• The current fragmented period covers currently announced programs and policies at the national, provincial, territorial, and regional levels from now to 2015. This period is characterized by multiple carbon policies all sending different carbon price signals into the economy. The risk with this fragmentation is that it creates investment uncertainty, leading to a delay in action, or insufficient action to place Canada on a technology trajectory that aligns with our longer-term GHG objectives. Fragmentation in this period is manageable from a cost perspective given that the expected emissions cap and resulting price is lower, thereby lowering the economic risk of a fragmented policy. However, the emissions cap and resulting price in this period will need to rise from zero (or a very low price) on some emissions to upwards of $50 per tonne by 2015 to ensure we are positioned to meet targets. It will also need to be broadly applied to all emissions, especially those in buildings, vehicles, and light manufacturing outside of the large industrial emitters.
  
  
• In a critical transition period, between 2015 and 2020, Canada must work to bring together the disparate carbon pricing policies, both across jurisdictions and emissions. At the end of this period all emissions—including those from households, transportation, and light manufacturing—will need to see a stringent cap that is likely to result in a unified permit trading price in the order of $100 per tonne by 2020. The policy should also prepare for linking with international emissions trading systems.
  
  

• A unified long-term carbon pricing period should be achieved by 2020 and continue through to 2050. At the start of this period, all emissions are covered under an emissions cap and resulting price of $100 per tonne CO₂e removed, but the expectation is that the long-term price is actually higher, in the order of $150–$200 per tonne of CO₂e removed. As prices increase, access to low-cost yet verified international reductions becomes increasingly important.

With each implementation period defined, we now move on to discuss the specific policy wedges of the proposed carbon pricing policy and map them onto each transition period.

4.2 The Detailed Design of the Policy Wedges

The three main policy wedges are as follows:

1. A single national cap-and-trade system generating a unified carbon price across all emissions with the cap apportioned between

a. large emitters, and
b. remaining emissions in the economy (buildings, transportation, and light manufacturing);

2. Complementary regulations and technology policies; and

3. International carbon abatement opportunities.

4.2.1 Wedge 1a. A cap-and-trade system for large emitters

The cap-and-trade system for large emitters representing approximately 51% of all emissions would involve setting the annual level of emissions reductions—a cap—by issuing emission permits. If individual emitters produce more emissions than they have permits, they can purchase additional permits through trading. Governments can fix the level of emissions to provide quantity certainty by determining the number of permits to issue, but the price of permits will be set by the market, and is thus uncertain.

The key policy design question is how to transition the current fragmented policies, based almost exclusively on cap-and-trade, to a unified or single national cap-and-trade system no later than 2015. A number of key steps need to take place for this to occur:

• Transition to a “hard cap” before 2015 to add quantity certainty early.

• Focus early on cost containment.

• Allow mostly free allocations on output, but transition to fixed allocations and full auction.

• Move quickly to a unified carbon price through domestic linking.

• Link with international trading systems to move toward a unified global carbon price.

The implementation and design road map for the large emitter policy wedge is presented in Figure 11, with specific details on each step following.

Step 1: Add quantity certainty early, transition to “hard cap” before 2015

Transition current large emitter policy to a hard cap. A first step will be to transition the proposed federal Regulatory Framework, with its intensity-based trading system and offset credits, to include a binding or “hard cap” soon after 2010. While this transition to a hard cap ensures quantity certainty, it does not ensure cost containment. Initially, there should not be a cap on some fugitives or process emissions from large industrial sources. The cap should be expanded shortly after 2015 to include all process and fugitive emissions (Figure 12).

Caps need to be announced well in advance, and reconciled with the medium-term, long-term and rest-of-economy emissions targets. The schedule for bringing down the “hard” cap should be announced well in advance of the implementation of the cap, with a schedule that ultimately corresponds to the share of large emitter emissions in the national target (e.g., 20% below current levels by 2020). Any allowance of short-term emissions above the cap to adjust for cost containment concerns will have to be reconciled with reducing the medium- and longer-term caps to ensure the long-term credibility of the caps. This balancing of short- and longer-term targets signals to participants that any relaxation in short-term caps will necessarily lead to even lower caps in the future—or deeper reductions from the large emitters and the rest of the economy, and a higher carbon price.

