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California’s carbon prices fell in its fourth cap-and-trade auction on news the state may increase the amount of free allocations it provides in 2014. But even though permit sales dropped 13% from May 2013’s record-setting auction, long-term indicators hint the state's emissions reduction market could wind up stronger than ever.

Air Quality

California Cap And Trade Comes To A Crossroads As Carbon Prices Fall

California’s carbon prices fell in its fourth cap-and-trade auction on news the state may increase the amount of free allocations it provides in 2014.

But even though permit sales dropped 13% from May 2013’s record-setting auction, long-term indicators hint the state’s emissions reduction market could wind up stronger than ever.

California’s cap-and-trade market recently held its fourth carbon allowance auction, with prices slipping below their expected level on news state regulators may increase the amount of free allocations they provide to polluters in 2014.

But even though permit sales to cover emissions trended downward for the first time in the system’s existence, dropping 12.7% from May 2013’s record-setting auction, three other long-term indicators hint California’s cap-and-trade market could be stronger than ever.

Regardless of how this auction’s tea leaves are read, one lesson looms large – California’s regulators have an important decision approaching and the outcome could decide if the world’s second-largest carbon market ultimately succeeds or fails. 

Cap And Trade Market Value Passes $1 Billion

First, the good news. All 13.8 million available carbon allowances for use in 2013 sold out at $12.22 per allocation, meaning California is still batting 1.000 in selling out all available current permits in each of its four auctions.

Compared to other markets like the European Union’s Emissions Trading System (ETS), the state has consistently showed strong demand for permits, garnering 1.62 qualified bids per available allowance in the most recent auction.

In addition, allowances sold nearly 20% higher than their “floor” reserve price of $10.71 and are still more than $2 higher than the system’s first auction in November 2012 when permits only cleared for $10.06 apiece.

Combine this auction’s $275 million payout with earlier auction revenue, and the overall market is now valued at more than $1 billion. “It’s like getting your driver’s license,” said Ashley Lawson of Thompson Reuters Point Carbon. “It’s a major milestone, but there could still be bumpy roads ahead.”

Demand Surging For Future Allocations

And by looking ahead to allocation demand for coming years, California could be in for an epically great road trip. August’s auction was the first one held where available allowances for future years also completely sold out.

9.5 million allowances for 2016 (essentially a way for polluters who think the market will still be viable with high allocation prices to hedge their bets) sold for $11.10 per allowance. 1.69 qualified bids were received for each available allowance, and the sales easily cleared the $10.71 floor reserve price with 96.3% of the future allocations were bought by program participants, not market speculators.

Compare these results to the previous best mark set this spring, when 7.5 million of 9.5 million available future allowances sold at the clearing price. Then add in the fact that over 7 million 2015 and 2016 allowances were purchased on secondary markets following the August futures permit sell-out, and it’s clear the market is taking the long-term prospects of California cap-and-trade seriously.


Could California Be Headed Toward A Dead End?

But even considering all these positive results, serious speed bumps could be just around the corner. Even though current year allowances sold out, prices in the fourth auction fell to their second-lowest level yet. The culprit, as in case of the EU’s ETS, is the threat of permit oversupply.

California is currently considering whether to provide 33% more free allowances starting in 2014 to companies like oil refiners that would face increased competition from out-of-state businesses that aren’t working to reduce their emissions. With the prospect of free permits in mind, bidders drove prices down.

“The market viewed the state’s plan as bearish and sold off,” said Lenny Hochschild of Evolution Markets to Bloomberg News. “Those companies that may receive free allocations would presumably have less buying to do.”

Governor Jerry Brown has also said he may use cap-and-trade revenue to help balance the state’s budget and regulators are weighing whether they’ll extend the system past 2020.

Cap And Trade Crossroads

So just months away from linking California’s system with Quebec and with potential long-term linkages to China and Australia hanging in the balance, cap and trade system regulators are at a crossroads. Do they maintain the system’s integrity and keep the engine of America’s best green economy humming, or water it down and risk running prices into a ditch like in Europe?

Either way, the stakes for the final three allowance sales of 2013 just got much higher.

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