California cap-and-trade takes carbon market to new heights

California cap-and-trade takes carbon market to new heights

While far from perfect, cap-and-trade emissions trading looks to be the future of combating climate change. California, a new entrant to the scene, is already making a big splash in carbon trading.

California is hardly the jurisdiction that comes to mind when one thinks of effective political leadership. Most would probably label Sacramento as a more deserving home to budgetary gridlock and massive debt. But in terms of tackling climate change through market-based mechanisms, California has set a compelling example for the rest of the world.

California’s one-year-old cap-and-trade program is the largest of its kind in the US and the second largest in the world. It requires freely tradable allowances for certain businesses that annually emit more than 25,000 metric tons of carbon dioxide equivalent (CO2e). In fact, the California program has already been linked to that of Quebec, increasing market liquidity as well as opportunities for carbon offset projects.

Under the pioneering 2006 California Global Warming Solutions Act, otherwise known as AB 32, emissions of greenhouse gases (GHG) in the eighth-largest economy in the world are intended to decrease to 1990 levels by 2020, and to 80% below 1990 levels by 2050.

California builds on EU cap-and-trade experience

One of the primary methods of achieving such lofty targets is cap-and-trade, with free credits doled out to large utilities and industrial facilities for the first 90% of their emissions — a percentage which is set to decline over time. The “excess” emissions over that year’s cap must usually be purchased from other private sector participants who emitted below their targets and thus possess leftover allowances.

The cap on GHG emissions also gradually reduces, with a 2% drop per year until 2015, and 3% annual reductions afterwards.

While a far cry from the EU’s massive Emissions Trading Scheme (ETS), which commands more than 90% of the global carbon credit market by value, the Golden State’s cap-and-trade program has learned a number of lessons from its European counterpart. For one, the amount of “hot air,” or excess carbon allowances allocated, is much lower. There are also stricter limits on both the amount of total allowances given away or auctioned and the annual fall in the emissions cap.

Sacramento’s cap-and-trade arrangement is also more expansive in scope. While the ETS covers roughly 45% of the EU’s GHG emissions, that of California will soon embrace 85% once the current rules are tightened next year to apply to distributors of transportation fuel and natural gas.

Additionally, what is widely perceived in the ETS to be a profusion of cheap carbon offsets — approved (and tradable) reductions in GHG emissions made at a separate location — has been addressed. Only 8% of a business’s compliance obligation can be essentially outsourced by purchasing carbon offsets, meaning that the majority of emissions reduction in California will occur “at the source.” This will also keep the carbon price from depressing too much due to an overabundance of approved offset projects.

Carbon price depression has especially plagued the ETS. Up to half of the EU-wide GHG emissions reduction can be made by purchasing offsets. While this allows more flexibility for European businesses, the net result has been a glut of carbon offsets, depressing the price of an EU carbon credit to, recently, $7.23 per ton (of CO2e). To put this in perspective, ETS credits peaked at € 32 per ton eight years ago.

In the California market, however, the price sits at $11.85 per ton.

Golden State reaps golden harvest from carbon sales

Although not purely market-based — given its mandated, slightly variable $11.34 per ton price floor for CO2e — California’s cap-and-trade program suffers from the same issues that result from choosing a “quantity instrument” over a flat carbon tax. And notwithstanding its stringent bound on carbon offset use, such mechanisms are still decried by many environmental groups for simply shifting responsibilities and often being awarded to projects which are merely business-as-usual.

More bad news has come from reports that a number of energy-importing bodies within California may simply be complying by “exporting” GHG emissions to other states.

Unsurprisingly, AB 32 has been swamped by a litany of high-profile lawsuits from both the left and right, including a failed challenge from environmentalists attacking the standards of offset approval and a recent case filed by the California Chamber of Commerce claiming that the statute amounts to an illegal tax.

Nevertheless, what may ultimately convince governments around the world to follow suit is the sheer amount of revenue that can be gleaned from a cap-and-trade program.

Thus far, Sacramento has generated $1.5 billion in revenue from a total of six auctions of carbon allowances. This number is guaranteed to swell in the coming years as more and more large-scale emitters are covered by AB 32.

Indeed, the state’s legislative analyst predicts that California will bring in between $12 and $45 billion by 2020 from carbon credit proceeds alone. The timing of this fortuitous announcement may have been more than a coincidence. Sacramento’s plans to issue bonds for Governor Jerry Brown’s high-speed rail legacy project were recently put in flux by state courts, and proceeds from cap-and-trade are now being sought as a convenient fix.

As other states and countries may soon realize, fighting climate change can have its fiscal benefits as well.

Categories: Economics, North America

About Author

Kevin Amirehsani

Kevin is a Denver-based policy and public engagement consultant. He was previously the head of operations for a solar energy startup in Lagos, researcher for the US Commercial Service in Cape Town and the Institute for Democratic Governance in Accra, and Peace Corps volunteer in Cameroon. He holds an MSc. in International Political Economy from LSE along with a B.S. and B.A. in Industrial Engineering and Political Science from UC Berkeley.