The International Policy Elements of a Long-term Energy and Climate Change Strategy for Canada

Advisory Note to the Minister of the Environment

Prepared by the National Round Table on the Environment and the Economy

This Advisory Note to the Minister presents advice from the National Round Table on the Environment and the Economy (NRTEE) on key international policy elements of a long-term energy and climate change strategy for Canada. It represents the third and final portion of a broader set of recommendations to the government from the NRTEE providing input on Canada?s climate change policy beyond 2012.

PDF Version:
The International Policy Elements of a Long-term Energy and Climate Change Strategy for Canada
(73 Kb - 18 pages)
Date: 2006

Introduction

This Advisory Note to the Minister presents advice from the National Round Table on the Environment and the Economy (NRTEE) on key international policy elements of a long-term energy and climate change strategy for Canada. It represents the third and final portion of a broader set of recommendations to the government from the NRTEE providing input on Canada?s climate change policy beyond 2012.

In the first phase of its work, the NRTEE provided guidance related to the 11th Conference of the Parties (CoP 11) of the UN Framework Convention on Climate Change, which Canada hosted in Montreal in November 2005. In its recently completed second phase, the NRTEE addressed the broader opportunities and challenges facing Canada in relation to its long-term energy and climate change future, looking ahead to the 2050 time horizon.

The present Advisory Note focuses on three international policy challenges for Canada that are important to any long-term energy and climate change strategy:

• integrating climate change objectives into Canada?s foreign policy and its international aid and development policies;
• enhancing economic opportunities for Canada by promoting trade in climate-related technologies; and
• ensuring that any potential Canadian carbon market is eventually linked to international carbon markets.

The Advisory Note briefly describes current and emerging major trends and issues in each of the three international policy areas, and then identifies opportunities for action in the form of recommendations for the government?s consideration.

The analysis and recommendations represent the consensus of the NRTEE members, and are based on commissioned research papers. 1 In the case of foreign policy, aid and development policies, as well as international trade policy, the information in these papers was supplemented by a meeting of stakeholders and technical experts.

Climate Change and the International Policy Dimension

The NRTEE believes that climate change, with its close linkages to energy policy, has emerged as one of the most important policy challenges confronting Canada and the international community in the 21st century.

Climate change cuts across economic, environmental and social policy boundaries. Given what is now known about impacts on Canada, particularly in the vulnerable Arctic region, the NRTEE believes that climate change policy needs to be seen as intersecting directly with Canada?s foreign policy, its aid and development policies, and its international trade policy, particularly where these policies relate to sovereignty, national security and global economic stability. Issues such as energy security only increase the need to integrate consideration of climate change into all relevant aspects of Canadian policy:

• Foreign policy: There is scarcely a foreign policy issue that will remain unaffected by climate change or Canada?s climate change policies. One potential way to link climate change concerns and Canada?s broader foreign policy is through Canada?s major bilateral partnerships and its role in major international institutions ? the G8, the North American Free Trade Agreement, the Arctic Council and others. How the participants in these relationships address ? or do not address ? climate change will affect Canada?s room to manoeuvre on the issue.
  
  The potential climate change impacts in Canada?s Arctic ? in particular, the vanishing of sea ice that currently keeps the Northwest Passage from being an international strait ? raises serious concerns about national sovereignty and security.
  
  Canada?s relationship with economies in development will also be affected by climate change. For instance, climate change may increase the incidence or severity of extreme weather events such as hurricanes, raising broad national and human security threats. Such events could create pressure for Canada to divert its limited military resources to assist victims in other countries. Climate change impacts could also feed scarcity-bred conflicts (particularly with respect to water and food) that add to Canada?s commitments to building peace and human security abroad and that trigger large-scale migrations of people and new waves of refugees. Canada must therefore address global mitigation and, where possible, national adaptation in these countries as priorities (see discussion below).
  
• Aid and international development policies: Canada?s aid and development policies must be concerned with the ability of developing countries to address the existing and emerging impacts of climate change. This means different things for different countries.
  
  For smaller countries and more vulnerable regions (such as low-lying coastal areas and island states), climate change poses a fundamental hazard to their economic and social well-being. These developing countries are likely to suffer an increased incidence of severe weather events, rising sea levels and changing precipitation patterns. Canada can help them to develop, over a relatively short period, the capacity to adapt to climate change.
  
