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Carbon Market

Mechanisms to Protect the Competitiveness of Large Industrial Emitters and Avoid “Carbon Leakage”

The cap-and-trade system for greenhouse gas emission allowances (C&T system) sets a price on carbon in the economy, i.e., it allows for pricing carbon so as to motivate companies and citizens to innovate and change their behaviour in order to reduce GHGs.

To accomplish this, the system exerts pressure by capping GHG emissions (caps) and progressively lowering the limit to ensure that emissions are reduced gradually, thereby fostering the transition to a strong and progressively lower-carbon economy in Québec.

However, these objectives could not be achieved satisfactorily if, in response to carbon pricing, companies decided to reduce or cease production in Québec and transfer it to a jurisdiction or country whose environmental requirements on carbon pricing are less stringent or non-existent. This is referred to as “carbon leakage.”

  • In this context, carbon pricing would not have achieved its objective since GHG emissions would not have been reduced, but rather moved from one place to another.
  • Carbon leakage of this sort can even lead to an increase in GHG emissions at the global level if the displaced activities release more GHGs in the jurisdiction or country where they are relocated due to lower standards or more polluting energy sources.

What companies are at risk of carbon leakage?

Carbon pricing is one of the factors that can influence the competitiveness of companies. Because of this, it must be considered and assessed in the same way as such factors as workforce cost and skill level, input costs, the cost of capital, the quality of the infrastructures, the distance from markets, and taxation.

Ideally, when assessing the risk of carbon leakage, all these factors should be taken into account in order to consider the company’s overall competitive context.

Some companies whose main competitors are located in territories where carbon pricing requirements are not as strict lack the necessary leverage within their markets to increase the price of their products. They cannot expect to recover all the costs incurred by carbon pricing without a risk of losing market shares.

In addition, this limited ability to transfer the cost associated with carbon pricing can be diminished still further if a company’s GHG emissions are significant and the costs they entail account for a considerable portion of its operating costs. Such companies are described as “emissions-intensive trade-exposed (EITE)” companies.

Proportionately speaking, many industrial establishments in Québec, such as aluminum smelters, steel mills, cement plants, and pulp and paper plants are EITE, which makes them more vulnerable to carbon leakage than establishments in other sectors. To help these companies remain competitive instead of relocating, and foster innovation in these sectors, the Québec government introduced a mechanism directly into the C&T system to reduce the risk of carbon leakage, as did other governments that have implemented such systems: the allocation of free emission units.

Learn more about the allocation of free emission units.

Back - Allocation of Emission Units at No Charge