Ontario s Climate Change Action Plan: Implications for companies and government

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1 Ontario s Climate Change Action Plan: Implications for companies and government

2 Ontario s economy is entering a new low-carbon era through a cap and trade program and climate change strategy and action plan. Although the carbon price signal might be moderate in the early phases of the program to mitigate the potential impact, it s designed to increase over time and accelerate the transition toward the low-carbon economy. Businesses will need to take a strategic view on the carbon issue sooner rather than later. It is our view that the cap and trade system will create winners and losers. At the same time, governments will need to constantly justify the system s economic and environmental legitimacy on the province s economic and the environmental balance sheets.

3 Ontario s cap and trade market Mandatory participants in Ontario s carbon cap and trade market, that is, companies operating facilities that emit greater than 25,000 tonnes of C02 equivalent (CO2e), otherwise known as large final emitters (LFEs), must reduce their internal greenhouse gas (GHG) emissions to an agreed-upon level, or cap, or offset emissions over the level set in each compliance period by acquiring credits or allowances. The first compliance period goes into effect on 1 January Companies operating facilities that emit less than 25,000 tonnes of CO2e may opt into the program, in which case they will also be capped and their emissions must be verified. In the first compliance period, LFEs can expect to receive most of the allowances, each equal to one tonne of C02e, they require to meet compliance obligations for free. However, allocated allowances will decrease each year. Companies will then need to either invest in emission-reduction initiatives, or purchase any additional allowances required at auction or from the secondary market. Offset credits can also be used in place of allowances, but only up to an 8% limit. Offset project protocols, however, are still under development. Also still under development is the regulation for early reduction credits, which the Ontario Government will recognize to reward early actions to reduce emissions. Accounting and tax implications for companies For the time being, emitters need to select and explain their accounting methodology and apply it consistently over time. This variability in reporting will negatively impact comparability and transparency until the appropriate accounting standards boards address emissions. Likewise, the federal Income Tax Act does not contain legislation that explicitly deals with emission trading regimes. Therefore, tax consequences are determined through the application of general principles, resulting in two concerns: double taxation and cash flow. First, if the Ontario government decides to grant an emission allowance for nil consideration, then the value of the amount received may be required to be included in taxable income. But, there is no provision in the Income Tax Act that would adjust the corresponding cost amount for tax purposes. Hence, double taxation may arise if the emission allowance is subsequently disposed. Second, receipt of a nil consideration emission allowance may be required to be included in taxable income upon receipt, but the corresponding deduction is not permitted until subsequently incurred. This impacts cash flow if there is a large gap between the inclusion and deduction dates. While the 2016 federal budget proposed looking at the Income Tax Act to address these concerns, specific legislation was not provided. The treatment of emissions on balance sheets varies significantly, even in mature markets such as the EU. Currently there is no prescribed accounting guidance for emissions credits and different views and interpretations are currently being discussed. Companies therefore will need to develop a point of view based on their current accounting framework and consultations with advisors and auditors. Ontario s Climate Change Action Plan: Implications for companies and government 1

4 Getting your business ready for cap and trade Participants can prepare for Ontario s cap and trade system by undertaking the following measures: 1 Develop a strategic compliance approach: Project emissions baseline based on business forecasts. Assess potential for internal efficiencies and emissions abatement opportunities. Model various compliance scenarios. Identify most cost-efficient compliance strategy. Review carbon disclosure approach considering both regulatory filing for compliance obligations, as well as voluntary carbon risk disclosures for investors. Define accounting/tax treatment approaches. 2 Factor the cost of carbon into operational expenses and budgets through estimates based on the price of allowances in California and Quebec, which have been aligned with floor prices defined by the regulation since Revise the capital expenditure strategy to take into account a likely future cost of carbon and revenue recognition for potential price recovery in a situation when there are expectations the cost can be passed on to consumers. 4 Participate in government consultations on the delivery model of the program. These regulations are complex; appropriately taking into account industry specifics is a daunting task for governments. 2 Ontario s Climate Change Action Plan: Implications for companies and government

