Posted October 23, 2014
On Jan. 1, California is scheduled to include gasoline, diesel and propane in its three-year-old, first-in-the-nation program that requires companies to buy carbon permits to cover their emissions of greenhouse gases. Yet a new report warns that design flaws in the cap-and-trade program could negatively impact markets that serve consumers.
Authored by Jean-Philippe Brisson, a carbon markets expert with the Latham and Watkins law firm in New York, the report commissioned by the Western States Petroleum Association (WSPA) cautions that design flaws “can result – and have resulted – in catastrophic implications for environmental markets around the globe.” The report:
Take, for example, California’s own South Coast Air Quality Management District RECLAIM cap-and-trade program for oxides of nitrogen and sulfur during the California power crisis of 2000-2001. RECLAIM had initially been designed to include certain cost-containment mechanisms, but these were ultimately left out of the program. When demand for power soared, the market simply did not have enough RECLAIM credits to cover emissions, and costs spiked from less than $2,000 per ton to over $60,000 per ton. In the context of the California cap-and-trade program, this precedent would be the equivalent of cap-and-trade allowance prices spiking from their current average of $12 to $360.
The report identifies five design flaws in California’s cap-and-trade program that should be corrected to avoid problems, including spiraling prices for the permits or “allowances” companies must buy under the program:
Allowances – The program’s “holding limit” on the number of allowances that an entity may hold at a given time, to minimize the risk of market manipulation, is set below the projected emissions of a number of parties that are obligated under the law. The program also allows “speculators,” those who participate in the market to make a profit, to keep as many allowances as obligated parties.
Auctions – Infrequent allowance auctions, just four a year, mean that companies have relatively few chances to comply with the program. Brisson writes that more frequent auctions would result in “increased market liquidity and improved price discovery,” mitigating some of the holding limit’s negative effects.
Price Containment – The program’s containment measures don’t adequately safeguard against possible price spikes.
Enforcement – Brisson writes: “Problems with the allowance market — infrequent auctions, restrictive holding limits, and a lack of adequate cost containment mechanisms — are exacerbated by ARB’s (California Air Resources Board) draconian and potentially arbitrary enforcement practices.
Federal Policy – The state cap-and-trade program isn’t aligned with federal greenhouse gas policy, such as the Clean Power Plan issued this year.
The report warns that program design flaws might not surface immediately. But under market pressure they could undermine the program:
Market design flaws, including those identified in this paper, may lay dormant for a period of time when markets are not under stress, providing a false sense of security to industry and regulators. When a program comes under pressure because of unforeseen conditions or simply because the program becomes increasingly stringent over time, latent market design flaws can significantly derail an environmental program, undermining both industry’s and regulators’ investments to achieve environmental objectives.
Key points in Brisson’s conclusion:
The cap-and-trade program in California is often viewed as a success. In certain fundamental respects, however, the program remains untested, as covered entities have not yet faced a real compliance deadline. Additionally, the program is scheduled to more than double in size starting in 2015. These new and changing circumstances, which will put new pressures on the program, underscore the need for ARB to correct existing program design issues.
WSPA’s blog post on the issue, here.
ABOUT THE AUTHOR
Mark Green joined API after a career in newspaper journalism, including 16 years as national editorial writer for The Oklahoman in the paper’s Washington bureau. Mark also was a reporter, copy editor and sports editor. He earned his journalism degree from the University of Oklahoma and master’s in journalism and public affairs from American University. He and his wife Pamela live in Occoquan, Va., where they enjoy their four grandchildren.