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Global Risk Insights

Global Risk Insights

GlobalRiskInsights.com provides the web’s best political risk analysis for businesses and investors. Our contributors are some of the brightest minds in economics, politics, finance, and…

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California Pioneering Market-Based Climate Change Solutions

California is hardly the place that comes to mind when one thinks of effective political leadership. Most would probably label Sacramento as a more deserving home to budgetary gridlock and massive debt. But in terms of tackling climate change through market-based mechanisms, California has set a compelling example for the rest of the world.

California’s one-year-old cap-and-trade program is the largest of its kind in the US and the second largest in the world. It requires freely tradable allowances for certain businesses that annually emit more than 25,000 metric tons of carbon dioxide equivalent (CO2e). In fact, the California program has already been linked to that of Quebec, increasing market liquidity as well as opportunities for carbon offset projects.

Under the pioneering 2006 California Global Warming Solutions Act, otherwise known as AB 32, emissions of greenhouse gases (GHG) in the eighth-largest economy in the world are intended to decrease to 1990 levels by 2020, and to 80 percent below 1990 levels by 2050.

One of the primary methods of achieving such lofty targets is cap-and-trade, with free credits doled out to large utilities and industrial facilities for the first 90 percent of their emissions — a percentage set to decline over time. The “excess” emissions over that year’s cap must usually be purchased from other private sector participants who emitted below their targets and thus possess leftover allowances.

The cap on GHG emissions also gradually reduces, with a 2 percent drop per year until 2015 and 3 percent annual reductions afterwards.

While a far cry from the EU’s massive Emissions Trading Scheme (ETS), which commands more than 90 percent of the global carbon credit market by value, the Golden State’s cap-and-trade program has learned a number of lessons from its European counterpart. For one, the amount of “hot air,” or excess carbon allowances allocated, is much lower. There are also stricter limits on both the amount of total allowances given away or auctioned and the annual fall in the emissions cap.

Sacramento’s cap-and-trade arrangement is also more expansive in scope. While the ETS covers roughly 45 percent of the EU’s GHG emissions, that of California will soon embrace 85 percent once the current rules are tightened next year to apply to distributors of transportation fuel and natural gas.

Additionally, what is widely perceived in the ETS to be a profusion of cheap carbon offsets — approved (and tradable) reductions in GHG emissions made at a separate location — has been addressed. Only 8 percent of a business’s compliance obligation can be essentially outsourced by purchasing carbon offsets, meaning that the majority of emissions reduction in California will occur “at the source.” This will also keep the carbon price from depressing too much due to an overabundance of approved offset projects.

Related Article: Obama’s On A Winning Streak In Drive To Curb Air Pollution

Carbon price depression has especially plagued the ETS. Up to half of EU-wide GHG emissions reduction can be made by purchasing offsets. While this allows more flexibility for European businesses, the net result has been a glut of carbon offsets, depressing the price of an EU carbon credit to, recently, $7.23 per ton (of CO2e). To put this in perspective, ETS credits peaked at $43.88 (€32) per ton eight years ago.

In the California market, however, the price sits at $11.85 per ton.

Although not purely market-based — given its mandated, slightly variable $11.34 per ton price floor for CO2e — California’s cap-and-trade program suffers from the same issues that result from choosing a “quantity instrument” over a flat carbon tax. And notwithstanding its stringent bound on carbon offset use, such mechanisms are still decried by many environmental groups for simply shifting responsibilities and often being awarded to projects that are merely business-as-usual.

More bad news has come from reports that a number of energy-importing bodies within California may simply be complying by “exporting” GHG emissions to other states.

Unsurprisingly, AB 32 has been swamped by a litany of high-profile lawsuits from both the left and right, including a failed challenge from environmentalists attacking the standards of offset approval and a recent case filed by the California Chamber of Commerce claiming that the statute amounts to an illegal tax.

Nevertheless, what may ultimately convince governments around the world to follow suit is the sheer amount of revenue that can be gleaned from a cap-and-trade program.

Thus far, Sacramento has generated $1.5 billion in revenue from a total of six auctions of carbon allowances. This number is guaranteed to swell in the coming years as more and more large-scale emitters are covered by AB 32.

Indeed, the state’s legislative analyst predicts that California will bring in between $12 and $45 billion by 2020 from carbon credit proceeds alone. The timing of this fortuitous announcement may have been more than a coincidence. Sacramento’s plans to issue bonds for Governor Jerry Brown’s high-speed rail legacy project were recently put in flux by state courts, and proceeds from cap-and-trade are now being sought as a convenient fix.

As other states and countries may soon realize, fighting climate change can have its fiscal benefits as well.

By Kevin Amirehsani




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