Werner’s blog: Is Quebec becoming a climate action laggard?

With an increasing federal price on carbon through 2030, most Canadians will face increasing incentives to reduce their use of motor fuels for driving and natural gas for heating. A notable exception is the province of Quebec, which is playing by different rules. In an excerpt from his latest blog post, Associate Professor Werner Antweiler discusses this discrepancy and argues why and how Quebec needs to rethink its approach to carbon pricing.

Quebec's approach to pricing carbon emissions is unique in Canada. The province has joined California in an emission trading system, also known as cap-and-trade. I wrote about this in May 2015 and October 2016. Quebec's carbon price is not keeping up with the increases in the federal carbon price, which today stands at $50/tonne of carbon dioxide emissions and is scheduled to increase in $15/tonne increments annually until it reaches $170/tonne in 2030.

Quebec was originally a climate leader by pricing carbon emissions years before a federal system came into place in 2019. At the 33rd auction in November 2022, the settlement price of $35.62 made it only 71 per cent of the federal carbon price. In other words, Quebec received a 29 per cent discount on carbon prices. It is time for Quebec to rethink how it manages its carbon pricing, so as to not become a climate action laggard.

Quebec's participation in the joint auction program with California comes with several important features:

• First, prices are determined jointly and thus move at a speed of reductions in the carbon cap that each side feels comfortable with. This can easily become the lowest common political denominator. While California is a climate leader in the United States, the state has also initiated numerous parallel climate programs that compete with carbon pricing.
• Second, exchange rate changes have an impact on Quebec's carbon price, because the cap-and-trade system imports price volatility from the USD-CAD exchange rate.
• Third, Quebec cap-and-trade system is a hybrid system with a reserve (i.e., minimum) price. For a long time, the settlement price (where the auction clears) was barely above the reserve price. A settlement price below the federal carbon price indicates that Quebec's carbon cap is not stringent enough to drive up prices to near the federal carbon price.
• Fourth, the joint Quebec-California trading system allows trading in allowances for the next compliance period. This advance auction has typically had a price that was virtually the same as the auction price for the current compliance period. If the markets anticipated Quebec to see increases in the auction prices similar to the increases in the federal carbon price, the forward premium should be well over $15/tonne for the 2025 auction vintage.

In 2021, Quebec's cap was 55.26 megatonnes of carbon dioxide (equivalent). The province is anticipating decreasing this by 1.235 megatonnes per year to reach 44.14 megatonnes in 2030 (source). According to an information sheet from the Government of Quebec, they expect the reserve price to increase from US$17.71 in 2021 to US$32.57 in 2030—which puts it just under CAD$45/tonne, as compared to the federal $170/tonne.

So, what are the options for Quebec to move forward and avoid becoming a climate action laggard? There are three scenarios.

Scenario 1: Decoupling from California

The first option is to detach the cap-and-trade system from California. This is Quebec's easiest route to embracing climate leadership again. It would allow Quebec to pursue more stringent reductions in the emissions cap, or alternatively set reserve prices for the auction that are close to the federal carbon price. The downside is that it will take time to unwind because the trading for the next compliance period (2022-2025) is already underway. So, the logical starting point for a new Quebec carbon pricing system would be 2026.

Decoupling Quebec's emission trading system from California does not pose any insurmountable difficulties. The original aim of joining another jurisdiction was to provide efficiency and liquidity. In an ideal world, such trading would be beneficial because emission reductions would occur where they are easier (that is – cheaper). If emission reductions are more expensive in Quebec than in California, then Quebecois companies could buy permits from Californian companies. However, as Canadian carbon prices are meant to rise faster than is currently anticipated in California, Quebec would need to lower its own emissions cap significantly to drive up prices in the joint market to match the federal targets, but that is unlikely to be agreeable to California.

Scenario 2: Move away from cap-and-trade

The second option is to scrap the cap-and-trade system altogether and either join the federal program or adopt a system similar to British Columbia. Politically, the latter option may be slightly more agreeable to an independent-minded Quebec government. It would give the Quebec government more degrees of freedom to develop the system on its own terms. Nevertheless, the federal carbon pricing is designed carefully and ensures that (1) households receive quarterly rebates (known as climate action incentive payments) that offset the income-regressivity of the carbon tax, and (2) emission-intensive trade-exposed industries are protected against adverse competitive outcomes through the output-based pricing system.

Scenario 3: Ottawa steps in

The third option is the least desirable politically, both for Ottawa and Quebec City. It involves a political battle where the federal government would assert its authority under the Greenhouse Gas Pollution Pricing Act (GGPPA), which has been upheld by the Supreme Court of Canada. If Quebec is not willing to close the carbon pricing gap, Ottawa will have no choice but to exercise its federal jurisdiction in the matter. Whatever Ottawa may need to impose on Quebec, the revenue from carbon pricing would stay in Quebec and would be returned to Quebec households. It would be much better for all sides if Quebec saw the wisdom in aiming for climate leadership.

Criticism of the carbon price differential comes from various sides. Some are merely trying to score political points, especially when the criticism comes from political corners that reject carbon pricing in the first place. Yet, the carbon pricing gap is real and will widen if not addressed. Under authority of the federal GGPPA, Ottawa must initiate talks with Quebec to rectify the carbon pricing gap, and Quebec needs to do its bit to find a workable solution.