March 7, 2014 by CaliforniaCarbon.info
CaliforniaCarbon.info, March 7, 2014: California market participants will be eagerly following the results of auctions held in North America’s two other compliance emissions trading schemes. In Quebec, allowances of both the current-year and forward (2014 and 2017) vintages cleared at the floor, just as they did last December, although bid ratios for both vintages showed marked increases as participants continue to ease themselves into the market. Participating entities in the Regional Greenhouse Gas Initiative (RGGI) have seen prices respond to the monumental 45-percent cap adjustment introduced at the beginning of this year, and CO2 allowances cleared at $4.00, the trigger value for the cost containment reserve.
Quebec participants easing into carbon market
Many had suggested in the period between the last Quebec auction and this that we would see an increase in demand at the second auction as compared to the first, as greater market and procedural familiarity would breed greater confidence amongst participants. California’s first auction in November 2012 had cleared a mere $0.09 off the floor, but the second auction last February cleared at $13.92, $3.21 above the floor.
Indeed, the second Quebec auction was almost three times as well-subscribed as the first. While the current vintage instrument last year saw a 34.5% subscription rate (and thus cleared at the floor), the current vintage at Auction 2 saw a 98.7% subscription rate (1,035,000 of 1,049,111), only narrowly missing out on clearing out. Demand for the forward vintage was also healthy, at 84.15% (1,285,000 of 1,527,000), versus 27.0% last time around. Both instruments cleared at CAD11.39 (USD10.26), an increase of CAD0.64 from the previous auction as the price floor has moved upwards since.
This clearing price is still significantly lower than that seen in California’s auction last month, where the current vintage cleared at USD11.48 and the forward vintage at USD11.38. The expectation that California and Quebec will soon be using a common auction platform – perhaps as soon as Q3 this year – may have encouraged Quebec participants to purchase allowances before the market picks up in anticipation of meeting the California price. California’s market is some four times larger than Quebec’s in the next compliance period.
Another explanation for the rise in interest in this auction may be that the actual occurrence of linkage. Being linked to a California gives participants the option of using instruments in a second, larger market. Quebec participants may now be experimenting with purchasing Quebec allowances to resell to California entities, although the need to hold separate Compliance Instrument Tracking Service System (CITSS) accounts for California and Quebec instruments may prove an administrative deterrent to California entities taking an interest in Quebec.
One of the reasons traditionally suggested for the initial sluggishness of the Quebec market – which is, by all accounts, a ‘shorter’ market than California’s since its targets are steeper and the projected emission reductions available from the switch of energy sources is far more limited – is the lack of an annual true-up obligation. This means that many entities coming into compliance in the second period (2015-17) will not need to surrender any instruments until November 2018, which translates into higher costs of ‘carrying’ capital. In contrast, there may be a more pronounced upsurge in price, interest, and traded volume nearer these triennial surrender dates, the first of which is next November. In California, covered entities are required to surrender 30% of each compliance year’s obligations the following November, with the outstanding amount due at the triennial surrender date (the November after the end of each compliance period).
RGGI exhausts 2014 containment reserve
RGGI began 2014 with a severe reduction in the number of allowances that would go on auction as compared to last year. With energy efficiency measures, the rise of renewable energy, and the ongoing fuel switch all making inroads into a peak emissions level that was seen in 2005, trading in 2012 witnessed a surplus of some 73 million allowances, and the cap was reduced by 45 percent this year to 91 million short tons, better reflecting 2012’s emissions of 92 million tons. Where the cap had previously been a static one, from 2014 onwards the nine-state bloc will have to reduce the emissions from its power sectors by 2.5 percent year-on-year, culminating in a 2020 cap at just over 78 million tons.
In addition, the distribution of allowances at auction up till 2020 has also been adjusted to account for the private allowance banks that have been built up in the early years of the program. In the first control period (2009-11) 57.4 million allowances were banked, and hence 8.2 million allowances will be taken off each year between now and 2020. The allowances banked during the second control period (2012-13), of a hitherto unannounced quantity, will be adjusted for starting in 2015.
As a result, only 82.8 million allowances will be auctioned by the nine states in 2014. The 18,491,350 allowances were just under a quarter of that total. Demand was strong at this auction, with the maximum bid of $11.85 nearly triple the cost containment reserve trigger price of $4.00, and the bid ratio at 3.1, even higher than the 2.7 witnessed at the previous auction in December. This was the 23rd auction conducted by RGGI.
With clearing prices triggering the cost containment reserve, an additional 5 million allowances (the entire budget for 2014) were auctioned, taking the total number of allowances distributed up to 23,491,350, and the auction clearing price to $4.00. Auction 22 had cleared at $3.00. This is the highest clearing price ever witnessed in RGGI, eclipsing the $3.51 seen in March 2009 at Auction 3. It remains to be seen if the unavailability of any reserve allowances for the remainder of 2014 will see expected strong demand push the clearing price further upwards.
The tightened cap has done much to reinvigorate speculative interest in this market. At a time when the lack of volatility in the California market is making it unattractive to risk capital, fewer than half the RGGI allowances went directly to compliance entities. At 45%, this share is only marginally higher than the 43% seen last December, after the cap-tightening announcement was made, which was the lowest ever recorded under the program. It is supposed that many compliance entities still have significant banked reserves to reach into for compliance in 2014 and even 2015, whereas speculative capital is anticipating a shorter period further into the decade, when the effective supply of allowances tightens upon the depletion of the banks.
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