  For many rapidly growing middle-income countries, mitigation is a key challenge. India, Brazil, China and Mexico are poised to become major emitters of greenhouse gases (GHGs), surpassing emissions from the older industrialized economies by 2020. Canada can help inform decisions made today in these countries about energy use, transportation infrastructure, forestry, agriculture and urbanization that will have a significant impact on future levels of GHG emissions.
  
• Trade policy: International trade and investment present opportunities for developing and disseminating energy- and climate-related technologies. Potential technology transfers cover a broad set of processes ? including flows of expertise, experience and equipment ? for mitigating and adapting to climate change. By improving these technology transfer processes, Canadian companies with expertise in climate-related technologies can tap into the significant new markets that will be created as countries around the globe respond to climate change.

This Advisory Note explores some of the most important challenges that arise for Canada in this sweeping policy context.

Challenge 1:
Integrating Climate Change Into Canada?s Foreign Policy and Its Aid and Development Policies

Observations

Canada?s approach to climate change must integrate a wide spectrum of domestic and international policies.

Climate change is an inherently global policy challenge. Any effective response will demand action by many countries, regions and peoples. It will require sustained leadership and coordination at the highest levels and across the full spectrum of relevant economic, environmental and social policies.

Even within Canada, the complex global and multi-dimensional nature of the climate change challenge means that no single department or agency can act on its own. A clear, coordinated and integrated approach is needed, starting with the federal government and extending to the provinces and territories, industry and other interested entities.

Canada must be strategic about where it puts its focus.

As an active participant in the international community, Canada can further its climate change objectives through a range of international partnerships and organizations. But it must choose these partnerships and institutions carefully. It must consider where it has influence, where there are countries with a common concern for the climate change challenge, and where there is already demonstrated capacity to integrate policies.

In addition to its ongoing commitment to the UN Framework Convention on Climate Change, Canada should turn to international institutions that are well positioned to integrate climate change with other relevant policy areas such as energy policy (including energy security), foreign policy, and aid and development policies. Foremost among these institutions are the G8, the North American Free Trade Agreement (NAFTA ? joining Canada with the United States and Mexico), and the Arctic Council (whose membership includes the United States, Russia and the Nordic countries).

The range of bilateral partnerships that Canada enjoys can be used to further its climate change objectives, particularly with respect to the United States ? our primary trading partner, but also our joint custodian of the North American Arctic region. Bilateral partnerships with the current major carbon emitters and emerging powers such as China and India can also be furthered. In addition, Canada?s relationship with key developing countries and economies in transition offers opportunities for both mitigation and adaptation.

Recommendations

The NRTEE has identified the following opportunities for action in the area of integrating climate change objectives into Canada?s foreign policy and its international aid and development policies.

1. Strategic Bilateral Partnerships

Recommendation:

Canada should develop an integrated approach to forging new bilateral partnerships and alliances that promote Canada?s economic and environmental interests with both energy ?demand? powers and energy ?supply? countries ? starting with the United States and Russia.

Rationale:

Canada?s wide range of bilateral partnerships presents the first tier of opportunities for furthering its climate change objectives through strategic alliances.

Canada already has bilateral arrangements focused on climate change with several key partner nations, notably the Canada?U.S. Bilateral Working Group on Climate Change and the Canada?China Framework Statement for Cooperation on Environment into the 21st Century, which has cooperation on energy and climate change as its priority. The challenge for Canada is to use these existing working-level groups as a springboard to initiate more senior-level and strategic discussions on climate change issues, particularly with its G8 and G20 partners. In this way, Canada can integrate existing and new bilateral instruments focused on climate change more closely into its foreign policy, and into the development and trade agreements made in conjunction with these countries.

A priority relationship for Canada on climate change should be with the United States, its major trading partner. The Canadian government has already indicated a clear commitment to enhancing Canada?U.S. relations. Cooperation on climate change would help revitalize the partnership in areas such as air quality and promoting the clean and efficient use of energy resources.

Canada will also need to consider how its climate change objectives may affect its relationships with countries beyond North America that are, or will soon become, major emitters of carbon ? notably Russia, China and India. Canada could consider developing strategic alliances with such countries, focusing on trade promotion. This approach recognizes the reality that Canada?s domestic market alone is insufficient to sustain a world-class climate-related technology sector. Canada could use these alliances to further its comparative advantage in clean technologies (such as carbon storage and enhanced oil recovery) and renewable energy sources (particularly biomass, hydrogen and wind), and to support technology transfer. This effort would include addressing issues related to market access and tariffs on environmental goods and services.

