On March 22, the California Air Resources Board (ARB) released proposed amendments to the cap-and-trade regulation that will authorize ‘linking’ with other jurisdictions – starting with Quebec in 2014. The release signals that the Governor should shortly issue the much-awaited findings authorizing ARB to officially link with Quebec. What does this mean for California, and how is this going to change the market?
No offense to our Northern neighbors, but it’s a fair question for folks who haven’t followed the ups and downs of North American climate policy for the past five years.
A (Very) Short History of the Western Climate Initiative
Let’s backtrack a bit. In early 2007, a few months after he signed AB32 into law, Governor Schwarzenegger launched a successful outreach effort to other states in the Western US, to get them to commit to developing a regional GHG trading program. The idea was, on the one hand, to garner political support for cap-and-trade at a time where climate policy was on the rise in the US, and on the other hand, to ensure a broader market with less risk of leakage – emissions being displaced from the state with strict GHG controls to other states without such controls.
In February 2007, the Western Climate Initiative was born, supported by the Governors of Arizona, California, New Mexico, Oregon, and Washington – all Democratic states at the time except for California. Over the next two years, the WCI gained new members: the Premiers of British Columbia, Manitoba, Ontario, and Quebec joined the initiative, along with the Governors of Utah and Montana. Utah was a big score, not only because it was it brought in another jurisdiction with a Republican Governor, but also because Utah is host to some of the largest coal power plants of the region. Indeed, one of the key issues for the WCI was dealing with emissions from the power sector, as the electricity grid is fully integrated across the Western US (the so-called WECC region) and trying to reduce emissions from California without addressing out-of-state coal power plants was going to be challenging… sounds familiar, right?
From Outsider to Sole Partner
From that standpoint, Quebec was always a bit of an outsider. The province is not on the same regional grid as the rest of the WCI members, as it actually exports electricity into Northeastern US states. The Regional Greenhouse Gas Initiative (RGGI) would have been a better fit for them from that standpoint, but for Quebec’s unusual emission profile. Quebec’s power sector is 97 percent hydro, so joining a regional cap-and-trade program that covers only emissions from the power sector, like RGGI, would have been somewhat pointless. The WCI had ambitious plans to cover emissions from industry and the transportation sector, and already boasted several Canadian members, making it a logical home for Quebec’s desire to join a regional program.
Fast forward to 2013: all the other US states have now pulled out of the WCI, which only comprises four Canadian members outside of California: British Columbia (BC), Manitoba, Ontario and Quebec. Of these four, two have backed out from plans for a regional market until further notice: BC and Manitoba, leaving only Quebec and Ontario in the run for a linkage with California over the short run.
How will the linkage work?
Because Quebec and California have been working together for so long, their programs are ready to be integrated. The regulations are very similar and only contain provisions that are fully compatible. The Quebec program is structured just like the California cap-and-trade, with a comparable price ceiling and price floor, quarterly auctions, offset quotas and rules of engagement. The jurisdictions share the same backend systems: registry, auction platform and market monitor, managed through WCI, Inc.
Starting January 2014, California emitters will be able to use Quebec-issued allowances and offsets for compliance, and Quebec emitters California instruments. The jurisdictions will hold joint auctions, so that emitters from both jurisdictions will be able to purchase allowances from either program the same day, on the same platform. This will ensure allowances clear at the same price and that the market receives a consistent price signal.
Market Implications for California
A Short Market
Quebec is considerably smaller than California in terms of emissions: the entire province’s 2012 emissions topped at an estimated 78.8 Mt, with a forecasted growth to 84.8 Mt in 2020 (according to the Quebec Ministry for Sustainable Development, Environment, Wildlife and Parks). Quebec has taken on a target to reduce their emissions 20 percent below 1990 level, which was right around 84 Mt as well. The estimated gap between business-as-usual emissions and the target could be anywhere between 12 and 17.5 Mt in 2020 for the province, depending if you believe the Ministry forecast for aggressive emission growth or if you assume emissions will remain fairly flat, just like they have – on average – over the past 30 years.
The cap for covered emissions is 23 Mt in 2013 and 2014 – covering only emissions from the industry, since emissions from the power sector are virtually zero. The cap increases to 65 Mt in 2015, when fuels are covered under the cap, decreasing slowly to 55 Mt in 2020. To put things in context, California’s cap this year is 163 Mt, scheduled to rise to 394 Mt in 2015, which means Quebec adds about 15 percent volume to the California market.
The Quebec Ministry’s forecast points to a short market – if emissions rise as fast as planned, I estimate the emission-to-cap gap in Quebec in 2020 could be up to 20 Mt, once you account for the price containment reserve set aside. Offsets are allowed but the protocols approved by the Quebec government may only be located in Quebec or Canada, severely restricting the potential supply. This means Quebec will likely be a net buyer of California allowances, which will likely push prices higher.
New Regulatory Intricacies
The other noteworthy market impact for California is the need for market participants in California to assimilate the rules and price drivers of a different region, with a different language, currency, and political culture. (We can help with that – see our upcoming training courses and advisory services offering). For example, the auction reserve price will now be set as the highest of the reserve price in either jurisdiction, as determined by the exchange rate of the day of the auction. Little things, but which can make the difference between a winning and an invalid auction bid.
The linkage is not quite done – but looking a hell of a lot better than it did even just a week ago. Two things need to happen:
1. The Governor needs to release his ‘findings’ that Quebec’s program satisfies the conditions laid out by the California legislature in June last year that the program requirements are “at least as stringent” as those of California, in particular for offsets. I expect those findings to be released in the coming week – and in any case before April 8.
2. The Air Resources Board will then be in a position to hear public comments (15-day comment period) on the amendments released last week and vote on the actual regulations. This will take place at a special Board hearing scheduled on April 19th in Sacramento.
In the big picture, beyond the immediate market impacts for California, I see the linkage with Quebec is a fascinating proof of concept. California and Quebec are showing that it can be done – linking across borders on top of it. This first step potentially opens the door to other linkages down the road – Ontario in particular is still considering joining their WCI partners, which would make a big difference in terms of market dynamics. Down the road, the question of working more closely with RGGI might come up, especially now that RGGI states have committed to addressing their over-allocation problem. It would take some work on program design, but create a broader, more liquid market with more political sway at the federal level.