KQED’s Kevin Stark spoke with me in connection with the dismal cap-and-trade auction results announced earlier today and their implications for the state’s climate budget. Here’s Kevin’s story and my quote:
But an undersold market could also signal that the state’s market is bloated with more allowances than are necessary, given the paucity of economic activity in the state.
“It's basically the worst-case result,” said Danny Cullenward, an energy economist and lecturer at Stanford University, referring to the latest auction. “Almost no revenue is coming into the state.”
“The bad outcome will get blamed on COVID but is much more the product of a weak program design that was vulnerable to surprises, with way too many allowances,” he said.
Kevin also quotes Stanford’s Chris Field, who suggests that the auction shortfall is just a COVID-related blip and that policymakers should wait and see before considering any program reforms.
It’s disappointing to see my colleague deflect blame for the bad auction because smart cap-and-trade programs with good market designs aren’t experiencing revenue crises—just look to the European Union or Regional Greenhouse Gas Initiative to see how policymakers can design programs that respond to macroeconomic surprises and produce predictable outcomes. Both the EU and RGGI programs have rule-based adjustments that automatically adjust market supplies to make the market tighter or looser in response to macroeconomic uncertainty. California does not. That’s the story.
The COVID argument doesn’t hold any water in numerical terms, either.
A new paper from the Global Carbon Project team in Nature Climate Change estimates that a national quarantine in the United States through July followed by prohibitions on non-essential travel and large gatherings through December would produce an annual GHG reduction of about 11.5% (5.4% to 18.5% CI) from 2019 to 2020 (Le Quéré et al., 2020: Table S14). California’s cap-and-trade emissions were 319.9 MMtCO2e in 2018, so a reduction of 11.5% normalizes to about 37 MMtCO2e (with 5.4% equal to 17 MMtCO2e and 18.5% equal to 59 MMtCO2e). Meanwhile, California is lifting its stay-at-home orders earlier than this scenario assumes, so these numbers are likely to be an upper-bound, not a central estimate.
In contrast, cap-and-trade oversupply clocked in at about 227 MMtCO2e in 2018, the year with the most recently available data (Cullenward et al. 2019). When we get 2019 data this November, we’ll see that number go substantially higher, likely heading toward 300 MMtCO2e. So I’m not buying the argument that a shift in demand on the order of 37 MMtCO2e (17 to 59 MMtCO2e) was enough to destabilize an otherwise sound market when that market was already long by 227+ MMtCO2e and counting. The regulator’s own pre-COVID assumptions about future market conditions would have produced a slack and oversupplied market all the way through 2030 (Inman et al., 2020).
So if COVID-related emission reductions are temporary, then any transient effects are small in relation to the structural oversupply problems that have plagued the California market since its origins. (How quickly we forget that oversupply caused another revenue crisis just four years ago; see Cullenward & Coghlan, 2016.)
Alternatively, it’s entirely possible that long-term emissions trajectories drop as part of a deep or protracted recession—a possibility that smart economists have been warning California climate policymakers about for some time (Borenstein et al., 2019). But that’s an argument in favor of rule-based program adjustments, not a wait-and-see attitude.
The advantage of rule-based program adjustments is twofold. First, these approaches automatically apply if and only if conditions meet predetermined triggering conditions, so policymakers don’t have to wait for problems to get worse before they implement a solution. Second, their preferred adjustments won’t take effect until they want they want them to—policymakers can set the trigger however they like.
It’s high time California started putting these basic climate governance lessons to use. Long-term market prices remain below the price floor, raising the possibility that future cap-and-trade auctions will meet a similar fate. After all, the alternative to making reforms is putting California’s climate, air quality, water, and fire prevention programs at risk of ongoing budget shortfalls.
References
Borenstein et al. (2019), Expecting the Unexpected: Emissions Uncertainty and Environmental Market Design, American Economic Review 109(11): 3953-77, doi.org/10.1257/aer.20161218.
Cullenward & Coghlan (2016), Structural oversupply and credibility in California’s carbon market, Electricity Journal 29: 7-14, dx.doi.org/10.1016/j.tej.2016.06.006.
Cullenward et al. (2019), Tracking banking in the Western Climate Initiative cap-and-trade program, Environmental Research Letters 14: 124037, doi.org/10.1088/1748-9326/ab50df.
Inman et al. (2020), An open-source model of the Western Climate Initiative cap-and-trade programme with supply-demand scenarios to 2030, Climate Policy, doi.org/10.1080/14693062.2020.1760774.
Le Quéré et al. (2020), Temporary reduction in daily global CO2 emissions during the COVID-19 forced confinement, Nature Climate Change, doi.org/10.1038/s41558-020-0797-x.