As I have noted in recent posts, the EU Emissions Trading System is suffering a decline in fortune. The price has been relatively low since the onset of the financial crisis, driven in part by a decline in industrial activity linked to the recession, but also to continuous overlaying of policy by both Member States and the Commission. Examples of the latter include the UK price floor proposal and the draft Energy Efficiency Directive from the Commission.

The next cab out of the ETS rank looks to be the California cap-and-trade system. Recently Point Carbon reported that:

 “California carbon allowances (CCAs) for 2013 delivery were bid at $16.75/t this week [NB: About 2-3 weeks ago] on news that companies would not have to surrender allowances to cover their 2012 emissions, market participants said.”

California emissions in 2008 (the last full GHG inventory) were as follows:

The total is 427 million tonnes against an allowance allocation in 2020 of 334 million tonnes. At least on first inspection there appears to be the necessary scarcity to ensure a robust carbon price

But California also has multiple policy approaches which operate in the same space as the cap-and-trade system. For example, by 2020 California is required to supply 33% of its electricity from renewable sources. In the transport sector, the Low Carbon Fuel Standard requires a 10% reduction in the carbon footprint of transport fuels by 2020, achieved through electrification, changes in the well-to-tank emissions of the fuel (e.g. through lowering refinery emissions) and substitution of gasoline with alternatives such as ethanol.

Many scenarios could play out here and the level of nuclear power will be critical, but these two policies alone could see emissions drop to 360-370 MT by 2020, removing much of the scarcity driving the carbon market.

Since the election of Governor Brown there is already talk of an even higher renewable energy requirement and there are other existing policies as well (Renewable Portfolio Standard, various energy efficiency standards, CHP requirements, vehicle efficiency measures).  In addition, what is not factored in here is California’s share of the overall drop in US emissions since 2008 as a result of the recession. But on the upside, at least from a carbon market perspective, is the compression of the whole trading period by one year as a result of the delay in implementation.

A back of the envelope analysis today indicates that the California system probably won’t see an allowance surplus through to 2020, nevertheless much of the apparent scarcity is removed by multiple policies operating within the cap-and-trade space. This means that the carbon market becomes a shorter term compliance mechanism rather than a longer term investment driver. It functions only as a check on the other policies.

Rather, investment is driven by mandates and standards on the back of a specific, predetermined design outcome for California’s future energy system – almost certainly a higher cost solution for the energy consumer, but with the same environmental outcome as the cap-and-trade would deliver if left to function on its own.