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California ready for cap-and-trade scheme

Uncertainty remains as state launches world's second-largest emissions trading scheme

California has launched the centrepiece of its of its fight against climate change, successfully auctioning more than 20 million carbon-emission permits on 19 November and laying the foundation for the state’s cap-and-trade scheme, the second-largest emissions trading scheme in the world.

Although successfully off the ground after years of planning, the market still faces major challenges.

The settled price for the 2013 permits was $10.09 per tonne of carbon dioxide (CO2), just 9 cents more than the $10 per tonne floor price set before the auction. California carbon allowances (CCAs) for 2013 were trading in futures markets ahead of the auction at around $12 per tonne, and market participants expected the price to be closer to that level. CCAs were trading for as high as $20/t earlier in 2012.

Although the price was lower than expected, and probably too low to encourage a major switch away from carbon-intensive power generation, demand for the permits appeared strong. The round was oversubscribed, attracting three times more bids than the 21m permits put up for auction. Some had feared ahead of the auction that some permits would go unsold.

That fear was fuelled by a slew of legal threats against the scheme, which have cast some uncertainty over the future of the market.

The California Chamber of Commerce (CalChamber) filed a suit against the state over the scheme in the days ahead of the auction. CalChamber says it is not seeking to overturn the whole of the cap-and-trade programme, which was approved by the state’s voters when they passed ballot measure AB 32 in 2006. But it is challenging the state’s authority to use the auction of permits to raise revenues for itself. It calls the funds raised through the auction an “illegal tax”.

CalChamber says that companies forced to buy the permits will pass those costs on, hurting consumers and making the state less economically competitive. It argues fees should only be charged to cover the administrative costs of setting up and running the programme, and 100% of the permits given away for free. The state gave around 90% of the programme’s permits away for free and auctioned the rest.

The auction of the remaining permits raised $233m for the state. Most of that will go back to the state’s utility companies, which are supposed to issue consumers “climate dividends” to keep their bills from rising as a result of the cap-and-trade scheme.

The programme faces a number of other potential legal challenges. Out-of-state power providers have threatened to sue over the programme, saying that it violates the Commerce Clause of the US constitution, which prohibits states from regulating interstate commerce. Some environmental groups have also threatened to sue because they say that the programme’s carbon offsets are too generous, providing offsets for measures that would be taken anyway.

Most analysts, though, say that the cap-and-trade scheme is likely to survive the legal challenges intact, even if some provisions of the scheme have to be tweaked. The strong demand for permits, and continued strong public backing for the programme, also indicate that it is on firm footing.

The state hailed the launch of the programme. “The auction was a success and an important milestone for California as a leader in the global cleantech market. By putting a price on carbon, we can break our unhealthy dependence on fossil fuels,” Mary Nichols, the head of California’s Air Resources Board, the regulatory body charged with overseeing the newly created CO2 trading market, said.

Bidders included oil majors ExxonMobil, BP, Chevron and Shell, refiners Valero and Phillips 66, the downstream spin-off of ConocoPhillips, as well as major electricity providers, miners, manufacturers and oil and gas producers that will have to comply with the emissions cap. In total, around 350 companies operating 600 facilities are covered by the programme.

California set the 2013 emissions cap at around 2% less than that the expected 2012 level. The emissions cap will be lowered by a further 2% in 2014 and 3% a year from 2015 to 2020. The aim of the programme is to cut California’s carbon emissions 15% by 2020. California’s carbon emissions currently constitute around 3% of global emissions.

The state has said that it designed the system to be integrated with other regional markets. In August this year, Australia and the EU agreed to link their emission-trading markets starting in 2015, potentially setting the stage for further integration of regional carbon markets.

The two have also discussed linking their carbon markets with proposed trading systems in South Korea, China and New Zealand. The World Bank says that at least 29 such emissions-trading markets have been launched or are under consideration.

Regional market integration could, proponents argue, see the emergence of a patchwork global emissions trading system. Global efforts over the past two decades to mitigate carbon emissions through international fora such as the UN have proved ineffectual and there is little likelihood of progress towards a binding agreement on  CO2 emissions this decade.

Cap-and-trade markets around the world, though, will have to learn from the failings of the EU market, which is the world’s largest carbon market and has served as a model for others. Carbon prices in the European trading scheme have traded at well below €10 ($12.79) per tonne this year, which has provided little economic incentive to move towards low-carbon technologies. The market has been plagued by an oversupply of permits and the continent’s sluggish economy.

California regulators also said that it hopes the programme will provide a model for a national cap-and-trade scheme. An ambitious national cap-and-trade proposal was put forward in president Obama’s first term, but a grand bargain that sought to bridge the gap between liberals and conservatives in congress as well as industry and environmentalists collapsed spectacularly in 2010. The experience appears to have stung president Obama, who has not put climate change legislation near the top of his second-term agenda.

Moreover, many of those in Washington pushing for action on climate change have turned their attention away from cap-and-trade to a direct carbon tax. And they have found some unlikely allies in that debate, such as ExxonMobil, which has long pushed back against any effort to put a price on carbon. Proponents of a carbon tax argue that it is more straightforward than cap-and-trade, provides companies with more predictability over the future price of carbon and would be a more effective policymaking tool for governments. Still, any proposal would have to be passed by a Congress that has shown little interest in taking on the issue.

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