Our assessment indicates that the cap for industrial sectors, if applied uniformly as a 20% reduction from 2006 emissions, would need to be 311 Mt in 2015, 276 Mt in 2020 and 274 Mt in 2025. These represent reductions in the order of 22% below forecast 2015 emissions and 35% below 2020 emissions. But given the need to focus GHG policy on carbon prices, ensuring cost containment is an important complement to the caps on emissions.

Step 2: An early focus on cost containment through a “price ceiling”

Set a high limit on the permit price to contain costs and reduce permit volatility. The costs of achieving the cap will be unknown initially and a “price ceiling,” or maximum carbon price, can be an option to control rapidly rising costs. A low price ceiling reduces expected costs and also price volatility, which is often larger at the beginning of a trading program.

To contain domestic costs through seeking lower cost international abatement opportunities, we set the maximum level of the carbon price ceiling below our expected carbon prices if the targets were achieved through domestic action alone, climbing from $50 in 2015 to $100 in 2020 and $200 after 2025. With this price ceiling in place in 2020, emissions under the carbon price limit for all large emitters are about 325 Mt in 2020, which is a shortfall of about 49 Mt relative to their target. This shortfall must be made up if targets are to be met. In lieu of additional domestic action to reduce emissions, firms would be required to pay an estimated $360 million¹⁴to a central government authority, which then makes international purchases to address the shortfall. During the fragmented period, with low carbon prices, a portion of the proceeds could also be used domestically for investments in viable low-emitting technologies to set the ground for later reductions.

Phase out domestic offsets. Offsets, which are reductions from sectors not covered by the cap-and-trade system, may initially be desirable to transmit a broad price signal. But these need to be phased out rapidly before the transition period concludes since most if not all offset opportunities would be eliminated before 2015 given the cap on emissions in the rest of the economy and the complementary policies.

Step 3: Mostly free allocations on output, but transition to fixed allocations moving toward full auction

Standardize allocations with a view of eventual linkage across jurisdictions and internationally. In transitioning from the fragmented period, how permits are allocated to firms will need to be standardized. If intensity-based systems that set performance standards for industry remain in Canada, as at present, it is likely preferable to continue on this emissions intensity path as the basis for future allocations for a set period of time.¹⁵In transitioning to a fixed cap, the approach that best aligns with the intensity standard is output-based allocations, which are based on performance relative to an average intensity and as a share of their contribution to production from the sector. Essentially, the intensity-based allocations can continue as long as their sum is less than the cap (Figure 13).

A movement toward auction should follow shortly thereafter, where most sectors will need to transition to a fixed allocation (some share free and some share auctioned) and ultimately zero allocation or full auction. However, the implicit subsidy to output using the intensity standards can be counterproductive in many sectors, as conservation is a legitimate means to reducing emissions.¹⁶

One option is to quickly ratchet the intensity standards down to zero, thereby requiring all emissions to be covered through auction or permit purchases. If some free allocation is still deemed to be necessary, the other option would be to use historical data on allocations (or production capacity) during the transition, averaging over the period and applying an appropriate factor to come up with a fixed allocation. While the prospect of future allocations will provide an extra incentive for production during the transition, that is preferred to basing allocations on emissions during that period, where the level of emissions would be influenced upward by the prospect of gaining more allocations later.

The choice of allocation mechanism may also affect the feasibility of linking internationally and the choice of policy for coping with international competitiveness concerns, which are discussed below.

