Comment Log Display

October 5, 2015

Ms. Rajinder Sahota, Chief
Climate Change Program Evaluation Branch
Industrial Strategies Division
California Air Resources Board
1001 I Street
Sacramento, CA 95814

Re: Comments Concerning Cap-and-Trade Program Rules

I appreciate the opportunity to provide comments regarding AB 32
rule changes that are needed to improve the efficiency of the
cap-and-trade program, streamline its complex rules and avoid
adverse outcomes.  The current Holding Limit and Limited Exemption
rules may encourage allowance market manipulation, rather than
preventing it, and will likely lead to increased market volatility.
 As the California Carbon Allowance (CCA) supply/ demand balance
tightens after 2018, allowance prices could increase very rapidly,
exceeding the third-tier allowance price containment reserve price.
 These effects are described in the attached paper and analysis. 
Post-2020 reductions will also experience volatility under current
rules.
  
Experience from emission trading programs around the world provides
several basic lessons:
1.	Over-allocation of emission allowances at the beginning of
cap-and-trade programs has led to low initial allowance prices,
while at the same time enabling participants and regulators to
refine procedures and market rules, in order to achieve long-term
market goals.  As emission caps become more binding, allowance
prices rise.  
Like other programs, California’s annual caps on greenhouse gases
(GHG) and allowance allocations have kept CCA prices close to each
year’s specified price floor.  
2.	Emission markets (and other thinly traded markets) have
exhibited significant volatility accompanied by rapidly increasing
prices that can be several times higher than prior prices.
Both RECLAIM and the U.S.E.P.A. national SO2 allowance program have
experienced significant price spikes.  In today’s cap-and-trade
program California compliance entities have acquired allowance
banks, subject to holding limit and limited exemption rules, in
order to ensure compliance and accommodate year-to-year variability
in emissions and related energy markets.  Undoubtedly, between 2018
and 2030, the CCA supply/demand balance will tighten periodically
and, under reasonably likely market conditions, allowance prices
could rise rapidly, as has happened in other commodity markets,
especially those with a limited number of participants.  
3.	Increasing the number of market participants and the size of the
allowance markets enables more efficient allowance trading that
reduces overall compliance costs and increases incentives for new
and improved technologies.   Of course, this is why California has
successfully expanded its program to include Quebec and, hopefully,
other future partners.  This is also why the EPA’s Clean Power Plan
encourages regional programs.
Several of ARB’s existing market design elements and rules could
reduce trading and cause higher, more volatile CCA prices.  These
are:  
1.	the “one-way” Compliance Account from which allowances may not
be removed, reducing the supply available for trading,  
2.	the limited quantity of allowances in the Allowance Price
Containment Reserve, potentially allowing uncapped prices, if the
reserve is exhausted, and  
3.	rules that limit allowance ownership (Holding Limits [HL] +
Limited Exemptions [LE]).  Limited Exemptions are required by
high-emitting firms that have annual emissions greater than the HL,
but LE are created only when a firm irrevocably transfers CCAs into
its Compliance Account.  
Experimental research and auction simulations have found that tight
holding limits can substantially lower the number of allowances
available for trade, lowering liquidity, increasing volatility, and
impairing the ability of traders to smooth prices over time. 
Hence, ARB’s current rules may encourage market manipulation,
rather than prevent it.  

In order to make the AB 32 program more efficient and to provide a
better model for regional applications under the Clean Power Plan,
I recommend that the Air Resources Board:   
1.  Add a firm price ceiling, i.e., a hard price cap, above the
tier 3 Allowance Price Containment Reserve price, thus, preventing
unlimited price increases, if the limited number of APCR allowances
is exhausted.
2.  Remove the “one-way” restriction on the Compliance Account to
allow trading of surplus allowances that are otherwise trapped in
these accounts.  This would enable more efficient trading,
especially when the CCA supply/demand balance tightens. 
3.  Modify the Holding Limits and Limited Exemption rules by
raising the fixed annual Holding Limit or adjusting it
proportionally for the few well-known, closely monitored,
high-emitting firms, in order to permit these firms to trade
surplus allowances.  The current holding limit formulas were
developed and applied to markets for more widely-traded
commodities, and the effects on market performance are evaluated
periodically.
4.  Evaluate the use of pivotal supplier tests and concentration
ratios to examine current and alterative holding limits under
projected emission caps and future market conditions.  This will
provide a greater understanding of the effects of these limits,
which were derived for larger established commodity markets, and
could suggest appropriate revisions to the holding limit rules. 
These proposed rule changes will help ensure that California’s
cap-and-trade program is successful and robust and will provide an
improved market model that can be adopted regionally, rather than
becoming a restrictive market that might fail due to particular
overly prescriptive and complex rules. 
Sincerely, 

/S/
Andrew J. Van Horn, Ph.D.
Van Horn Consulting
www.vhcenergy.com