5 Financing the transition to low carbon In addition to cap and trade, Ontario s Climate Change Action Plan describes its desired financing structure for expanding or bringing to market available clean technologies, including solar, georthermal systems and energy storage, to name a few. The financing mechanism is a green bank, structured loosely on a blend of two US models: Efficiency Vermont and the New York Green Bank (NYGB). Both organizations help de-risk cleantech investments, but in different ways. Efficiency Vermont is a research and advisory organization that will support the uptake of cleantech investments by providing guidance to smaller investors on which technologies will best fit their energy reduction needs, similar to existing conservation demand management programs offered by Canada s utilities. Barriers to investment for cleantech companies are addressed by reducing the uncertainty of technological outcomes through the organization s vetting process and investment incentives. NYGB offsets risks associated with clean energy to reduce the cost of capital that has previously prevented such projects from achieving scale. NYGB can provide loan guarantees, serve as the senior lender, or make long term debt or equity investments in certain projects or portfolios. It serves as the intermediary until projects or portfolios of projects achieve the scale required to attract private capital. It is currently funded in part by proceeds from New York State s regional cap and trade system; however, future profits will be used to invest in new projects. Central to the green bank paradigm is the private/public investment ratio, with the objective of maximizing private investment over time. Achieving this objective requires strong governance, accountability and transparency over the use of cap and trade proceeds and other public funding to finance deals, along with measureable results encompassing both environmental and financial performance metrics. Existing green bank-like institutions such as those in New York, Conneticut and Rhode Island, as well as national structures such as the UK Green Investment Bank, were all established as quasi-governmental agencies operating in the private sector with the objective of de-risking clean energy investments. In addition to providing access to capital, green financing mechanisms are designed to increase knowledge in clean energy solutions, aggregate projects to build scale, and create new market structures to stimulate demand. A banking mechanism can serve as a catalyst to unlock capital for the larger or riskier projects our economy needs to achieve our transition to low carbon. If done well, both structures can provide opportunities for companies to bring their technologies to the Ontario market and reduce the potential risks of investing in energy and emissionreduction initiatives for both companies and individuals. Ontario s Climate Change Action Plan: Implications for companies and government 3

6 Climate risk disclosure In the slow but steady transition to a carbon-constrained landscape, the world is moving into a new era of carbon disclosure, characterized by rapidly growing concerns among investors on the existence and enormous potential financial impacts of carbon reduction policies and resulting stranded assets. This shift is also reflected in the rapid rise of investor-driven international initiatives, such as the Financial Stability Board s Task Force on Climate-related Financial Disclosures, chaired by Michael Bloomberg, which is mandated to develop voluntary guidelines for businesses to assess and disclose climate related information, including carbon risk. The Task Force s Phase 1 report was issued on 31 March 2016 to the chair of the Financial Stability Board, Mark Carney. In this transition, companies are increasingly considering their exposure to carbon risk at two levels: 2 Assessment and disclosure of carbon risk and impacts on the business: As evidenced through voluntary reports and initiatives such as the Carbon Disclosure Project many corporate leaders are beginning to assess and disclose how a global legislative scenario might impact their assets. Investors have become clamorous in their concern over assets that may become stranded as a result of legislation to drastically reduce carbon emissions. As more details are announced on implementation of the Ontario Government s climate change initiatives, heightened scrutiny of disclosure practices will become a more significant issue for corporate executives. 1 Integration of carbon pricing in their business forecasts: According to EY s report Shifting the Carbon Pricing debate, more than 430 companies around the world have already set internal prices for their carbon emissions compared to a mere 150 in An additional 583 companies stated that they will adopt carbon pricing in the next two years. 4 Ontario s Climate Change Action Plan: Implications for companies and government

7 How we see it As with any region, Ontario s transition to a low-carbon economy will succeed if the government works with the private sector to create and implement enabling market structures. Private sector executives will need to adapt their business models, processes and corporate disclosures to comply with the government s imminent climate change regulations in a manner that reduces their risk exposure and capitalizes on the new opportunities that will be generated. Similarly, the government s nascent strategy will require robust execution in which the business case for its environmental protection initiatives is consistently and regularly demonstrated. Learn more To find out how EY s Climate Change and Sustainability Services team can help your business navigate through Ontario s Climate Change Action Plan, please contact one of the following professionals: Thibaut Millet Partner, National Leader, Climate Change and Sustainability Services Thibaut.Millet@ca.ey.com Susan McGeachie Central Market Leader, Climate Change and Sustainability Services Susan.Mcgeachie@ca.ey.com Tom Di Emanuele Partner, Tax Services Tom.DiEmanuele@ca.ey.com Shannon O Mahony Partner, Financial Accounting Advisory Services Shannon.OMahony@ca.ey.com Steve Power Central Market Leader, Power & Utilities Steve.R.Power@ca.ey.com Ontario s Climate Change Action Plan: Implications for companies and government 5

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