There is, in particular, an opportunity to develop a robust relationship with Russia. To date, too little attention has been paid to the potential of a special partnership with Russia. Canada and Russia are responsible for the largest land and sea areas of the rich and sensitive northern region of the planet. Both are federations of diverse peoples and cultures. Perhaps more than any other country, Canada is uniquely positioned to build a strategic partnership on climate change with Russia, focusing initially on protecting the Arctic.

With respect to developing countries, Canada should nurture its relationships with important developing economies such as India. India is a fast-growing emerging power, a founder of the Asia-Pacific Partnership on Clean Development and Climate, and a country with demographic and Commonwealth links to Canada. Canada has announced its intention to negotiate a bilateral free trade agreement with India, which presents an opportunity to highlight and promote Canada?s climate change objectives.

2. A Focus on a North American Policy Response

Recommendation:

The Ministers of the Environment and of Foreign Affairs should ensure that Canada?s foreign policy in relation to climate change places priority on a North American perspective, putting to use effective instruments already in place, such as the International Joint Commission, the Commission for Environmental Cooperation, and the Security and Prosperity Partnership of North America.

Rationale:

As noted in Recommendation 1, perhaps the greatest immediate potential for integrating Canada?s climate change objectives into its foreign policy exists in North America. There is also a compelling reason for focusing on the North American policy response: given their shared North American geography, Canada and the United States will have to deal jointly with climate change. They need to find ways sooner rather than later to address possible conflicts driven by the projected impacts of climate change (over Arctic sovereignty, over boundary waters, etc.) before these escalate into more serious disputes.

Several instruments are already in place to pursue climate change objectives at the regional level in North America. These instruments can help Canada and the United States further their agenda for strengthening bilateral cooperation, and can also enhance trilateral Canada?U.S.?Mexico engagement. One such instrument is the Commission for Environmental Cooperation (CEC), which already has a mandate to integrate environmental and economic concerns including climate change and trade.

The Security and Prosperity Partnership (SPP) process is emerging as a second key vehicle through which Canada, the United States and Mexico might effectively pursue a North American approach to energy and climate change issues. There is an immediate opportunity for Canada to pursue its climate change objectives within the SPP process, which covers a broad range of issues including energy, transportation and the environment. Canada can highlight climate change not only within the SPP?s environmental work program, but also within its energy and transportation work programs ? emphasizing the need for an integrated and coordinated approach within the agreement. It can also employ institutions such as the International Joint Commission on boundary water issues to explore cooperation on adaptation issues. Groups such as the CEC and SPP could, by working together, help to put forward an integrated approach to North American governance on a range of issues associated with climate change.

3. Putting a Priority on the Arctic

Recommendation:

Canada should quickly develop a strategy for climate change mitigation and adaptation for the Arctic in partnership with other countries. There are immediate opportunities to update and strengthen Canada?s northern foreign policy program and to improve the Arctic Council?s ability to foster circumpolar relations and coordinate policy.

Canada should also consider whether to negotiate a shipping management and regulatory regime for the Northwest Passage with the United States, Denmark and Russia.

Rationale:

The challenges posed by climate change in the Arctic demand that Canada integrate climate change considerations into its foreign policy objectives through existing unilateral, bilateral and multilateral instruments. Foreign policy as it relates to the North is integrally linked to Canada?s climate change objectives, to Canadian sovereignty and security, and to the region?s fragile, globally significant environment and the culture and livelihoods of its people.

There is growing evidence that the impacts of climate change are already intensifying Canada?s foreign policy and Arctic sovereignty challenges ? threatening to melt the ice cover of the Northwest Passage and turn the open waters into an international strait. Canada now must consider how the region?s communities and environment can be protected in these changing circumstances. For the same reason, Canada should also reach out to other countries (such as Denmark, the United States and Russia) that also have territories in the Arctic.

Canada has a number of opportunities to promote mitigation and adaptation in the Arctic by strengthening bilateral and circumpolar cooperation. Since 2000, Canada?s foreign policy in the North has been guided by the document The Northern Dimension of Canada?s Foreign Policy. While the policy set out in this document stresses the importance of Canada?s bilateral relations with other northern powers, notably Russia, it does not include any meaningful discussion about the threat of climate change. This policy needs to be updated to accommodate the emerging and near-future realities of climate change in the North, particularly with reference to incorporating the findings of the Arctic Climate Impact Assessment. Canada?s new government has indicated that there will be new resources and investments in Arctic capabilities. Moreover, the new Prime Minister?s first foreign policy statement addressed Canada?s role in the Arctic.