Move toward full auction by 2020. The rationale for auctioning is to capture, for public use, the value inherent in emissions. Auctioning requires firms to bid for emission permits in order to cover their remaining emissions after abatement has been undertaken. Most cap-and-trade systems are moving toward full auction, including the EU emissions trading scheme and most US proposals. Since permit prices are expected to increase at the start of the transition period and a cap limiting emissions would occur shortly thereafter, it seems unrealistic to rapidly transition from free allocations and no cap, to full auction with a cap. Instead, auctioning should be phased in during the fragmented period, culminating in full auction by 2020.

The exception is auctioning in the electricity sector, which should occur immediately. Permit costs in electricity markets can be passed though to customers. Experience from various trading regimes worldwide, including the EU emissions trading scheme, has shown that free allocations to electrical utilities transfers to their shareholders significant wealth that can take the form of windfall profits as carbon costs are passed on to customers, but the permit value is retained by the utility. While effective policy design should address this issue, it might not be as significant an issue in Canada given provincial jurisdiction for electrical utilities. An additional rationale for auctioning in the electricity sector is that by passing on the permit value under auction to customers, electricity prices and conservation are increased.

Once full auction is in place at the end of the transition period, the value of emission permits from large industrial emitters in 2020 would be in the order of $9.5 billion.¹⁷This would be a significant revenue stream requiring careful consideration as to its use and allocations.

Use allocations to mitigate competitiveness effects on trade and cost-exposed sectors, but decrease use of free allocations as competitiveness pressures lessen. There is no doubt that some segments of the economy will be impacted more than others under carbon pricing. These sectors tend to be both emissions intensive, meaning they use high quantities of fossil fuels, and are trade exposed, which means a high percentage of their output is exported or they compete with imports domestically. But competitiveness concerns are principally about two issues: relative carbon pricing between Canada and its trading partners and carbon leakage that occurs if Canadian production moves to countries without carbon pricing, lowering Canadian economic activity but not global emissions.

If Canada’s trading partners implement similar carbon prices and adopt similar carbon pricing schemes, competitiveness concerns decrease. Most of Canada’s top trading partners representing 86% of Canada’s exports and 72% of imports in 2006 figures are considering implementing climate policy before 2020. This points to a narrowly focused concern over competitiveness for a small number of sectors, with particular risks in the short- to medium-term given the fragmented nature of international carbon prices.

Border carbon adjustments, or taxes or restrictions levied on imported products, are often cited as a means to address competitiveness issues. However, our assessment shows that their broad application increases total costs for Canada. If border tax adjustments are broadly applied on all imported goods, for example, all prices rise, which then impacts not only consumers but also producers as they see their input costs rise. This exacerbates competitiveness concerns by broadly raising production costs, unless the border carbon adjustment includes relief for Canadian exports.

A more effective strategy is to maintain the output-based allocation scheme for trade-exposed and emission-intensive sectors and not move to full auction until major trading partners do the same. This accomplishes two things: first, the output-based allocation acts like a subsidy to production since more allocations are provided with more production while the cap contains emissions growth. Second, the cost of the permits on the remaining emissions is not present, and thus a major source of financial cost is avoided. However, once most trading partners have comparable carbon pricing, output-based allocations generate a larger efficiency cost than they legitimately reduce in leakage, and they should be phased out for these sectors as well.

Defining rules to identify which subsectors would experience a financial hardship under carbon pricing is not easy. Care is needed to validate that impacts are due to carbon pricing and not to normal market competitiveness pressures. A screening system could be developed that assesses the ability of the sector to pass on costs to consumers, the extent of trade and carbon exposure relative to foreign competitors, and the financial impact on profitability.

Step 4: move fast to a unified domestic carbon price through domestic linking

Move from equivalency to standardization in domestic cap-and-trade regimes. While equivalency agreements between provinces, territories, and the federal government can be considered as initial steps in standardizing emissions caps and resulting prices across Canadian jurisdictions, the road to carbon unification will require a rapid standardization of more than just prices. Rules that define and underpin carbon as a traded commodity will also be needed. A movement to standardization will then smooth the transition to a single unified system.

