California-Quebec auction hits a record low (and that's probably a good thing)

What if you held a sale and customers bought hardly any of your product? You might conclude that your product wasn’t very popular. If your product happened to be carbon allowances, essentially permission slips to emit carbon pollution, that lack of popularity sounds like a good thing for the climate.

This is essentially what happened last week when California and Quebec, who have joined their carbon markets, announced the results of their most recent auction of allowances. Companies who must buy allowances decided they didn’t need the full amount being offered, presumably because their emissions are declining.

California and Québec began their carbon markets in 2013, and the partners have held joint auctions of allowances every three months since November 2014. Each jurisdiction sets a limit on nearly all fossil fuel combustion at an amount that declines each year (the cap). Businesses responsible for that fossil fuel combustion have to buy allowances at auction to cover their emissions.

Historically, businesses have bought more than 90 percent of the allowances offered. But at the most recent auction, only about 10 percent of the allowances were sold.

This is great news. It means that carbon emissions are going down, and at a faster rate than the policy requires. If emissions were going up, prices at auction would be high. If emissions were going down at the same rate as the cap, then prices might be low but the auction would still sell out.

Market forces, like declining costs of renewable power, are part of the reason why emissions are declining. Businesses can use cost-effective alternatives to fossil fuels in their operations.

Also factoring into the results are the numerous other policies California and Québec have in place to drive down emissions, including ones aimed at increasing energy efficiency. That means businesses use less energy overall.

Is there any reason this might be considered bad news? Well, if you were counting on the money from the sale, it’s a problem.

California has anticipated generating billions in revenue through 2020 from the allowance auctions. But with few allowances sold, that state revenue source drops dramatically. California’s auction revenue is directed to various clean energy programs across the state, which means those programs could be in jeopardy if auction sales remain low.

So, is this an example of cap-and-trade working or not working? I would argue this is how cap-and-trade is supposed to work. The government sets a cap based upon its climate goals, the cap creates a price in the market, and companies incorporate the carbon price into their business decisions. If emissions are low (more accurately, if they are lower than the cap), then businesses don’t buy carbon allowances, pure and simple. Both California and Québec agreed upon rules for handling unsold allowances before their programs started, so businesses know what to expect.

A larger and more difficult question is whether this is an example of carbon pricing working. In both jurisdictions, the cap-and-trade program is only one of many policies aimed at reducing emissions. It’s unclear at the moment to what extent the carbon price is driving down emissions (and allowance demand) versus other policies. A sophisticated statistical analysis is required to answer that question, and as the cap-and-trade program continues there will be observations to enable just such an analysis. 

There is often a heated debate around implementing new policies, and it is not unusual to hear predictions that regulating carbon emissions will cause economic doom. But time and again, experience has shown that businesses adapt quickly to new conditions and keep doing what they’re good at – giving us the products and services we want to buy. That they’re doing this while keeping their carbon emissions below a set level is something to celebrate.