The Arctic Council, a forum for promoting cooperation and coordination among the Arctic states, has a key role to play in the stewardship of this sensitive area, which is so vital to the earth?s natural climate control system and so vulnerable to the effects of climate change. Canada was a founding member of the Council in 1996. The Council?s membership now includes the United States, Russia, Sweden, Norway, Finland, Denmark and Iceland, as well as representatives of northern indigenous peoples.

The Council is well positioned to play a major role in helping Canada integrate climate change into its foreign policy, because it has already achieved a level of integration in its institutional operations that does not exist in any other international organization in which Canada participates. Climate change is already high on the agenda of the Arctic Council. Given that it represents the governments and peoples most directly affected by climate change and a region already experiencing the costs of inaction, the Council is a highly useful forum for Canada to use in furthering circumpolar relations and policy coordination. Canada can, for example, work toward careful expansion of the Council?s membership, promote key technical assessments and identify opportunities to further these assessments at the domestic level and in other international forums. In particular, Canada can help the group focus on controlling climate change, promoting human security and fostering sustainable development in the region.

In light of this potential, the federal government should consider creating a domestic institution to support Canada?s influence in the forum, one that includes not only the key federal departments and territorial governments, but Arctic indigenous peoples as well.

4. Canada?s Development Policy

Recommendation:

Canada should mobilize its development policy and the promised new financial resources to explicitly support the government?s climate change goals.

Rationale:

With the new government promising new resources for development assistance, there is an opportunity for Canada to systematically integrate its climate change objectives into its development cooperation. Canada can also build on the efforts underway at the Canadian International Development Agency to support the efforts of developing countries in climate change mitigation and adaptation.

In particular, there are opportunities for action in the following areas:

• Employing environmental analysis and strategic environmental assessments for international development projects and policies, to ensure that climate change mitigation and adaptation are incorporated upfront into policy and project implementation;
• Using the OECD?s Development Assistance Committee to coordinate donor official development assistance more fully, in a way more aligned with the priority of climate change mitigation and adaptation;
• Working with recipients of official development assistance to prioritize climate change issues within national development plans; and
• Building capacity for adaptation and integrating it into multilateral development programs.

Challenge 2:
Promoting Trade Opportunities for Climate-related Technologies

Observations

Expanded trade in climate-related technologies represents a significant economic opportunity for Canada.

As an energy-exporting, trade-dependent country, Canada has a strong national interest in promoting climate-related technologies. These technologies are among the most important tools in helping Canada and other countries reduce greenhouse gas emissions and improve energy efficiency. They cover a range of energy efficiency, renewable and alternative energy technologies ranging from ultra high-efficiency gas turbines and small-scale hydro production, to biofuels, hydrogen fuel cells and more energy efficient waste treatment technologies.

Canadian companies have international expertise in a number of these areas. In particular, Canadian expertise is recognized in hydrogen fuel cells; forest management; small-scale, run-of-river hydro; solar energy; biofuels; and geological and biological carbon sequestration.

Domestic markets alone are insufficient for a sustainable climate-related technology sector.

The Canadian market is too small on its own to support a thriving climate-related technology sector. Canadian companies with expertise in these technologies will have to tap into the $1-trillion (and growing) global market if they are to flourish. But they need help in pursuing export opportunities and in collaborating with one another in penetrating world markets.

It is time for a new trade promotion strategy focusing on the specific trade opportunities presented by climate change.

Canada needs a strategy to strengthen and enhance the competitiveness of its climate-related technology providers. As a start, the government should develop a clear understanding of the existing capabilities of Canada?s climate-related technology sector and the niches that this sector can fill in both international and domestic markets.

A new Canadian trade promotion strategy for climate-related technologies should reflect:

• the entrepreneurial capability and technological capacity of Canadian firms, including management experience, human resources capacity, technological excellence and ability to secure financing;
• a clear understanding of market drivers, recognizing the realities of market initiation, development and sustainability; and
• responsiveness to time frames, both within the current Kyoto Protocol and beyond.

These factors converge to create the necessary conditions and market readiness for successful technology exports.

Recommendations

The NRTEE has identified the following opportunities for enhancing international trade opportunities for Canada?s climate-related technologies.

5. Existing Canadian Trade Promotion Strategies and Programs

Recommendation:

The federal government should lead in the development of a more integrated and streamlined trade promotion effort for climate-related technologies.

