Market Launch: Cap and Trade Goes Live

California’s Unique Design Features

IEPA 31st Annual Meeting

September 20

Jan Mazurek, PhD

ICF International

Sacramento, CA

jmazurek@icfi.com

icfi.com© 2006 ICF International. All rights reserved.

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CA’s Unique Design Features

Design feature CA EU ETS

GEOGRAPHY

Caps imported electricity Yes No

Bans resource shuffling Yes No

Industry benchmarks Yes Yes

MARKET SIZE

Holding limits Yes No

Allowance reserve Yes No

Offsets central to cost containment

Yes Not as much

CDM No Yes

Offset buyer liability Yes No

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Geography

“California never intended to go it alone”

ARB Chair Nichols

“Leakage”– Electricity: “Shuffling” low GHG-intensity electricity to CA; high to other states

• First deliverers and attestation meant to address US Constitution Commerce Clause

• Suspending attestation requirements 18 months– Some worry about legal risk?

– Low auction demand if there is shuffling

– “Trade exposed” industry—refineries, cement, food processors, paper, glass, steel• Uncapped outside of California, in neighboring states and other countries.

• Industry benchmarks based on output– Are ARB formulas satisfactory to those sectors (10 percent haircut, heterogeneity)?

– Some worry about over allocation based on EU ETS experience.

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Market Size

• Holding Limits– Restricts the number of allowances that may be held at any one by a covered entity.

• Designed to address threat of market manipulation due to relatively small market• Limit set below compliance obligation of some large entities (though ARB provides a limited

exemption), and takes allowances out of circulation to comply with the holding limit (concerns about liquidity, market power).

• Compliance Offsets– Essential to cost containment (CA sits high on MACC)

• ARB model shows cutting supply in half causes allowance prices to double

– First four protocols (forestry, urban forestry, livestock, ODS) based less on supply• Next two, CMM, Rice

– CMM could produce 1.9 MMTCO2e but delay in announcement may cause contracts to lapse

• ICF estimates supply short in CP2, CP3; ACR estimates 29% short CP1; 67% short CP3• Buyer liability may be an additional constraint on protocols subject to reversal (ag, forest)

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Other potential issues

• Whither linkage?• November “surprise” (new litigation)?• Ongoing competition for allowance use value• Experiments to test market design (with attention to market

manipulation):– Allowance reserve– Holding limits– Low hydro

• Preliminary results available by October 25, Environmental Markets Association, Santa Monica

– University of Virginia and Power & Energy Analytic Resources.* *Pacific Gas & Electric, Sacramento Municipal Utility District, Southern California Edison, Chevron, NRG Energy,

Northern California Power Authority, Southern California Public Power Authority, Los Angeles Department of Water and Power

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Further information

Jan Mazurek, PhDSenior Fellow

ICF International

916.231.9534

916.201.5200

jmazurek@icfi.com