CA Cap & Trade Program Set to Expand in 2015

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Beginning in 2015 the California Cap & Trade program expands to cover natural gas and transportation fuels.  2015 marks the beginning of the second compliance period for the program, and expands the program beyond the industrial and electric power sectors covered in the first compliance period.

First Compliance Period:  2013-2014
Second Compliance Period:  2015-2017
Third Compliance Period:  2018-2020

In this post we will look at the impact on industrial and commercial sectors of the inclusion of natural gas in the Cap & Trade program.

Who is Covered?
Starting in 2015 natural gas suppliers that have annual emissions of 25,000 metric tons or more of CO2e are covered by the California Cap & Trade program.  For the purpose of determining who is covered it is assumed that all of the natural gas supplied to California customers is completely combusted or oxidized.  This means that any entity that supplies 472,000 MMBTUs or more will be covered in 2015.  Section 95811 of the California Cap & Trade regulation defines natural gas suppliers as outlined below.

(c) Suppliers of Natural Gas. An entity that distributes or uses natural gas in California as described below:

(1)    A public utility gas corporation operating in California;
(2)    A publicly owned natural gas utility operating in California; or
(3)    The operator of an intrastate pipeline not included in section 95811(c)(1) or section 95811(c)(2) that distributes natural gas directly to end users.

What is the Compliance Obligation?
A covered supplier of natural gas has a compliance obligation for every metric ton CO2e of GHG emissions that would result from full combustion or oxidation of all fuel delivered to end users in California — less the fuel that is delivered to entities already covered by the program (e.g., large industrial users).

Natural gas suppliers are required to report according to California’s Mandatory Greenhouse Gas Reporting Regulation (April 10 reporting deadline, 3rd party verification by September 1).  Within 30 days of verification the California Air Resources Board (CARB) will inform natural gas suppliers of the number of metric tons that the supplier must obtain emission allowances for.  An emission allowance is a tradable permit to emit 1 MTCO2e, which are sold at CARB quarterly auctions, or in some cases freely distributed by CARB.

Will Natural Gas Prices be Impacted?
Natural gas consumers in California that are not already a part of the Cap & Trade program will see an increase in natural gas prices as suppliers pass compliance costs through to end-users; the size of the increase remains to be seen.  At the start of 2014 natural gas suppliers were required to purchase all of the emission allowances needed to be in compliance, but amendments to the Cap & Trade regulation that became effective in July mean that most of the allowances needed to be in compliance will be freely allocated to natural gas suppliers.  As with the electric utility sector, free allocation was added to protect ratepayers from price shocks when they are added to the program in 2015.  The table below shows the percentage of allowances that are freely allocated, the consignment requirement and the net allocation through 2020.

Year Pct. Freely Allocated Consignment Requirement Net Allocation
2015 94.4% 25% 70.80%
2016 92.5% 30% 64.75%
2017 90.7% 35% 58.96%
2018 88.8% 40% 53.28%
2019 86.9% 45% 47.79%
2020 85.1% 50% 42.55%

Each year through 2020 the percentage of freely allocated allowance decreases while the percentage of allowances that must be consigned to auction (i.e., sold) increases.  According to Section 95893 (d)(3) of the California Cap & Trade regulation the auction proceeds from consigned allowances:

… shall be used exclusively for the benefit of retail ratepayers …  Any revenue returned to ratepayers must be done in a non-volumetric manner.

Though proceeds from consigned allowances are to be used to benefit ratepayers there will likely be a redistributive component; a larger percentage of proceeds going to residential and small business owners than to larger businesses.  California electric utilities redistribute funds to ratepayers via the California Climate Credit; on a monthly basis to small businesses and twice a year to households.  This may serve as a model for how natural gas suppliers redistribute funds from the sale of consigned allowances.

What is the likely magnitude of the impact on natural gas prices?
A metric ton of CO2 is released for every 18.86 MMBTUs of natural gas that is combusted or oxidized.  Given this, and the price of emission allowances we can calculate the per MMBTU impact on the price of natural gas.  The graph below shows the per MMBTU premium that inclusion in the Cap & Trade program will add to natural gas, assuming the full cost of compliance is passed on to the ratepayer.  For example, the auction reserve (floor) price for the most recent auction in August was $11.34 per emission allowance.  This price would add $0.60 to every MMBTU of natural gas sold.  In 2015 natural gas suppliers will get 70% of allowances for free, passing on 30% of the cost or roughly $0.054/MMBTU.  This does not account for any additional funds distributed to ratepayers from consigned allowances.

CA Nat Gas Premium

The auction reserve price helps define the lower end of the price impact on natural gas.  Though there is no cap on how high the market can drive allowance prices the auction reserve price set by CARB defines the floor.  Regulation requires the reserve price to increase 5% per year plus an adjustment for inflation.  The graph below shows the increase in auction reserve prices assuming a 2% inflation rate.  Under this assumption the reserve price for an emission allowance rises from $11.34 today to $17.26 in 2020 at the end of the third compliance period.  A $17.26 allowance price would add $0.915 per MMBTU; the net allocation of free allowances in 2020 is 42.55% resulting in $.52/MMBTU being passed on to ratepayers.

CA Reserve Price

California Public Utilities Commission Proceedings
The California Public Utilities Commission (CPUC) is currently developing rules to provide natural gas suppliers with the authority they need to be in compliance with the Cap & Trade program.  After taking comments on an Order Instituting Rulemaking (#14-03-003) the CPUC decided in July to split the rulemaking into two phases.  The first phase will cover issues that need to be decided quickly in order to ensure natural gas suppliers have the authority on January 1, 2015 to begin complying with the Cap & Trade program.  The second phase will cover all remaining issues.

Phase I Scope

  • Procurements Authority – rules giving natural gas suppliers authority to procure Cap & Trade emission allowances
  • Cost Recovery – rules defining how cost recovery should be done, allocation of costs between core & non-core customers, required tariff changes
  • Forecasting – methodology for forecasting Cap & Trade costs and revenue, and rules for making forecasts public
  • Other – ensuring large industrial users already in the Cap & Trade program do not get double charged, publishing of Cap & Trade related costs

Phase II Scope

  • Consignment Percentages – what percentage of allowances should be consigned?  Though CARB suggested percentages that should be consigned, shown in the table above, CPUC may raise this number if it believes it will benefit ratepayers
  • Consignment Revenue – how should revenue from sale of consigned allowances be used to benefit rate payers
  • Education and Outreach – the scope of education and outreach regarding natural gas and greenhouse gas emissions

It is expected that CPUC will release rules covering Phase I issues in November 2014.  Full details on the rulemaking can be found at the CPUC here R.14-03-003.