An Analysis of QC & Cali’s First Joint Auction

The numbers are in for Quebec and California’s first joint auction of GHG allowances (for convenience’ sake, I will use “allowance” and “permit” interchangeably in this post). The auction held on November 25th marked the last step in the linking of their cap-and-trade systems. Since January 2014, compliance instruments are fully fungible, meaning allowances or offsets from either jurisdiction can be used by firms in California or Quebec to cover their emissions.

The linking of the two markets has led to greater coverage, which provides not only lower-cost reduction options to covered entities but also sets a path for the inclusion of additional partners, which could provide further economic and environmental benefits. Recently in Canada, Quebec and Ontario signed a memorandum of understanding (here) under which “La Belle Province” will share its experience from the linkage, with the possibility of Ontario joining the Quebec-California cap-and-trade system.

As firms bid on emission permits, these auctions reveal a carbon price (and also generate government revenue). Participants in the joint auction purchased 100% of the 2014 emission allowances available for sale. The market clearing price was $12.10 US dollar (USD) per permit ($13.68 Canadian dollar), which is above the price floor of $11.34 USD. While future allowances for 2017 emissions were sold as well, for now let’s take a closer look at the results for current allowances, which were the 2014 emissions in this auction.

Figure 1 puts the harmonisation of clearing and floor prices in context by showing both prices for Quebec and California’s auctions over time. Auctions 1-5 were for 2013 emission allowances and 6-9 for 2014 emission allowances. Using the joint auction’s exchange rate, Quebec’s previous floor prices are lower than California’s (at parity they are essentially the same). However, the story here is more than the level of the price (for reasons why exchange rates are not a significant factor see here).

For all of California’s previous auctions, the clearing price has consistently exceeded the floor price, whereas for Quebec, auctions had only cleared at the floor price. With the new price harmonisation, for the first time Quebec emitters purchased allowances above the floor price.

The simplest explanation for the permit price in the first joint auction exceeding the floor price is that as a larger market, California drove outcomes consistent with its previous auctions. But more fundamentally, why have California’s past auctions occurred above floor prices while Quebec’s have not?

SP’s initial work on linking (here) predicted that Quebec’s prices would be higher than California’s before the harmonisation. However, the reverse has happened. Three factors can help shed some light on why:

• First, participation in the auctions from diverse players, such as financial institutions (which are non-covered entities by the cap-and-trade systems) has been active in California, while absent in Quebec. A higher proportion of participants results in a higher demand, hence a higher permit price.
• Second, Quebec covered emitters may be delaying purchases of allowances. This would mean lower demand in the province’s auctions. The first redeeming of allowances by Quebec emitters will be in November 2015, whereas Californian emitters were required to surrender 30% of their 2013 emission permits in November 2014.
• Third, while both markets are over allocated, Quebec’s market is more so. Indeed, 2013 emissions by Quebec’s covered entities amounted to about 80% of its 2013 total available permits, whereas California’s covered entities’ emissions were about 90% of its 2013 cap. As supply is greater than demand, this puts downward pressure on prices and this pressure is larger for Quebec (while this suggests floor prices for California as well, the other two factors might overwhelm this effect). Complementary climate policies and reduced economic growth can explain the occurrence of this gap between emissions by covered entities and the cap.

Furthermore, the system is still evolving. As of now, only about 30% of respective jurisdictional emissions are covered by the cap-and-trade system. In 2015, the inclusion of fuel distributors and importers in the scheme will increase coverage to about 85% of Quebec and California’s respective emissions. This will bring important new dynamics to the demand for permits. The next scheduled linked auction is February 18th, 2015. Stay tuned, I know we will!

Some numbers presented in this blog are the author’s calculations. For references or questions contact: vthivierge@sustainableprosperity.ca