Transition to a single domestic regime with unified rules but decentralized revenue management. Prior to 2020 the federal, provincial, territorial, and regional systems now underway will need to unify under a common set of rules. Ideally these rules would be set under a national authority, agreed to by provincial and territorial governments, to ensure a unified carbon pricing policy across all jurisdictions and prepare the country for international trading. But given the scale and scope of the challenge ahead, active participation of the provinces and territories is essential. Two important functions will need to be determined: setting and implementing the rules of the game, and the fiscal distribution arrangements of generated revenue. Ideally these two functions would be separate, with new administrative functions developed for setting and administering trading rules while existing federal-provincial fiscal arrangements for revenue sharing from corporate and income taxation could be considered for use of auction proceeds until new ones are devised. The key point here is to separate the carbon pricing policy decisions from the revenue recycling or distribution issue in order to maintain the efficiency of the pricing policy to meet our GHG reduction targets. The more the two mix, economic efficiency is likely jeopardized as issues of income redistribution cloud the design of an efficient carbon pricing policy.

Step 5: link international trading systems to move toward a unified global carbon price

Enable two-way international trading to contain and harmonize carbon costs. If the price ceiling is set low, and more permits issued when the price ceiling is accessed, other trading regimes may not want to link with this system given uncertainties over the credibility of the permits and the associated devaluation of permits. Similarly, if the cap-and trade system includes an intensity cap, or broad offset provisions, linking becomes less desirable for other systems. In the case of the former, the EU emissions trading scheme does not have a price ceiling, which would make linking the current proposed system in Canada with the EU difficult. Similarly, most US climate bills currently before Congress, and the Western Climate Initiative’s provisions, limit international offsets. Consequently, a goal of the transition is to look forward with an eye on standardization to make eventual linkage smoother and workable.

Linking may be best introduced on a gradual basis, waiting to observe the evolution of carbon pricing policies and prices in partner countries and then adapting accordingly. Large carbon price differentials could trigger significant financial flows in the form of permit transfers between linked systems. A related point is that permit sellers and permit buyers will not fare the same way under linked systems given that with linking, permit prices will either rise or fall. Falling prices may benefit buyers, but sellers would be worse off. What influences permit prices and hence the gains or losses from linking is the relative targets in the two linked systems and the subsequent costs of achieving those targets. Given uncertainty in both of these, it is not clear linking will automatically be beneficial for Canada. While linking is a fundamental objective of a unified carbon pricing policy for Canada, how it is accomplished must be carefully considered.

4.2.2 wedge 1b: Cap-and-trade for the rest of the economy

Rapidly expand the carbon price to cover all emissions to keep total costs down. To do so means determining a pricing mechanism for those remaining emissions outside that of large emitters. This includes buildings, transportation, and light manufacturing. We propose a cap and resulting price on the carbon content of fuel purchased by these energy users that would escalate to about $50 per tonne CO₂e by the end of the fragmented period (2015) and then increase to $100 by 2020—the same as the price ceiling and expected price in the large emitting sectors under the main cap-and-trade system. At this point fuel distributors upstream would be required to obtain all of their permits from auctioning through the cap-and-trade system. Full trading between this portion of the economy and the large emitters wedge would be enabled under the single national system. No free permits would be allocated to avoid any prospect of creating windfall gains. With the cap-and-trade in place, emissions in this wedge are forecasted to fall from 282 Mt in 2005 to 267 Mt in 2020, and to 190 Mt in 2030. This is set out in Figure 14.

Avoid double carbon price hit for large emitters. Because large emitters are facing an emissions cap and resulting price on their emissions under cap-and-trade, the addition of an emissions cap and resulting price on fuels could result in a double carbon cost for some. As a result, there will be a need to either exempt fuel sales to purchasers who are in the large emitter cap-and-trade category or alternatively reconcile charge payments through tax returns. This process should be not unlike dealing with value added or general sales taxes on inputs for these businesses.

