How Ontario's cap-and-trade system works

Ontario's first cap-and-trade auction takes place on Wednesday. Here is a basic explanation on how the cap-and-trade system is expected to work.

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• Ontario has set a greenhouse gas emissions cap of roughly 142 megatonnes for 2017.

Companies that pollute at least 25,000 tonnes per year will have to have a number of allowances equal to their emissions.

One allowance is equal to one tonne of carbon dioxide equivalent.

The allowances will be available for purchase at quarterly auctions. Participating businesses can also buy and sell credits to each other on a secondary market.

Most large emitters will receive allowances for free until 2020, which the government says is meant to prevent them from moving to jurisdictions without carbon pricing.

Fuel distributors and electricity importers will not receive the free allowances.

The emissions cap will decline each year, from 142 megatonnes in 2017, to 136 megatonnes in 2018, to 131 megatonnes in 2019, to 125 megatonnes in 2020, which is equal to the government's target of getting emissions 15 per cent below 1990 levels by 2020.

As the emissions cap declines and fewer allowances are available, the government hopes the incentive increases for companies to invest in technologies that cut their emissions.

The floor price on carbon is expected to be set for auctions at between $17.50 and $18 per tonne, though demand could push the price higher.

Participating companies can also purchase and use offset credits to meet up to eight per cent of their emission allowance requirements.

Offset credits will be created by projects outside Ontario that reduce or remove one tonne of greenhouse gas emissions, such as tree planting or capturing and destroying methane gas, and those credits can then be sold to Ontario cap-and-trade participants.

Companies can also get some early reduction credits for work already done to reduce emissions.

Cap-and-trade proceeds are directed to a Greenhouse Gas Reduction Account to fund green projects such as home and business retrofits.

Ontario's cap-and-trade system is expected to be linked to Quebec and California's in 2018.