Industrial carbon pricing systems reduce emissions while protecting Canadian competitiveness, and they will be more effective if they are modernized.
Large-emitter trading systems are Canada’s most important climate policy. As 440 Megatonnes has shown in the past, they drive more emissions reductions than any other policy while protecting the competitiveness of Canadian industry.
Their design features—which ensure low costs while enabling revenue generation for low-carbon projects and shielding producers from foreign carbon tariffs—are valuable amid the uncertainty generated by tariff threats from abroad. As export markets rapidly change and new border measures and tariffs emerge, these benefits will only grow in value.
Yet though large-emitter trading systems are powerful, they are not perfect.
Our research has also shown that without updates, the trading markets created by these systems could start to unwind in the years ahead, undermining the revenue streams and certainty needed for emissions-reducing projects.
The Canadian Climate Institute has just published an independent assessment of carbon pricing and a summary report explaining how large-emitter trading systems can be modernized, founded on economic modelling, real-time data, and discussions with governments and experts. The summary report makes five recommendations to modernize LETS so that they can continue delivering benefits for the climate and Canadian competitiveness in the long term.
Recommendation 1: Address the risk of credit market oversupply.
As we’ve explained elsewhere, the whole purpose of large-emitter trading systems depends on the functioning of the trading markets that they create. These markets are designed to ensure that emissions reductions have value—but some markets are not on track to continue providing that value.
LETS need well-functioning markets. The independent assessment shows that modernizing the systems across the country would deliver a minimum of 18 Mt of additional greenhouse gas emission reductions in 2030 compared to existing system design.
We propose five actions that governments can take to ensure that their markets continue to function as intended. Chief among these, provincial governments should tighten performance standards where there is a clear risk of oversupply.
Our assessment identifies the greatest risk in British Columbia, Alberta, and Saskatchewan, but also notes all systems are at risk.
Governments can refine the design of their systems in other ways, including implementing market stability mechanisms. The federal government could also require provincial and territorial systems to demonstrate that they have additional net demand for credits in their systems. Meanwhile, all governments can minimize these risks by reviewing and assessing other policies for the ways they interact with LETS.
Recommendation 2: Align sub-national systems to improve their effectiveness and ensure fair competition
Large-emitter trading systems should also set a fair playing field for emitters. Facilities that make the same product should compete against common standards. That’s better for competitiveness within provinces and between them too.
Today, however, performance standards in some jurisdictions can send perverse incentives, allowing more emissions-intensive facilities to gain credits while competing against cleaner facilities that pay more. And there are persistent differences between provinces and territories too, which adds competitiveness barriers when policymakers are looking to remove them.
The Institute’s report outlines a further five actions that would align sub-national systems and minimize existing competitiveness distortions. Above all, governments should move toward having one performance standard for all facilities within each jurisdiction that make the same product. They can also harmonize the rates at which their performance standards tighten, or increase costs in time. Systems should set common, lower thresholds for the size of facilities that participate in LETS, and they should work to cover more of the same emissions. Finally, systems should not return revenues to emitters in ways that undermine the incentive to cut emissions.
Recommendation 3: Facilitate pan-Canadian alignment for credit trading
One of the key advantages of large-emitter trading systems is that they have very low costs and give facilities various options to comply. However, those advantages are smaller in smaller markets. Canada is a fragmented landscape with multiple LETS trading markets. Combined markets would offer lower compliance costs and further reduce competitive distortions.
Building a unified market for LETS is a long-term proposition, but at a time when Canada is looking to reduce internal trade barriers, now is a good time to start. To begin that process, policymakers can establish an intergovernmental harmonization process, create credit standards that are ready for cross-border trading, and develop secondary markets that allow other participants into the system.
Recommendation 4: Enhance system transparency
Transparency is linked to system effectiveness. The problems in large-emitter trading markets are an open secret, but important system design features, and most credit trading, are entirely private. This makes it hard to track and resolve problems within the systems.
Policymakers can enhance the transparency of LETS in several ways. Most importantly, they should make it mandatory to disclose the prices at which credits are traded, so that participants and regulators have more insight into the incentives in the system. The Institute’s report identifies other types of information that regulators should publish, notably on competitiveness impacts, and proposes the development of a central registry where all information can be compiled accessibly.
Recommendation 5: Prepare for future challenges
Canada is sailing in turbulent waters, but there are even bigger storms ahead: the ongoing transition to new forms of energy and lower-carbon forms of production, combined with the growing threat of border carbon tariffs. These challenges point toward the need for continuing emissions reductions, but in the most efficient and flexible way possible.
Large-emitter trading systems can continue to provide emissions reductions while serving as a shield for low-carbon growth. But that will be easier if systems are adapted with the future in mind. Governments can update their LETS with emerging border carbon tariffs in mind, including initiating a process to determine how the prices in Canada’s systems compare to the levies being imposed abroad. Other updates, like providing advance notice of carbon price adjustments, and aligning LETS with other sectoral policies, would similarly help set up systems for long-term effectiveness.
Large-emitter trading systems are working: they effectively cut emissions and support Canadian industries’ competitiveness. Their modernization would address oversupply risks, improve transparency, and align sub-national variations. By implementing these five key recommendations, policy-makers can ensure that LETS fulfill their potential in driving low-carbon investment, safeguarding industry, and positioning Canada for future climate and trade realities.
Dave Sawyer is Principal Economist at the Canadian Climate Institute. Ross Linden-Fraser is a Research Lead at the Canadian Climate Institute.