4.2.3 Wedge 2: Complementary regulations and technology policies

Complementary regulations and technology policies are necessary for two reasons: to expand coverage of the carbon pricing policy to all possible sectors, thus lowering costs; and to complement the carbon price in order to address the issue of market barriers that are present in technology adoption and are not corrected by the imposition of a broad market-based carbon price signal.

In our research and analysis, we were able to lower the carbon price required nationally to attain the targets by both broadening coverage of the overall policy and addressing market barriers through complementary regulations and technology policies. This was achieved by addressing market coverage issues in upstream oil and gas, pipeline emissions, landfill gas, and agriculture sectors, and concentrating market barriers in the buildings and transportation sectors. Note that these regulations are set at levels to align with the carbon prices expected in each period, which do not exceed $100 per tonne in 2020 and $200 per tonne in 2050. This ensures that the complementary policies impose similar costs to the carbon pricing element of the policy.

Specific areas were assessed to reduce emissions further and help lower overall costs:

• High upstream oil and gas venting, flaring, and pipeline leaks: Regulations would require the phasing out of venting and flaring (other than for safety reasons). Similar regulations could be used for pipeline leaks, with perhaps lower stringency given the technical impossibility of completely eliminating such leaks. Modelling estimated that a program of regulation aligned with fast and deep pricing could cut emissions from these sources by around 42 Mt CO₂e per year.
  
  
  
• Landfill gas fugitive emissions: Most abatement opportunities from the capture of landfill gas cost around $15–$25 per tonne CO₂e. Regulation could require the capture and destruction of landfill gas from all landfills (above a minimum size threshold). Modelling estimated that 25 to 28 Mt CO₂e per year could be reduced this way.
  
  

• Agricultural emissions: A significant portion of Canada’s GHG emissions come from enteric fermentation (25 Mt), manure management (8.6 Mt), and agricultural soil management (23 Mt). Agricultural emissions reductions can be achieved through promoting significant changes in land use and agricultural practices, developing codes of practice, and updating current policies. Policies relating to these agricultural practices already exist but could be improved to meet GHG objectives. We modelled estimated reductions of 8 Mt in 2020 and 13 Mt in 2050 from this sector.

Specific regulations assessed to reduce emissions further and help lower overall costs, include the following:

• Vehicle emission standards to accelerate reductions in the transportation sector: Regulations could involve the national adoption of California’s GHG emissions intensity policy out to 2020, gradually increasing in stringency to a zero GHG intensity policy by 2040. These regulations imply either complete electrification of the transport fleet or switching to an alternative liquid or gas motive fuel; biofuel and hydrogen are two candidates. The policy delivers 11 Mt CO₂e in 2015, gradually increasing to
  68 Mt CO₂e by 2050.
  
  
• Standards to overcome barriers in the building sector: A widely acknowledged market failure is the disconnect between those who determine the day-to-day use of energy in building structures, and those who own them. The owners of buildings cannot necessarily recover investments in energy efficiency. Rather, the renters or leaseholders, who determine the energy load and pay the energy bills, reap the rewards, but have little incentive to make significant energy efficiency investments as they seldom have secure tenure to their residence. A Leadership in Energy and Environmental Design (LEED) standard or equivalent could be used as a base level for all new commercial buildings, and at least a 50% increase in shell efficiency for all residential buildings compared to current and planned codes. Further opportunities to increase energy efficiency in the commercial buildings sector can be found in a recent NRTEE report entitled Geared for Change: Energy Efficiency in Canada’s Commercial Building Sector.

Figure 15 shows the positive effects of the complementary policies in inducing emissions reductions when they are used to complement the cap-and-trade system. In 2020, the complementary policies achieve 40% of all reductions and in 2050, 18% of all reductions as the carbon price signal takes effect. In terms of carbon costs, these targeted regulations were able to reduce costs nationally in the order of 15% in 2020, and 35% after 2025. Conversely, we found that misaligning the cost imposed by technology regulations relative to the national carbon price increased overall costs.

