Overview of The California Market
The California Air Resources Board holds quarterly carbon emissions allowance auctions, which represent significant liquidity events in the market. The auction format consists of a single round, sealed bid, uniform price. To participate, prospective auction participants must open a Compliance Instrument Tracking System Service Account (“CITSS”) and register with the auction administrator. Each auction consists of both a Current Auction as well as an Advance Auction.
Current Auctions offer allowances with a vintage date of the current compliance year. The auctions held in 2014 will be for vintage 2014 allowances. At each auction, a small proportion of the allowances with a vintage of the current calendar year plus 3 years will be offered for purchase in the advance auction. The 2014 advance auctions will be for vintage 2016 allowances.
Auction Format The California Air Resources Board (“CARB”) holds quarterly carbon emissions allowance auctions, which represent significant liquidity events in the market. The auction format consists of a single round, sealed bid, uniform price. To participate, prospective auction participants must open a Compliance Instrument Tracking System Service (“CITSS”) account and register with the auction administrator. Each auction consists of both a Current Auction as well as an Advance Auction. Current Auctions offer allowances with a vintage date of the current compliance year. The auctions held in 2014 offer allowances with an allowance vintage date of 2014. Additionally, at each auction, a small proportion of the allowances with a vintage of the current calendar year plus 3 years will be offered for purchase in the advance auction. The 2014 advance auctions will be for vintage 2016 allowances.
Auction Reserve Price
CARB has, in its Cap and Trade regulations, provided for an Auction Reserve Price (“ARP”) that applies to both the Current Auction and the Advance Auction for each calendar year of the program. No allowances are sold by CARB at bids lower than the ARP. The ARP for the November 2012 auctions, the first official allowance auction, was set at $10 and has increased to $11.34 for all auctions held in 2014. The ARP is announced each December prior to the calendar year in which it will take effect. It is calculated as the previous year’s ARP increased by 5% plus the rate of inflation. Assuming ~2% inflation it is reasonable to expect that the ARP will follow a similar schedule to the below:
ARB has created a reserve pool of allowances in an effort to prevent unacceptably high allowance prices. This pool was populated at the beginning of the program from a carve-out from each of the annual allowance budgets: 1% of the allowance budget for years 2013 and 2014, 4% from years 2015-2017, and 7% from years 2018-2020. Allowances in the reserve will be split into three equally sized price tiers, set initially at $40, $45, and $50 in 2013, and rising by 5% each year thereafter. The reserve sale, if distributed, is distributed on a first come, first served basis. In March 2013, CARB made allowances from the reserve available six weeks after the completion of each quarterly allowance auction. However, whereas no entities registered for the March 2013 reserve auction it was cancelled. This trend has continued into 2014. When compared to current prices in the secondary market, the established reserve prices are relatively quite high. The CARB board and EMAC have also began to consider a mechanism to either increase the supplies of reserve allowances in the event that the allowance reserve is depleted or provide a “hard cap” on prices.
An interesting and important fact to note is that all Allowances carved out are of a universal vintage and available for any compliance year. As such allowances in the Price Containment Reserve are essentially 2013 vintage allowances, regardless of the year they were actually taken from.
Exchange Trading Via Intercontinental Exchange
ICE is an electronic trading platform that offers access to regulated futures exchanges, global OTC markets and clearinghouses in North America and Europe. In terms of the California market, ICE has become the most successful and liquid exchange platform for California Carbon Allowance (“CCA”) products including futures and options. ICE transitioned all of its cleared OTC energy swaps, including CCA products, to futures in order to provide regulatory certainty amid the continued evolution of new swap rules under Dodd-Frank financial reform legislation.
The ICE futures contracts are settled physically with delivery made via CITSS account transfer if CITSS is operational. If at delivery the Market Tracking System (“MTS”) or CITSS is not capable of transferring allowances or such allowances do not exist then the contract will financially settle at the ARP for the year of delivery. The language of the ICE contract also allows the seller to deliver the contracted vintage allowances or an earlier vintage. Based on recent history in the federal emissions markets, CAIR allowances continued to trade even in the absence of a mandate. It may be reasonable to assume at this point that if California Cap and Trade were to be cancelled or stayed for any reason, the MTS could still function and thus delivery obligations would need to be met.
Secondary Market Purchases
Outside of the ARB quarterly auctions, there are two common methods of procuring and trading compliance instruments. The first is via Exchange Trading such as the Intercontinental Exchange (“ICE”) and the second is in the “Over-The-Counter” (“OTC”) trading market.
Bilateral or OTC transactions are transactions that occur directly between two parties (including brokered transactions) instead of on an exchange. They typically involve two parties agreeing on how a particular trade will be settled in the future. Significant differences can exist from one contract to the next. OTC transactions are particularly useful when transacting in highly specialized products, such as offsets, because of the uniqueness in protocol, vintage, invalidation risk, conversion and other terms that can exist in the contract.
ARB vs California Chamber
Because carbon markets are correlated with each other, the result the ARB vs Cal Chamber is a very intriguing case for Cap and trade programs around the country and Canada. The premise of this case is that ARB has exceeded its authority. The cap-and-trade program itself isn't being challenged, but certian provisions in the program are illegal.
Exceeding authority doesn’t seem to be the biggest issue at hand, but it seems that the real question being posed is, “Is cap-and-trade a tax or a fee?” Allowances are an asset so it does not quite fit to call them a tax. A fee is only supposed to mitigate harms caused by pollution. Previous precedence does not seem to fit this particular case. To answer this question the court will likely need to create a new test to define allowances. This case is only made trickier by the revenue that is generated in a cap-and-trade program. Especially since cap-and-trade is used as a way to generate government revenue.
AB 32 Scoping Plan
The California Global Warming Solutions Act of 2006 (AB 32), created a multi-year program to reduce greenhouse gas emissions (GHG) in California. Provisions in the bill require a Scoping Plan to be developed that describes the approach California will take to reduce emissions to 1990 levels by 2020. The Scoping Plan will be evaluated and updated every five years, with the first update approved May 2014
The first update identifies opportunities to leverage existing and new funds to further drive GHG emission reduction though strategic planning and targeted low carbon investments. This update defines climate change priorities in the next five years and highlights California’s progress toward meeting 2020 GHG reduction goals.
For more information visit http://www.arb.ca.gov/cc/scopingplan/scopingplan.htm