info peg the WCI market’s cumulative surplus at 300 million tonnes of carbon allowances to 2020, during the same period that the Ontario government is targeting revenues nearing $8 billion. “That’s if they sold all the allowances, but they could also sell less in the broad WCI market and that would reduce revenues available,” Rotherham notes.

Retrofit incentive take-up recommended

Although a promised Climate Change Action Plan has not yet been released, leaked information prominently highlighted in the Globe and Mail and various hints in official government communications indicate there will be opportunities for the real estate sector to recapture some of the money it will be paying out. Ontario Premier Kathleen Wynne has suggested that the document supporting a May 16 published report isn’t necessarily the final version of the plan. However, the purported $1.3 billion for energy retrofits in commercial, multi-residential and institutional buildings is partly repeated in a May 25 release from Ontario’s Ministry of Municipal Affairs and Housing that promises $400 million for energy upgrades in private rental housing and $500 million for work in the province’s social housing stock.

The Ministry’s accompanying statement: “To ensure that carbon pricing does not negatively impact tenants and that private building owners take advantage of retrofit programs, the province will also consult and develop options to make it illegal to pass these costs onto tenants,” nevertheless causes some concern. Adam Krehm, principal with O’Shanter Development Company predicts that a prohibition on recouping capital costs in excess of any government funding could be something of a “poison pill” discouraging landlords from tapping into funds, particularly when factoring in past experiences of lengthy approval processes for incentive programs.

“In the private sector, owners who are investing in energy efficiency do it because it is cost-effective and they do it with their own money,” he says. “If I want to put in a new boiler, I use my own money, and I just go and do it without delays.”

Rotherham stresses that funding for the Climate Change Action Plan is actually commercial and residential energy consumers’ money. “They will be paying potentially hundreds of millions into this. They’ve got to get something back out,” he urges.

Cap-and-trade presents few other perks for the buildings sector as it’s unlikely — despite what Rotherham characterizes as “persistent irrational exuberance” — that energy efficiency gains will qualify as an eligible offset that could be sold into the marketplace. Few organizations, with the possible exception of university campuses or health care facilities with co-generation, will even hit the threshold to be voluntary carbon market participants (with annual emissions in range of 10,000 to 25,000 tonnes of CO2e) since that is to be measured at the building level rather than portfolio-wide.

Compliance hammer has political repercussions

As for the cap-and-trade free-riders, there are broader economic reasons why large industrial emitters will be given the emission allowances they need. “They’re the entities that could pick up stakes and leave the province or they could go bankrupt if they’re hit with costs that their competitors elsewhere don’t have,” Rotherham says.

“I have serious doubts about whether the system will ever really be applied to large industrial emitters,” Winfield concurs. “So what it is, effectively, is a de facto carbon tax on heating and transportation fuels.”

Albeit, not a simple tax. “Administratively, cap-and-trade can be a nightmare and offsets add whole new dimensions to the complexity,” he adds.

In choosing the more complex alternative to carbon tax, the Ontario government theoretically has more environmental control. Carbon tax doesn’t reduce emissions if consumers remain willing to pay it, whereas emitters could actually be forced to shut down production once the cap is reached. Yet, with no large emitters to target, the Ontario government would have to drop that hammer on the end-users of heating and transport fuel — also known as voters.

Looking west, Alberta legislators have opted to present their constituents with a straightforward carbon levy instead — beginning at $1.01 per gigajoule of natural gas in January 2017 then jumping to nearly $1.52/GJ in January 2018 — and have promised to reinvest $645 million of the collected revenue in energy efficiency and micro-generation initiatives over the next five years.

“In reality, no one has really implemented a cap-and-trade system that has produced a meaningful price on carbon,” Winfield says. “Lots of jurisdictions have done meaningful carbon taxes.”

Barbara Carss is editor-in-chief of Canadian Property Management.

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