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California’s cap and trade expansion

Hydrocarbon Engineering,

A new report commissioned by the Western States Petroleum Association (WSPA) has been launched just as California prepares to launch a major expansion of its three year old cap and trade program. The report identifies a series of major design flaws that make the program vulnerable to market meltdowns and also offers a number of solutions that would mitigate impacts passed on to Californian consumers.

The expansion

As of January 1 next year, California will include transportation fuels such as gasoline and diesel in its carbon emission cap and trade scheme. No other state in the US or country around the world has attempted to regulate the sale of gasoline under such a program before. Jean-Phillips Brisson, carbon markets expert with Latham & Watkins said, ‘past experience demonstrates the importance of proper design. Market design flaws can result, and have resulted, in catastrophic implications for environmental markets around the globe.

Brisson was part of the WSPA analysis team who looked at the structure of California’s cap and trade program and assessed its vulnerabilities prior to the expansion. The program is administered by the California Air Resources Board (CARB). Brisson has said that it is essential for CARB to address five major issues before expanding the program to avoid a situation in which allowance prices spiral upwards.

Flaws and analysis

The five flaws mentioned above are:

  • The current structure of the holding limit.
  • The infrequency of auctions.
  • The Air Resources Board’s cost containment policies.
  • CARB’s approach to markets and the rule of law.
  • The program’s relationship to impending federal GHG regulations.

The report analysis has made a comparison against a program designed in California which was designed to reduce emissions of oxides of nitrogen and sulfur through a similar, but much smaller, cap and trade system. When demand for electricity increased dramatically during the state’s electricity market deregulation crisis, the emission credits created by the program spiked from US$ 2000 /t of emissions to more than US$ 60 000 /t.

Brisson commented, ‘in the context of the California cap and trade program, this precedent would be the equivalent of cap and trade allowing prices spiking from their current average of US$ 12 to US$ 360.’

Catherine Reheis-Boy, WSPA’s President has commented on the expansion and the report analysis. ‘California’s petroleum industry has long supported well designed market based programs to reduce GHG emissions, with the emphasis on well designed. Mr. Brisson’s analysis shows what we fear most, design flaws that open the door for the kind of chaos and price volatility we saw in the disastrous attempt to deregulate our electricity markets in 2000 and 2001.’

Next steps and requests

The WSPA has requested that CARB postpone the expansion of its cap and trade program to allow time for the agency to correct the design flaws that have been identified in the report and by Brisson. Brisson said, ‘market design flaws, including those identified in this paper, may lay formant for a period of time when markets are not under stress, providing a false sense of security and regulators.

‘When a program comes under pressure because of unforeseen conditions or simply because the program becomes increasingly stringent over time, latent market design flaws can significantly derail an environmental program, undermining both industries’ and regulators’ investments to achieve environmental objectives. Accordingly, ARB should address these issues now rather than waiting until the program experiences a significant stress, at which point corrective action may come too late.’

Edited from press release by Claira Lloyd

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