US: Transport exclusion would be significant but unlikely

A proposed bill to exclude the transport fuel sector from California’s cap-and-trade carbon market has already injected an element of uncertainty among participants despite its chances of passing being “very low”, according to industry participants.

And while the bill’s legislative path is a rocky one with little momentum behind it so far, its impact in the case of approval would be significant, experts say.

California Senate president pro tempore Darrell Steinberg introduced a bill in February to block the inclusion of transport in the programme, instead introducing a sector-specific carbon tax ( see EDCM 20 February 2014 ).

Under existing rules, transport will fall under the scheme from the second compliance period in 2015, with suppliers of natural gas, propane fuels and transportation fuels forced to cover emissions associated with the consumption of their products by purchasing California carbon allowances (CCAs) or offsets. Hence the passing of the bill would mark a major shift in the market’s assumed development. If the exclusion is passed, the scheme will continue to cover only emissions from electricity generation and industrial plants.

Market participants are sceptical that the Steinberg bill has a chance of success in the state legislature because of the political climate and the size of the hurdles the bill will have to pass on the way to approval, with the threshold set higher for taxation proposals.

“The bill’s odds are very, very low,” Emilie Mazzacurati, managing director of carbon consultancy Four Twenty Seven wrote in an online post.

A new tax would need a two-thirds majority to pass, while Steinberg’s party, the Democrats, have a bare majority. Governor Jerry Brown – who can veto the bill – is also facing elections this year, and so is unlikely to support a new tax, Mazzacurati argued. Brown has actively supported the introduction of a carbon market in California.

Furthermore, most green groups oppose the bill, and fuel trade associations are not openly leading any charge, despite expressing interest, she added.

Potential impact

With the inclusion of the transport sector expected to be a major change for the scheme, the impact of its potential exclusion would also be significant, creating a certain degree of uncertainty among participants.

Fuel suppliers such as ConocoPhillips, Chevron, Tesoro and BP West Coast Products, which will not receive any free allocation, are expected to be the primary demand drivers in the second compliance period. The scheme’s carbon cap would also be doubled to match the expansion.

According to University of California at Davis economic professor James Bushnell – who is on the emissions market assessment committee that advises marker regulator the Air Resources Board (ARB) – the impact on the market would be significant.

“It would certainly risk making it more volatile. The whole (cap-and-trade) system has been set up so that the fuel sector gives liquidity,” he told ICIS.

Mazzacurati agreed the move could potentially trigger short-term volatility, because fuel providers are already actively buying allowances to prepare for their compliance obligations. Market participants said it is unclear how previously purchased CCAs by the fuel sector would be exchanged if the Steinberg bill was to pass.

On top of this, Mazzacurati noted that a smaller market can be more prone to volatility.

“For example, a heat wave would have a comparably larger impact in a market where the power sector drives over half of the demand than it would in a much larger market with more sectors covered.”

Jonathan Ornelas, director of US emissions at the analytics division of ICIS, said the scheme could see far less liquidity, especially in the future vintages, without participation from the fuel sector.

However, in terms of market supply, the impact will depend on how the ARB adjusts the cap in a programme without the fuel sector’s inclusion, and on the potential setting of a 2030 target – which is also mentioned in the proposal.

Ornelas said: “If the bill includes setting 2030 or even 2050 targets it could be just as significant. An aggressive 2030 target could change the market behaviour of compliance entities in the near term, potentially leading to additional banking of allowances, especially at the price levels we have today.”

According to Four Twenty Seven’s Mazzacurati, however, merely discussing potential rules changes with so little time before the start of the second compliance period can already influence the market.

“An extended discussion on the fate of fuels under the cap could create a sluggish buyer mood and hamper liquidity in an already slow market until the road is clear for fuel distributors to enter unreservedly,” she added in the note. Silvia Molteni and Dan McGraw