Going Once, Going Twice…California Auctions First Carbon Permits

Yesterday California announced the results from its first ever auction of carbon allowances, which was held on Wednesday last week. All permits offered for sale were purchased at a price of $10.09 per tonne of carbon. These permits represent the right to emit one ton of carbon in 2013.

Futures (derivative) contracts for those same allowances had been trading over-the-counter at much higher prices – as high as $20 a tonne last summer, and $12-13 dollars a tonne just a weeks ago according to the Intercontinental Exchange (ICE). What does the auction clearing price mean, and how is that going to help climate change anyway?

California cap-and-trade in the starting blocks

The Golden State is getting ready to launch its cap-and-trade program on January 1, 2013. Going forward, companies that emit carbon dioxide or other greenhouse gas (GHG) emissions, will have to surrender carbon allowances for each tonne of carbon they have emitted. Emitters have a choice of options: they can reduce their emissions, or they can buy carbon allowances, or they can buy offsets.

But there’s a trick. Some companies actually receive allowances for free – that’s true of most industrial facilities in the state. Some receive as much as 90 percent of what they need for free, and they only need to buy the remaining 10 percent – or reduce their emissions, of course. That’s also true of municipal utilities: those small, publicly-owned entities typically own just a few power plants and have limited options to reduce their emissions in the short term.

So who really needs carbon allowances? The private utilities, known as “investor-owned utilities” (IOUs), namely Pacific Gas and Electric, Southern California Edison and San Diego Gas and Electricity, some industrials and independent power producers, and oil companies.

How does the auction work?

The auction is not like what you see on TV for art shows. In this kind of auction, everybody bids at the same time on an internet platform, and all the bids are kept secret. There’s more than one winner, and the winners don’t necessarily pay what they bid – everybody pays the price of the last winning bid. For example, if I bid to buy 1000 tons at $12, but more allowances are still available after that, the computer system will automatically distribute allowances to the next bidder, say at $11.50 a tonne. This continues until all the allowances have been (virtually) distributed. In Wednesday’s auction, the clearing price was $10.09, just a few cents above the minimum reserve price of $10.

What does the auction result tell us about the California program?

This $10.09 price was about as low as it could get, but the surprise was that all the allowances sold out – this was not a sure thing because of the policy uncertainty surrounding the program.

Over the past weeks, rumors had been flying about upcoming lawsuits against the cap-and-trade program, and sure enough, the day before the auction, the California Chamber of Commerce filed a complaint against the way permits are allocated in the program. Some participants were even concerned the California Air Resources Board (CARB) would run into technical issues with the auction platform – these concerns were ultimately unfounded.

In addition, CARB kept signaling they planned to make changes to their own rules – who gets free allowances and who doesn’t, what the maximum price of an allowance should be, etc. That makes it very hard to estimate what the price of the allowances should be, and how many allowances one should buy.

So emitters went for the safe bet – they bought as few allowances as possible, at the lowest possible price. But in the aggregate, it created enough demand for all the allowances that were offered. Not a bad outcome – it shows people take the program seriously, since they’re willing to put money on the table. But they’re careful to not overspend their money in a context of uncertainty, so they bid low volumes and low prices.

This is just the beginning of the California program – there will be more political rollercoasters as the lawsuits unroll and more price fluctuations. But down the road remains the key message: carbon now has a price in California, and companies will now have to take that price into account in all their energy and production decisions. Welcome to the 21st century!

*** Emilie Mazzacurati is an expert on U.S. climate policy and carbon markets and an affiliated consultant Real Options International, a carbon advisory firm. Emilie has published extensively on federal climate legislation, regional programs and the interaction of carbon with other commodity markets.

Image credit: California State Archives