California Fights to Save Market Plan to Cut Carbon Emissions

Most carbon credits go unsold at auction, lowering the price of CO2.

Manhattan Beach, Calif., with Chevron’s El Segundo refinery in the background.

Photographer: Patrick T. Fallon/Bloomberg

In 2012, when California began its cap-and-trade program, it was hailed as a model for the rest of the world. While Congress had failed to pass a similar system two years earlier, California was going to demonstrate how a large, industrialized economy could cut greenhouse gases while also raising billions of dollars for clean energy projects. The idea was fairly straightforward: By forcing oil refiners, power plants, and factories to buy permits to emit greenhouse gases and then gradually shrinking the supply of those permits, the state could steadily raise the cost of carbon dioxide pollution and compel businesses to lower their carbon footprint.

State officials initially set a minimum price of $10 per metric ton of CO2. The California Air Resources Board, which runs the auctions where companies bid on carbon permits, projected that prices could eventually reach $50 a ton. Instead, prices have traded closer to $12 per ton, leading to far less revenue than anticipated and raising questions about what, if any, effect the program has had in lowering the state’s carbon emissions.

Chart: California's Cooling Carbon Market

In the last fiscal year, ended on June 30, California’s cap-and-trade revenue fell about $600 million short of the $2.4 billion that Democratic Governor Jerry Brown had forecast. This year the shortfall looks to be much larger. The latest cap-and-trade auction, held on Aug. 16, fetched just $8 million for the state, with about two-thirds of the emission permits going unsold. That follows a May auction where only 10 percent of the permits were sold and only $10 million raised. Brown had hoped cap-and-trade revenue would hit $2 billion this fiscal year, money he was counting on to help fund his pet green projects, specifically a $64 billion high-speed rail system.

One reason companies have stopped buying carbon permits is that they may soon become worthless. The California Chamber of Commerce has challenged the constitutionality of the auctions, arguing in a lawsuit that cap and trade amounts to an illegal tax. An appeals court is expected to rule sometime in 2017. In the meantime companies are hedging their bets and buying futures contracts, which allow them to lock in a price to purchase carbon permits at a later date, while only paying about 10 percent of the cost upfront. “Why would anybody bid into the auction right now and pay hard cash?” asks Alex Rau, a principal at the carbon-trading advisory group Climate Wedge.

Even if cap and trade in California survives the legal challenge, its future is unclear. There’s a debate over whether the state has the authority to operate the program beyond 2020. Despite his best efforts, Brown hasn’t persuaded the legislature to renew it. “The cap-and-trade program has been a failure,” says California State Senator Jim Nielsen, a Republican. “It really is a poor way to fund programs. It’s just a big way to get money for government.” Brown is considering whether to put a cap-and-trade measure on the ballot in 2018 and let voters decide its fate.

Lawmakers have tightened California’s carbon emissions standards, passing a bill on Aug. 24 that requires a cut to 40 percent below 1990 levels by 2030. The previous target was to reach 1990 levels by 2020. Those stiffer emissions rules could breathe new life into cap and trade if it survives past 2020, says Bloomberg Intelligence analyst Rob Barnett. “I think it probably could increase demand for those permits, but that’s over the long term,” he says.

California’s program is one of a host of climate initiatives the state put in place over the past decade, including mandates that require refiners to cut the carbon intensity of their fuel and utilities to buy more solar and wind power. Those other initiatives may also have undercut the effectiveness of cap and trade.

Instead of spending money on carbon permits, some of the state’s biggest emitters are focusing on complying with other mandates. Sacramento’s municipal utility, for example, is buying more renewable energy and investing in energy conservation so it can comply with the Renewable Portfolio Standard that Brown signed into law last year requiring utilities to get half their electricity from renewables by 2030. One of the state’s largest utilities, Southern California Edison, is doing the same thing and says the RPS will drive future emissions cuts and ultimately reduce its need to buy carbon permits at auction.

Alex Jackson, legal director of the Natural Resources Defense Council’s California Climate Project, concedes that cap-and-trade revenue is lower than expected. “But let’s not lose sight of the fact that the program is about reducing emissions, not raising revenue,” he says. “If emissions are staying below the cap, then it is working as designed.” Greenhouse gas emissions from California’s power sector are already 20 percent below their 1990 levels, but the state’s overall emissions fell by just 1.5 percent from 2012 to 2014.

California’s cap-and-trade program is hardly the only one struggling with low prices and weak demand. The price of permits in the world’s largest carbon market, covering the European Union, is down 51 percent this year. It’s not that carbon markets are inherently flawed. It’s that they’re not getting a fair chance, says Louis Redshaw, who runs an emissions-trading company, Redshaw Advisors in London. Instead of establishing strict emission ceilings and allowing carbon markets to work, politicians set lax limits and buttress cap and trade with renewable energy subsidies and other environmental measures. “In theory, carbon markets are the perfect answer,” says Redshaw. “The problem is the implementation by the politicians.”

The bottom line: California’s cap-and-trade program is being challenged in court, leading to a lack of demand for the carbon permits it auctions.

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