The chair of the California Air Resources Board, yesterday brushed away concerns that the state’s cap and trade program had failed to give the energy industry enough market certainty.

Mary Nichols told delegates at the Navigating the American Carbon World conference in San Francisco yesterday said she saw no problem with traders in the US power markets adopting a “wait and see mode” on whether the pioneering scheme would begin next year.

“I’m not sure what they’re waiting for since there’s nothing for them to do at this moment but I would encourage them to look at the trajectory and see that we have been marching forward at a steady pace.

Moving Quickly, But Not Too Quickly

Brett Orlando, director of environmental financial products at Deutsche Bank, claimed that doubts about the start of the program had been created by legal action last year, the postponement of the first compliance period to 2013, the delay of the first auction from August to November and a more recent legal action challenging the offsets component of the cap and trade system.

“A lot of people in the energy and industrial community are deeply skeptical about whether this program will start on time,” he said.

Nichols said that the agency had been moving at “lightning speed” balanced with a need for caution in order to avoid past mistakes.

“We have been very mindful of the need not to disrupt our energy system in California. If there’s one fear that haunts any of us involved with [the state's] energy system, it’s the specter of what happened in 2000-2001 when California went ‘nuclear’ [with the] deregulation of its electricity system.”

Broader Engagement Will be Crucial

Nichols said that linkage with Quebec’s cap and trade system was progressing well and that she expected fresh climate legislation to be introduced to Congress after the presidential elections in November. But she admitted that the system would struggle to survive if the program could not link with broader markets.

“Clearly if by 2020 we don’t have a government in the US and Canada that has stepped up to the plate and adopted some form of national commitment to reduction GHGs then our claims for leadership aren’t all that they were cracked up to be. Clearly our intent here is to be superseded, incorporated into something bigger.”

Risk of leakage was still a concern for the agency’s rulemakers and not all costs of compliance would be equal, she said.

“I don’t want to say I feel sorry for the oil business because they’re doing pretty well, but if I were a utility I would be giving a lot of thought to what my business was going to look like.
“For businesses heavily dependent on electricity, it’s a challenge for them and keeping the cost of doing business in California competitive is going to be challenging.”

California businesses have recently raised concerned about the costs of compliance as projections have shown that the system may fall short of offsets which can only be used to meet 8% of requirements.

There are currently only four protocols approved by Carb for cap and trade compliance: forestry, urban forestry, ozone depleting substances and livestock.

Nichols indicated that new protocols would be considered to widen the pool of offset projects but ruled out the use of Certified Emission Reduction (CER) credits, international offsets used by the EU Emissions Trading System.

“We expect we need offsets to moderate the price of allowance, as the cap gets tighter the number of allowances is reduced between now and 2020. We know that there is going to be a need for offsets to help keep the price of allowances in line and keep the participants in the market in compliance.

Businesses Fear Excessive Economic Burdens

“If there are too many offsets and they flood market, that isn’t good for the offset sellers or good for the market either, it discredits the whole program.”

Thomson Reuters Point Carbon last week published estimates that these four protocols combined would generate 79 million tons of offset credits by 2020, leaving the scheme two-thirds short of potential requirements. Under that scenario, allowances could cost up to $27 a ton in 2013, which oil companies and utilities say would create excess economic burdens.

Julia Bussey, climate change analyst at Chevron said, that the company was not so concerned about the first compliance period. But the second compliance period starting in 2015 would include transportation fuels and natural gas distribution.

“We expect relative smooth sailing in the first compliance period but we have concerns about the second compliance period when there will be a reduction in number of allowances. Trade exposure and competitive disadvantage to refineries will be exacerbated. That will open up advantages to companies outside of California in terms of leakage for jobs and investment that will go out of state.

Bussey said that increasing the supply of offsets and linkage with other markets was critical to keeping costs bearable by the energy industry in California.

For background and further detail regarding California’s AB 32 legislation from Breaking Energy, click here.

“We see potential for instability in the market due to the introduction of fuels under the cap which is introducing a very large number of allowances and a large economic burden on the state if it’s introduced without any other states in the US and local economies having the same burden.

“Holding limits [for carbon allowances] will freeze a large number of allowances and take them out of the market resulting in high prices, and also may result in other entities linking with California, but if we have high prices there’s no incentive for entities to link because we’re transferring our higher costs to them.”

California’s Low Carbon Fuel Standard (LCFS), another key program under the state’s AB32 climate legislation that is currently the subject to a commerce clause legal challenge, would also drive up costs, she said.

“LCFS is in concept a great idea – to try to technologically push fuels to the low carbon limit. However, if those fuels are not available – and at the moment we don’t see any adequate supply in 2015 – we’ll see a tremendous cost increase.

“This is something that needs to be examined. The confluence of all these policies can lead unfortunately to economic hardship for consumers and companies and push companies out of state.”