Yosemite National Park, California. iStock.
The results of the latest joint California-Quebec cap-and-trade auction were released today. As expected, the auction was significantly undersubscribed, something not seen since February 2017. The low revenue from this auction points to a need for California to develop a diversified, long-term strategy to fund critical climate programs, even as the state works to balance many important fiscal priorities. At the same time, the resilience of the cap and trade program even during periods of instability provides a critical backstop, ensuring California’s targets for reductions in climate pollution are achieved.
Here’s a quick recap of the results:
- 21,161,000 current allowances sold of the 57,540,731 offered for sale. This is the lowest percentage, 37%, of current allowances sold since the August 2016 auction when 35% sold.
- Current allowances settled at $16.68, which is $1.19 below the record-high clearing price in the February 2020 auction.
- 8,672,250 future vintage allowances were offered for sale, and 1,763,000 of them sold. Like the previous auction, this is a smaller volume of future vintage allowances offered than in 2019 auctions.
- The future allowances cleared at the floor price of $16.68. These allowances cannot be used for compliance until 2023.
- The auction raised approximately $25 million for the Greenhouse Gas Reduction Fund, significantly lower than the $600 million raised in February, but still valuable revenue for important climate priorities.
- Quebec raised over $83 million CAD (approximately $60 million USD) for their own climate investments.
While the results are a significant deviation after 12 consecutive sold out auctions, there are several important factors to keep in mind.
- The primary purpose of the cap-and-trade program is to reduce emissions; its success is determined by consistent decline in California’s greenhouse gas emissions, not the price of an allowance or the volume of allowances sold at auction. California has been successful at reducing emissions, including returning to 1990 emission levels back in 2016, and starting to turn the corner on transportation emissions even before the current COVID-19 crisis.
As the economy begins to recover from the COVID-19 induced slowdown, it is likely that emissions will increase from today’s levels. The key will be ensuring that as we recover, we build back our economy in a healthier, more sustainable and equitable way. The role of the cap-and-trade program going forward will be to ensure that we stay on the right path to meeting our 2030 greenhouse gas reduction goals. The program’s innovative features can help make permanent some of the reductions we’ve seen in the last few months even as economic activity restarts.
- The cap-and-trade program is designed to withstand external shocks and market volatility, while securing critical reductions in pollution. The results of today’s auction reflect broader economic uncertainty; the program itself is still working as intended. Auction prices at the price floor demonstrate the importance of this design feature in guaranteeing a minimum carbon price, which provides a consistent incentive for regulated businesses to continue to reduce emissions. It’s also worth noting that without such a feature, carbon prices (and auction revenue) could potentially trend even lower.
Another important feature is the so-called “24 month rule,” which provides two levels of temporary cap tightening. Allowances that go unsold at auction will not be offered again until two consecutive auctions are fully subscribed. If allowances go unsold for 24 months (eight consecutive auctions) they are moved to the Allowance Price Containment Reserve (APCR). Allowances from the APCR only become available if prices hit certain, pre-determined points, making this a more permanent form of cap tightening. This is a good outcome for the environment. California has never seen prices high enough to be close to the APCR. In the longer term, the 24 month rule could significantly reduce the volume of allowances offered at future auctions—and can help ensure that some of current emission reductions that are well below the required cap level are permanent.
- Cap and trade has successfully weathered market uncertainty before. In 2016 and early 2017 auctions were undersubscribed due to pending litigation, as well as ongoing legislative negotiations to extend the program beyond 2020. As soon as these issues were resolved and there was more certainty about the future of the cap-and-trade program, the auctions were again fully subscribed. As the external shock subsides, it is reasonable to anticipate that auction demand will recover as well.
- Cap and trade could help to make permanent some of the emission reductions California is seeing right now. The climate crisis is accelerating, and it is reasonable to evaluate opportunities to increase the ambition of the cap-and-trade program. It may be appropriate to consider making some program adjustments once the full extent of this crisis is understood.
One option CARB could consider in a rule-making process is to add an Emissions Containment Reserve (ECR) to the program, a feature the Independent Emissions Market Advisory Committee is also considering. An ECR could be designed in a similar manner to what is employed in the Regional Greenhouse Gas Initiative (RGGI) on the East Coast, and is basically the mirror image of the APCR California already has adopted. An ECR works by setting certain, pre-determined price points near but above the price floor. Allowances are automatically withheld from the market unless prices rise from the floor to meet those price points, at which point additional allowances are released: as prices fall, allowances are withheld. As they rise, allowances are released. This has the effect of limiting the number of allowances that are available at low prices. The withheld allowances could be moved to the APCR, or retired from the program altogether as is the case with RGGI. An ECR would help California to achieve greater emission reductions while allowance prices are low.
Greenhouse Gas Reduction Fund
While it is clear cap and trade will be critical to ensuring California continues to secure the necessary emission reductions, even as the economy recovers, in the near term uncertainty remains regarding available revenue for the Greenhouse Gas Reduction Fund (GGRF). This is important because California has heavily relied on revenues from the GGRF, rather than other sources or the General Fund, to invest in securing targeted greenhouse gas reductions, local air quality improvements, and initiatives to begin to rectify longstanding environmental injustices.
As the very purpose of cap-and-trade, or any carbon pricing mechanism, is to reduce emissions, the program would actually be most successful if emissions were so low, and the cost of reducing remaining tons so cheap, that revenue decreased dramatically. Therefore, it is important in the long-term for the state to ensure funding for the most critical climate priorities is resilient. Many important programs beyond climate are hurting right now, and decision-makers will have to make hard choices as they consider California’s budget. At the same time, an innovative initiative like the AB 617 Community Air Protection Program, which contributes to the health and economic vitality of the state’s most vulnerable communities, deserves prioritization for General Fund spending or funding from other dedicated revenue streams.
Today’s results demonstrate the durability of cap and trade, and the purpose of the program in reducing climate pollution remains the same. However, this auction is also an illustration of the need to diversify funding for complementary climate investments. Rather than relying solely on a program specifically designed to reduce emissions and lower mitigation costs (and therefore revenue), California should move toward ensuring climate priorities are a core part of the state’s long-term fiscal priorities.