California and Quebec complete second joint carbon dioxide emissions allowance auction

March 11, 2015

California and Quebec have announced the completion of their second joint carbon dioxide (CO2) allowance auction through a cap-and-trade system. Despite geographical distance and economic differences, California and Quebec have worked to align their CO2 emissions markets and policies. Previous auctions sold emissions allowances for electric generators and large industrial sources. The most recent auction, held in February 2015, also included allowances for the transportation sector, covering wholesale gasoline suppliers.

The California and Quebec program is the first international carbon allowance program to be enacted at the subnational level (i.e., between parts of two different countries). Similar programs in Europe were the first to establish markets across several countries (European Union's Emission Trading Scheme) and were also the first to cover certain transportation components.

Three factors widely cited as driving expectations among participants in the joint auction are:

Persistent carbon allowance surpluses in both the California and Quebec markets The likelihood that, given the divergence between the two economies, Quebec will be a perennial buyer from California Coverage of both programs widens in 2015 to include the transport fuels under the cap, creating additional uncertainty as to which way falling oil prices will affect carbon demand.

The results from the auctions conducted in 2014 suggest how perceptions of linked markets have converged in the most recent auction.

California had established an emissions cap of 162.8 million metric tons (MMmt) of CO2 in 2013, but ultimately emitted about 11% less, leading to a surplus of 17.8 MMmt CO2 emissions allowances. Another 1.7 million offsets were certified, potentially expanding the surplus. Final data for 2014 are not yet available, but leading indicators suggest another year of surplus. In order to reduce emissions, California's cap declines by 2%, but based on EIA data, total retail electricity sales fell more than 3% on a year-to-date basis through November 2014. Similarly, Quebec reported CO2 emissions from affected sources of 17.7 million tons for 2013, or about 6% lower than their annual 18.9 million metric ton budget, netting a 1.2 million allowance surplus.

California will likely have more low-cost CO2 reduction opportunities than Quebec. In the electric power sector, nearly 95% of Quebec's generation is from nonemitting sources (almost all hydropower), while only 39% of California's generation is from nonemitting sources (including about 9% from hydropower). While both programs have similar targets (15% reduction from 2005 CO2 levels by 2020), California is seeking just one-third of that total from its cap-and-trade program, with the remainder from complementary measures such as renewable portfolio and low-carbon fuel standards. Quebec intends to meet its goals relying purely on the cap-and-trade program.

Setting the cap in a program with gradual reduction requirements (which include most carbon cap-and-trade systems) requires maintaining a delicate balance. If economic conditions vary markedly from expectations, prices can fluctuate significantly. In order to avoid price collapse, the designers of the California-Quebec auction set a minimum bid, or reserve price, that will be accepted in each auction. Thus in a typical year at the outset of a new program, the total number of allowances auctioned would be set slightly below the level of actual emissions in previous years.

For instance, the allowances allocated for the fuels sector in 2015 are in the range of recent historical emissions: California reported 204 million metric tons (mmt CO2) of transportation emissions in 2013, and the state set its 2015 emissions cap at 198 mmt CO2. Similarly, in Quebec the 2013 emissions from the transport sector were 36 mmt CO2, with a 40 mmt CO2 allowance allocation for 2015.

Emissions allowances in both California's and Quebec's auctions have often sold at or very near the reserve floor price. This wasn't always the case; in the first few auctions in California, below-normal hydroelectric conditions and the unexpected loss of a nuclear plant helped increase demand for emissions allowances, pushing prices up to $14/mt CO2 by the May 2013 auction. However, since then actual emissions fell faster than expected, decreasing the need for allowances, and allowances were sold at or just above the market reserve price of $10/mt CO2.

Quebec held its first auction in November 2013. Initially, insufficient bid interest meant that just over one-third of the first allowances were sold, and the price cleared at the auction reserve floor price of $10.10/mt CO2 (in U.S. dollars). With the announcement of the joint auction schedule, bid interest grew sufficiently so that, in all but one instance, all of the allowances were sold, clearing at the reserve floor price.

In the February auction, all current vintage allowances were sold at a settlement price of $12.21/mt CO2, just above the $12.10/mt CO2 reserve floor price and 1% above the preceding auction's settlement price.

Principal contributor: Thaddeus Huetteman