Yesterday, Thomson Reuters Point Carbon published an updated forecast for allowance prices in the California carbon market, causing many skeptics to pontificate the beginning of the end for cap and trade as we know it.
But many failed to recognize what the market IS doing: Putting California on a fast track to reach its greenhouse gas reduction goals and at a cost much lower than expected.
While the Reuters forecast has raised concerns about the potential of an over-supplied market, there are three key implications of their analysis, presuming the numbers are accurate.
- California’s climate law (AB 32) is working.
The cap and trade program limits pollution from over 350 major sources in California, yet it is just one among a suite of tools to cut climate pollution to 1990 levels by 2020. It complements and provides a backstop to other statewide policies. Point Carbon’s analysis says that it is because of policies like the Renewable Portfolio Standard (RPS) and Low Carbon Fuels Standard that regulated entities in the power and transportation sector will see an emissions decline. This means, together, the AB 32 measures are working to get the state to its 2020 goal – a huge success.
- Achieving the cap is proving to be much less costly than originally expected.
Naysayers of the program and many regulated businesses have continually expressed fear of high compliance costs. Even Point Carbon projected $70+ prices just a few years ago with a similar type of report. This new forecast is in stark contrast to those fears, and predicts that the regulated entities will be able to reduce their emissions at much lower costs than expected. Even if prices are at the floor, the cap is what matters in achieving our climate goal. A price signal on carbon today also incentivizes investment in low carbon projects that lock in critical benefits long into the future.
- This is a marathon, not a sprint, and post 2020 goals are crucial.
California has aggressive goals beyond 2020, with an 80% reduction below 1990 levels by 2050 as an objective established in a previous executive order. We see cap and trade as an important part of meeting that goal. Because markets are forward looking, if the market anticipates better economic conditions and if there are expectations that businesses may bank allowances for use after 2020, prices could jump, particularly if there is a shortage of offsets. Low costs are good news, as long as California meets its cap, but we need to think ahead to post-2020 when it will be particularly important to ensure more ambitious reductions can be met at reasonable costs. Offsets, banking, and other cost containment mechanisms will continue to be important features of the program.
Point Carbon’s forecast is based on a particular modeling approach and assumed set of conditions. As with all models, it is hard to verify the results without intimate knowledge of the model’s assumptions, inputs and sensitivity analysis. For example, depending on assumptions about the supply of offsets, this analysis could be contrary to conclusions based on assumed offsets shortages that Point Carbon and the American Carbon Registry have predicted in the past. The analysis assumes the “slow economic recovery” will continue and cites this as one of the major reasons for their revised forecast. California’s economy, however, has recently shown great economic strides, with evidence that the state is outpacing the rest of the country in employment growth.
There will undoubtedly be more analysis and commentary about California’s groundbreaking carbon market and EDF will continue keeping a close eye on the market’s performance, which thus far has produced clear signs that cap and trade is working – and that California’s environment is better off because of it.