Results from California’s first auction of greenhouse gas emissions allowances indicate the emissions reductions goals of the state are obtainable, apparently at lower cost than many observers thought likely.
The first sale of emissions allowances in California attracted substantial attention because of competing claims about the design and expected performance of the auction. In that context, the big headline is that the auction worked as anticipated. The responsibility for compliance begins in January 2013, but effectively California’s cap-and-trade program is now off and running.
The format was a single-round, sealed-bid uniform price auction. Here’s how it worked. Pre-qualified participants submitted bids for allowances, each of which authorizes emission of one metric ton of carbon. Allowances were awarded to the highest bidder, then the next highest and so on until the volume of allowances ran out. Crucially, all bidders paid not the price they bid, but the price bid by the last participant to receive an allowance (or a minimum “floor” price of $10, whichever is greater). There were really two auctions—one for allowances useable in 2013, the first year of the program, and another for allowances only useable in 2015 or later years.
Allowances for 2013 sold at a clearing price of $10.09, just above the floor price. All of the available allowances were sold. About 97% were purchased by entities with a direct compliance obligation—that is, by GHG emitters; the remainder were purchased by investors.
Only a small portion of the 2015 and later allowances were sold, and their price was equal to the minimum acceptable price of $10.00.
The auction for 2013 vintage allowances raised $233 million, and another $56 million was raised in the auction for 2015. Some of the money will be returned to electricity ratepayers to offset higher bills, and the remainder will be directed to clean energy and energy efficiency programs.
The auction price was lower than many observers expected, which could be good news or bad news. A low price suggests the emissions cap will have a minimal impact on the California economy. However, it also means that less money will be available.
Three factors contribute to the low price. One is the fundamental characteristics of the market. Many complementary measures already in place (“substitute” measures according to my colleague Tim Brennan) will lead to emissions reductions and therefore lower demand for emissions allowances. There are over a dozen such complementary measures in California, including a renewable portfolio standard, a low-carbon fuels standard and energy efficiency standards. It is reasonable to expect some of these complementary measures to over-perform and others to under-perform. For example, the surprising decline in the cost of some renewable energy technologies indicates they may penetrate the electricity sector more easily than imagined just a couple years ago. On the other hand, the fate of the low carbon fuel standard lies in the hands of the courts.
California regulators designed the cap-and-trade program with these performance issues in mind. If complementary measures are less successful than anticipated, the cap will pick up the extra reductions—cap-and-trade acts as a backstop for other policies.
On the other hand, if these complementary measures are more successful than anticipated, they might achieve enough reductions so that emissions are below the cap. In this case, allowances would trade at the price floor—incentivizing further emissions cuts. Either way, California’s cap-and-trade is designed to ensure that reduction targets are met on time.
A second factor is the threat posed by lawsuits that could affect the long-run performance of the California market. Although few legal scholars seem to think the suits filed so far are likely to succeed, they nonetheless reduce the incentive to buy and hold allowances. A last-minute lawsuit by the California Chamber of Commerce seemed specially timed to have this effect.
Third, policies at the national level also could also affect the California market. Just last week the American Enterprise Institute, along with Brookings and RFF, hosted a day-long conference on a possible national carbon tax. Such a tax would provide an additional economic incentive to reduce emissions nationwide, making it easier to achieve the emissions cap in California. Although the likelihood of a national emissions tax remains small, the possibility reduces incentives to buy emissions allowances in advance.
For now, the results of the first auction indicate a well-designed cap-and-trade program.
