No other state or country in the world has attempted to regulate the sale of gasoline and diesel under a cap-and-trade program, but on January 1, 2015, California will, for the first time, include transportation fuels — gasoline, diesel and propane — in the nation’s first carbon emission cap-and-trading scheme. As California readies to launch this major expansion of its three-year-old cap-and-trade program administered by the California Air Resources Board (CARB), the Western States Petroleum Association (WSPA) is calling the program flawed. Under this program, power producers operating in California must purchase carbon allowances from CARB to cover their emissions of greenhouse gases.
Specifically, a new report from Latham & Watkins law firm and commissioned by WSPA identifies what it calls “major design flaws” that make the program “vulnerable to market meltdowns.”
“Past experience demonstrates the importance of proper design,” writes report author Jean-Philippe Brisson, a carbon markets expert with the Latham & Watkins law firm in New York and a former Goldman Sachs vice president and commodity trader. “Market design flaws can result — and have resulted — in catastrophic implications for environmental markets around the globe.”
The report contends that it is essential for CARB to address five major issues before expanding the program “to avoid a situation in which allowance prices spiral upwards,” including the current structure of the holding limit; the infrequency of auctions; CARB’s cost containment policies; CARB’s approach to markets and the rule of law, and the program’s relationship to impending federal GHG regulations.
The analysis made a comparison to a program in California designed to reduce emissions of oxides of nitrogen and sulfur through a similar, but much smaller, cap-and-trade system. When demand for electricity soared during the state’s electricity market deregulation crisis, the emission credits created by the program spiked from $2,000 per ton of emissions to more than $60,000 per ton.
“In the context of the California cap-and-trade program, this precedent would be the equivalent of cap-and-trade allowance prices spiking from their current average of $12 to $360,” Brisson wrote.
WSPA has requested that CARB postpone expanding its cap-and-trade program to allow time for the agency to correct these design flaws.
“Market design flaws, including those identified in this paper, may lay dormant for a period of time when markets are not under stress, providing a false sense of security to industry and regulators,” said Brisson. “When a program comes under pressure because of unforeseen conditions or simply because the program becomes increasingly stringent over time, latent market design flaws can significantly derail an environmental program, undermining both industries’ and regulators’ investments to achieve environmental objectives. Accordingly, ARB should address these issues now rather than waiting until the program experiences a significant stress, at which point corrective action may come too late.”