Severin Borenstein, James Bushnell, and Frank Wolak “California’s Cap-and-Trade Market Through 2030: A Preliminary Supply/Demand Analysis” (July 2017) | WP-281 | Abstract

California’s cap and trade market is perhaps the most important contribution the state has made to global understanding of the institutions that will help reduce greenhouse gas emissions and climate change.  State policymakers are currently discussing the terms for extending the market to 2030. In this paper, we attempt to inform that policy process by estimating the distribution of potential outcomes of the cap and trade market under alternative assumptions about the market rules and the additional state policies for reducing greenhouse gases.

We extend our earlier analysis of the 2013-2020 cap-and-trade program (Borenstein, Bushnell, Wolak and Zaragoza-Watkins (2016)) to analyze the supply-demand balance in California’s cap-and-trade market for greenhouse gasses (GHGs) through 2030.  We estimate the distribution of business-as-usual (BAU) emissions and then consider the impact of different sources of GHG abatement, including both abatement that is responsive to the price of emissions allowances and the state’s other GHG reduction programs.    As we showed in our earlier work, there is significant uncertainty in the BAU emissions levels due to uncertainty in economic growth and other factors. Our analysis also illustrates how most of the planned abatement will not be sensitive to the price of allowances, although there is a large amount of uncertainty about the aggregate impact of these abatement sources.  The combination of uncertainty in BAU emissions and in the supply of abatement implies a high probability that the equilibrium price of allowances evolves either to the price floor or to a price ceiling at which additional allowances would be released.

In our base case in which safety valve allowances from the Allowance Price Containment Reserve (APCR) are available only at a ceiling price $60 above the floor price and a hard price ceiling is enforced at that level, we find that there is a 34% probability of the price hitting this ceiling, a 47% probability of the price settling at the floor, and a 19% probability of a price between the floor and the ceiling.  The distribution implies a probability-weighted expected price in 2030 of $51.62 (in 2015 real dollars).   We also analyze the potential price distribution if the allowances in the APCR are made available at intermediate price steps (“speed bumps”) between the floor and ceiling.  In this analysis, the probability of reaching the price ceiling is reduced to 16%.    We also examine a scenario in which the price ceiling is lowered from $60 above the floor to $40 above the floor, and perform sensitivities in which the supply of abatement through complementary policies is increased or reduced.