Rationale:

There are concerns about the lack of coordination and integration between current trade promotion programs and climate change programs. From the perspective of the Canadian companies they are trying to serve, the slate of current federal and provincial trade promotion programs can be confusing and, at times, contradictory.

In addition, new federal programs addressing the development and promotion of climate-related technologies have been created in parallel to existing programs. Sometimes, new organizations or mandates are created within particular policy areas, such as urban infrastructure, Aboriginal programs, technology development and forest management. This can result in organizational fragmentation, with new export development assistance being dispersed and not necessarily coordinated with previous programs. New layers create new processes, new schedules, new eligibility requirements and new transaction costs. Often, the potential incremental value of assistance is small in relation to the costs of obtaining it.

Finally, there is a concern that Canadian programs in niche areas tend to deal with limited aspects of the overall market as experienced by technology suppliers, customers and the government as a whole. For example, Canada may limit its support of a particular product to the sales aspect, while its trade competitors may be coordinating efforts on a more systematic basis to include sale of the product, multi-stage development financing, training programs and government-to-government assistance on relevant policies and regulations. Gaps in support programs can cause companies to lose competitive advantage in the global marketplace. The array of Canadian programs pertinent to climate-related technology should match technology market development from the R&D stage all the way through to foreign market penetration.

6. Domestic Technology Platforms

Recommendation:

The federal government should take the lead in developing technology platforms, focusing on leading Canadian climate-related technologies, to help demonstrate commercial potential and export viability.

Rationale:

Canada should be cautious about promoting solutions for other countries that are not yet solutions at home. To provide the necessary domestic experience with a new technology, technology platforms can be created to bring together researchers, industry, governments and other interested parties. These platforms involve the development of a long-term vision and coherent strategy for addressing both the technical and non-technical requirements for the optimal development, deployment and use of a particular technology. They help domestic markets generate and test new technologies and thereby help ensure trade readiness and success. Coupled with international demonstration projects in potential market countries, the technology platform concept can be instrumental in demonstrating commercial potential and export viability. Platforms can provide a focus for investment, leading to expanded trade in climate-related technologies and services. One high-profile platform in Canada is the International Test Centre for Carbon Dioxide Capture at the University of Regina and the affiliated Boundary Dam field test facility.

The European Commission is establishing technology platforms to foster effective public?private partnerships among the research community, industry, financial institutions, users and policy-makers. These technology platforms ? for hydrogen, photovoltaics and nanotechnology among other technologies ? are expected to deliver the impetus to mobilize research and innovation, and facilitate the emergence of ?lead? markets.

For Canada, it will be important to ensure that technology development and deployment strategies recognize and augment current initiatives that are already showing promise. There needs to be support for initiatives such as Sustainable Development Technology Canada, Technology Early Action Measures, the Natural Resources Canada CANMET Energy Technology Centre laboratories and RETScreen International Clean Energy Decision Support Centre, and others. As noted in Recommendation 5, coordinating government programs at all levels is essential for bridging gaps and building partnerships. Examples of coordinated efforts include Trade Team Canada Environment and the Energy Innovation Network (or EnergyINet).

7. Canadian Content Rules

Recommendation:

Trade promotion programs should be given greater flexibility to focus on how benefits to Canada are realized, rather than having to adhere to strict Canadian content rules at the early development stages.

Rationale:

Early development of climate-related technologies typically knows no borders. Rather, it shares many attributes across international borders, such as knowledge, workers, capital, workplaces and state funding. It is also difficult to define ?Canadian content? at this early development stage.

Nevertheless, current Canadian content thresholds are part of all program support screens. Applicants must sometimes make concessions or incur costs in order to meet eligibility criteria, to their disadvantage or to no clear benefit. The ultimate benefits to Canada, in the much larger commercial market, may not be related to Canadian content at the early stages.

For early-stage development, any strategy to promote climate-related technologies should place more emphasis on long-term global prospects and less on Canadian content rules. Although Canadian content is important, trade promotion programs should be given the flexibility to focus on how the benefits to Canada are realized.

8. Early-Stage Market Development

Recommendation:

The federal government should help smaller Canadian companies gain an early market position in other countries through continued and enhanced targeted support for project design and development.

Rationale:

Federal support of early feasibility work is a potential ?foot in the door? for smaller Canadian firms. Competing countries often fund 100% of this type of early work, in order to secure the benefits and ensure an early market position for their companies.

