Hal Harvey’s Insights and Updates – California cap-and-trade 2.0

California has the most successful carbon cap program in the world – doing its intended job of sweeping up remaining emissions left over from the state’s (also) world-class fuel efficiency standards, appliance and equipment efficiency standards, utility efficiency programs, and building codes, all while generating billions in revenue to reapportion for state infrastructure projects and disadvantaged communities.

Many state actors—from the environmental justice community and local officials, to industry voices and labor groups—have expressed their support for the program’s extension to at least 2030, citing it as a keystone policy for meeting California’s ambitious emissions reduction targets. This strong backing is crucial, since the state is hoping to pass any extension bill with a two-thirds majority, as added assurance in case the program is ultimately deemed a tax, requiring two-thirds legislative support, rather than a fee which requires a simple majority (though recent rulings seem to indicate the court is leaning in favor of upholding the program’s fee status).

In last week’s quarterly carbon auction, 100 percent of carbon allowances sold out at 23 cents above the program’s price floor. Our Director of Research Chris Busch was one of few analysts to have predicted this rebound in auction results (three of the last four auctions sold less than 35 percent of allowances) and explains how policy and market fundamentals were responsible for the break in the trend.

Though this recent strong auction strengthened momentum, until the legal authority for the post-2020 cap-and-trade program is secured, our longer run forecasts suggest that some shortfall in demand (some allowances going unsold at the auction floor price) could return. True, the California program is performing better than any other, but it too still suffers from oversupply. We find between 70-80 percent of allowances will be needed for compliance through the end of 2020.

Extensive working and thinking through the contours of California Carbon Cap 2.0 is happening in executive and legislative branches, but exactly what goes into the extension bill still looms. Two proposals have already been introduced: Assembly Bill 378 (C. Garcia, Holdren, E. Garcia) would extend the California Air Resources Board’s current authority of the program, but adds a handful of new stipulations aimed at creating more equitable and just conditions in disadvantaged communities. Senate Bill 775, written by Senator Wieckowski and supported by Senate President pro tem Kevin de León proposes modifications to how cap-and-trade revenues are allocated, including dividends payable to California citizens, and proposes prices floors and ceilings for cap-and-trade allowances.

As much as media seeks tensions between the two bill proposals and other ideas, it’s important to note much more common ground exists between AB 738 and SB 775 than differences. For example, both bills maintain the state’s requirement to reduce carbon emissions to 40 percent below 1990 levels by 2030, both require covered industries to obtain allowances in order to emit, and both also steadily reduce the number of available allowances offered each year. These elements are fundamental to any future carbon cap program for the state. But beyond this, in order to serve its intended purpose of reducing emissions while generating revenue and accounting for disadvantaged communities, California’s next carbon cap program would benefit from the following four elements:

    • Set price collars—a price floor and price ceiling—to prevent allowance prices from ranging out of control. The floor would create an automatic adjustment mechanism that holds back allowances if carbon prices get too low (California’s current carbon program already does this, and it’s proven to be a key feature of its successes to date). The ceiling would have the opposite effect, creating an economic safety value that allows extra permits to be sold if carbon emissions prove to be too expensive for covered emitters. The price ceiling proposal has received some backlash, but 1) so far, across the world, emission reductions have proven to be cheaper than expected, so it’s unlikely that a reasonable ceiling will ever be reached, and 2) it would be negligent of state lawmakers to pass a bill that omits a strategy to protect its economic vitality.
    • Use auction revenue intelligently—split between a carbon dividend, infrastructure programs, and R&D efforts. California’s future carbon cap program—in whatever form it may take—is estimated to generate billions of dollars each year to 2030. These revenues have the opportunity to make an enormous impact in California’s economy and communities. Providing a carbon dividend to every California household is strongly progressive, creating net benefits for anyone making less than $80,000 a year, and neutral for those making $81,000-$200,000 a year. Infrastructure funds will drive much more near-term, tangible carbon, air quality, and livability benefits in disadvantaged communities than do the dividends. And R&D is a long-haul investment, driving down the cost of future low-carbon technologies and positioning California as a hub for future clean energy business endeavors.
    • Establish a clear strategy to help disadvantaged communities. California’s new carbon cap program must go even further to diminish the concentration of emissions in existing hotspots—which have historically been minority-dominated, low-income communities. A stipulation in the current cap-and-trade program requires 25 percent of funds to go toward projects benefiting disadvantaged communities, and 10 percent of projects to be located in disadvantaged communities (in reality, these figures are closer to 51 percent and 39 percent, respectively). In order to ensure that infrastructure projects in disadvantaged communities are well designed and ubiquitous, another Senate bill, SB 263, proposes the establishment of ten technical assistance centers to help these communities better access state funds.
    • Introduce some new constraints around offsets use, determined by auction prices. Offset schemes—in which companies buy remote carbon reductions when it is too costly to achieve them with their own facilities—are viewed by some as being at odds with efforts to improve air quality conditions in disadvantaged communities, since it gives the larger industrial sources the ability to locally emit CO2—and possibly attendant conventional pollutants—if they account for their emissions in reduction efforts elsewhere (often outside of California). Others view offsets as essential for extending the price signal to uncapped sectors like agriculture and forestry, and worry that changes will have destructive effects on existing program linkage with Quebec and planned linkage with Ontario. We are working to find a compromise position that would allow fewer offsets when allowance prices are low, and more if allowance prices rise, with backstop protections for local air quality in high pollution areas.

We have no doubt that California will continue to lead the world in climate action. Maintaining its carbon cap program—and improving upon certain elements of it—is a valuable cog in California’s climate policy machine.

Hal Harvey’s Insights and Updates offers monthly thoughts and analysis on current energy and climate topics. These newsletters are written by Energy Innovation’s CEO Hal Harvey. Sign up here to receive Insights and Updates straight to your inbox.