California carbon is trading at a record low as legal threats, political opposition and rule changes plague the days leading up to the first auction of permits under the state’s greenhouse-gas program.
Less than a week before the first allowance sale, the program is facing scrutiny from legislators, economists and companies such as San Antonio-based Valero Energy Corp. (VLO:US), whose chief executive officer described the regulations last week as being “hijacked” by academics and extremists. Two Oregon power utilities say that the state may end up unfairly governing trade outside its jurisdiction.
“Any time there’s a whisper or threat of a lawsuit, it puts a damper on folks’ thinking about when to start in this market,” Harold Pestana, senior manager of portfolio management at San Francisco-based Pacific Gas & Electric Co., said by phone. “There’s a general sense now that there may not be as many people participating in the auction. There’s a wait-and-see attitude.”
California, the world’s ninth-largest economy, developed an emissions program after the U.S. federal government failed to come up with a system of its own in 2010, and created the world’s second-biggest carbon market behind the European Union’s emissions trading system. The regulation will eventually cover 85 percent of emissions released in a state whose economy was worth $1.74 trillion last year.
Futures contracts based on California carbon permits for 2013, the first year of compliance under the program, dropped 40 cents to a record $12.25 a metric ton yesterday, data compiled by CME Group Inc. (CME:US)’s Green Exchange in New York show. Prices are set to fall for a ninth straight week and are down $3.50 a ton, or 22 percent, for the year.
EU permits for delivery in December rose 0.6 percent to 8.33 euros ($10.60) a ton today on the ICE Futures Europe exchange in London.
Liquidity has been “crippled by buyers’ hesitation to sign forward contracts,” Thomas Marcello, a Bloomberg New Energy Finance analyst in New York, said yesterday. Allowance prices will average $29 a ton between 2013 and 2020, $1.70 lower than previously forecast, according to a Nov. 6 Bloomberg New Energy Finance research note.
Beginning next year, California plans to “cap” carbon emissions from power generators, oil refineries and other industrial plants and cut that limit gradually to achieve a 15 percent reduction by 2020. Companies must surrender carbon permits to cover their emissions over three phases of the program, and those whose emissions are under the cap can sell or trade their allowances.
California released 370.9 million tons of carbon from fossil-fuel combustion in 2010, making it the second-largest polluter in the U.S. behind Texas, Environmental Protection Agency data show. The state wants to prove that a carbon-trading program can yield emissions reductions at a reasonable cost, Mary Nichols, chairman of the state Air Resources Board, said in an interview Aug. 13 in San Francisco.
The California air board is giving away about 90 percent of the permits at the onset of the program and selling the rest at auction. The free allocations are set to shrink over time.
The number of allowances for sale on Nov. 14 is enough to weigh on prices, Jeff King, managing director of environmental markets at Scotiabank in Toronto, said Nov. 7. They total 23.1 million to be used during the first phase of the program, which begins Jan. 1, and 39.5 million for the second starting Jan. 1, 2015. Each permit allows the release of one ton of carbon.
California decided in March to cancel an auction scheduled for August and fold the permits that would have been available then into next week’s auction.
“It’s two auctions in one before even the first year of compliance,” King said. “The truth is that people realize that this auction is now just a week away and there’s a large number of allowances coming in at one time. The current consensus is that it’s likely to clear somewhere around $12 and $13.”
Futures prices tumbled by more than a $1 a ton after PacifiCorp, a Portland, Oregon-based utility and part of Warren Buffett’s Berkshire Hathaway Inc. (B:US), asked the Federal Energy Regulatory Commission on Oct. 22 to reconsider a decision that may hold companies sending power to certain points just outside of California’s limits responsible for greenhouse-gas emissions costs under the state’s program. Power utility Portland General Electric Co. (POR:US) is backing PacifiCorp’s request.
“We have tried to resolve these issues in California, without success, which unfortunately forces us to raise these concerns with FERC to seek clarity,” Jan Mitchell, a PacifiCorp spokeswoman in Portland, Oregon, said by e-mail Oct. 26.
The U.S. Commerce Clause, which gives Congress power over interstate trade, is being used in court by ethanol producers and oil refiners to fight California’s low-carbon fuel standard. The rule discourages the state’s fuel manufacturers from using feedstock deemed “carbon intensive,” such as crude from Canadian oil-sands and ethanol produced in the U.S. Midwest.
