Testing Out Cap-and-Trade in California

http://legalplanet.files.wordpress.com/2012/04/fig-3-advance-allowances.jpgYou may have heard: California recently held its first auction for carbon dioxide emissions credits. The auction was orchestrated by the California Air Resources Board (CARB) as part of the state’s efforts to curb CO2 emissions and represents the second largest carbon exchange in the world, behind only the European Union.

The auctioning of these “pollution permits,” as they are often referred to, is part of a cap-and-trade program mandated by California’s 2006 regulations on global warming. Essentially, CARB sets limits (caps) on the level of emissions a company can produce, and companies must either adjust their technology so that emissions remain within the mandated limits or purchase “allowances” to emit excess pollution. Allowances can be purchased when they are initially offered at auction or from companies in the marketplace with a surplus of permits (which is where the trading comes in). CARB will reduce the emissions caps each year. By doing so, companies are forced to adopt improved technology because, eventually, the decreased caps will cause demand for permits to rise to the point where the purchase price of needed permits is more costly than installing new technology. While this method is considered “technology forcing,” its benefit is that companies are free to implement new technology incrementally and to plan for new emissions requirements over the course of many years when drawing up annual budgets.

In this auction, CARB sold 23.1 million permits at a price of $10.09, with each permit allowing the emission of one ton of CO2. To me, this seems like a very small price to pay for emitting an entire TON of CO2; after all, the average American household produces 24.1 tons of CO2 each year (12.4 tons from household uses and 11.7 tons from automobile use). Even in a mandated zero-CO2 emissions world, each American household would pay just $243.17 per year to go about their lives as usual with no changes in their energy consumption. But, of course, large companies produce emissions at a much higher level. In fact, the Energy Information Administration (EIA) estimates that U.S. manufacturers emitted over 1.4 billion tons of CO2 in 2002. Obviously, offsetting corporate emissions will be exponentially more expensive. The real question is, will the cost of purchasing these pollution permits actually deter the emission of CO2?

More than 300 companies participated in the auction, representing industries including utilities providers, petroleum refiners, and food processing companies. If all companies purchased an equal number of permits (highly unlikely, but useful for this mental exercise), each would have paid $776,930 for permits. While corporate budgets are quite large, three-quarters of a million dollars is still a substantial amount of money and will surely force the companies’ leaders to consider whether implementing new technology will be less expensive over the long run.

Regulated companies purchased 97% of all permits, with only 3% being purchased by financial traders.  Even though CARB received triple the number of bids than available permits, final prices remained very close to the minimum bid of $10. To me, this indicates that regulatory compliance was the major motivating factor in this auction, rather than speculation. Fears that market prices for CO2 would skyrocket are thus far unwarranted.

While to many people this program seems like a very practical and reasoned approach to incrementally reducing industrial CO2 emissions, cap-and-trade certainly has its opponents. Unsurprisingly, many regulated industries are opposed to the program, and the California Chamber of Commerce has filed a lawsuit arguing that CARB is acting beyond its authority by implementing a tax of sorts (I have no doubt this will be hotly debated, as some are not convinced that this auction represents a tax. For a quick overview of the lawsuit, see this post by environmental law blog, Legal Planet). It will be very interesting to see how this lawsuit turns out, as it could impact the ability of other states to implement similar programs.

As for me, I am sure there are kinks to be worked out of the cap-and-trade system, but I do admire California’s commitment to reducing its greenhouse gas emissions and applaud their substantial efforts to make that commitment a reality. What about you? Do you support cap-and-trade?

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