The scale of transformation to our energy systems necessary to meet medium- and long-term emission reduction targets is significant, and the sustained technology rollout required important. A number of barriers exist that impede this technology rollout:

• Limited financing. Risk and payback horizons also influence investment decisions; if the private perceptions of these factors do not align with the public ones, then policies may be needed to assist financing and manage risks for publicly desirable projects. Technologies for which capital costs are very large are more likely to need preferential financing or guarantees to reduce private investment risks.
  
  
• Scale economies. Economies of scale are an issue for many new technologies. Until enough units have penetrated the market, production costs are high and support services are scarce. Policies to address this barrier and increase market penetration can legitimately help some new technologies gain acceptance, lower production costs, and get off the ground, but they should be careful to avoid extended support for uneconomic technologies.
  
  
• Distortions from existing regulations and institutions. Inefficient regulations can impede technical progress. Unnecessary legal and regulatory barriers often favour incumbents and impede the diffusion of new technologies or market entrants. A related point is a lack of regulations to address new and emerging technologies, such as carbon capture and storage (CCS).
  
  
  
• A lack of information. For markets to function, they require not only good property rights and competition, but also information. Some product characteristics are easily observable, but others—like energy consumption rates—are not available or credible without government intervention and certainty.
  
  
  
• Networks and infrastructure. Some technological options require new infrastructure and support networks in order to function. However, private actors are reluctant to take on activities that supply public goods, and most would prefer to wait for someone else to do it. The resulting network externalities are one important cause of “path dependence” or “technological lock-in,” and public intervention may be required to change paths. Important examples lie in the distribution of fuels for transport: biofuels, hydrogen, compressed natural gas, or plug-in electric would require new fuel (or battery) distribution and storage equipment, as well as new vehicle engines.

Our research and analysis indicate that all these complementary policies will be required at some point during the implementation of the carbon pricing policy. But, there is a need to support technology development and deployment during the implementation period above and beyond the carbon price signal. We note that the need for deployment of technology must occur sooner rather than later. This is particularly the case in the fragmented and transition periods (before 2020), when emissions caps and resulting prices are low relative to those needed to trigger the investments required to achieve the longer-term emission reductions. This scenario requires a targeted public investment strategy, supported by auction revenue, that focuses on the right kind of carbon emission reduction technology. This should be integrated with a government-led, non-prescriptive, broad-based research and development investment strategy.

Given the cost of such an effort, it will be important to develop a clear and affordable framework that focuses on the right kind of investment, eliminates distortionary subsidies, and leverages public and private sector resources from within the sector and across affected jurisdictions. Consideration should be given so that these investments are “scaled” and “sunsetted”—scaled to meet the required need and match capital stock turnover cycles, and sunsetted once the full carbon price signal takes effect, private sector affordability issues diminish, and the technology rollout is in force. To be effective, public investment must be accompanied by sectoral policies (including regulations, standards, and information programs) designed to encourage an efficient application of that money to the right technologies.

4.2.4 Wedge 3: International carbon abatement opportunities

Our research and analysis indicate that impacts on consumer welfare and gross domestic product associated with achieving Canada’s emission reductions targets can be significantly reduced if we purchase international carbon permits and link our domestic trading system with other systems. This strategy helps us to avoid some of the most costly domestic abatement actions by looking abroad, despite the international financial transfer associated with this type of emission permit trading or purchases.

Ideally, carbon costs faced by other major trading partners, such as the EU and the US, would inform the level at which we cap domestic carbon costs and the level at which we then seek international purchases of carbon permits. This policy wedge has the additional benefit of allowing Canada to work internationally to influence carbon pricing to levels that match Canada’s domestic abatement effort. While international carbon prices are difficult to forecast, in all likelihood international real and verifiable emission reductions can be obtained at prices lower than the domestic carbon price we have forecast.