The battle between California and out-of-state companies echoes a clash between the U.S. and Europe over aviation emissions. The Senate passed a bill on Sept. 22 that shields U.S. airlines from the European Union’s emissions program, setting the stage for a potential trade war.
A letter from Philip Moeller, a FERC commissioner, has already triggered California’s air board to suspend a different provision of the emissions program. Moeller told California Governor Jerry Brown in August that the program’s ban on “resource shuffling” may freeze power trading in the region by creating uncertainty.
State regulators agreed to spend 18 months reviewing and not enforcing the ban, which prohibits companies from bringing low-emission electricity into California while sending more carbon-intensive power to other states. The air board issued some clarification to the rule on Nov. 6.
A spate of refinery upsets that drove retail gasoline prices in California to a record $4.671 a gallon on Oct. 9 also intensified opposition to the program, with Sacramento-based nonprofit CalWatchdog warning the same day that prices at the pump were “a pimple of what is to come” when the state starts capping emissions.
The combination of “market-design concerns, regulatory uncertainty and fear of litigation” has exacerbated an already- weak market, Samantha Katz, managing director of carbon broker BGC Environmental Brokerage Services, said in a telephone interview from New York Nov. 6. Trades were made as low as $12.05 a ton last week, she said.
A coalition of businesses and taxpayer groups known as the AB 32 Implementation Group, based in Sacramento, has asked Governor Brown to call off the first auction, saying that the state’s economy will suffer. A group of state legislators, led by Democratic Assemblyman Henry T. Perea, voiced similar concerns in an Aug. 27 letter to Brown. The AB 32 group is collecting signatures for a petition to stop the sale.
Valero “continues to look at our options” for the Benicia and Wilmington oil refineries in California, CEO William Klesse told investors on a conference call Oct. 30. The regulatory environment in California “is not constructive to the California economy, not constructive to the working person and not constructive to our industry,” he said.
Chevron Corp. (CVX:US) Executive Vice President Michael Wirth told investors during a conference call Nov. 2 that California is starting down “a path of even greater isolation from world fuel markets.” The state’s “go-it-alone” plans will hurt its economy and won’t make any meaningful emissions reductions, he said.
Chevron also told investors that the sole crude unit at the 240,000-barrel-a-day Richmond refinery, Northern California’s largest, will remain shut through the end of the year following an Aug. 6 fire, fanning speculation that it may not need as many carbon credits to cover emissions as previously expected.
Tesoro Corp. (TSO:US) agreed in August to buy BP Plc (BP/)’s 266,000- barrel-a-day Carson refinery in Southern California, a move that would cut emissions at Tesoro’s Wilmington refinery near Los Angeles by at least 30 percent through an expansion of the plant’s hydrotreating capacity.
“Six months ago, it seemed like all news was bullish,” King said. “Now it seems like a lot of news is bearish.”
Amid the criticism, power utilities such as Pacific Gas & Electric and Edison International (EIX:US)’s Southern California Edison have continued to uphold the cap-and-trade program as the best option the state has to cut emissions.
“We’ve been supportive of a cap-and-trade structure to achieve greenhouse-gas emission goals all along, and we’re still there,” Gary Stern, Edison’s director of market strategy and resource planning in Rosemead, California, said by telephone Nov. 7. “The market structure is a lower-cost means of achieving the goals than other command and control approaches might be.”
Two days after the AB 32 coalition wrote Brown asking him to call off the first auction, another group in California sent its own letter asking the state to put an end to debates and move ahead with the program.
The state’s climate change legislation “has been the law of the land for six years,” the California Business Alliance for a Green Economy said in the letter. “There have been dozens of public hearings and workshops, and tens of thousands of public comments submitted. Uncertainty is bad for business.”
The results of the Nov. 14 auction may signal whether futures prices will keep falling or rebound on demand as companies build more confidence in the market and gear up for the first compliance period, Pestana said Nov. 6.
“The market is in its early stages, so it’s not easy to tell what might become the trigger to really get this market going,” he said. “The first auction will be a factor. We’ll just have to see how big it is.”
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