Regulatory Round-up: ARB’s preliminary regulatory amendments outline post-2020 caps and put sell-by-date on surplus auction allowances

July 18, 2016 by Harry Horner

(CaliforniaCarbon.info, July 18, 2016)  Last Tuesday ARB published a preliminary draft of the proposed regulatory amendments they intend to enact in the coming year. The report detailed proposed amendments, great and small, relevant to almost every aspect of California’s Cap-and-Trade program.

Whilst this is a ‘preliminary draft’ and ARB is only set to vote on the amendments in March 2017 after a legal review and two public hearings, the recent release provides meaningful clarity on the direction staff are set to take.


Emission Caps post-2020

In this release, ARB confirms a linear rate for decreasing the emissions cap after 2020. Given the existing 2020 cap of 334.2 MMTCO2 and the extrapolated cap of 200.5 MMTCO2 from the 2030 state-wide target, the rate can be identified at a highly ambitious 5% reduction annually. Staff have also proposed to set initial caps through 2030 to 2050 to inform investment decisions. Using the state-wide ‘80% under 1990’ 2050 target, the linear reduction rate comes steps up to 5.4% a year after 2030, this leads to a 2050 covered sector emissions total of just 66.5 MMTCO2.

However, both these and ARB’s calculations assume a constant proportion of capped emissions within wider state emissions. Given the covered sectors are explicitly regulated to achieve an acceleration in reductions, you might expect and even hope for the share of covered sectors to fall over the years of the program.

(Source: ARB preliminary draft of proposed regulatory amendments)

(Source: ARB preliminary draft of proposed regulatory amendments)

Perhaps most crucially of all, ARB has quashed the suggestion of a 2021 step-down in the emissions cap to account for the annual surplus otherwise projected. ARB’s Scoping Plan modelling puts 2020 covered emissions at 322.6 MMTCO2, giving an 11.6 MMTCO2 annual surplus in 2020, this will only add to the large cumulative surplus from previous years.

There has been pressure from stakeholders to reassess the post-2020 caps, so as to curb the surplus and provide more genuine market signals for emission reductions. Indeed, large information and forecasting companies had even included such a step-down within their models. However, with this announcement ARB has stuck to its guns, most likely this is due to concerns from large compliance entities aired over carbon prices in the latter half of the decade.


Changes to Allowance Price Containment Reserve (APCR)

Whilst the headline ‘2021 emissions cap step-down’ did not materialise, two proposed amendments to the APCR partially redress the long-term surplus in the market in a more understated manner.

Firstly, as seen in the figure above, the annual contribution to the APCR decreases over the decade. The annual contribution will be formulated using the linear-rate reduction caps and the projected annual emissions from ARB’s Scoping Plan analyses, the contribution falls to zero as these paths meet in 2030 at 200.5 MMTCO2.

In aspect, this resembles ARB retailoring the non-APCR market caps. In effect, this proposal will subtly frontload reserve contribution so as to gently constrain the surplus of allowances offered at ‘normal market prices’. This will affect the first half of the decade when the role of the surplus will be greatest in the market; the move ought to boost auction proceeds and lift the price front above the reserve price marginally earlier than in comparison to an even schedule giving the same-sized reserve.

Secondly, ARB has proposed that if auction allowances remain unsold for 24 months, or 8 auctions, they are transferred to the APCR. If effected, this move will have similar consequences to the above proposal in diminishing the surplus available at ‘normal market prices’ to entities.

To put both the timeframe and the magnitude of potential transfers in perspective: some market stakeholders have placed the number of consecutively undersubscribed auctions to now follow be anywhere between three to seven, whilst the number of unsold V2016 allowances amounts to almost 64 million. For any unsold volume to be released at auction the two previous auctions need to have been fully subscribed; ARB can then offer unsold allowances of up to 25% of the current vintage auction volume (notably 25% of a diminished target, being a future year). Thus it is by no means in conceivable that in May 2018, some or all of the 64m unsold V2016 allowances are transferred to the APCR. If maximised, this equates to more than a third of the 2030 emission cap only becoming available at a supernormal market price.

