In summary

Rather than pretend everything is fine, the Air Resources Board should commit to reform its cap-and-trade program to deliver more stable outcomes.

By Danny Cullenward, Special to CalMatters

Danny Cullenward is a lecturer at Stanford Law School and a member of the CalEPA Independent Emissions Market Advisory Committee, He wrote this commentary for CalMatters.

Revenues from California’s quarterly cap-and-trade auction collapsed this week for the second time in four years.

Results from the Air Resources Board’s May 2020 quarterly auction show that just 35% of the climate pollution allowances made available for purchase were sold, raising less than $25 million for the state’s Greenhouse Gas Reduction Fund. 

Successful auctions normally bring in between $600 million and $800 million per quarter to support a wide variety of air quality, climate and fire protection programs, but now – in the middle a massive budget crisis – those funds are gone. So how did a program touted as the leading approach to climate policy produce yet another crisis?

Simple: the program has too many allowances. Every year to date, the Air Resources Board has made more allowances available to market participants than there are climate emissions. That has led to a growing private “bank” of unused allowances that depress market prices and risk revenue shortfalls at quarterly auctions. 

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None of this is new. California’s comprehensive climate law, AB 32, authorized cap-and-trade only through the end of 2020. When it became clear that polluters had so many surplus allowances that they could coast through 2020 without buying more, demand cratered at the May 2016 auction and revenues collapsed.

The auction freefall resolved a year later when new legislation, AB 398, extended the program to 2030. Because it needed a two-thirds vote, however, the bill required major concessions to the fossil fuel industry: it rolled back local air districts’ ability to regulate greenhouse gas emissions and prevented the Air Resources Board from issuing new rules for the oil and gas industry. 

The worst giveaway in AB 398 was the Air Resources Board’s political agreement to keep extra pollution allowances in circulation. Although the bill required the board to “evaluate and address” the problem of excess allowances, the board put out faulty analysis that independent experts and market watchdogs widely criticized. There was no serious effort to re-balance the market, despite the board designating it the single biggest driver in its climate policy portfolio. 

Defenders of the AB 398 compromise rightly point out that any two-thirds vote would require concessions and that a companion bill, AB 617, would help deliver much-needed investments to improve California’s air quality. But funding for those investments – along with a wide array of programs to support electric vehicles, clean trucks and climate-resilient communities – relies on revenue from functioning cap-and-trade auctions. 

Many will be tempted to blame a bad auction outcome on the economic fallout from COVID-19, rather than poor market design. But the numbers don’t add up. A recent study estimated that even if the U.S. maintains stay-at-home orders through July as well as gathering restrictions through December, emissions would fall by only 11.5%. Normalized to California’s cap-and-trade emissions, that reduction is equal to about 37 million allowances. For comparison, the market surplus was already 227 million at the end of 2018 – the most recent year for which data are available – and that number is likely approaching 300 million now. 

There’s no serious argument that the pandemic is responsible for the auction shortfall. Faulty market design is the real culprit. Experts have been warning about this problem for years, and even before the pandemic it was clear that the program has too many allowances – possibly all the way through 2030

Rather than deflect blame or pretend everything is fine, the Air Resources Board should commit to reform its program to deliver more stable outcomes. Policymakers have no shortage of options – both the European Union and East Coast states’ Regional Greenhouse Gas Initiative programs show cap-and-trade programs can deliver predictable results, and the board’s own advisory committee (on which I serve) has offered a range of options the board could consider in a rulemaking.  

Long-term market prices show we’re at risk of another bad auction in August. Whether you care about climate, air quality, water or wildfire, holding our breath isn’t an option. 


Danny Cullenward is a lecturer at Stanford Law School and a member of the CalEPA Independent Emissions Market Advisory Committee, He wrote this commentary for CalMatters.

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