Will policymakers rescue California’s GHG cap-and-trade program?
Uncertainty continues to surround California’s greenhouse gas or (GHG) cap-and-trade program. The latest quarterly auction of California and Quebec GHG allowances held on February 22, 2017 sold less than 20 percent of available current vintage allowances, continuing a trend of low subscription levels that began in 2016.
California-Quebec joint GHG allowance auctions (current vintage only)
When the Trend Began
The trend began after a California appeals court in April 2016 requested additional briefs on key aspects of an ongoing lawsuit (California Chamber of Commerce, et al. v. California Air Resources Board, et al.). This signaled to some that the court found some of the arguments of the case possibly valid, increasing the likelihood of the lawsuit’s success. The lawsuit challenges both the use of state revenue from California GHG allowance auctions and that the allowance auctions constitute an improper tax that was not passed with two thirds majorities in both houses of the state legislature, as required for new taxes by the California Constitution under Propositions 13 and 26. Oral arguments for the case were heard on January 24th of this year and a ruling on the case is expected by late April 2017.
This development in the lawsuit, combined with uncertainty over the cap-and-trade program being extended beyond 2020 and a large bank of accumulated allowances in the combined California-Quebec GHG allowance market, has caused recent quarterly allowance auctions to go undersubscribed. Policy and legal uncertainty continue to overshadow the market.
GHG Cap-and-Trade: Next Steps
Extending the cap-and-trade program beyond 2020 is a top priority for Governor Brown. In 2016, ARB proposed amendments to cap-and-trade program to extend it beyond 2020. However, ARB’s legal authority to extend the program without additional legislation is in question. Efforts are underway in the state legislature, through multiple bills, to extend the program with a two thirds approval and protect the cap-and-trade program against legal challenges. To encourage passage of legislation extending the program, Governor Brown is even withholding a spending plan on state GHG allowance revenue.
Although Democrats have recently regained a supermajority by controlling two- thirds of the state senate and assembly, passage of legislation and what is contained in that final version of legislation is uncertain. Some policymakers have recently expressed interest in a carbon tax that would provide stable revenue that is not at risk of undersubscribed auctions. There is also growing pushback from some policymakers that cap-and-trade does not do enough to reduce local pollution in disadvantaged communities, aligning with the arguments of the environmental justice community.
The influence of the environmental justice community has been growing in recent years. In 2016, passage of SB 32, which requires a 40 percent reduction from 1990 levels in California’s GHG emissions by 2030, was accompanied by AB 197. AB 197 gives the environmental justice community more of a voice at ARB and requires the prioritization of direct emission reductions. The influence of the environmental justice community could be a determining factor as to if and how the cap–and-trade program gets extended.
Assuming the cap-and-trade program survives legal challenge and gets extended there is also uncertainty around details of the cap-and-trade program beyond 2020 and linkage with Ontario that is not yet final. In a workshop held in October 2016 by the ARB on cap-and-trade regulation amendments, discussions took place around lowering the use of offset credits, as well as allowing the retirement of some of the unsold allowances (over 180 million current vintage California and Quebec GHG allowances worth ~2.4 billion USD have gone unsold in quarterly auctions since 2016). If implemented, both measures would serve to tighten market fundamentals.
Also, in a February 16th ARB meeting, Chairwoman Mary Nichols delayed consideration of cap-and-trade program amendments to June of this year to allow more time for the environmental justice community to weigh in, further highlighting its growing influence. This delay also gives more time for opponents of the cap-and-trade program to argue against its extension or its key components.
In summary, uncertainty from legal and policy challenges to California’s GHG cap-and-trade program including: the California Chamber lawsuit, extension of the cap-and-trade program beyond 2020, details of the program after 2020, and challenges from the environmental justice community, in combination with a large bank of accumulated allowances, has led to low interest in the most recent quarterly allowance auctions. However, despite these uncertainties, California’s cap-and-trade program is still seen as a model for other jurisdictions that desire a market-based emission reduction mechanism.
This example for the rest of the world, combined with the political will of California to stand in contrast to the recent change in direction of US federal climate change policy, could be enough to carry the program forward. With Democrats in charge of the state environmental policy there is a strong likelihood that policymakers will eventually extend the program through 2030, causing allowance auction subscription levels to rise.
For other California-related materials from ABB’s Energy Market Intelligence, please see Webcast: Market Implications of California Senate Bill 350.
Author: ABB Energy Portfolio Management Advisors