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California’s Second Carbon Auction Today: An Explainer on Cap-and-Trade

The views expressed are those of the author and are not necessarily those of Scientific American.


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At the beginning of this year, the Golden State officially launched its long-discussed market-based system to reduce greenhouse gas (GHG) emissions. California’s GHG cap-and-trade program is not the first of its type. Carbon trading schemes are popping up around the world. But, it’s only the second program to takeoff in the U.S.

Photo courtesy of CARB

The first, the Regional Greenhouse Gas Initiative, or RGGI, opened for business in 2009, and concentrates on the carbon emissions emitted by power plants in 9 northeast states. California expanded its focus to include emissions from power plants and manufacturing, with transportation fuels joining the effort in 2015.

The program is just one of the State’s myriad efforts to reduce its GHG emissions to 1990 levels by 2020, a goal set by AB 32, the state’s Global Warming Solutions Act of 2006. The California Air Resources Board (CARB) regulates the program – no easy task considering that California is the ninth largest economy in the world.

But what exactly is a cap-and-trade program? Cap-and-trade systems use the interaction between supply, demand and price to reward companies for reducing pollution below a set level. The level, or “cap” is gradually decreased over to time to minimize the amount of pollutants released, until an established goal is achieved. In California’s case, the cap will diminish 2-3% annually until it reaches its goal by 2020.

Until recently, California-based businesses didn’t have a roof on their GHGs. The State’s total emissions from 2012 were estimated at 470 million metric tons of carbon dioxide (CO2).  About 40% of these emissions originate from a combination of electric power plants and industrial factories, which are now regulated under the cap-and-trade program.

For the first round of the scheme (2013-14), the 360 businesses involved are limited to emitting 163 million tons of carbon in 2013, or about 34% of the Golden state’s overall emissions. This means that from now on refineries, power plants and industrial facilities that emit more than 25,000 tons of CO2 annually will need to show a permit, or allowance, for every ton of CO2 they release.

What’s a permit? A permit is a license to emit GHGs. In the case of the cap-and-trade scheme, one permit enables the owner to emit 1 ton of CO2 in a year. In 2013, the state of California will offer 10.6 million of allowances for sale by auction.

The first auction took place on November 14, 2012. All the allowances sold. About 90% of the total number of allowances for 2013 was distributed by the CARB for free prior to the auction to help businesses get accustomed to the new scheme. The auction played out that one ton of carbon sold for $10.09, just slightly above the $10 floor price established by regulators. Another auction is taking place today, where 2.5 million  2013 allowances  will be sold on behalf of the state, along with over 10 million allowances consigned by power utilities. The remaining three auctions this year will occur in May, August and November.

As the years go by, the total number of available permits will decrease. In theory, this limit on GHG emissions increases the price of carbon, which in turn increases companies’ interest in finding ways to reduce emissions and invest in clean energy projects.

How does the trade part of the scheme work? The idea here is to remain within the emission cap. To do this, a company has a few options. The first is finding ways reduce their emissions. Or, they can buy more allowances to emit more CO2 – either from the government or from other capped companies. Finally, they can “offset” their emissions by investing in projects that reduce GHGs elsewhere, such as a project to destroy refrigerant gases (PFCs) from old refrigerators and A/C units, a forestry projects that involves planting trees, and agricultural methane project that captures effluents from waste ponds in dairy farms. The polluter pays in this regard. The more GHGs a business wants to emit, the more it will cost. Companies that emit less than their given number of permits can sell their extra permits for profit.

How much do permits cost? California allowances were trading for $14 a ton on Friday, February 15 on the Intercontinental Exchange (ICE), where most transactions for the secondary market take place. The prices fluctuate following emissions in the state –slow economic growth would lower emission levels, and bring prices down, for example, while an increase in industrial production would mean a higher demand for emissions permits, and push prices up.

California has set boundaries on what the permits could sell for: the state will not sell permits for less than $10.71 at today’s auction, and will release more permits for sale if prices get in the $40-$50 range.

What gases fit within the program’s parameters? You can think of this list of gases as climate change’s heavy hitters:

  • Carbon Dioxide (CO2)
  • Methane (CH4)
  • Nitrous Oxide (N2O)
  • Sulfur Hexafluoride (SF6)
  • Perfluocarbons (PFCs)
  • Nitrogen Trifluoride (NF3)

Will California’s program link to any others? Why yes. California is part of the Western Climate Initiative, also involving British Columbia, Manitoba, Ontario and Québec. The vision is to link California and Québec’s cap-and-trade programs so that businesses in both jurisdictions can achieve their goals. The first joint auction is supposed to take place this August. The other provinces are still pondering whether to pursue an emission trading program – Ontario is the next most likely to link.

