Tuesday, November 13, 2012

The California Cap passes its first test, barely

News coverage of the California cap-and-trade auction results diverged fairly sharply into whether it went well or had problems. Put me in the half-full category that it went well enough, but just barely.

The Air Board announced a sale price of $10.09 a ton, just barely above the reserve price of $10 and lower than the expected $11-15. Digging around a little doesn’t make the auction mechanics very clear – many bids were far higher than this. The reports imply that everyone paid $10.09, which would mean some type of Dutch auction setup.  (UPDATE:  confirmed it's a Dutch auction arrangement where everyone pays the same price.  Good explainer of the whole auction by Reed Smith is here.  The reserve price is a minimum that keeps the market from collapsing - if there's not enough demand for all the allowances to keep the price above that minimum, the effect of the reserve price is to reduce the supply of allowances being sold.)

I doubt it’s coincidental that the price is just above the reserve – that suggests the ‘market’ expectation is that it won’t be too hard to for California emitters to meet the cap, something that’s uncomfortably close to the problem of the European market that has too high a cap and a collapsed market. OTOH, emitters didn’t have to buy any allowances if they thought they could meet the cap on their own, so their expectation is that the Air Board will keep the California market from collapsing. I put the word ‘market’ in scare quotes because a sealed-bid auction barely qualifies – we’ll get a better idea of market price when trades start happening on a regular basis.

So it worked. A somewhat higher price would suggest a better-functioning market and more incentive for carbon reductions, although a much higher price would provide ammunition to critics’ ridiculous claim that the cap harms California’s economy.

Critics of the system include the state-level California Chamber of Commerce, treading a perilous line against California green energy businesses. The state Chamber filed a lawsuit against the auction on the day before it started. I expect they’ll take some flak for waiting so long to file, but I’ll have to save a look at their legal interests for another day.

The economic interest here is that free carbon allowances actually benefit emitters – the allowances have economic value that can be resold, and California is issuing 90% of the first emissions for free (that percent will decline over time). A 90% benefit isn’t good enough for the Chamber though – they want it all for free, forever. At least they claim they’re not trying to destroy the cap market – they just want free allowances – and that distinguishes them from the evil that is the US Chamber.  This isn't a trivial distinction from the US Chamber, by the way, and shows some-if-inadequate level of responsiveness to in-state business politics.

Even a 100% auction in my opinion would benefit California green businesses and help cement the leadership this state has on the green economy. The state Chamber is being short-sighted on a number of levels, especially if their effort to change the cap market ends up destroying it. This might be a good place for the state legislature to step in and backstop the Air Board’s decision, something that could be possible now that the Democrats have two-thirds majority in both houses, a requirement under the tax-revenue stupidity of California's Proposition 13.

An aside - there is a dividend component to the cap.  In a somewhat complicated procedure, utilities get all their allowances for free but are required to sell some and split the proceeds so 15% goes to reducing greenhouse emissions and the remainder as a credit applied to utility bills.  Seeing that credit will help counter the inevitable claim that the money is just going to solar power fat cats.