The Ground Rules for Effective OBAs: Principles for Addressing Carbon-Pricing Competitiveness Concerns through the Use of Output-Based Allocations

Abstract

The federal government’s decision to impose a minimum national price on carbon emissions has the potential to make certain businesses in the country less competitive. Specifically, there are emissions-intensive and trade-exposed industries across Canada that compete against producers from other jurisdictions where governments do not put a price on carbon. For these industries, the obligation to pay a carbon price creates a competitive disadvantage. Specifically, these businesses will face higher costs and may encounter a loss of market share to international competitors from jurisdictions that lack the same emission-control measures. That not only hurts Canadian businesses, it could also negate any emissions reductions that carbon pricing in Canada achieves on a global scale. The federal government has opted to protect such emissions-intensive, tradeexposed businesses using subsidies called output-based allocations (OBAs). This is the same system that Alberta is introducing through its forthcoming Carbon Competiveness Regulation. It also shares certain similarities with cap-and-trade programs, such as those in Ontario and Quebec, which provide free allocations of emissions permits to certain firms. OBAs are a desirable complementary policy to a carbon price as they maintain the incentive for producers to invest in production methods and facilities that are less emissions intensive. So while producers are still, nevertheless, subsidized to offset the tax burden of the carbon price, they will, under an OBA system, see greater benefits the more they work to reduce their emissions intensity. Still, to function most effectively and most efficiently, an OBA policy should follow certain key principles. The most critical principle in the design of an OBA policy is ensuring that OBAs are allocated to facilities independent of their individual emission levels, and allocated equally (on a per unit basis) to facilities producing the same product. One of the major flaws with Alberta’s current Specified Gas Emitters Regulation (SGER) is that it does not follow this principle. Rather, subsidies under SGER are allocated based on a facility’s historical emissions intensity. As a result, more generous subsidies are given to those facilities that are “dirtier” (that is, those with higher emissions intensities) than to “cleaner” facilities with lower emission intensities. Secondly, it is important for a well-designed OBA policy to have transparent costs. Including a clear accounting of OBAs in government finance reports will ensure the public is fully aware of the revenues being directed to the subsidies. Thirdly, OBAs for different facilities are best allocated using a classification system based on the product being produced, and not using more conventional industry-classification codes. Commonly used conventional industry classifications—for example, conventional oil and natural gas extraction—group together facilities that produce distinct products and compete in different markets. Consequently, this classification will not recognize the various levels of emissions intensity and trade exposure within an industry. This will result in some facilities receiving more OBAs than they should and others receiving less than they should. Finally, a well-designed OBA system should seek to be as administratively efficient as possible with minimal implementation costs imposed on government and businesses. It is important to recognize that the federal carbon price and OBAs are a new policy and that many large emitting facilities have been making investment decisions based on a previous regulatory environment. Therefore, a compromise approach may be to initially provide an output subsidy based on a facility’s past emissions intensity (as Alberta has historically done under its SGER system) and then to transition gradually to the optimal OBA system over time.