By Rory Carroll
SAN FRANCISCO (Reuters) - California's greenhouse gas reduction program is in a battle for its life, and uncertainty about its future has spooked buyers of its carbon permits
California in 2012 became the first U.S. state with a comprehensive cap and trade program for carbon emissions, which are implicated in global warming, and now finds the program sputtering.
The woes include a glut of pollution permits, a lawsuit that could invalidate the premise of the program and political differences over whether it should continue after 2020 when it is due to expire unless extended by the state legislature.
The latest round of bad news came on Tuesday when the state announced that it had raised just $10 million from the May carbon permit auction, more than $500 million less than it brought in during the February sale.
It also marked the first time that California failed to sell any of the permits it offered to cover 2016 emissions at an auction. [nL2N18M2AS] (For a graphic of the California carbon market see: http://tmsnrt.rs/1sThH6S)
Oil companies, manufacturers and market speculators had little incentive to purchase permits from the state since they could be found on the secondary market at a discount.
Earlier this month, Governor Jerry Brown, the program's chief advocate, acknowledged uncertainty about the program's future and said he has yet to work out a deal with the legislature to extend it beyond 2020.
"The question is exactly what role the legislature will play, what role the Republicans will play. If not, what are the alternatives? Those are always available," he said.
Brown had tried to set a greenhouse gas reduction target for 2030 via executive order, but California's Legislative Counsel Diane Boyer-Vine said the governor overstepped his authority in doing so.
While Brown said the lack of demand for permits is an indication that the program is meeting emissions goals, Senate Republican Leader Jean Fuller said it is an indication that the business community may be losing confidence in the program.
"What is clear is that ambitious and expensive pet programs like high-speed rail may be on the chopping block if these auction results continue," Fuller told Reuters.
The carbon market, which has raised just over $4 billion so far, devotes 25 percent of its revenue to the $68 billion high speed rail project, a legacy project for Brown.
Democratic lawmakers like California Assembly member Adam Gray are eager to have a conversation about the future of the program and worry that its policy of accepting carbon offset credits generated by projects in other states is costing California money.
"A theme you are going to see develop over the summer is that elected officials need to be at the helm on this," he said.
"The extent to which we're being asked to sign off on big extensions and a lot of money and let unelected bureaucrats decide where it's spent – that's not going to be happening anymore."
That would likely mean taking power away from the California Air Resources Board (CARB), a body of environmental policy experts appointed by the governor.
California launched its carbon market in 2012 amid skepticism that the ambitious environmental program could survive court challenges or the pitfalls that derailed a similar system in Europe.
For years, the market proved the skeptics wrong. Investors and businesses had little trouble buying at state-run carbon auctions and permits changed hands over exchanges at decent volumes. Lawyers for CARB defeated early lawsuits.
But an appellate court recently breathed life into a years-old challenge to the program by the California Chamber of Commerce.
The lawsuit argues that the state's quarterly carbon auctions amount to an illegal tax on companies like oil refiners and manufacturers, who are required to surrender permits to cover their carbon emissions.
The judge sent seven questions to lawyers on both sides of the case, including one asking what remedies would be available if the auctions were deemed to be a tax. Taxes need the support of two-thirds of the state legislature, something the carbon market's underlying legislation did not receive.
A court decision is expected before the year's end.
TRADERS PUT THROUGH THE RINGER
The court action spooked carbon traders, who were already in a selling mood after the Supreme Court stayed the Obama administration's Clean Power Plan in February.
Observers thought the Clean Power Plan, which seeks to reduce carbon emissions from power generators, would encourage states to join the Northeast's nine-state Regional Greenhouse Gas Initiative (RGGI) cap and trade program, boosting market liquidity.
Instead, the market has stagnated. "Traders have been put through the ringer lately," one carbon market source said.
The chamber lawsuit threatens the program's ability to raise revenue in the future. The California program is expected to raise $2.3 billion in fiscal 2016-2017, according to the Legislative Analyst Office.
"It has given people in the market some pause," said Todd Maiden, a partner with the law firm Reed Smith. "If the court was to suddenly invalidate the auctions, where do you go from there? Does that mean we go back in time and refund the money? And that's just the tip of the iceberg."