(April 13, 2011) Aldyen Donnelly takes issue with the federal parties that are advocating for cap and trade, while ignoring the likely blow-back from the provinces.

I think the NDP and Liberal representatives sincerely believe that “cap and trade” is a potentially successful mechanism for controlling GHGs.  I think that tells us only one thing: that they do not actually know what cap and trade is or how it works.  In the politicians’ defence, few of Canada’s “experts” on this topic have read any existing cap and trade regulations or really understand what it is, either.  Given the potential for the NDP and Liberals to hold a combined majority of seats after the upcoming election, and their common commitment to cap and trade, isn’t it time to have a more informed debate about cap and trade?

This topic got only a few paragraphs in the combined NDP and Liberal platforms.  However, any Government of Canada that truly attempts to impose a cap and trade market rule on the provinces will likely spark a new constitutional conflict that could make the free trade-spawned one look like kindergarten.  There is no single commitment in any platform with more significant economic implications for Canada.  But we are not even talking about this.  The parties that have committed to taking us down this path are not even talking about this.

I am an environmentalist. I believe that Canada must address climate change and also that regulation is the most effective and potentially efficient way to incent market participants to invest in efficiency and reduce GHG releases.  The question is, however: what kind of regulation will be both effective and efficient?  (Dr. Jaccard and others advocate for carbon taxes because they are relatively efficient when we consider the incremental cost of administering the tax regime.  The problem with the carbon tax–as is well illustrated with the still growing BC GHG inventory and in every EU nation that has experience with carbon taxes–is that it is a relatively ineffective GHG control tool.  It is simply another public revenue grab.  And once governments become addicted to carbon tax revenues, they find they cannot afford carbon emission reductions.)

“Cap and trade” is a fancy name for quota-based supply management and will operate, for the GHG-intensive sectors (energy, building products and food production) just like Canada’s dairy quota regime operates in respect to milk, butterfat and cheese: a government commission decides how much quota will be available, nation-wide, for each year; the national quota supply is distributed to provinces according to a not-yet-agreed distribution formula; the provinces then decide how their limited GHG quota allocations will be distributed to industry and/or consumers.

In the dairy quota case, Quebec always gets 37% of the entire Canadian quota and BC always gets only 2.7%, even though BC citizens consume about 13% of the milk consumed by Canadians.  This distribution that so aggressively favours Quebec was a pre-condition to Quebec participation in Canada’s dairy quota system.  The dairy quota regime ensures that BC citizens have to import milk, butterfat and cheese from Quebec, in perpetuity.  This formula for quota distribution makes Canada’s market highly inefficient, even if every other aspect of the quota system is designed to perfection from an efficiency standpoint.  What basis for establishing the provincial distribution of national GHG quota do the NDP and Liberals propose?

Because cap and trade is a quota regime, Canada’s constitution precludes the federal government imposition of the regime on any province without that province’s prior agreement and full support.  (Canada’s diary, chicken and other quota regimes were built–over many years–up from provincial systems, and its continuation relies entirely on continuing provincial approvals, as required by our constitution.)  What process does the NDP propose to negotiate the required provincial support?  (Since the NDP budgets for revenues from quota sales as early as 2012, they must perceive that they will be able to negotiate provincial approvals almost immediately.)

The NDP budget forecasts significant revenues from GHG quota sales starting in 2012.  The Liberals commit to auction GHG quota but do not include any revenues from GHG quota sales in their two-year budget forecast.  Any market value that attaches to GHG quota is value that has to be deducted from the market value of the GHG-emitting assets that currently freely discharge GHGs but will be covered by the quota regime in the future.

Look at any diary farmer’s before-and-after quota balance sheets.  Before the dairy quota regime was introduced, their barns, land and cattle had significant market value.  Now, most of the value reflected in the asset section of the balance sheet is attributed to their quota holdings, and the buildings, land and cattle have a near-0 market value for any owner who does not also hold quota.  Any GHG quota market will operate the same way, in that any price paid to the government at GHG quota auctions will be reflected as write-offs on the balance sheets of Canadian companies that produce energy, building products (cement, aluminium, pulp and paper products, and food–the carbon emitting sectors), the cap and trade system proposed by the NDP and Liberals simply expropriates asset value from shareholders who own those existing assets to the Government Treasury.

Because this is true, any cap and trade regulation will attract legitimate demands for compensation for expropriated asset values.  This is why, for example, when the federal government introduced Individual Tradable Quota in fisheries management (entirely under federal jurisdiction, so the constitutional barrier which applied in the dairy quota case and applies in the GHG quota case), the federal government agreed to compensate fishing boat owners whose assets became write-offs as a direct result of the introduction of the quota regime.

In the dairy quota example, once provinces know their annual quota supply, most provinces now auction that entire supply.  In other words, provinces collect any and all revenues from quota auctions.  Since the federal government cannot constitutionally impose a cap and trade regime on the provinces without their prior approval and support, how realistic is it for the NDP to assume that GHG quota auction revenues will be held in the federal treasury?

Every provincial dairy quota auction restricts participation to entities that operate dairy farms within provincial boundaries.  A Quebec company can buy a BC dairy farm.  But that same Quebec company cannot buy part of a quota holding BC farm, then shut it down to export that quota to expand production in their Quebec operations.  No province, prudently led, would agree to let any of its limited supply of GHG quota be exported–they don’t even let diary quota get exported and GHG quota covers most of the entire provincial economy.  (This largely explains why the Canadian constitution protects provinces from the federal imposition of such a quota regime without provincial approval.  These same constitutional provisions are also why it has proved so difficult for the Government of Canada to impose a single national securities regulatory on the provinces, though the constitutional argument against a single national securities regulatory are weaker than those against cap and trade.)

There is no provision, in either the NDP or Liberal budgets, for the obvious and inevitable compensation claims that will arise from the introduction of any provincially-approved quota regime, particularly a regime in which the quota is auctioned.  There are no resources or time set aside to accommodate the extensive negotiations required to establish multiple province approval of any single national quota regime.  There is no recognition, in the limited dialogue to date, that provinces that will not allow their dairy quota to be exported are unlikely to approve the unconditional sale of GHG quota to private entities who may export precious provincial GHG quota to the highest international bidder generating no return to Canada in terms of cash, taxes or jobs.

One of the primary reasons, in my view, that the Liberal and Conservative governments have failed to regulate GHGs for almost 14 years since the signing of the Kyoto Accord has been the federal and some provincial bureaucracies’ obsession with cap and trade–which measure delivers complete control of the Canadian economy to whichever bureaucracy controls the determination of the national quota supply and distribution.  To date, the bureaucracies pushing for cap and trade have failed to present a single draft cap and trade regulation to the Justice Department that passes even the most basic constitutionality test.

I am not a Conservative.  But the Conservative Party’s final (late) decision to walk away from cap and trade and move towards more traditional, constitutionally acceptable GHG regulatory strategies opened the door, for the first time in a long time, to real federal action on greenhouse gas regulations.  If the Liberals or NDP take us back into cap and trade, we will be doomed to years and years of debate, federal-provincial discord and potentially a new constitutional crisis which will make that which was spawned by the free trade debate look like kindergarten.