Canada needs to further enhance direct support for strategic, early-stage market development activities such as project design and development based on the four pillars of trade promotion: raising awareness, showcasing technology, nurturing an enabling environment and winning in the global marketplace. Smaller firms often have the potential, but not the financial resources, to do this early feasibility work.

9. International Trade Regime

Recommendation:

Canada should continue to support its domestic climate-related technology industry by working toward an international trade regime that encourages the diffusion of environmental technology and expertise.

Rationale:

It is in Canada?s interest to become more competitive in the development, commercialization and marketing of leading-edge technologies for clean energy. Active participation in World Trade Organization negotiations enables Canada to position itself for trade opportunities and relations.

Challenge 3:
Ensuring Canada?s Domestic Carbon/GHG Emissions Market Is Linked to International Markets

Observations

The global carbon/GHG emissions market has already arrived, and it is projected to be worth $3 trillion by 2020.

Access to global carbon markets is critical both to economically efficient compliance and to the financing of technology deployment. Carbon markets can make the carbon reductions inherent in a project serve the dual purposes of both helping to finance a project and ensuring that the value of the project continues after its initial installation.

The foundation of a global carbon/GHG emissions market is a reality today, with various regional markets already in play or planned (see below). Although there has been much speculation about the future potential of a global carbon market, estimates are that such a market could be worth $3 trillion in less than 15 years.

Past experience has shown that emissions trading markets can enable industry to achieve environmental compliance in an economically efficient manner. In fact, these markets are well understood and have a proven record of reducing emissions while saving money for industry. In 1995, the U.S. Environmental Protection Agency set up a sulphur dioxide trading system in the northeastern states to address the challenge of acid rain. This program achieved an 80% reduction in sulphur dioxide emissions and did so at a fraction of the cost originally estimated by industry. This example has made industry a strong advocate of access to trading systems as part of an overall compliance strategy.

Any emissions trading market in which Canada chooses to participate must be carefully designed to ensure that all credits are linked to projects that are environmentally effective, that is, they result in demonstrated reductions in GHG emissions.

Emissions trading systems are already up and running in Europe, Australia and the United States.

Several trading systems are already operating:

• European Union Emissions Trading Scheme (EU ETS)
  Launched in January 2005, the EU ETS has become the largest emissions market in the world. In its first year, 362 million EU Allowances were traded, with a value of approximately 7.2 billion euro. The EU ETS will operate in two phases. In the first phase, up to 2007, the program is covering only carbon dioxide emissions from several major industrial sectors (energy, metals, minerals, and pulp and paper). In the second phase, from 2008 to 2012, the program could be expanded to regulate all six GHGs and to cover the aviation, chemical and aluminum sectors.
  
• New South Wales (NSW) Greenhouse Gas Abatement Scheme (GGAS)
  This program, launched by the Australian state of New South Wales in 2003, sets GHG emissions targets for NSW electricity retailers and other companies that voluntarily participate in it. Targets are set on a per capita basis, and allowable emissions by the participants are linked to these targets. Over the life of GGAS, GHG emissions targets are being progressively reduced. By 2007, emissions targets will be approximately 85% of the 2003 targets and will be maintained for the remainder of the program. GGAS is scheduled to continue until 2012, and could be extended until 2020 if no broader national trading scheme is established.
  
• Regional Greenhouse Gas Initiative (RGGI)
  The RGGI is a planned cap and trade system for fossil-fired power generators in seven northeastern U.S. states: Connecticut, Delaware, Maine, New Hampshire, New York, New Jersey and Vermont. Under a memorandum of understanding (MOU) signed by the participating states in 2005, carbon dioxide emissions from power generators will be limited starting in 2009. Regulated entities will be allowed to use a variety of compliance instruments, including allowances, early reduction credits (i.e., credits for eligible reductions occurring after the MOU was signed and before the start of the program), and offsets from landfill gas (methane) capture and combustion and from afforestation.
  
• Chicago Climate Exchange (CCX)
  The CCX is a voluntary GHG reduction program. It was established to achieve a number of objectives, including furthering the development of a flexible cap and trade program. Companies comply by making internal reductions, purchasing allowances from other companies, or purchasing credits from emissions reduction projects that meet specific criteria. All six GHGs are covered by the CCX. Companies that join the program make a legally binding commitment to reduce direct emissions below an emissions baseline. By the end of phase I (December 2006), all participants will have reduced direct emissions to 4% below a baseline based on average annual emissions from 1998 to 2001. The CCX grew from 77 to 129 members in 2005, and participants have tentatively agreed to extend the program for four more years. Average prices for credits have been slightly less than $2 per tonne.

