Econ 100 1Winter 2012: Professor Bushnell

California’s Carbon Market: Choices and Challenges

James BushnellUniversity of California at Davis

Econ 100 2Winter 2012: Professor Bushnell

Outline

• California’s carbon market one year in

• The economic theory of cap-and-trade

– And why it (mostly) doesn’t fit carbon markets

• Things to look for going forward

• Key Takeaway: Price Collars are Really Important in Carbon Markets!

Econ 100 3Winter 2012: Professor Bushnell

The Carbon Market: One year in

Econ 100 4Winter 2012: Professor Bushnell

The Carbon Market: One year in

Econ 100 5Winter 2012: Professor Bushnell

The Carbon Market: One year in

Econ 100 6Winter 2012: Professor Bushnell

California Allowance Prices

Econ 100 7Winter 2012: Professor Bushnell

Theory of Cap and Trade

• Market based environmental regulation– Regulator sets how much pollution is allowed– The “market” decides who reduces pollution

and how they do it.• Preferred to taxes in settings where we

are more worried about hitting a specific emissions target than the costs of hitting that target.

Econ 100 8Winter 2012: Professor Bushnell

Regulator decides how much?

Econ 100 9Winter 2012: Professor Bushnell

Regulator decides how much?

Econ 100 10Winter 2012: Professor Bushnell

Econ 100 11Winter 2012: Professor Bushnell

Market decides who and how?

Energy Efficiency, 20, 11%

Renewable Energy, 24, 14%

Cleaner Power Plants, 7, 4%

Cleaner Cars and Trucks, 41, 23%

Smart Growth, 6, 3%

High GWP Gas Reductions, 20,

12%

Cap-and-Trade Program, 34, 20%

Forestry, 5, 3%

Industry and Waste Management, 2, 1%

Low-Carbon Fuels, 15, 9%

Econ 100 12Winter 2012: Professor Bushnell

Climate and cap-and trade theory• Should not take quantity targets too literally

– Local action to reduce global pollutant– All targets to date well short of what is needed

• Much talk of adding a consistent cost of GHG emissions to business planning and consumer activity– But caps are a bad way to do that

• Key question: what is the best way to build forward momentum for reducing global GHG?

• Key Takeaway: Price Collars are Really Important in Carbon Markets!

Econ 100 13Winter 2012: Professor Bushnell

Supply of Allowances

Allowance Price

0

Offsets

Price Containment Reserve

$40

$50

$10.5

2380 mmTons

125mmTons

125 mmTons

Cap (less Reserve)

Econ 100 14Winter 2012: Professor Bushnell

Demand for Allowances

Allowance Price

0

$40

$50

$10.5

~2700 mmTons

BAU emissions

Econ 100 15Winter 2012: Professor Bushnell

Demand for Allowances

Allowance Price

0

$40

$50

$10.5

~2700 mmTons

BAU emissions

~ 200 - 400 mmTons

Complementary Policies

Econ 100 16Winter 2012: Professor Bushnell

Demand for Allowances

Allowance Price

0

$40

$50

$10.5

~2700 mmTons

BAU emissions

~200 – 400 mmTons

Complementary Policies

Electricity, Gasoline, and Natural Gas Demand

Response ~ 40-60 mmTons

Econ 100 17Winter 2012: Professor Bushnell

Supply and Demand

Allowance Price

GHG Emissions0

Offsets

Price Containment Reserve

$40

$50

$10.5

2380 mmTons

125 mmTonsCap (less Reserve)

125 mmTons

$20

Econ 100 18Winter 2012: Professor Bushnell

Supply and Demand

Allowance Price

GHG Emissions0

Offsets

Price Containment Reserve

$40

$50

$10.5

2380 mmTons

125 mmTonsCap (less Reserve)

125 mmTons

$20

Econ 100 19Winter 2012: Professor Bushnell

Possible Distributions of Allowance Price

Allowance Price

0$40 $50

Probability Price = X

$10.50

Econ 100 20Winter 2012: Professor Bushnell

Econ 100 21Winter 2012: Professor Bushnell

Econ 100 22Winter 2012: Professor Bushnell

2006-07: EU Carbon price crashes

€ 0

€ 5

€ 10

€ 15

€ 20

€ 25

€ 30

€ 35

Apr-05 Jul-05 Sep-05 Dec-05 Mar-06 May-06 Aug-06 Nov-06 Jan-07 Apr-07 Jul-07 Sep-07 Dec-07

Pric

e pe

r ton

ne (E

UR

)

Carbon Price, Phase I

Carbon Price, Phase II

Event Window

Econ 100 23Winter 2012: Professor Bushnell

California Allowance Prices

Econ 100 24Winter 2012: Professor Bushnell

Things to Look for Going Forward

• End of Phase I (2013 – 2014)– Reporting of electricity imports

• What happens if there is a positive shock to emissions before 2020?– The importance of transportation– Policy supporting the price-containment reserve

• What will happen post 2020?– Banking of allowances supports minimum prices– Relationship with rest of US?

Econ 100 25Winter 2012: Professor Bushnell

Summary

• Price Collars are Really Important in Carbon Markets!– A good price-collar makes up for a lot of flaws

in any cap and trade market– Stable non-trivial carbon prices best way to

steer investment and consumption on to a low carbon trajectory

Econ 100 26Winter 2012: Professor Bushnell

Thank You!

Special Thanks and Apologies to the websites of • Environmental Defense Fund• SNL Financial• Carbon Policy Initiative