The California Air Resources Board (CARB) held a public workshop on 29 October on how the state’s emission trading system, now called “cap-and-invest” rather than cap-and-trade, will incorporate new requirements of the law that state legislators passed to extend the world’s second biggest carbon market through 2045. CARB revised its proposed supply trajectory through that year to account for emissions inventory updates that require lowering the cap by 118 Mt – this will be done across the years 2027–2030, with the annual allowance budget for 2045 remaining at 30.3 Mt. Further reductions in annual allowance budgets resulting from the program’s new offset design will begin in 2028. CARB also presented updated cap adjustment factors (CAFs) for industrial allocation and highlights concerns for new electric distribution utility (EDU) allocation timelines. Regulators indicated that they will release a long-awaited formal document – detailing which of their previously contemplated reform measures they will opt for – by the end of the year.
The new annual allowance budgets (which represent supply through 2045) proposed in the public workshop are aimed at achieving the state’s greenhouse gas reduction targets of 40% below 1990 levels by 2030 and 85% (or net neutrality) by 2045. At their previous public workshop, CARB regulators had laid out a scenario (Supply Option 1) that resulted in a 2030 cap of about 160.6 Mt and a 2045 cap of 30.3 Mt. The 30 October session laid out a supply trajectory 62 million allowances lower than that, resulting in a 2030 cap of about 171 Mt but still retaining the 2045 budget of 30.3 Mt. To account for inventory adjustments necessary to reflect verified emissions from past years of the program, 118 Mt will be deducted from the allowance budgets of the years 2027-2030. This supply reduction is largely in line with the current Veyt Base Case, which assumes a 100 Mt supply reduction from 2027 – 2030 budgets, followed by a linear reduction to a total budget of 30.3 Mt by 2045.
CARB regulators also clarified the new California ETS design element not yet reflected in Veyt’s base case for lack of timing information. The legislation that extended the ETS through 2045 included a key change to the way offset use is structured. Covered entities may still cover up to 6% of their compliance obligation with offsets (CCOs) rather than allowances (CCAs), but now a number equal to the amount of offsets they collectively retire will be deducted from the next year’s allowance budget. This creates a reciprocal dynamic between near-term offset use and longer-term allowance supply, as taking advantage of the ability to use offsets means tightening the program’s cap going forward. In the workshop, CARB clarified that the new offset rule would apply from 2026 emissions, for which covered entities surrender offsets in 2027, such that the cumulative amount surrendered will be deducted from the 2028 allowance budget. CARB did not specify how the deduction would take place but showed sample scenarios based on previous offset use in earlier years of the program where the amount is simply not put into circulation by not being offered at quarterly allowance auctions.
CARB flagged a potential market dynamic this could create: since the program has 3-year compliance periods allowing emitters some flexibility in timing of compliance units, they are required to cover only 30% of their annual compliance obligations for two years, then fulfill the entire compliance obligation after the third year. This makes for a pattern by which significantly more offsets are surrendered following the last year of a respective compliance period, such that the following year’s allowance budget will be decreased proportionately more. In other words, application of the new offset-cap-reduction dynamic will see the program’s annual supply decline in “bumps,” with one steeper decline every three years. At the workshop, officials requested feedback on this aspect of program implementation.
Regulators also noted that selling fewer allowances due to this new provision may lead to sizable losses in revenues from allowance auctions. Their calculated annual revenue loss at auctions, however, does not take into account the impact the tighter cap (as a result of the offset regulation) will have on allowance prices. According to our initial modeling, the reduction in supply due to the new offset provisions will increase allowance prices by 8% compared to the previous regulation. So, although there will be fewer allowances available at auctions as result of the new offset rule, allowance prices will likely be higher than initially forecasted, which may make up for some of the potential “loss” in future auction revenues.
Highlighting the impact of tariffs and the loss of federal funding for industrial decarbonization, regulators presented potential updates to the program’s allocation to industrial facilities. Currently, the quantity of free allowances allocated to most covered industrial facilities (to prevent them from moving out of the state to avoid its carbon prices) decline each year per the cap adjustment factor (CAF): the CAF declines respectively with the annual cap. Some facilities at greater risk of leakage have an alternate CAF, which declines at half the rate of the standard CAF.
In the workshop, regulators presented alternative scenarios, including reducing the CAF at the rate of the new supply budgets (incorporating the 118 Mt reduction) and maintaining the CAF and alternate-CAF at a rate that declines proportionally to the supply budgets in the current regulation (without the 118 Mt reduction). CARB requested feedback on whether to use allowance revenue to increase support for industrial decarbonization projects going forward, in order to disincentivize leakage. Specifically, regulators asked what sectors and facility investments should receive such support. They noted how other ETS manage leakage protection measures, pointing out that Quebec in 2024 switched its procedure from giving allowances to industries for free to auctioning them on consignment and giving the resulting revenues to those industries in the form of funding decarbonization measures. Regulators indicated California industrial leakage protection could follow this example.
According to the legislation extending California’s cap to 2045, free allowances currently going to natural gas corporations must instead go to electrical distribution utilities by 1 January 2031. CARB requested feedback on when this transition should begin, the pace at which it should occur, and how the allowances from natural gas entities should be distributed among electrical utilities.
Public feedback on the workshop and the different regulatory changes proposed can be submitted through 12 November, after which CARB intends to release the formal decision on which Supply Option it has chosen. Regulators confirmed this will happen before the end of the year. CARB aims to consider the ETS amendments in April 2026 and have the new regulation in effect by 1 September 2026, in time for 2027 allowance allocation in October 2027.
We are currently working on modelling the impact of new regulatory proposals presented in the workshop on allowance prices and will provide an update shortly.
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