A Closer Look at the Cap-and-Trade Investment Plan in Gov. Brown’s Proposed Budget

Governor Brown delivered this week the State of the State address to the California legislature, in a speech that included several references to climate change and California’s climate policy. The drought is naturally on everybody’s mind in California, as the state experienced its driest year on record (and possibly since 1580, according to scientists). The Governor proudly mentioned AB32 and the array of renewable energy and energy efficiency efforts across the state. However, he said, “in terms of greenhouse gases, our biggest challenge remains the amount of gasoline Californians use. Each year, our motor vehicles use more than 14 billion gallons of gasoline to travel over 330 billion miles. To put those numbers in perspective, the sun is 93 million miles away.”

The State of the State comes on the heel of the proposed budget 2014-2015, released earlier this month, which included the much-awaited proposal for disposing of auction proceeds. Anxiety ran high late last year at the thought that the Governor might withhold those funds again. Instead, his proposed budget included a detailed and thoughtful allocation to an array of new and existing state programs that reduce greenhouse gas (GHG) emissions and promote other desired goals, such as increased water efficiency, higher recycling rates and lower risk of wildfires.

We take a detailed look at the Governor’s policy and budgetary priorities for 2014-2015 and discuss market implications for California cap-and-trade.

Revenues

The governor plans for $850 million dollars of revenues for the GHG Reduction Fund in 2014-2015, a conservative estimate in our view. Auctions so far have brought in $532 million, of which $500 million was loaned to the General Fund last year. We forecast $1300-$1500 of auction revenues in 2014-2015, a large increase compared to revenues in 2013-2014 due to the inclusion of fuels under the cap starting in 2015. The $850 million also includes the repayment of $100 million from the funds borrowed last year, with the rest to be reimbursed “over the next few years”.

Expenses

The investments fall in three broad categories (see Figure 1 below):

  • Sustainable Communities and Clean Transportation (blue)
  • Energy Efficiency and Clean Energy (red and grey)
  • Natural Resources and Water Diversion (purple and grey)

Figure 1. Proposed Cap-and-Trade Expenditure Plan (Dollars in Millions)

Auction Proceeds Proposed Budget 2014-2015

Data source: Governor’s Proposed 2014-2015 Budget.

Sustainable Communities and Clean Transportation

The first category gets the lion’s share, with 71 percent of the monies allocated to three overarching programs: $300 million (35 percent) for “rail modernization”, $200 million (24 percent) for low carbon transportation and $100 million (12 percent) for “sustainable communities.” Rail modernization is a euphemism for high-speed rail, possibly one of the most controversial items in the entire budget – see below. The other two are much needed funding for existing and developing initiatives: the implementation of SB 375, the deployment of zero-emission vehicles (ZEV), for which the Governor has set a target of 1.5 million vehicles by 2025, and the transition to low-carbon freight.

Energy Efficiency and Clean Energy

The Energy Efficiency and Clean Energy bucket gets a much smaller share, 16 percent of the auction proceeds in total, which stands to reason given that so many programs and different sources of funding already promote energy efficiency and clean energy. The funds in this category are used for targeted programs: assistance for efficiency upgrades and weatherization of low-income dwellings, state green buildings, and projects focused on reducing methane and nitrous oxide emissions in the agricultural sector.

Water Action Plan

Water-related projects straddle the energy efficiency and natural resources buckets for a total of $50 million, dedicated to water efficiency projects that reduce GHG emissions and to wetlands and watershed restoration. These projects have significant co-benefits: water supply is always an issue in California, but is even more so now because of the drought and the expected shifts in temperature and precipitation patterns that climate change will bring to the Golden State. Wetland restoration is also an important measure to prevent catastrophic flooding that may become more frequent as the sea level rise. Both projects are part of the wider state strategy for water resources detailed in the Water Action Plan.

Natural Resources and Waste Prevention

Another $50 million goes to fire prevention, another project type that helps curb GHG while improving resiliency to drought and climate change. Budget cuts at the Federal and state level over the past years have limited the ability of firefighters and foresters to conduct effective fire prevention programs, so using auction proceeds to support forest health seems is a wise move. Urban forestry also gets dual benefits since in addition to sequestering carbon, trees help shade streets, regulate temperature, and avoid urban heat island effect – all of which are particularly useful as heat waves are due to become more frequent, hotter and longer in California.
Last but not least, waste diversion is $30 million to expand infrastructure and develop clean composting technology. As landfills are regulated and not eligible for offset credits in California, this provides an economic incentive to balance out the regulation and support technological innovation in the field.

