California ‘Freebies’ Drive Carbon to 2013 Low: Energy Markets

Carbon prices in California have slumped to the lowest level this year as the state weighs increasing the number of free permits offered to polluters in an effort to kick-start the fledgling market.

Allowances for December delivery, which can be used by companies from BP Plc to Chevron Corp. to cover emissions as early as this year, dropped to $13.25 a metric ton, the lowest since Dec. 10, according to data compiled by CME Group Inc. Permits auctioned Aug. 16 sold for $12.22 each, the lowest price since November and more than a dollar below analysts’ forecasts, according to results posted on the state’s website today.

California, the world’s 10th-largest economy, said July 18 that it will consider increasing by one-third the number of free allowances issued to refiners, metals producers and other companies facing higher costs and even job losses as they seek to comply with state regulation designed to cut emissions 15 percent by 2020. California’s program began in 2012, creating the world’s second-largest carbon market.

“The market viewed the state’s plan as bearish and sold off,” Lenny Hochschild, head of global carbon trading for broker Evolution Markets in White Plains, New York, said by telephone. “Those companies that may receive free allocations would presumably have less buying to do than they otherwise would have.”

Higher Prices

The auction, the fourth since California’s program began, had initially been expected to attract the highest prices so far because of increased demand for emissions-intensive power generated by natural gas after the closing of the state’s largest nuclear plant. Chevron also increased processing rates at the Richmond refinery, Northern California’s largest polluter, and a summer heat wave was expected to bring more power plants online.

Bloomberg New Energy Finance forecast on July 31 that the allowances would instead sell for about $13.25 a ton. BNEF cut its forecast clearing price from $14.12 a ton projected in May. Similar efforts to ease the burden of carbon programs in Europe and the U.S. Northeast contributed to a flood of allowances and record-low futures.

Futures for California permits to be delivered in December have declined 12 percent this year. The spread between California allowances and those traded as part of the world’s largest carbon market run by the European Union shrank 1.3 percent today to the narrowest since February.

Drifting Lower

California carbon prices could “drift lower” even after the decline in last month’s sell-off, Anthony D’Agostino, director of emissions markets at RBC Capital Markets in New York, said by e-mail Aug. 19.

Under California’s “cap-and-trade” system, the state Air Resources Board issues a capped number of allowances through a combination of free allocations and quarterly auctions. Companies must obtain enough permits to cover their emissions as the pool gradually shrinks through 2020. Those with more than they need can trade the excess.

The air board received 1.62 bids for every allowance offered at the Aug. 16 auction, the lowest demand in three sales.

Breweries and food manufacturers are among the companies that would receive more permits for free should the state air board adopt amendments recommended by its staff last month. Natural gas suppliers would also be entitled to a share.

While the board will have more research done next year to determine how many allowances to give away, companies have said they need certainty now on how many they’ll get, Steve Cliff, branch chief of the agency’s cap-and-trade program, said during a workshop on the proposed changes July 18.

More Help

“We were sympathetic to that argument and put forth this proposal to include additional transition assistance,” Cliff said. “We don’t have specific data. It’s really an argument against various outcomes.”

Groups including the Environmental Defense Fund have blasted the changes, warning that they will only generate more profits for the state’s largest polluters.

Refineries “don’t need a massive handout to do what’s right,” Timothy O’Connor, EDF’s California climate and energy initiative director in San Francisco, said to the air board last month. “They’re posting record profits in the billions while also charging record prices for their products and making record investments in the facilities in California. This just doesn’t point to an industry in need of another freebie.”

‘Jobs Leakage’

Extra permits will help refiners cut their trade exposure, minimize “jobs leakage” and control the costs of the state’s environmental regulation, the Sacramento-based Western States Petroleum Association, an industry group representing fuel suppliers including BP, Chevron and Exxon Mobil Corp., said in an Aug. 2 letter to the air board.

An overallocation of allowances and an economic slowdown created a glut of carbon permits in the European Union’s emissions system, causing prices to slide to a record low in April. Futures for December were unchanged today at 4.36 euros ($5.85) a ton on ICE Futures Europe in London at 10:23 a.m.

Permits traded as part of the Regional Greenhouse Gas Initiative, a U.S. Northeast cap-and-trade program, were selling at the lowest price allowed before a proposal was released in February to eliminate 45 percent of allowances.

Ahead of California’s recommendations, carbon futures had been trading above $14 a ton for five straight months. The market’s failure to break through the $16-a-ton level may have contributed to the recent decline, Hochschild said.

“You had all of this bullish news, but the price still failed to break out on the upside of $14.50 to $14.60,” he said. “It got people thinking, ‘Well, if it’s not going to break out to the upside after being range-bound for so long with all this bullish news, then what is going to happen?’”

Smaller Market

The increase in free allowances is set to shrink California’s carbon market and cut the size of auctions by 25 percent beginning in 2015, William Nelson, a Bloomberg New Energy Finance analyst in New York, said by telephone Aug. 13.

Long-term and medium-term models “point to a bearish 12 months ahead,” with the allowance market oversupplied by 10 percent, Nelson and Colleen Regan, another Bloomberg New Energy Finance analyst in New York, said in a July 31 research note. Allowances could “ride the floor,” the minimum price set by the state, without shortages through the decade, they said.

With its proposed changes, the air board is sending a message that “we’re not going to let prices get out of hand,” Jon Costantino, executive director of the Association of Carbon Market Participants, said by telephone Aug. 13 from Sacramento.

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