California specifically designed its program so that it could be harmonized with other such schemes. This enables the trading system to become more global in nature.

Will the program work? California’s program has a lot going for it, explains Emilie Mazzacurati, a carbon market expert.It took about 6 years of thought and work before launching, and California has had time to learn from other programs, which have all run into some issues, with the level of their cap in particular. One of the key benefits of cap-and-trade is that it provides certainty about the amount of emission reductions that will take place over the duration of the program. In practice, implementation can be challenging. California’s program has had a fairly smooth beginning, but it’s only just getting started…

[Thanks to Emilie Mazzacurati for providing much of the information in this blog]

Robynne Boyd About the Author: Robynne Boyd began writing about people and the planet when living barefoot and by campfire on the North Shore of Kauai, Hawaii. Over a decade later and now fully dependent on electricity, she continues this work as an editor for IISD Reporting Services. When not in search of misplaced commas and terser prose, Robynne writes about environment and energy. She lives in Atlanta, Georgia.

The views expressed are those of the author and are not necessarily those of Scientific American.





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Comments 14 Comments

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  1. 1. Sisko 9:48 am 02/19/2013

    The article asks the question “Will the Program Work?”

    I ask what is the goal of the program? If it is designed to make people feel that they are doing something to help the climate and to redistribute funds then the program will meet the intended goal.

    If the program is supposed to reduce CO2 emissions enough to prevent the climate from changing, it will have no measurable impact.
    Cap and trade is a very inefficient process. It involves the hiring of government workers to administer a program that will not reduce CO2 emissions enough to be noticed in any way. It takes funds away from being spent on things that would actually help to reduce harms from bad weather.

    Please- help me understand how a program that cost funds but accomplishing nothing else of importance makes sense.

    Link to this
  2. 2. davidwogan 10:15 am 02/19/2013

    Excellent post! One question: are the permit values based on a CO2 or carbon equivalent measure? What I’m getting at is the regulated GHGs have different global warming potentials (the more complex PFCs and HFCs being stronger than say, carbon dioxide itself). So a plant releasing 1 ton of PFCs would use more of its allotment than releasing 1 ton of carbon dioxide. Thanks!

    Link to this
  3. 3. sault 10:54 am 02/19/2013

    David,

    Look at “Table WCI.10-1. Global Warming Potential Factors for Greenhouse Gases” in this document:

    http://www.westernclimateinitiative.org/component/remository/Reporting-Committee-Documents/Final-Essential-Requirements-for-Mandatory-Reporting

    Global warming potentials are taken into account, but CO2 will still present the overwhelming majority of greenhouse warming out of all the other gases covered in the program.

    Link to this
  4. 4. sault 11:09 am 02/19/2013

    Re: Sisko,

    Sorry, the scientific community has moved on from the question of whether our GHG emissions are changing the climate or whether these changes will be mostly negative or not.

    You want to know what’s inefficient? Letting dirty energy sources pollute our environment (causing $100B to $500B in yearly damages to the USA from coal pollution ALONE!) while changing our climate in dramatic and chaotic ways.

    To prevent these disasters, you have to start somewhere. Since fossil fuel interests have basically coopted one political party in the US and completely stalled progress at the federal level, states are having to exercise their right to a clean environment instead. Sure, a carbon tax may be less complex, but the “Cap” part of “Cap & Trade” at least guarantees predictable emissions reductions.

    And once half or more of the USA’s GDP is under either RGGI or the WCI, then we can start seeing larger reductions in the future. Since the USA is responsible for the vast bulk of cumulative emissions floating around in the air, it is up to US to show some of that global leadership expected of the greatest country on Earth and work to prevent climate disruption.

    Each ton of GHGs not emitted means a little less warming. You have to cut a million tons before you cut a billion. And the rest of the world won’t step forward until the country that has benefitted the most from using the atmosphere as a free-for-all dumping ground starts to do something about it first. Yeah, BRIC countries will try to weasel out of equitable emissions cuts, but they are very dependent on trade with OECD countries too. We shouldn’t expect them to clean up as quickly as developed countries, but trade policy can go a long way towards preventing “carbon leakage” too.

    Again, you have to start somewhere. While RGGI and the WCI might be small on a global perspective, they are demolishing the claims that carbon limits will harm economic growth. Now if we can just get corporate money(and fossil fuel money especialy) out of our elections, we’ll have this problem solved in a few decades.