There is also growing interest in a national U.S. GHG trading program.

Several prominent U.S. legislators continue efforts to introduce a national emissions trading program in the United States. One proposal (sponsored by Senators John McCain and Joe Lieberman) would create a mandatory cap and trade system for large emitters in the energy sector and selected industrial sectors, as well as for upstream suppliers of transport fuels, based on absolute emissions targets. It would cover 85% of national GHG emissions, including upstream emissions from the transport sector. Initial targets are set for 2010?2015 at approximately year-2000 levels. In addition to U.S. allowances, valid compliance instruments under the proposal would include tradable allowances from another nation?s market, a registered net increase in sequestration, a registered GHG reduction (i.e., an eligible offset), and a credit against future reductions.

Another proposal (sponsored by Senator Jeff Bingaman) would create a mandatory trading program for all upstream sources plus downstream sources of process emissions based on emissions intensity targets. It would provide even broader coverage than the McCain?Lieberman proposal, because all upstream sources would be covered. Initial targets would be set for 2010?2019. The total allocation in 2010 would be equal to forecast gross domestic product for that year multiplied by an emissions intensity target equal to 2.4% below 2009 forecast intensity. Each subsequent year, the intensity target would be reduced by 2.4%. This proposal would allow for a wide range of compliance instruments, including offset projects in another country, but not allowances or credits that are issued by a foreign country.

Canadian companies could benefit from participation in a global carbon market.

It is very much in Canada?s national interest to participate in international carbon markets sooner rather than later. Access to these markets would benefit not only Canadian emitters that may have to adhere to compliance obligations but also firms in the Canadian environmental industry that have the products and expertise to expand in this growing global market.

Emissions trading markets enable industry to achieve environmental compliance in an economically efficient manner. By attaching a value to emissions reductions, an emissions trading program with mandatory targets creates incentives for emitters to reduce their emissions below target levels. At the same time, a trading system provides a more cost-effective means for sources with higher marginal costs to meet their compliance requirements. By equalizing marginal costs across the trading system, a trading system minimizes total compliance costs.

Linking a domestic trading program to international markets significantly expands these benefits. By increasing the number and range of sources covered under the linked programs, linking expands both cost-saving opportunities and incentives to sources to reduce their emissions. In addition, it facilitates efficient emissions reductions within and between companies with operations in multiple countries.

Linking the Canadian market to international markets would provide Canadian companies with additional flexibility to meet any compliance requirements cost-effectively. Such linking efforts would help lend momentum to the creation of a single, efficient, GHG market in which emissions reductions are implemented where and when they are most cost-effective, and in which overall costs of meeting targets are minimized.

The future direction of Canada?s domestic carbon market is not yet certain.

The question of whether Canada will have a carbon market is tied to the question of whether the federal government will set GHG emissions targets for emitters. If companies are given targets, then they will want access to a trading mechanism that enables them to meet those targets in an economically efficient manner. A carbon market not only encourages economic efficiency in meeting reduction targets, but it also provides a critical source of funding to support abatement projects. The key point is that the targets create the market and drive its operation.

Emissions markets have proven effective in facilitating the achievement of emissions reduction goals in Europe. Given this fact, it is highly likely that a carbon trading system will form a fundamental part of the global response to climate change beyond the end of the first Kyoto commitment period in 2012.

For Canada, then, the challenge is to put the necessary infrastructure in place so that Canadian companies and organizations can learn how to operate in an emissions trading environment while looking to link, where possible, with other trading systems to broaden access and opportunities. In this way, Canadian financial institutions can learn the intermediary functions needed to be successful in this evolving market.

There are challenges associated with linking a Canadian emissions trading system to any of the other international systems.

Linking a Canadian emissions trading system to that of another country or region would benefit Canadian companies through an expanded market and compliance cost savings. However, a number of policy and technical issues stand as potential barriers. Key issues include differences in types of targets, Canada?s potential use of a price cap, differences in the eligibility of various instruments for ensuring compliance, differences in approaches to allocating credits, the stringency of targets, the need for agreement on ?comparable efforts,? and penalties for non-compliance.

Recommendations

The NRTEE has identified the following opportunities for action in linking domestic and international carbon markets.

10. A Post-2012 Trading Market With the United States

Recommendation:

Canada?s policy focus should be on preparing for a common carbon/GHG emissions market with the United States that would come into effect after 2012. Short-term efforts should focus on exploring opportunities at the North American level for carbon trading and on how to ensure that such a market would be based on high standards regarding monitoring, compliance, regulatory and financial practices to ensure environmental effectiveness.

