Carbon prices rise in Californias cap-and-trade program as legal certainty grows
14 February 2017 | Mitigation
California’s cap-and-trade program, which anchors North America’s largest carbon market, is starting 2017 on a strong note ahead of its first quarterly auction on February 22. The market has generated more than $4 billion in revenue for carbon emission reductions and, despite an uneven performance last year, is strengthening through rising prices as legal certainty over the program’s future takes shape.
Last year, the program’s second and third quarterly auctions posted weaker-than-average demand for carbon allowances, the currency of compliance under the program. Some observers interpreted the results as a carbon market in a tailspin, but this failed to see the forest from the trees.
Falling Emissions Reduced Allowance Demand
Several events accounted for the less-than-stellar performance of these auctions. First, California has progressed toward its 2020 emission reduction target much faster than anticipated due to the success of other state policies like efficiency standards for cars and buildings. Faster-than-expected technology innovation, as well as the 2008-2009 economic slowdown that hit after most program design occurred, also contributed to sub-par auction performance. These factors reduced emissions and thus demand for carbon allowances.
The first time 2016 auction demand was low, analysts did not widely recognize secondary market data provided advance indications of what was to come in advance of the weak auction results. Prices for allowance trading on the secondary market had remained consistently below the auction price floor—the minimum price the California Air Resources Board (CARB) will accept for allowances at auction—before each auction.
The same secondary market data, which reflects transactions between allowance holders and buyers outside of government-managed auctions, now indicate the rebound that started in the November 2016 quarterly auction will continue in February’s auction. Allowance prices have recently risen to a high of $13.80 per ton of carbon dioxide emitted — $0.26 above this year’s auction price floor— which could portend strong demand in the upcoming auction.
Increased Legal Certainty Over Cap-and-Trade Authority Spurring Demand
The jump in secondary market prices is attributable to growing legal certainty over cap-and-trade authority. On January 24, a state appeals court heard arguments over whether the state’s auctioning of carbon allowances should be considered a tax (the purpose of which is revenue) or a fee (the purpose of which is regulation).
On one side, a lawsuit by the California Chamber of Commerce contends the cap-and-trade program’s auctions should be deemed a tax on businesses. On the other side, CARB defended the auction revenue as fees. The deciding factor is whether or not the spending is closely tied to the purpose of the program.