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As described above, a strong policy would be required for Canada to meet its Kyoto target in such a short time frame. In theory, the approach could involve a number of elements, including taxes, regulations and trading. Practically, however, introducing new direct GHG regulations would not be possible as new regulations generally require several years to develop and implement. While existing regulations (e.g. Energy Efficiency Regulations) could be made more stringent, they would have minimal effect in the short term.
It is likely that Canada would have to rely to some extent on international trading of credits for Kyoto compliance (e.g. CERs, or AAUs). However, international trading has its own constraints that would need to be addressed in the overall policy. For one, there is widespread hesitancy to purchase excess AAUs given the "hot air" risk (EU countries are expected to generate very few, if any, excess AAUs for sale internationally that would represent real GHG reductions). Furthermore, as noted above, it seems that at best there will be approximately 85 Mt of project-based credits available worldwide in each year of the Kyoto first commitment period which could conceivably be purchased by Canadian business.10 In theory, this could equal roughly 30% of the annual emissions reductions Canada would need to make. In reality, it is unlikely that Canada would be able to purchase all available credits, as Japan and several EU states will also be in the CDM/JI marketplace.
Based on these considerations, the following scenario has been assumed to be the most reasonable and administratively practical way for Canada to meet its Kyoto targets. An economic modeling analysis was conducted to generate an overview of the major implications for Canada's economy:
Introduction of a carbon tax, at a nominal rate of approximately $195 for each tonne of GHGs emitted, that would apply to all GHG-producing activities by the industrial, commercial and household sectors.11 The tax would be payable by businesses and individuals at the point of sale for consumption of fossil fuel energy, as well as on emissions generated by industrial sectors from activities not directly related to fuel consumption (e.g. petroleum refining).
Electricity producers would see the charge applied to the coal, oil or natural gas consumed in their facilities, while consumers would see the charge applied to the gasoline they buy at the pumps, as well as to their heating fuel bills.
Such a carbon tax would generate a great deal of revenue for the government. These revenues are first used to ensure that the total government balance remains unchanged from projected values. The remaining revenues are recycled into the economy through reductions in other taxes for households and businesses.
In recognition of the very high environmental risks associated with a reliance on non-CDM/JI credits, Canadian business is assumed to purchase only CDM/JI credits. It is further assumed that Canadian businesses would be able to acquire about 75% of the total global supply of these credits (about 65 Mt out of 85 Mt) that is currently forecast to be available for each year of the Kyoto period. This would be equal to about 25% of Canada's total required reductions, with the remainder to be realized through domestic action in response to the carbon tax.
The cost of CDM/JI credits is assumed to be $25 per tonne. This cost is derived from the latest available information on the CDM credit price, which is about $20 Canadian per tonne.12 It was further assumed that Canada's entry into this market would increase the demand for permits significantly and drive the price up to $25 per tonne, implying a Canadian entry premium of 25%. The figure of $25 per tonne could, of course, be higher or lower over the Kyoto period, but for the purposes of this analysis any reasonable divergence from this price would have a relatively marginal impact on results due to the implied ceiling on the volume of credits that could be purchased abroad (no more than 25% or so of Canada's Kyoto target).
9 The modeling structure includes a detailed energy-technology model that interacts with a macroeconomic model of the Canadian economy.
10 CDM Pipeline, United Nations Environment Programme (UNEP) Risoe Centre on Energy, Climate and Sustainable Development.
11 The carbon tax rate is set at a level that will raise the cost of consumption of fossil fuels to a point high enough to induce accelerated adoption of available energy efficiency technologies, to the limited degree possible in the short term, and changes in economic output such that 75% of Canada's Kyoto target emissions reductions over the Kyoto period are met through domestic action. The other 25% is assumed to be made through international credit purchases.
12 Point Carbon, CDM & JIMonitor, March 21, 2007.