Finally, the structure of the APCR itself is proposed for modification. The current more complex three-tiered system is likely to give way to a fixed single tier alternative. Previously, price point of the tiers had risen at 5% annually plus inflation, meaning that the entry price of the APCR would markedly diverge from the steadily rising auction floor. Under the new proposal, the APCR price would remain a fixed $60 above the auction floor. This is hugely significant for the later years of the program. For example, in 2030 under the old method the highest APCR tier would be approximately $120, under the new formula the entry price will be closer to $90.

In sum, the aggregate effects of the above proposed changes may serve to reduce the surplus in the early part of the decade. Potentially, some rather astute tinkering by ARB.


Washington and ‘Retirement-Only Linkage’ 

ARB staff have responded to Washington’s Clean Air Rule by formulating proposal 95945, which provides for a ‘Retirement-Only Linkage’; the program stringencies of SB 1018 are waived in this case. After public process and Board approval, a state (Washington) would be permitted to use Californian Allowances within their own emission reduction program. In fact, the outlined process would mean that the allowances never actually leave ARB’s domain, they are merely retired by ARB on behalf of the foreign entity and a verification of compliance will be sent to the foreign regulator.

Whilst this proposal was designed explicitly for Washington, it creates a pathway for other such one-way linkages. Such linkages cause an effective tightening of emission caps for Californian entities, and will also reduce the allowance surplus, even only marginally.


Ontario Linkage

There is far less to report on this front. Given that the Governor finds Ontario’s program to be compliant with the stipulations of SB 1018, the linkage remains on target for 2018. All highly likely, as Ontario’s program has been designed with SB 1018 in mind.


Sector-based offsets (REDD+) 

Equally little to report here, discussions are ongoing and ARB believes further public process is required before REDD+ offsets from Acre can be used in California’s Cap-and-Trade. The aim is to start such offset usage in the third compliance period starting 2018.


Clean Power Plan compliance

The long-expected amendments have been included so as to allow for a ‘State Measures’ compliance, namely:

–       Alignment of program periods starting 2020

–       Regulatory requirement for all CPP affected EGU’s to participate in Cap-and-Trade

–       Provisions for mass–based targets on aggregate emissions from affected EGU’s.

–       Provisions for a federally enforceable backstop if the Cap-and-Trade program does not achieve the required results.

Crucially, the above amendments will only take effect if the EPA approves California’s CPP compliance plan (and of course only if CPP makes it past the Supreme Court).


Industrial Allocation

ARB has proposed to eliminate transitional assistance beginning 2021, but will continue allocating allowances to industries based on leakage risk. The assistance factors, based on an industry’s leakage risk, will be updated in line with several new studies published on quantifying leakage.


Electrical Allocation 

Firstly, ARB staff is proposing to switch the allocation of allowances from the EDU’s to industrial entities for emissions associated with industrial demand for power. This is apparently logical as the calculation for the above allocation is run on an industry basis regardless of the EDU.

More generally, ARB’s proposals look to direct auction consignment revenue away from associated costs of compliance to MRR and AB32, and towards ratepayers and genuine emission reductions. ARB proposes a 10-year time limit for EDU’s to spend their auction revenue on the above.


Future Schedule

–       Jul. 19 – ARB provides a draft of the formal regulatory package to Office of Administrative Law (OAL).

–       Aug. 2 – ARB revises the draft documents and will publish final versions online.

–       Aug. 5 – Formal public comment period begins

–       Sep. 22–23 – ARB Board Hearing to consider proposed amendments.

–       Oct. – Continued stakeholder engagement and 15-day formal comment period.

–       Mar. 2017 – periods for any changes to the proposed amendments.

–       Mar. 23–24 – Second Board Hearing to vote on proposed amendments.

Harry Horner – (harry@californiacarbon.info)

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