OTTAWA – In a move that was expected but not guaranteed, the Supreme Court of Canada, in a 6-3 decision, upheld the federal Greenhouse Gas Pollution Pricing Act, settling the constitutional question on carbon pricing. The court found that the federal government has the authority to impose a price on pollution, primarily because the effects of climate change are of national concern (ie. not limited to the jurisdiction in which the pollution was generated).

Writing for the majority, Chief Justice Richard Wagner said that climate change is “an existential threat” which justifies the federal government’s implementation of a national policy under the peace, order and good government (POGG) provisions of the Constitution.

“This context, on its own, provides some assurance that in the case at bar, Canada is not seeking to invoke the national concern doctrine too lightly,” Wagner wrote.

Immediate political implications

First, the decision is a rebuke of the three Provincial Premiers who sought to strike down the 2018 federal law. The Court not only rejected their arguments around jurisdiction, but specifically endorsed pollution pricing as the best way to combat climate change. Premiers Ford, Kenney and Moe must now decide whether to begrudgingly accept federal pollution pricing, or to continue fighting the policy through other means.

Second, it puts the squeeze on the Conservative Party leader Erin O’Toole to have a comprehensive plan for the environment in a Conservative platform. Last weekend, Conservative Party attendees voted down adding additional wording to the policy book that included, “climate change is real”. While O’Toole correctly pointed out that the resolution was non-binding, it demonstrates the fundamental internal tension within his caucus and party if he decides to proceed with some sort of carbon regulation scheme.

Third, while this is a victory for the governing Liberals, they will also own the political downside of their plan to implement a $170/tonne carbon price by 2030. This will not be an easy transition, with impacts on consumers and industry. Trudeau is now all-in on carbon pricing and would find it very difficult to reverse course.

What’s next

Last December, the Liberal government announced an ambitious net-zero plan that included their intent to boost the carbon price from $50 per tonne in 2023 to $170 by 2030. With today’s ruling, it is clear that the only way this plan can be dismantled is via a change in government at the federal level.

Until that happens, the Liberals are proceeding with their climate plan to meet the 2030 climate targets. This means businesses and organizations need to plan for a future where the price of gasoline at the pumps and the cost of home heating via natural gas will continue to increase.

A refresher on how the carbon price works

The federal carbon price is revenue neutral – which means all carbon price revenue collected is transferred back to individuals. This also explains why the Supreme Court ruled that it is not a tax.

Climate Action Incentive Payment Amounts are adjusted annually by the federal government based on provincial carbon price payments, and directed back to individuals in the province where it was collected. As a result, individuals in provinces that use more carbon (and pay more for it) get a higher rebate. For 2021, a family of four in Ontario will get $600 on their tax return, while the same family in Alberta would get $981. By 2030, as the carbon price increases, the Ontario family is projected to get $2000 annually, while the Alberta family would receive $3250 – a significant amount for many families.

On average, consumers will see the full costs of their carbon usage offset via carbon rebates, as the average federal rebate is slightly larger than the average carbon price per household. However, this means carbon price revenue is redistributed from high-carbon users to low-carbon users.

The politics of market-based solutions

In crass terms, carbon pricing means people who drive gas guzzlers or heat large homes with a gas furnace will feel a hit to their wallet, while those who use public transit and live in small apartments will come out further ahead.

In political terms, that means carbon pricing financially benefits younger, lower-income and urban voters – which is a good chunk of the Liberal voter coalition. It places higher costs on rural voters – who tend to vote Conservative. Suburban voters – like those in the GTA and Lower Mainland of BC who tend to determine the winner of federal elections – make carbon pricing politically risky for the Liberals.

Carbon pricing is considered a market-based solution, because it provides consumer incentives to reduce carbon use. It makes it more economical to buy a zero-emission vehicle or retrofit your home. But as the cost of living continues to increase, especially in hot housing markets, these low-carbon investments may not be within reach for everyone. As a result, the Liberal government will feel more pressure to subsidize retrofits, public transit and zero-emission vehicles.

Provincial equivalency

Today, the federal carbon backstop only applies on four provinces – Ontario, Manitoba, Saskatchewan and Alberta. All other provinces have their own carbon pricing or cap and trade regimes that meet federal stringency requirements.

However, as the federal carbon price increases, provincial plans will need to become equally more stringent. Provinces that could swallow administering a $50/tonne carbon price may not wish to take the political heat for jacking it up to $170/tonne. As a result, it is possible that more provinces will jettison their plans and resort to the federal backstop.

Industrial carbon pricing

Likewise, the Supreme Court decision also impacts industry, as the federal carbon price applies to industry via the Output-Based Pricing System (OBPS) and equivalent provincial regimes. While industry does not pay a carbon price on fuel inputs, they are required to pay a price on their carbon outputs above a certain threshold.

Most provinces have negotiated equivalency agreements with the federal government to cover their industrial sectors, with Ontario and New Brunswick expected to leave the federal OBPS in the near future. However if the federal industrial standard becomes more stringent in lockstep with the rising consumer carbon price, provinces may find it more difficult to maintain equivalency. This could force a standoff, where the federal government invokes an override and directly regulates industrial emissions.

Federal industry carbon thresholds are based on the trade exposure of sectors that compete with products made in jurisdictions that do not have a carbon price, and the technology available to reduce emissions. Steel, cement and fertilizer have higher thresholds, which means they pay a lower price on their total emissions, than oil and gas or forestry. It is unclear if these thresholds will change over time.

Thresholds aside, in theory, as the federal carbon price goes up, so will the cost to industry. But for trade exposed sectors, there is a risk higher costs will provoke capital to flee Canada for lower cost jurisdictions. This means that the federal government will need to strike the right balance to encourage lower emissions from industry while still keeping business thriving domestically.

Carbon border adjustment

The elephant in the room is what the Americans are planning to do on climate change. Early signals suggest that they will not be following Canada in putting a national price on carbon. Rather, they will likely take a sector by sector approach, using a mix of regulations and financial incentives to try and reduce GHG emissions, starting with the electricity sector.

While this approach will certainly have an effect, it is likely to fall short of the Canadian plan, and could create a real disparity in the carbon profile and cost of doing business in each country. Over time, this may cause Canadian manufacturers to relocate to the United States or elsewhere, simply moving our GHG emissions (and Canadian jobs) offshore.

One policy proposal that is gaining momentum on both sides of the order is the idea of a carbon border adjustment. Under such a scheme, the Canadian government would levy a tariff on high carbon products imported into Canada. This would take a long time to negotiate given the complexity of carbon policies in different jurisdictions, but it would provide an incentive for other countries to price carbon if they want to keep exporting goods.

Today, the Biden administration has signalled its intention to set up its own carbon border adjustment, primarily targeted at goods imported from China, a country with less than half the per-capita CO2 emissions of the United States. In this scenario, we could see a tariff ring around the CUSMA trade zone, imposing tariffs on goods originating in carbon intensive jurisdictions.

A harmonized North American carbon border adjustment scheme would only be plausible if the United States implemented a domestic price on carbon, or some regulatory scheme that put a hard cap on GHG emissions. Whether or not Biden has the political capital to do this remains a big question mark – but it has even bigger implications for Canadian industry after today’s court decision.