Politics of Carbon Auction Proceeds – The Battle Ahead

Carbon and the California Budget

The Governor’s office is busy preparing its proposal for the 2014/15 budget, which is due to the legislature by January 10th. After years of ongoing budgetary crisis, California is, for the first time in a decade, looking at a forecast of budget surpluses for the years to come. In November, the Legislative Analyst Office projected a $5.6 million budget surplus by June 2015.

While this year’s budget turned the corner with a projected surplus of over one billion dollars, California still face major budgetary challenges in fixing its education, social and prison systems, and paying back the so-called Wall of Debts, a massive amount of debts in the form of loans and deferrals to local communities and various state programs accumulated over the years.

One such loan came from the Greenhouse Gas Reduction Fund, established by AB32 and funded by proceeds from carbon allowances. The 2013/14 budget included a $500 million loan from the GHG Reduction Fund to the General Fund, arguing that the Air Resources Board (ARB) needed to complete the Scoping Plan Update first to ensure better investment decisions (see below for more on the Investment Plan).

The budget did not include a specific timetable for the loan repayment, indicating only that the loan would be “repaid with interest immediately when needed to meet the needs of the Fund.”. As the 2014/15 budget debate ramps up, the question is: what will the Governor do with 2014/15 auction proceeds, and when will last year’s loan be repaid and invested?

Politics of Carbon Investment Planning

The Governor’s Budget Proposal in January should include a proposal for the use of auction proceeds in 14/15, and possibly address the issue of borrowed funds in 13/14. The Governor has not given any indications at this point of what he intends to do with auction proceeds – past and future.

Meanwhile, the Democratic Caucus in the CA Assembly released on December 11 its budget blueprint, which mentions specifically cap-and-trade revenues as a means to bolster job growth. The same budget highlights as a priority the need to repay debts and loans promptly, which could bear on the auction proceeds loan. In parallel, a coalition representing California businesses, local government, health, transportation, economic justice and the environment called last week for the Governor to repay the $500 million loan.

A poll from the Public Policy Institute of California from July 2013 shows a large majority of voters favor spending auction revenues on public transit, such as more buses or reduced transit fares (78%), and repaving roads and highways (72%), and 83% support spending this money to support disadvantaged communities.

These positions indicate that the Governor may not get away with another ‘loan’ from the GHG Reduction Fund this time around. A clear commitment to invest auction proceeds this year would go a long way towards assuaging concerns that the loan would never be reimbursed – while another loan would revive fears of political holdup over the cap-and-trade revenues. As the Governor looks at a possible reelection campaign in 2014, we expect he will tread carefully and avoid a new loan so as not to taint his shiny environmental record.

Billions of Dollars at Stake

Why so much fuss, you might ask? The state of California has raised $532 million since the beginning of the program: $256 million in fiscal year 2012/13 and $275 million in FY 13/14. In our estimates, revenues for FY13/14 should add up to a little over that half million loaned to the General Fund, around $530 million. This amount, though, will almost triple overnight when the second compliance period starts and the cap rises to 400 million tons (from 165 Mt). Depending on market conditions, revenues could rise to about $1.5 billion in FY14/15 and to $2.4 annually in 15/16 and 16/17.

We developed three scenarios to illustrate a range of revenue estimates for the duration of the program (Figure 1), building on ARB’s estimate of state-auctioned allowance budget by fiscal year (see below for more details on the scenarios and results). For the sake of the budget discussion, we consider that our main scenario provides a reasonable, conservative forecast for revenues, totaling over $12 billion through 2020. This is no trivial amount, and how and when it will be spend will make a noticeable difference in California’s ability to reach its emission reduction targets.

Impact on California Emissions and Economy

recent study by the consultancy ICF International compares the benefits of different “revenue recycling” scenarios, looking at different “distribution” options – a lump sum to all California residents, free allocation to fuels (which would shrink by two-thirds auction proceeds in 2015-2020), and “investment” options – energy efficiency and clean transportation. The study finds investment options fare best for job growth and wages and economic growth, while the lump sum dividend is most beneficial to low income groups. The study also includes a ‘blended approach’ that attempts to maximize the benefits for all groups with a mix of investments and dividend.

The study does not quantify GHG reductions for each scenario, but investment options would logically fare better to distributive options. If $12 billion are invested as planned in energy efficiency, clean energy, and clean transportation over the next seven years, the impact on California emissions will be noticeable and should contribute to keeping carbon market prices low through the second and third compliance period. And as with any other investment, the sooner the investment starts, the larger the benefits down the road.

Conclusion

We expect the 2014/15 budget will provide for auction proceeds to be invested towards emission reductions, even if last year’s loan is not paid back immediately. With over a billion dollars to be spent in the next fiscal year, monitoring how the monies are spent will be crucial to forecasting the pace of emission decrease in California and supply and demand dynamics in the carbon market through 2020 and beyond.

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Forecasting Revenues – Our Scenarios:

  • Our main scenario assumes a conservative clearing price at the reserve price through 2020.
  • Our ‘bearish’ scenario includes the same clearing price, but assumes that not all allowances get sold, as might be the case, for example, if emissions continue to decrease faster than the cap.
  • Our ‘bullish’ scenario assumes prices rise moderately to $30-40/ton through 2020 as the market anticipates deeper reductions post-2020.

Figure 1. Scenarios for Forecasting Auction Revenues
AuctionRevenueForecast-Dec2013
Source: Four Twenty Seven

In our ‘bearish’ and ‘main’ scenarios, revenues decrease after 15/16 as the decline in volume (cap and auction subscription rate) outweighs the slow increase in the reserve price. In our bullish scenario, the price effect makes up for the decrease in the allowance budget, except in 19/20 where no ‘advance auction’ occurs since the post-2020 has not been set yet.

Table 1. Auction Revenue Forecasts by Fiscal Year (million dollars)
CarbonAuction Revenues by FY
Source: Four Twenty Seven
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Backgrounder: The Investment Plan

The implementing legislation for auction proceeds lays out a number of goals that the investments should further, ranging from the obvious – emission reductions – to larger policy goals, such as economic growth, job creation, and environmental and health benefits. The money could be stretched to fund state climate adaptation efforts, as another goal is to ‘lessen the impacts and effects of climate change on the state’s communities, economy and environment.” Last but not least, a percentage of the money is earmarked for projects that benefit disadvantaged communities.

In line with legislation passed in 2012, the Department of Finance submitted a Three Year Investment Plan for auction proceeds developed jointly with the ARB and other relevant agencies. This plan identifies three broad sectors that will be the focus of those investments, based on a gap analysis of California’s current greenhouse gas reduction strategy:

  • Sustainable communities and clean transportation
  • Energy efficiency and clean energy
  • Natural resources and waste diversion

The legislature will appropriate funding to State agencies, consistent with the three-year investment plan.

ARB is in the process of finalizing its Scoping Plan Update, which will include policy recommendations to reduce GHG emissions in these very sectors, so that part of the GHG Reduction Fund is logically expected to fund new measures to reduce emissions as proposed by ARB. Yet as of right now, with the Scoping Plan Update still in the works, the details of how the money will be spent within those sectors remain unspecified.
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