Rationale

An international market for carbon/GHG emissions cannot be said to truly exist if the biggest economy (and largest emitter) on the planet is not part of it. Outside the Kyoto Protocol, there are other options for linking worth considering that would take advantage of recent progress and heightened interest in trading systems in the United States (such as the RGGI), and proposals from several U.S. senators for national bills to establish carbon trading systems.

Building on this growing interest and experience, Canada should engage in exploratory discussions on linking to a U.S. program in the future. These discussions should be undertaken well before 2012. Coordination of policy development with the United States could help reduce or prevent the emergence of future linking difficulties relating to differences in eligible compliance instruments, eligible domestic offsets, emissions measurement methodologies, and use of a price cap, among other issues. Such discussions could be coordinated via bilateral channels, perhaps as part of broader multi-pollutant ?clean air? discussions and/or via a North American three-nation approach through the Commission for Environmental Cooperation under NAFTA.

11. Trading Between Systems

Recommendation:

Canada should, as early as possible, consider the need for bridges or ?gateways? to enable Canadian participation in the trading systems of other countries.

Rationale:

Different trading schemes are going to evolve in different international jurisdictions. These trading schemes will each have their own features, creating challenges in linking them into a larger global trading system. For example, Canada could face compliance problems if it chooses to participate in U.S. or Australian emissions trading schemes and those countries remain outside an international agreement under the UN Framework Convention on Climate Change.

Anticipating this issue, Canada could explore setting up a ?gateway? system under which Canadian entities would be allowed to participate in the U.S. or Australian systems as long as the number of Canadian compliance units sold into these systems was less than or equal to the number of U.S. or Australian units sold to Canada. This approach would tend to diminish the efficiency of the trading system, but would be necessary to ensure Canada?s compliance under the international regime. The problem would disappear if Canada, the United States and Australia all participated in a common post-2012 regime ? in which case reductions in each country would have value and be recognized under the regime.

12. Canada and the European Union Emissions Trading System

Recommendation:

Canada should begin evaluating options for addressing technical issues that could stand in the way of linking with the large, well-established European system.

Rationale:

If Canada chooses to stay within the Kyoto Protocol, the obvious market that it would want to link with would be the European Union Emissions Trading System. The EU ETS is the largest, most active, highest volume and best established carbon trading system in the world. There are, however, several technical issues that need to be addressed if Canada wants to move in that direction.

Canada has up to now adopted intensity targets for industry, but these targets do not align with the absolute targets established under the European system. To respond to this challenge, Canada should analyze its options for overcoming these technical ? though very real ? differences. First, Canada should undertake an analysis evaluating the range of absolute emissions reductions that could be achieved by Canada?s large final emitters (LFEs) compared with the number of LFE credits that would be issued by the government. If the difference is small, then there would be no real difficulty for Canada. Another option would be to back Canadian LFE credits with assigned amount units. 2

13. Canada?s Proposed Price Cap

Recommendation:

Canada should consider eliminating the proposed price cap in the design of a post-2012 trading system, to ensure that Canadians can realize the benefits of linking with other trading schemes.

Rationale:

Canada?s proposed price cap may be one of the most significant barriers to linking a Canadian emissions trading system with other international systems. Price caps distort trading systems and make it extremely difficult to link capped and non-capped systems.

While it is recognized that the promised price cap has been an important aspect of industry?s acceptance of the proposed caps, the government should consider eliminating a price cap in the design of the post-2012 Canadian carbon/GHG emissions market, to remove this barrier to wider linkages with other international trading systems.

Endnotes

1 These papers are: Options Paper: Integrating Canada?s Climate Change Objectives into its Foreign Policy, Aid and Trade Objectives, by John Kirton and Sarah Richardson, 2006; Development of a Trade Promotion Strategy for Climate-related Technologies in Canada, by Strategies for Change, 2006; and Consistency in Carbon Markets: Linking Canada?s Domestic Market to International Markets, by Natsource, 2006. For copies of these papers, contact the NRTEE at , or by telephone at .

2 The assigned amount is the total amount of greenhouse gases that each country is allowed to emit during the first commitment period of the Kyoto Protocol. This total amount is then broken down into measurable assigned amount units (AAU), where each AAU represents the tradable right to emit one tonne of carbon dioxide equivalent.