Ontario Cap-and-Trade first auction results

Cap-and-Trade Program is fully in place in Ontario as illustrated by the results of the first government auction that took place last March 22nd. All 2017 vintage units were sold at a final price of CAD $ 18.08 (1 cent above the reserve price), leaving 14% of bids unfulfilled – in our opinion these units could have been replaced by allowances from the future auction. In any case these results confirmed the current need for participants to purchase emission allowances through government auctions as other options are currently limited. Indeed, protocols for carbon offset projects have not yet been approved. In addition, as long as markets are not linked Ontario participants will not likely buy California-Quebec market allowances since they cannot be used for compliance in Ontario.

However, it may seem surprising that only 26% of 2020 Vintage allowances were purchased. Indeed, a unique feature of the Ontario Program is that the first compliance period lasts four years, from 2017 to 2020. Thus, it is possible to use 2020 Vintage for the current compliance period. This peculiarity of the system (that we highlighted in a previous article) is a missed opportunity for participants who, rather than running out of emission rights, should consider acquiring 2020 Vintage allowances, which final price was lower (CAD $ 18.07) than 2017 Vintage allowance. This subtleness in the Program is part of a long list of ways that participants can use to leverage their compliance goals at a lower cost. Consequently, many participants find themselves spending more than they should. This is true in Ontario, but also in Quebec.

These results stand out in comparison with the lack of participation in the recent auctions on the Quebec-California market. Indeed, only 18% of the allowance units were sold at the February 2017 auction. The legal pitfalls (discussed below), are the main reasons for the disaffection of Californian participants. It should be noted that, despite this low participation rate, the reserve price mechanism prevented a collapse of the allowance price, which sold for CAD$ 17.84.

Legal issues

While the US federal government is undoing various environmental regulations, there are specific concerns in California that brought uncertainties to the market.

On the one hand, the auction principle is challenged in court by both the California Chamber of Commerce and Morning Star Packing Co., on the basis that it would constitute an illegal tax. In order for a tax to be approved it must be passed by a two-third majority in both House of Origin and the House of the California Legislature, which was not the case when the AB 32 legislation was approved in 2006. After a first ruling in favor of the California Air Resources Board (CARB) in 2013, the California Court of Appeal upheld this decision on April 6, 2017. Despite these two rulings, the observers expect the case to be brought before the Supreme Court of California.

On the other hand, there is uncertainty about the extension of the Cap-and-Trade system after 2020. Although the target of 40% reduction by 2030 has been voted and approved in 2016, the system has no legal basis for continuing after 2020. Governor Jerry Brown therefore proposes to pass Bill AB 151 with a two-thirds majority not only to extent the system, but also to undermine the law suits referred to above.

Lessons learnt from the Ontario Cap-and-Trade first auction

Ontario has set up its carbon market in record time. The results of the first auction seem to indicate that the Ontario market is not flooded with allowances and that a certain scarcity may occur, at least until the junction with the Quebec-California market. Also, Ontario participants understand that there is no reason to believe legal challenges in California will affect the future of Cap-and-Trade system in their own jurisdiction. That being said, businesses must realize that 2017 offers unique opportunities to minimize compliance costs, and that the first auction being already behind us, it’s now time to seize these opportunities!

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