An Integrated Climate Strategy

All in all, projects with direct climate adaptation co-benefits total $100 million and promote actions aligned with the top priorities in California’s draft update climate adaptation plan, Safeguarding California, released in December 2013.

One missed opportunity in this iteration of the budget is funding to develop localized smart grids. These grids can help bring small renewable projects online, and promote resiliency of the electricity system in case of extreme weather events, wildfire or flooding that can affect transmission lines or large power plants. Those projects typically reduce emissions and would satisfy the requirement that projects funded by auction proceeds contribute directly to emission reductions, and would also help prevent one of the most disruptive and immediate impacts of climate change for people and businesses alike.

Investing in Disadvantaged Communities

SB 535, passed in the summer 2012, required that at least 10 percent of the proceeds received by the state be invested within the most impacted and disadvantaged communities and at least 25 percent of the proceeds be invested to benefit these communities. The Investment Plan developed a methodology to identify ‘disadvantaged communities’ based on an array of indicators reflecting “burden of pollution,” including exposure and environmental effects, and “population characteristics, which includes socioeconomic factors. The map below maps the top 10% highest scoring (most disadvantaged) zip codes.

Figure 2. Mapping Disadvantaged Communities in California

DisadvantagedCommunitiesMap

Source: California Final Investment Plan, April 2013

Many of the proposed investments have a clause to ensure disadvantaged communities receive this funding in priority; and the budget proposal estimates that a minimum of $225 (26 percent) will go to those communities.

Should Auction Proceeds Fund the High-Speed Rail Train?

The high-speed train has garnered a lot of political and media attention – it is a stated priority of the Governor, receives 30 percent of the proposed allocation, and has been subject of a heated debate for decades in California.

Supporters of the project, starting with the Governor, argue that it is an overdue infrastructure that will help reduce emissions in California and steer the state towards low-carbon economy. Critics raise all kind of issues with the plans, notably legal and budgetary – only a small amount of the total funds are secured so far, which could endanger the viability of the entire project.

Two criticisms are directly relevant to the use of auction proceeds and the carbon market at large. First, according to an analysis by the Legislative Analyst Office (LAO), the high-speed train’s emission reduction benefits will only be felt in the very long-run – mostly after 2020 – while the construction itself will generate GHG emissions, yielding a net increase in emissions over the 2014-2020 timeframe. Second, the LAO and environmentalists all argue the same investments would generate more emission reductions faster if invested in local transit improvements, which also bring a number of social and environmental co-benefits to communities with reduced local pollution, better health outcomes and better access to job opportunities for low income households.

The takeaway from this discussion is that the flagship investment proposal for auction proceeds is vulnerable to legal challenges, on the ground that it does not help achieve AB32’s primary goal of reducing emissions by 2020, and vulnerable politically, since a cost-benefit analysis might show that other investment options could generate more emission reductions at a much lower cost per ton. We expect the issue will be up for debate in the Legislature over the coming months, and it is uncertain whether the Governor will be able to keep auction proceeds as a source of funding for the high speed train.

Market Implications

In its update on the status of scoping plan measures from 2011, the Air Resources Board provided estimates of emission reductions measures included in the Investment Plan.

ARB estimated the high speed train would reduce emissions by 1 million metric ton CO2 (Mt) by 2020. Goods movement and medium/heavy duty vehicles, which overlap with the “low carbon transportation” investment category, were expected to yield 0.2 Mt and 0.9 Mt respectively, albeit with a high uncertainty since most measures were not fully developed at the time. Solar roods and solar water heating together would lower emissions by 1.2 Mt.

These estimates are to be compared with the emission reductions expected from leading measures, such as 15 Mt from LCFS, 30 Mt from Pavley standards or 12 Mt from energy efficiency programs.Thus from a market standpoint, none of these measures taken individually are market movers. However, over the long run, these investments contribute to the downward trend in carbon emissions for the state, and the likelihood that prices will stay near the floor on the carbon market for the coming years.

Conclusion

As auction revenues rise with the inclusion of fuels under the cap in 2015, the allocation of auction proceeds will gain increasing importance. The question of whether the high speed train qualifies as an eligible use of auction proceeds becomes all the more crucial because it will set a precedent for future investment plans. If it is allowed, then a larger portion of revenues will likely be directed towards the train in the future, since billions more are needed to complete the construction. If not, the government will have to be more creative on how to use the monies in a cost-efficient manner, which could bring about more innovation and also more support for projects with climate adaptation co-benefits.