A Major Cap and Trade programme provides polluters with a flexible transition path and provides funding for public sustainable development projects

Summary

California decided to fulfill a large part of their GHG emission reduction pledges through a Cap and Trade programme forcing large polluters to pay for part of their emission allowances through market-based mechanisms. The programme provides large GHG polluters a flexible, gradual, and self-determined pathway for transition towards low-carbon solutions, and at the same time provides the California state with important economic resources to promote climate friendly and sustainable initiatives. See also the EU ETS story.

Sector	Carbon Pricing & Trade
Sub-sector/ Technology	Cap and Trade market-based trading system
Climate Action	Mitigation
Elements	Large-scale carbon market based on Cap and Trade quantity instrument. State-wide cap on emissions shrinking over time and mandatory participation of large industries. Allocation of free emission allowances and auctioning and trade. Revenue spend on sustainable initiatives.
Applicability	Inter-state unions, states, provinces, regions, cities.
Barriers	Political will, careful design, solid monitoring, verification and reporting system, avoiding allowance surplus, hoarding, and leakage.

Full Story

The Californian cap and trade programme began in 2013 and covers in early 2018 around 600 large industrial plants, power plants, and fuel distributors from a total of 350 companies. Together, they are responsible for almost 80% of GHG emissions in California. It is the 4th largest cap and trade scheme worldwide and is the major instrument for achieving California’s planned emissions reduction to the 1990 level by 2020, to 40% below the 1990 level by 2030, and to 80% below 1990 level by 2050.

The programme is in many ways similar to the European Union Emission Trading Systems (EU ETS) and the story here on this site, provides more in-depth discussion on the “cap and trade” principle. It is included here as a success story as it provides a good example of how a carbon pricing scheme can also be implemented in a setting much smaller and less complex than the EU. As of end 2017, there are also active cap and trade programmes in Canada (Ontario, Québec), US (Regional Greenhouse Gas Initiative RGGI), Switzerland, China (Beijing, Shanghai, Tianjin, Chongqing, Hubei, Fujian, Shenzhen, Guangdong), Korea and Japan (Tokyo, Saltama), New Zealand, and several others are under preparation (Mexico, Brazil, Ukraine, Turkey, Russia, China (national), Japan (national), Taiwan, Vietnam, and Thailand (see this ICAP report for more).

The California cap and trade is linked to the Canadian Québec and Ontario cap and trade programmes so that allowances can be auctioned jointly and companies can trade allowances across programmes.

As the EU ETS, the California version also has a general cap on emission, is obligatory for large industries (emitting more than 25.000 tCO2e/year), distributes free allowances on a yearly basis to ease transition and prevent leakage (polluters moving to other regions with less stringent emission policies), and has established a supply-and-demand based market where a fixed amount of allowances are put on auction 4 times a year so that companies can buy extra allowances as needed. In 2018, 358,3 million allowances (each representing 1 tCO2e) will be put on auction. Allowances bought on the auctions don’t expire and can be stocked for later use or sold, within an upper limit determined as a function of the company’s allowance budget. Free allowances are determined based on an assessment of leakage risk and transition assistance need for each type of industry. For example, in 2014, the 8 companies participating from the dairy industry received 369.863 allowances in total, out of altogether 54.394.368 free allowances distributed that year (California Air Resources Board).  A company also has the option of off-setting up to 8% of its total compliance obligation by paying to registered greenhouse gas reducing projects in the US. Participating companies must report their emissions annually. It should be noted that a cap and trade carbon pricing scheme like the one described here, is not quite the same as a carbon tax. See the textbox in the EU ETS story for a short discussion of this issue.

As with the EU ETS, the cap is being reduced every year (3% annually until 2020), but a significant difference from EU ETS is that a minimum price for allowances is fixed (at $10/allowance in 2012), and which increases by 5% over inflation every year. In this way, the major problem of the EU ETS with falling prices is avoided. The California model has, however, suffered from the same problem of oversupply of allowances as the EU ETS due to slow economic activity in some years, and a faster and more efficient than expected transition to low-carbon measures. The oversupply was expressed in low uptake of the allowances auctioned in 2016-17, but since mid-2017 all allowanced on auction has been sold. The low sales figures were also likely to be related to political uncertainty about the future of the programme at the time.

The auction price of an allowance was at the November 2017 auction $14,76 (almost 12€) per allowance and as such pretty close to the EU ETS allowance price level of around 9€/EUA (early 2018). The auction works with a single round, sealed bid, and uniform price. As is also being implemented in early 2019 in the EU ETS, an Allowance Price Containment Reserve (APCR) has been established which sets aside a small percentage of allowances. Allowances in the APCR can be auctioned if the market price reaches a defined upper level (3 price levels $40, $45, and $50 in 2013 increasing 5% over inflation annually).

This sale generates a significant income for the California state ($6,5bn in 2017) who is obliged by law to spend it on environmental purposes, since 2017 specified as:

• Reducing air toxic and critical air pollutants
• Promoting low- and zero-carbon transportation
• Sustainable agriculture
• Healthy forests and urban greening
• Reducing short-lived climate pollutants
• Promoting climate adaptation and resilience
• Supporting climate and clean energy research

This puts California in a good position to initialise major and expensive transitions towards a low-carbon and climate change resilient economy, and as such promotes its brand as being a open-minded, progressive, and innovative corner of the world. The programme has in 2017 been approved by the legislature to continue through 2030.

Critique of the cap and trade programme

Besides being perceived by some groups as a badly disguised additional company tax, concerns have been raised about the risk of companies hoarding allowances while the prices are still relatively low, and using them later to avoid more costly mitigation activities. However, such a practise may quickly prove to be more expensive than to invest in emission reducing measures. The programme has also been criticised by some environmental groups for being too generous with free allowances and as such not bringing about much real improvement. The free allowances were deemed necessary to prevent leakage to other states. Other, more moderate environmentalists, support the initiative as a reasonable compromise between proactive climate change action and short-term economic costs. The inherent flexibility is popular with many affected industries who prefer flexible, gradual, and predictable limitations that they themselves can find ways to adapt to, rather than being ordered how to cut down emissions immediately.

While not being the most drastic or efficient policy initiative possible to reduce CO2 emissions, the California Cap and Trade scheme nevertheless manages not only to put a price on carbon and force polluters to pay in a flexible and predictable way that encourages self-initiated mitigation measures, but also extracts, from the polluting companies, a major source of financing for climate change mitigation and adaptation activities. It is a good example of a political compromise that paves the way for better solutions. For this reason, the scheme is included here as an example of a sustainable success story that may inspire other states or regions to embark on a similar path.

For more information:

California Air Resources Board who manages the programme

A detailed article on the programme from C2ES

A 2018 Los Angeles Times article on the potential hoarding issue

An 2017 article questioning the effect of the programme from East Bay Express

A stepwise explanation of the programme from the Environmental Defence Fund

Graphic: Wesley Bedrosian / Berkeley Political Review

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