Our scenario caps domestic carbon prices somewhat below the levels required to achieve domestic action alone, but high enough to reflect the increasing scarcity and rising cost of international reductions as more countries look abroad for low-cost opportunities. There can be benefits to allowing Canadian firms to sell domestic permits to other firms in international markets. Capping domestic carbon costs at $100 per tonne in 2020 and $200 after 2025 indicates that international carbon purchases would need to approximate 52 Mt in 2020 and close to 200 Mt in 2050. The associated financial transfer could be in the order of $1.9 billion in 2020 and $200 million¹⁸in 2050. Any linked permit trading under a unified cap-and-trade system would be additional to this, assuming reductions could be purchased at prices lower than the capped carbon cost outside Canada. This implies an upper threshold price on domestic carbon costs below which linked permit trading could occur with the US or Europe, but above which payments from emitters would be used by government for international carbon purchases.

Access to international carbon abatement options is necessary to keep domestic costs down, but can result in significant wealth transfers and questionable environmental effectiveness if not managed well. The environmental effectiveness of such a policy can be reduced if real and verifiable international emission reductions are not sought. The World Bank–managed Prototype Carbon Fund, for example, has received criticism from environmental and community groups for funding large-scale development projects such as a eucalyptus plantation in Brazil, a hydroelectric dam in Guatemala, and a landfill in South Africa. These groups argue that such projects will offer little benefit to mitigating the effects of climate change and may cause social and environmental harm. There may also be distributional concerns over how the reductions are achieved in other countries. A protocol to ensure that the reductions are real, equitable, and sustainable could aid in guiding international carbon purchases.

4.2.5 Emission reductions and cost summary of the carbon pricing policy

With the carbon pricing policy implemented in 2020, including a national cap-and trade system with full auction, complementary regulations and technology policies, and international abatement opportunities, the total compliance costs could be conservatively estimated at about $3.4 billion.¹⁹The policy would generate $18 billion²⁰in economic value since the remaining emissions beyond the 2020 emissions reduction target can be bought and sold in the trading market.

To reduce emissions either domestically or abroad to meet the 2020 target will require annual expenditures totalling $3.4 billion in 2020. Emissions are reduced by 278 Mt in 2020, of which 178 Mt of are from the national cap-and-trade, 52 Mt are from the complementary policies and with the $200 price ceiling, another 48 Mt from international abatement opportunities.²¹This then triggers compliance costs of $1.9 billion for those covered under the cap-and-trade, $800 million for the complementary policies and $700 million in international purchases. These figures mask some of the financial flows since the trading market could see permit sales of $800 million between emitters. As well, with the international purchases, about $1.7 billion in domestic compliance costs are avoided.

If international purchases were lower cost, the forecast savings would be higher. We have also not included large emitter trade with the US or Europe, which could further lower costs through permit sales and purchases.

The value of the remaining emissions is $18 billion in 2020. With the policy implemented and the 2020 target achieved, there would still be 570 Mt of emissions remaining. These emissions are valuable since they can be bought and sold in the trading market. How this value is distributed is important given its size. The NRTEE’s carbon pricing policy initially recommends free allocation of permits, transitioning to full auction by 2020 to ensure funds are available to smooth the transition to a low carbon economy. Beyond 2020, a minimal amount of free allocations are still recommended on a conditional basis to deal with any interim competitiveness concerns.

There are a number of ways that the auction could be designed, including a uniform auction where the highest bid sets the overall price, and a block pricing auction, where permits are sold at differentiated prices based on bids. Each option leads to a potentially different distribution of the $18 billion emissions value between government and those large emitters and fuel distributors requiring permits. In Figure 16, we show the maximum value accruing to the government through a uniform auction, where the highest bid price sets the overall auction price for all emissions. As part of the policy, the total auction value is then fully disbursed principally for technology development and deployment, and some select support for impacted households and businesses as well as tax reductions. These revenue options are further discussed in section 5.5.

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