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05/30/2024 | Press release | Distributed by Public on 05/30/2024 07:23

Designing for Uncertainty: Amendments to California's Cap and Trade Market

Designing for Uncertainty: Amendments to California's Cap-and-Trade Market

The California Air Resources Board is considering reducing the number of greenhouse gas emissions allowances in California's cap-and-trade market, which could affect emissions, government revenue, allowance banking, and allowance prices.

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Date

May 30, 2024

Publication

Report

Reading time

2 minutes

Executive Summary

California is looking to extend its greenhouse gas cap-and-trade program forward in time and to make adjustments to the trajectory of the annual emissions cap. This report looks at the possible reforms suggested by the California Air Resources Board (CARB) using RFF's Haiku Emissions Market Model. We analyze the allowance price, emissions, revenue, and banking impacts of cap reduction options proposed by CARB given uncertainty about technology, the effectiveness of regulatory programs, investment strategies, economic activity, and banking behavior. We consider the three methods of implementing the "48 percent target cap" adjustment proposed in the Standard Regulatory Impact Assessment (SRIA) that intend to reduce cumulative allowance supply by 265 million tons by 2030:

  • Option A, nominal cap reduction;
  • Option B, partial nominal cap reduction and partial allowance price containment reserve (APCR) reduction; and
  • Option C, APCR reduction.

The nominal cap describes the introduction of new emissions allowances in a given year. The emissions outcome will differ from the cap because of the availability of banked allowances and offsets.

Additionally, we examine the full set of options included in CARB's October 5, 2023, workshop (the 40, 48, and 55 percent "budget" and "target" cap reductions) that would achieve cumulative reductions in allowance supply ranging from 115 - 390 million tons by 2030. We also consider the impact of additional potential program design features, including an emissions containment reserve (ECR); facility-specific caps, as suggested by the California Cap-and-Trade Environmental Justice Advisory Committee (EJAC); and modifications to free allocation.

Key Findings focusing on the Options A, B, and C for the 48 percent target scenario as identified in the SRIA:

  • Future emissions and allowance price pathways vary across scenarios. In sensitivity analysis investigating uncertain technology and energy demand, we find greater variation in allowance demand, emissions, and prices.
  • Removing allowances from the nominal emissions cap will lead to a higher allowance price. However, removing APCR allowances increases price variability.
  • Although Options A, B, and C appear to have the same cumulative allowance supply, the tighter nominal cap (A) yields lower emissions than B and C, especially if, as CARB's SRIA assumes and this report reaffirms, APCRs are never triggered.
  • Tightening the cap in any of the ways CARB proposes will increase allowance value above baseline even as allowances decrease, but the choice of where to remove allowances (from auctioned supply or freely allocated allowances, or from the APCR) will have distributional impacts by changing the share of allowance value accruing to the Greenhouse Gas Reduction Fund (GGRF) relative to that accruing to recipients of free allocation.
  • Assuming the program continues beyond 2030, tightening cumulative allowance supply leads to roughly 40 percent reduction in the size of the bank by 2030, after which the bank continues to be drawn down slowly through 2045. Increased cap stringency will raise the value of banked allowances.
  • Adding an ECR would support allowance prices and revenue in low-demand scenarios and reduce uncertainty about prices, revenues, and emissions.
  • Adding facility-specific caps would have very little impact on the market (less than a 2.8 percent increase in allowance prices) but could reduce uncertainty around health outcomes for disadvantaged communities.

Looking beyond the 48 percent target scenario options, we consider 40, 48, and 55 percent budget and target cap reductions. We find the qualitative impact of tighter caps on prices, missions, revenue, and banking remains consistent. However, the range of outcomes varies widely, with prices at the floor in the less stringent cases and rising to the price ceiling in the more stringent cases. An ECR, or facility-specific caps, can be added to any of these cap adjustments with the same effects as for the 48 percent target A, B, and C options.

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