the Clean Air Industrial Regulatory Agenda

The Globe and Mail has been analyzing leaked documents describing the Conservative plan for an emissions trading system for big industry. Basically, it looks like the Liberals' old Large Final Emitters (LFE) system, with slightly tougher targets and of course a brand new name. Unfortunately, this means that most of the flaws of the old LFE system could still be present:

• intensity targets - the biggest flaw - no guarantee that absolute emissions will decline. It also makes for a more complex system to set up (you need to set targets for all kinds of industrial products), and leaves a lot of room for industries to negotiate relatively soft targets without the general public noticing.
  
• free permits - the emitters in the system will (I am assuming here) once again get their permits free. Given international experience so far with emissions trading, this is a big transfer of wealth to industry, and will likely give many emitters a windfall profit, without necessarily rewarding good work.
• an offset system - again, I'm assuming the Conservative model will reflect the Liberal original, here. The LFE system included a complementary offset system, where farmers, landfill operators, etc. could sell credits to the big emitters based on carbon sequestration or methane capture. An offset system can in theory be a great market-based tool, but is very complex to set up and administer (lots of project evaluation methodologies) and creates opportunities for double-counting reductions and diluting the emissions trading system itself.
• a price cap on emissions - the Liberals promised industry that they would sell unlimited permits at 15$/tonne if the price rose that high. This amounted to a fairly low-set safety valve and would have eliminated a lot of emissions reductions from the market. If Canada's market had ever been linked to international carbon markets, then it could have also led to arbitrage (traders buying Canadian permits as a hedge against market volatility, etc.)

On top of these problems, the Conservative system won't go into effect until 2010. Back in 2004 when the LFE system was nearing completion, industry was already ready for a 2008 roll-out, so this seems like an unnecessary delay.

One plus of the draft Conservative system: long term, gradually tightening targets - it sets out targets for not only 201-2015, but stricter targets for 2015-2020. This gives predictability to industry, particularly for capital investment decisions.

So what would the ideal Canadian emissions trading system look like? Here are some key points:

• an absolute target - forget the intensity targets and replace them with an overall, absolute cap on emissions, to guarantee real reductions.
  
• auctioned permits - auctioning permits is more economically efficient, a lot simpler to set up and administer, and removes most opportunities to hide favouritism towards particular industries. It also creates revenue that can be used to run the program AND create a double dividend (see my post) by using it to reduce income taxes or what have you.
• simplicity and clarity - a simple system makes for more liquid markets, more participant confidence, and more transparency. Using an absolute target and permit auctioning would get rid of a lot of the unnecessary complexity of the LFE system. Eliminating the offset system would also help, but this would also remove a big incentive for offset-type reductions - the compromise solution would be to design as simple an offset system as possible.
• no/higher caps on permit price - the 15$/tonne permit price cap was too low and will stifle innovation if its reinstated. Either remove the cap altogether, or announce a much higher cap - 80-125$/tonne (I use these figures since they've been cited as approximating the true costs of CO2e emissions)
  
• long term, gradually tightening targets
  
• roll-out as soon as possible - 2008 if possible.
  

Link to Globe article
Link to further Globe coverage
Link to a US EPA Guide to desigining and operating a cap and trade program - a great resource covering all of the topics discussed above.