Cap and Trade is All Right: California and Quebec held an auction for allowances in mid-May. Allowances are an important commodity in a cap and trade system. Not only are they the predominant means for complying with an emissions cap, but auctions generate revenues that jurisdictions like California can use to pay for initiatives to lower emissions, particularly in disadvantaged communities. Unless you follow this market closely, you may not have heard about the results of the last auction; proving the old saying that no news is good news.
The last five auctions leading up to the latest one have been dismal, with California failing to sell most of the allowances it has offered. Such results have led many observers to proclaim this as proof that cap and trade is faulty and should be radically overhauled or scrapped. But a closer look reveals the two main culprits were the effectiveness of other carbon reduction programs and a legal cloud hanging over cap and trade. California’s other reduction measures have over-performed, reducing demand for allowances. Additionally, demand was further suppressed by a legal challenge.
With the economy growing and the state appeals court rejecting a lawsuit in relation to cap and trade, the last auction saw bidders come out in force. The results expressed strong sentiment around cap and trade with demand exceeding supply by 17 million allowances, and the auction clearing 10% above the program’s mandated floor price.
Although the last auction shows that certainty is the biggest factor in promoting a robust program, there are ominous signs on the horizon. Usually, when an auction posts strong results, future allowances offered at the same auction generally have stronger results. After all, current positive sentiment should translate into longer term optimism. This was regrettably not the case here. Only 22% of 2020 vintage allowances were purchased. The main culprit behind this result is Senate Bill 775, which would radically change how allowances are purchased and banked.
With legal uncertainty largely removed, cap and trade is finally working as intended. Let’s hope that policies intended to fix cap and trade don’t break it.