California, Quebec Carbon Deal Could Pave Way For Other Linkages

The US state of California and the Canadian province of Quebec has formally signed an agreement that will link their cap-and-trade programs beginning in January. The linkage could be the first step toward creation of a broader carbon trading program in North America.

4 October 2013 | WASHINGTON, DC | California and Quebec have signed an agreement to link their cap-and-trade programs via the Western Climate Initiative (WCI), a decision that could pave the way for linkages to other trading programs, observers said.

Yves-Francois Blanchet, Minister of Sustainable Development Environment Wildlife & Parks, Quebec, announced the signing of the agreement by the two jurisdictions at the International Emissions Trading Association’s Carbon Forum North America conference in Washington, DC on Tuesday.

“The regulatory provisions of both systems were very similar and often identical,” he said. “We had to ensure that obstacles to the linkage were removed for both governments. One by one, we succeeded in tackling the challenges we faced.”

The Ministry of Environment Quebec spent significant time reading through the regulations for both jurisdictions to ensure they were identical where they needed to be identical, said Jean-Yves Benoit, Economist, Climate Change Office for the Ministry. For example, California and Quebec decided to hold joint auctions and make their compliance instruments completely fungible and had to figure out the currency exchange situation as their floor prices were set in US and Canadian dollars, respectively.

“In other areas, we could just differ,” he said.

Benoit jokingly referred to the agreement with California as a “prenup.”

“Like any marriage, we expect to be married forever,” he said. But the agreement outlines the responsibilities of each jurisdiction in the event of a divorce, such as how much notice one jurisdiction must give to its partner before ending the linkage and how incurred costs must be split.

Who’s Next?

Quebec’s regulations governing its cap-and-trade program allow for linking of its system with other provinces and states.

“The government that I serve is well aware that for a carbon market to be as successful as possible, it must include as many partners as possible,” Blanchet said. “We must welcome new partners and not only in North America. Let us keep our cap-and-trade program user friendly and attractive.”

“The collaboration shown by Quebec and California in the WCI framework is an excellent example of North American regional cooperation that is economically and environmentally beneficial for both partners,” Blanchet continued. “Now that (the linkage) has been created, we very much hope to see the WCI carbon market expand as soon as possible.”

California and Quebec are still waiting for fellow WCI members British Columbia, Manitoba and Ontario to move forward with trading programs, Benoit said.

The Regional Greenhouse Gas Initiative (RGGI), which is the regional carbon trading program in the Northeast US, is the most obvious next candidate for a potential linkage, said JP Brisson, Vice Chair of law firm Latham & Watkins’ Air Quality and Climate Change practice group. The WCI and RGGI were previously in discussions about a potential linkage, but those talks stalled as the oversupply in the RGGI program had allowance prices hovering near the floor.

But the RGGI states engaged in a comprehensive program review in 2012 that led RGGI officials to decide to reduce the 2014 emissions cap by 45%, a decision that has led to increased demand for allowances, a burst of trading activity in the secondary market and higher allowance prices since the decision was announced in February.

“I think as we see that cap having an impact on the market, from a policy perspective California will reconsider its decision to link with RGGI and hopefully going forward we may have a linking in the United States across the two coasts,” he said.

But future linking could take a different form with California, for example, deciding in 2015 to allow covered entities to submit RGGI allowances for compliance for up to a specified percentage of their compliance obligations, Brisson says.

“This form of linking between markets brings in fungibility, it brings in liquidity, it levels the playing field, but it does not require the two jurisdictions to spend as much time as Quebec and California have spent over the last year and a half to essentially harmonize their markets,” he said. “I think going forward we need to be more efficient at linking by considering other options.”

Cap-and-trade programs do not have to be identical to link, Brisson said. Quebec, for example, ultimately chose not to follow California’s lead in implementing buyer liability provisions, which hold the buyers of offsets responsible for replacing invalidated credits.

In contrast, California set holding limits that are lower than the compliance obligations of several covered entities, over the strong objections of industry, a policy that has migrated north of the border.

“That’s what I call the contamination of market flaws to Quebec,” he said. “Unfortunately, the good policies in Quebec are not coming down to California.”

“As we go forward, we need to identify those good market policies that we would like to see across markets and we need to push for those to be replicated,” Brisson added.

Crossing an ocean?

In July, regulators in Australia and California signed a memorandum of understanding (MOU) to cooperate in addressing climate change. In September, California and China’s National Development and Reform Commission signed a MOU committing to a joint effort to combat climate change, promote clean and efficient energy and support low-carbon development.

“But I would be very hesitant to anticipate that that would guarantee a link in any near-term horizon,” said Michael Mehling, president of the Ecologic Institute. “I think it’s an important and very useful step to share practices to perhaps keep that door open for linking in the future, but it certainly is no guarantee.”

Creating broader linkages is critical because California’s market during the first compliance period is only about one-tenth the size of the European Union Emissions Trading Scheme, with smaller markets more vulnerable to market manipulation and illiquidity, Brisson said.

“Linking with Quebec is just a small step in the creation of liquidity so hopefully additional markets can join,” he said.