Senator pro-tem proposes to exclude transportation fuels from cap and trade

February 20, 2014 by CaliforniaCarbon.info

CaliforniaCarbon.info, February 20, 2014: Today, California’s senator pro tempore, Darrell Steinberg, is announcing the introduction of a bill to exclude the transportation fuels sector from the state’s cap and trade program. Oil giants such as British Petroleum or Shell can instead expect to pass a 25-dollar-a-ton carbon tax through to their customers at the point of retail, should this bill be passed into law in the coming months.

A leaked memo, dated Feb 5 and addressed to Steinberg, presumably coming from someone in his office, outlines both the rationale for introducing a tax in place of the cap under which the fuels sector’s emissions will come beginning 2015, and the proposed implementation of the new direct regulation. It argues that a tax protects the fuels industry – and ultimately consumers – from the cost-inefficiency, price volatility, and legislative uncertainty of the cap and trade program, while also allowing for remedial measures against the regressive incidence of carbon pricing.

In sharing his views on how the proposed policy would work, Steinberg has claimed that ‘carbon tax may help keep AB32 strong’, since it will keep pump prices stable ‘more stable and predictable […] for decades’, and stave off popular pressure on the climate change program. However, market stakeholders that CaliforniaCarbon.info has spoken to do not, by and large, seem to share the Senator’s positivity regarding his proposed alternative.

Instead, the sense is that were such a bill to go through, the implications on California’s cap and trade program, and all participants within it, are unlikely to be small. Proper consideration of the various spheres of impact ought to precede any hasty actions. The bill is expected to be debated both within and outside the Senate in the weeks to come.

Transportation fuels – more than the 38 percent
While the transportation fuels sector is expected to contribute 38 percent of the cumulative 2.51 billion tons of covered emissions through 2020, it is expected to pay a disproportionately large role in the state’s primary and secondary allowance markets. This is because, unlike with the stationary power generation sector or other manufacturing sectors defined as trade-exposed and bearing high leakage risks, no free allowances are provided to entities with obligations under this sector.

While the economy-wide nature of the emissions cap means that there is no way of determining what this sector’s exact emissions will be, and hence what proportion of the demand for unallocated (i.e. auctioned) allowances it will contribute, the leaked memo to Steinberg estimated this to be 76%, or double the contribution to covered emissions.

This could have grave implications for the allowance market, which observers are already predicting to be long. Many have suggested that the fuels are regarded as particularly influential, since emissions abatement is thought to be harder to achieve in a sector with no genuine carbon-free alternatives. The renewable fuels standard has faced considerable pushback because its dependence on corn ethanol has had a detrimental upward effect on agricultural prices, while the low carbon fuel standard has been under sustained attack from the Western States Petroleum Association (WSPA).

A kick in the teeth for cap and trade
The introduction of this bill comes on the day after Senator Fran Pavley – the author of the original bill which gave the Air Resources Board (ARB) the mandate to implement cap-and-trade policies in the first place – had herself introduced a bill designed to hasten the process of setting mid-term emission reduction targets. Last week, the ARB’s Scoping Plan Update – which will go before the Board for a vote in the spring – had suggested such a target, an effective midpoint between the 2020 and 2050 goals, would not be decided upon until 2017. Pavley’s bill, if passed, will direct the regulators to offer a timetable of reductions through 2050, by no later than January 1, 2016. Stakeholders in the market have spoken of the need for clarity in midterm targets in order to boost market confidence in the short term, as such clarity is needed for the financial sector to take positions.

The potential removal of a highly influential industrial sector from the program almost certainly counteracts any positive sentiment that may have emanated from yesterday’s Senate proceedings regarding the future of cap and trade. Environmental organisations CaliforniaCarbon.info has spoken to have stressed the need for the program to remain intact, if only as a clear symbol of faith in and commitment to the vision of achieving optimal emission reductions through a market-based trading scheme. With emerging markets offering potential opportunities for partnership and cooperation, and on the back of a successful commencement to linkage with Quebec, this would have been seen as a time for California’s program to expand, not contract.

Potential effect on prices
Prices on the InterContinental Exchange (ICE) have been on a downward trend this week, though it remains unclear if this has to do with auction expectations or the leakage of the Steinberg memo. It may be telling that prices for current-year deliveries have in fact climbed slightly – the benchmark V2014 delivering in December 2014 has risen from $12.18 to $12.22 in the last three days, for example, while prices for forward vintages with later delivery dates have slipped slightly, with the V2015 delivering in December 2015 inching down from $12.44 to $12.36, and the V2016 delivering December 2016 sliding from $12.95 to $12.85, in the last three days.

We are unlikely to have any clear answers at least until the results of this week’s auction are made known next Monday. Given the uncertainty over the extent to which knowledge of the leaked bill had been disseminated prior to Wednesday’s deadline for bid submissions, however, it is unclear if this auction can continue to perform a price discovery function. Representatives from the oil industry, notably WSPA president Catherine Reheis-Boyd, have denied any prior knowledge of the proposed bill, although political commentators remain unconvinced that they can be completely exonerated. The market awaits indications of whether the auction settle price accounts for any uncertainty over the continued participation of the transportation fuels sector in the program.

Potential effect on other program elements
The diminution of the cap and trade pool will also have ramifications for other program elements, not least the offset industry which is presently struggling to keep its head above water. An anticipated CP2 price boost in the CCA market, which would likely have brought offset prices up along with it, would have given project developers the level of margins required to justify their continued investment in the program.

Yet a reduced compliance market will continue to hurt demand for offsets, and is likely to perpetuate a situation in which neither demand nor supply approaches the eight percent usage limitation. The potential removal of the transportation fuels industry means the removal of a disproportionate number of entities with large obligations. This is significant – smaller compliance entities have often been reported not to see value in taking on the invalidation risks and transactional costs associated with offsets.

The offset program in California has been touted as a means by which program revenue is distributed back to communities which bear a disproportionate amount of the burden associated with its increased costs. The agricultural methane project type, for instance, redirects revenue towards farmers whose cost baselines have been expanding. It is unclear if the proponents of the new bill have considered the serious implications of the bill upon the internal dynamics of California’s flagship environmental program.

Getting the bill passed
It is by no means certain that the Steinberg bill will be passed. Given it requires passage this year in order to come into force before the commencement of the compliance period for the transportation sector under the cap-and-trade program in 2015, a two-thirds majority needs to be secured quickly. Stakeholders whom CaliforniaCarbon.info has spoken to have expressed their doubts over whether there will be that extent of support for this bill. A senior regulatory analyst has suggested that it will either run its due process and appear for voting in the summer, or be quashed and given a very public send-off within the next month.

In a year which other jurisdictions have begun by sending firm price and market signals – in RGGI, by slashing the cap 45 percent, and in the EU, by implementing the much-awaited ‘backloading’ scheme – and in which it seems climate change finance is slowly finding its feet again, California would want to ensure that, whatever the outcome of the Steinberg bill, it sends the right message to the wider market community around the world.