Making a deal on California’s cap and trade: It’s all about the cap

Inside the California State Capitol building in Sacramento. Photo via Flickr/ kkanouse

California politicians are deep into negotiations over how to extend the backbone of the state’s climate policies, the cap-and-trade program. The Governor’s office and legislative leadership are nearing a compromise that can lock in the 2/3 vote that would provide the strongest legal foundation for a future cap-and-trade program and accelerate the state’s progress to cleaning up the air.

The integrity of the cap is critical, because it is the cap that provides the guarantee that California will meet its climate target.

The comedian Larry David once said “A good compromise is when both parties are dissatisfied.” Elected leaders can probably identify with that sentiment, as they take on the unenviable task of constructing a deal among multiple parties — one that would be a critical step forward for climate action, but might still leave everyone involved at least a little dissatisfied.

As they do, we at EDF will be laser-focused on one question related to cap-and-trade design: Does the deal protect the environmental integrity of the cap?

In the current negotiations, the issue of integrity comes to the fore with one particular aspect of the draft proposal: the design of a "price ceiling" for emission allowances.

It’s all about the cap…

The integrity of the cap is critical, because it is the cap that provides the guarantee that California will meet its target. California has a portfolio of climate policies working together to reduce emissions, and all have their role to play. The signature feature of the cap-and-trade program is that it places a firm limit on carbon pollution and holds the state accountable for achieving the climate targets set in law.

The central importance of the cap in ensuring that the state meets its goals is critical to keep in mind when considering one key aspect of the compromise deal being discussed in the Capitol: a so-called “price ceiling” on the allowances polluters need to comply with their obligations under the cap. While a limit on allowance prices might sound like a good idea, if poorly designed it could come at a significant cost to the integrity of the program — because the only way to keep prices from rising above the ceiling is to allow unlimited emissions.

In other words, a price ceiling is potentially a blank check to polluters that risks busting a hole in the cap. That introduces the risk that California blows past its targets — undermining its claim to climate leadership, and raising the chances of climate catastrophe.

A plan to board up the busted cap

The potential saving grace in the current proposal is that they have a plan for how to board up the hole in California’s climate target if the price ceiling is deployed. The Air Resources Board is required to use revenue raised through compliance at the price ceiling to secure high-quality reductions to make up for any excess above California’s cap. It’s important that this provision be protected, by guaranteeing that all the revenue from a price ceiling is used to reduce emissions, and by imposing a requirement that the emissions debt created by the price ceiling is repaid on at least a ton-for-ton basis.

Now, a far better strategy would be to use or strengthen the tools that have kept cap-and-trade costs down so far, like a reserve of allowances and offsets to avoid getting close to the price ceiling in the first place. But a plan for boarding up the hole is better than nothing at all.

Price ceiling should be a “Break glass in case of emergency” — and only an emergency strategy

The best argument that can be made for a price ceiling is that it can prevent even worse outcomes, such as prices rising high enough to threaten the continued existence of the program. To be clear, such an outcome is highly unlikely — but anyone who lived through the electricity crisis of 2000 knows that we can’t rule anything out.

If a price ceiling is to be included, it must be as a last resort — a kind of “Break Glass In Case of Emergency” strategy. And just like a fire alarm behind a pane of glass, it should really be reserved for genuine emergencies — not simply to let polluters off the hook.

EDF will be laser-focused on one question related to cap-and-trade design: Does the deal protect the environmental integrity of the cap?

It’s also important that the program itself be allowed to function as intended. The beauty of the cap-and-trade program is that it lets the price rise or fall to whatever level is necessary to cut emissions in line with the target. A high price serves as a valuable signal to spur investment in new innovations that can then drive costs down. Set the price ceiling too low, and you cut off that signal — potentially driving prices up in the long run.

All of that means that the price ceiling needs to be high enough that it doesn’t threaten the integrity of the program, or interfere with the ordinary working of the market.

The current proposal wisely provides some very clear and specific direction to the Air Resources Board which will be able to carefully consider and get extensive stakeholder input before setting on a final number. This is not giving carte blanche to an executive agency but rather identifying factors that will dictate an acceptable range and also recognizing the complexity and importance of setting the right price ceiling number.

EDF would much prefer that the signature feature of California’s climate policy, the cap, not be put at risk in the first place. But we are also committed to actively working toward a deal while still fighting for the best possible safeguards for the cap.

Even as we have to contemplate compromises in California it is important to keep our eye on shining optimism that California does represent. The state is debating how not whether to act on climate and for many enduring the sometimes demoralizing swamps of D.C. this is an enviable place to be.

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