Keep Calm and Tighten the Cap

The results of California’s latest cap-and-trade auction were announced today, yielding what on first impression looks like a stunning result—just $25M for the state’s coffers, compared to $613M from the previous auction in February. But the result was largely in line with forecasts, as California’s greenhouse gas emissions have fallen sharply in the wake of the state’s shelter-in-place orders to combat the spread of COVID-19, in turn reducing demand for emissions allowances at the auction (the parallel panic in financial markets also caused a selloff on the secondary market, which traded below the floor price of $16.68 in the weeks leading up to the auction).

Revenue generation is important—but not the primary purpose

Reduced demand for pollution permits is not in itself cause for alarm: after all, the point of the program is to cap emissions, not raise revenue. The Air Resources Board, which implements the program, employs a “self-ratcheting” mechanism that withholds unsold state allowances—in this case, 26.9M—from future auction budgets until two consecutive auctions clear above the floor price, and transfers them into a price containment reserve (only accessible at much higher prices) if they remain unsold for eight consecutive auctions. ARB employed this mechanism previously when uncertainty about the post-2020 program caused auctions to sputter in FY16-17, resulting in lower revenues that FY but higher revenues in the fiscal years when those allowances eventually sold.

But volatility is not without a cost. In particular, the uncertainty has made effective program planning difficult for the many worthy programs funded by auction proceeds, which accrue in the state’s Greenhouse Gas Reduction Fund. California has relied on GGRF to fund critical investments in low carbon transportation, low-income weatherization, healthy soils, and more—as well as essential community needs such as safe and affordable drinking water. Absent additional funding, these programs face the prospect of being zeroed out next fiscal year—underscoring the importance of developing a diversified funding strategy that can also jumpstart California’s economic recovery.

Moreover, the cause of California’s precipitous fall in GHG emissions—a global pandemic—is neither cause for celebration nor likely to prevent emissions from rebounding as the state opens up. Thanks to the performance of California’s suite of complementary policies, the cap already has significant slack in the form of a large pool of unused allowances that has built up over time. The ability of compliance entities to bank allowances for future use has raised questions about whether the program as designed could indeed backstop the state’s mandatory 2030 emissions limit, as envisioned by ARB in the 2017 Scoping Plan.

While rushing to judgment on the basis of one auction would be a mistake, the results add urgency for ARB to address these issues comprehensively in the post-2020 program. In particular, ARB should heed the advice of its Independent Emissions Market Advisory Committee by initiating a rulemaking to evaluate and implement rule-based adjustments to adjust the supply of allowances as needed to ensure the state achieves its climate goals.

One thing is clear: in an uncertain world, our climate policies need to be resilient too.