    Link to this
  5. 5. drafter 11:30 am 02/19/2013

    California companies welcome to Texas. If I were a manufacture in California I’d move no questions asked. And if I had to make the expanse of a move I would probably move all the way to China since every State will eventually have these job killing laws anyway, so why pay to move twice just pay once to go out of this country.

    Link to this
  6. 6. Sisko 11:37 am 02/19/2013

    Sault

    If I am understanding what you have written correctly, you support Cap & Trade although you acknowledge that it is an expensive program that will lower CO2 emissions very little and will have no measureable impact on the climate.

    How is this the best use of limited financial resources?

    Link to this
  7. 7. davidwogan 11:38 am 02/19/2013

    @sault: thanks for the link. It is weighted by GWP.

    Link to this
  8. 8. outsidethebox 12:45 pm 02/19/2013

    Competition is the rule of the world. If it is more economically efficient to produce goods in other places than California then that will be what happens.

    Link to this
  9. 9. Leroy 1:53 pm 02/19/2013

    @Sisko “will lower CO2 emissions very little and will have no measureable impact on the climate”

    No measurable impact for the next century. That’s about how long it takes CO2 to cycle out of the atmosphere. It’s not that long, really. Your grandkids will thank you.

    There’s also a potential multiplier affect in cap and trade. It provides a great economic incentive to innovate, and those innovations can be sold on the global market, which not only generates income but will also contribute to global carbon reductions. With rising global energy prices and increasing air quality issues in China, India and elsewhere, there will be demand for these innovations.

    Link to this
  10. 10. Soccerdad 1:54 pm 02/19/2013

    Fortunately this scheme is very much voluntary for the businesses involved, at least in the long run. Simply head for the border and get out of there.

    Link to this
  11. 11. sault 4:06 pm 02/19/2013

    Re: drafter,

    Well I guess you’ve got some unique business acumen because hardle any businesses are moving from California to Texas. And thanks for letting us know how unpatriotic you are by showing your willingness to outsource your business to China.

    The startup culture in California is alive and well. The knowledge base in the state is one of the best and the brightest people want to live there if they don’t already. You can’t beat the weather too, or the natural beauty!

    Sorry if I sound like a California commercial, but I’ve lived in TX and Cali, and I prefer the Golden State over the Lonestar state hands down.

    Link to this
  12. 12. sault 4:23 pm 02/19/2013

    Sisko,

    Please stop putting words into my mouth. I never said any of those things, so why would you think I did? While the WCI and RGGI Cap & Trade arrangements are small compared to global emissions and somewhat more complex than a straight carbon tax, they are important first steps.

    Don’t you agree that GHG emissions reductions have to start somewhere, and that the fossil fuel companies’ stranglehold on US energy “policy” has made it so that the states / provinces have to get the ball rolling? Don’t you also agree that the CAP part of “Cap & Trade” determines the level of reductions, so that it can have whatever impact is necessary by reducing the cap accordingly?

    And finally, I know for certain that you, me, or anybody else has NO IDEA exactly where the tipping points are in Earth’s climate system. Who knows when certain glaciers will get destabilized or what the timing of the ocean temperature / CO2 release feedback or the arctic temperature / methane from melting tundra feedback will be. Or when EXACTLY the Amazon will switch from a carbon sink into a carbon source…I’ll admit right now that we don’t know the exact timing of these disasters. However, we DO know that they WILL happen as the climate warms and faster rates of warming will bring them about faster as well. The more GHGs we release, the higher the odds are that the Earth will start going over these threshholds, making it MUCH harder to get things under control in the latter half of the 21st Century.

    So how are YOU so certain that a few hundred million tons annually will make no difference? How are YOU so certain that these agreements will never demolish the silly notion that CO2 limits will harm the economy and set the stage for national, and eventually international action? How are YOU so sure about the timing and temperature threshholds of these feedbacks that can bring about a totally unrecognizable climate for many generations in the future? How are YOU so sure this brave new climate won’t be detrimental to the wellbeing of those future generations?

    Link to this
  13. 13. Sisko 4:25 pm 02/19/2013

    Leroy

    Sorry but the reductions in CO2 that would occur as a result of implementing cap and trade would not be noticed in the climate ever. In 100 years if CO2 was at 480 ppm vs 485 ppm do you BELIEVE the climate would be measurably different?

    What would be different is that there would be less funding available to actually reduce harms from adverse weather. What reduces harm when bad weather occurs? Good infrastructure! Will bad weather stop occuring- no.

    Link to this
  14. 14. 13inches 10:25 pm 02/19/2013

    All humans exhale CO2. All humans in California are now required to buy a yearly Exhale Permit.

    Link to this

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